Do court vacations matter: evidence from the Bombay High Court

by Tushar Anand, Pavithra Manivannan, and Bhargavi Zaveri-Shah.

Introduction

Court vacations are often invoked as a problematic feature of the Indian judiciary. The discourse on this includes blaming court vacations for case delays, petitions to reduce the length of court vacations, and substituting them with staggered leave for judges. This discourse is characterised by the classic divide that cuts across most Indian discourse on court reforms. Lawyers and judges emphasize the importance of court vacations for overall judge productivity. Often, they perceive the criticism of court vacations as being politically motivated or as an attack on judicial integrity. Other stakeholders underscore the problems of delays and pendency, and compare the courts' calendar with that of other public organisations. In the event, neither side is able to support their argument by demonstrating the extent of delays attributable to court vacations. The puzzle on how much do court vacations actually affect case durations and disposal continues to remain unanswered. This article presents some first estimates on the impact of court vacations on these outputs.

During the vacation period, courts function with minimal capacity. This allows us to compare the functioning of a court during its vacation and non-vacation periods. Using a dataset of civil and commercial cases filed over about six years at the Bombay High Court, we evaluate the extent to which vacations at the court affected its productivity, measured in terms of case disposal rates and the lifecycle of cases.

Unsurprisingly, we find that there is a significant drop in the daily number of cases filed and disposed by the Bombay High Court during vacations, compared to the non-vacation periods of the year. However, this gap shrinks over time. Second, the fact that a case is filed during the vacation period affects its initial phases, but does not affect the duration within which it will get disposed of. In sum, while court vacations affect the initial phase of a case schedule, dispensing with court vacations will not make a significant difference to the disposal rates or the disposal duration of cases at the Bombay High Court.

Court vacations

Indian courts, such as the supreme court, high courts and district courts, and most tribunals, are scheduled to take three vacations - summer, festive, winter - each year. The summer vacation lasts for a little more than a month and the festive and winter vacations last for a little more than week. While the concept of court vacations is traceable to the colonial origins of the Indian judicial system, they eventually became a part of the rules governing the functioning of the Supreme Court and High Courts. The practice is not unique to India and is followed in several developed countries, such as the United States, Australia and Singapore.

During vacations, Indian courts function with vacation benches of judges to hear urgent matters that come up during this time, and a lower staff at the court registry. A comparison of the sitting list of judges for the Bombay High Court shows that, on a non-vacation day, 27 courtrooms are functional. On the other hand, on vacation days, not more than four courtrooms are functional. A reduced number of judges will likely affect the scheduling and eventual disposal of cases filed during vacations. A reduced registry capacity will likely affect the filing of new cases and scheduling of proceedings for existing cases. To be sure, court vacations affect not only the working hours of courts, but also the entire ecosystem around it. For instance, it is generally hard to find lawyers to appear for litigants before vacation benches during this time, further slowing down proceedings. Since these changes are endogeneous to court vacations, it is hard to isolate the impact of lower judges from that of the absence of lawyers willing to work during the vacation period, on the lifecycle of a case. Finally, what cases are construed as 'urgent' varies across judges' interpretation of urgency.

In this institutional setting, we ask the following questions to evaluate the impact of court vacations on overall case durations at the Bombay High Court:

1. Do case filings and disposals drop during vacation periods?
2. Do cases filed during court vacations take longer to get their first hearing?
3. Do cases filed during court vacations take longer to get disposed of?

Data and Methodology

We collect and analyse the data of cases involving all civil suits and commercial suits, which were filed at the Bombay High Court during the seven year period from January 2017 to December 2023 (Study Period). For each of these cases, our dataset captures information on the entire life-cycle of the case available on the respective courts' websites. This includes the date of filing, the dates on which hearings were conducted, and the date of disposal. Table 1 shows the total number of cases in our dataset and their status, that is, whether the cases were pending or disposed, at the time of data collection. We then count the number of days on which these courts were on vacation during our Study Period, using the vacation dates published on their websites. On an average, the Bombay High Court has 52 days of vacation per year and the average number of working days is 235.

Table 1: Data description

Cases
Disposed	1379
Pending	2529
Total	3908

One caveat. Our results account for select case-types (civil suits and commercial suits), as our dataset comprises such cases. Given that criminal cases or writ petitions, particularly those pertaining to questions of liberty or reliefs pre-empting State actions, have a higher element of urgency, it is possible that the findings for these case types will differ from our findings for civil and commercial cases.

Impact of court vacations on case filing and disposal

We begin by comparing the daily average number of cases filed and disposed before the Bombay High Court during the vacation and non-vacation period (Table 2). At the Bombay High Court, on an average, the number of cases filed during non-vacation days is thrice the number of cases filed during vacation days. Further, the Bombay High Court is able to dispose four times the number of cases on non-vacation days, compared to the vacation days.

Table 2: Average number of cases filed and disposed per day

	Vacation days	Non-vacation days
Cases filed	0.67	2.23
Cases disposed of	0.21	0.88

We examine whether the difference between the number of cases filed during vacation and non-vacation periods or between the number of cases disposed of during these two periods, is statistically significant. The standard t-test and z-test used for determining statistical significance assume a normal distribution of the underlying data. However, our data is not amenable to this test for two reasons. One, the number of observed cases in non-vacation period is five times than that in the vacation period. Second, the distribution of the per day number of cases filed and disposed of is right-biased, with a long tail. We used a two-sample Kolmogorov-Smirnov test to confirm that the two samples come from different distributions. In the absence of the standard tests (t-test and z-test), we use a bootstrapped sampling method to estimate the statistical significance of the difference in means of the two sets (vacation and non-vacation) of our data. This method allows us to create a normal distribution of the data by repeatedly drawing random samples from each of the two sets. This approach shows that the difference in means for the number of cases filed and disposed during vacation and non-vacation days is statistically significant at the five percent level.

At first glance, these findings might suggest that had the court not been on vacation, case disposals would have increased by a factor of four. However, this disposal rate is likely not linear. For instance, a quarter-wise analysis of cases filed and disposed of shows that these differences reduce (Table 3). That is, the difference in the number of filings and disposals in Quarters 2 and 4 that are affected by vacation days (Apr-Jun and Oct-Dec) and Quarters 1 and 3 that are not affected by vacation days (Jan-Mar and Jul-Sep), are much smaller.

Table 3: Quarter-wise average of cases filed and disposed

	Q1	Q2*	Q3	Q4*
Cases filed	162.57	128.29	134.86	132.58
Cases disposed of	51.29	38.71	58.43	46.00

^{*Denotes quarters affected by vacation days.}

Impact of vacations on case timelines

The analysis in the previous section would reflect the impact of court vacation on the overall productivity of the court. However, what is the impact of court vacations for an individual litigant? In this section, we examine whether the timelines for important milestones in a case vary for a litigant who filed her case during the vacation period, compared to a litigant who filed her case during the non-vacation days.

We estimate the time taken for cases to be scheduled for its first hearing and time taken for them to be disposed of. These estimations are made using the survival analysis approach used by Manivannan et al, 2023. This approach is a useful measure of individual case life cycles. It shows the likelihood of a case awaiting an important milestone, such as a first hearing or disposal, at different points in time.

Table 4: Probability of first hearing

	Vacation days	Non-vacation days
1 month	6.47%	7.24%
3 months	25.10%	23.35%
6 months	49.39%	47.20%

Table 4 shows the probability of a case getting its first hearing within one month, three months and six months of filing. The table compares these probabilities for cases filed during vacation days and non-vacation days. The probability of a case filed during the non-vacation period getting its first hearing within one month of filing is only slightly higher than the corresponding probability of a case filed during the non-vacation period. As time progresses, this difference disappears. In fact, after the first month of filing, cases filed during the vacation period have a marginally higher probability of getting their first hearing than cases filed during the non-vacation period. In sum, our analysis suggests that the "vacation effect" on case scheduling persists for not more than a month.

Similarly, we estimate the probability of a case getting disposed of within one to two years of its filing. Table 5 compares these probabilities for cases filed during vacation days and non-vacation days. At the Bombay High Court, there is about 5-6% higher disposal probability for cases filed during the non-vacation days. Overall, the "vacation effect" is marginal and temporary, and does not seem to affect the case duration for a litigant.

Table 5: Probability of disposal

	Cases filed on
	Vacation days	Non-vacation days
6 months	6.95%	11.03%
1 year	11.62%	17.95%
2 years	22.59%	27.11%

Conclusion

Our analysis provides the first estimates on the impact of Indian court vacations on some measurable elements of a court's functioning. Historical data from the Bombay High Court for civil and commercial cases shows that court vacations have a statistically significant impact on the number of cases filed and disposed of on a daily basis. While this finding is perhaps unsurprising, these differences disappear over time. Further, they do not substantially affect the overall duration of the case, even as they have a small effect on the initial phases of cases filed during court vacations.

A key limitation of our analysis is that it does not account for the impact, if any, of court vacations on a judge at the individual level. That is, it does not capture the possible intangible productivity gains that accrue from a holiday. It is possible, for instance, that when a judge goes on a vacation, she writes more judgements, reads more jurisprudence or returns with boosted productivity. The data available in the public domain does not allow us to measure these impacts on judge productivity. Besides, if there were such impacts on a judge, they are not a powerful explanation for a court vacation where all the judges go on vacation simultaneously. These benefits would accrue even where judges take leave as per their own convenience during the calendar year. Therefore, while measuring such impacts is important for its own sake, it does not add to the vacation-related discourse which our analysis speaks to.

Finally, several scholars have started adopting the empirical approach in evaluating Indian courts and tribunals, using a variety of tools ranging from simple summary statistics to more advanced analyses grounded in statistics, and using the tools of natural language processing and artificial intelligence. We provide yet another demonstration that questions pertaining to the impact of interventions in the Indian court system are amenable to empirical research. Expanding such analyses to other courts will strengthen the discourse on court vacations by shifting from pure normative perspectives to empirically grounded questions on whether vacations actually increase the productivity of a court.

References

Pavithra Manivannan, Susan Thomas and Bhargavi Zaveri-Shah (2023), Helping litigants make informed choices in resolving debt disputes, The Leap Blog, 15 June 2023.

Law Commission of India (2009), Reforms in the Judiciary: Some suggestions, Report No. 230, August 2009.

Alex Tsun (2020), Chapter 9, Applications to Computing, Probability & Statistics with Applications to Computing, 2020.

Tushar Anand and Pavithra Manivannan are researchers at XKDR Forum and Bhargavi Zaveri-Shah is a doctoral candidate at the National University of Singapore. The authors thank Susan Thomas and Geetika Palta for useful discussions.

How substantial are non-substantive hearings in Indian courts: some estimates from Bombay

by Pavithra Manivannan, Karthik Suresh, Susan Thomas, and Bhargavi Zaveri-Shah.

The problem

If we think about court as a services production organisation, then the number of staff, technology and other resources would be inputs to deliver well-defined outcomes of litigants' cases being decided satisfactorily. In between these inputs and outcome are hearings as the output of courts. Hearings are where the matter of the dispute is presented in front of a judge. When hearings are substantive, progress is made in resolving the dispute.

Not all hearings are substantive. Some non-substantive hearings are inevitable, involving procedural matters such as the filing of documents. When a hearing is non-substantive because the matter is rescheduled to a later date, this imposes a burden of time and cost upon litigants and the court.

Such unexpected non-substantive hearings are an important problem in the Indian legal system. The Civil Procedure Code (1909) prescribes a limit of three adjournments per case, but reality often diverges from this stated limit. In 2021, the e-committee of the Supreme Court has proposed an alert for judges to be informed about breaches in this 3-adjournment rule within its case management system. There is thus a recognition of the presence of this problem.

What is not, at present, known is a quantitative sense of the improtance of the problem. In this article, we estimate the magnitude of non-substantive hearings for one group of situations. The working of the Indian legal system varies widely by venue and case type. In order to measure the phenomenon of non-substantive hearings, we pick one relatively homogeneous class of disputes --- debt dispute resolution --- which are heard at three courts in Bombay. They are the National Company Law Tribunal (NCLT), the Debt Recovery Tribunal (DRT), and the Bombay High Court (Bombay HC). For these three venues, we seek to estimate four quantities:

1. What is the fraction of substantive hearings in these courts?
2. Out of the hearings in a case, how many are substantive?
3. How much time elapses till a first substantive hearing?
4. How likely is the first hearing to be a substantive hearing?

Definitions and estimates

An understanding of the number and likelihood of such hearings is important to set litigant expectations about the time and costs spent when seeking redress from the court. Regy and Roy (2015) use the term 'failed hearing' in their work on understanding what causes delays at the Delhi Debt Recovery Tribunal (DRT). They classify failed hearings as those hearings that satisfy three criteria: the hearing resulted in an adjournment without any judicial business, the adjournment was avoidable and the adjournment was not penalised. Khaitan et al. (2017) record hearings as 'inefficient' in their study on court efficiency, where the definition of an efficient court is based on whether the court meets set deadlines or not. In their work on cases from the Delhi High Court, they record hearings as 'inefficient' when there is a failure, either because of the court ('insufficient time to hear the case', 'absent judge') or because of either party ('counsel sought time', 'Absent counsel', 'Delay condoned', 'Restoration'). These papers present us with the earliest estimates of non-substantive hearings. Regy and Roy (2017) record 58% of hearings at the DRT as failed hearings. Khaitan et al (2017) record 48% of hearings at the Delhi HC as inefficient. Both suggest that attempts to reduce adjournments could reduce court delays by up to 50-60%, based on these estimates.

The Ministry of Law, Justice and Company Affairs, in the context of fees payable to government counsel, refer to 'Effective hearings' and 'Substantial work'. Effective hearings are where either one or both parties are heard by the court, while 'non-effective' hearings are where 'the case is mentioned and adjourned or only directions are given or only judgement is delivered by the court'. The same memorandum refers to substantial work as 'when the case has been admitted by the Court after hearing of preliminary objections or filing of the affidavits/counter-affidavits etc. by the Counsel'. These definitions guide a distinction between adjournments and non-substantive hearings.

In this article, we broaden the notion of differentiating non-substantive hearings beyond adjournments. Only hearings where there is application of judicial mind to the resolution of the dispute, are classified as 'substantive'. Thus hearings that involve disposals, withdrawal, admission, reporting settlement, are classified as substantive hearings. Adjournments are classified within non-substantive hearings. A reading of the order for an adjourned hearing may simply have a next date given for a hearing. These may be adjournments on account of paucity of time, time sought by parties, non-appearance of parties, wrongly listed or technical glitches. We also classify hearings as non-substantive when orders in which the court gives directions to file pleadings or take on record pleadings. Hearings that involve matters of procedure, without a substantial impact on the resolution of the dispute itself, are taken as non-substantive for a litigant.

The dataset

We hand-constructed a novel dataset, where for a sample of cases, we built the existing case life-cycle by collating all the hearings for a given case. We then read and classified each hearing in the case life-cycle as a substantive or a non-substantive hearing using the approach listed in the previous section. Since each judge records what transpired at the hearing in her own style, parsing and classifying every order necessarily involved a subjective judgement about whether it is a substantive hearing, or not. Therefore, once we had classified orders, we then subjected the classification to a double-blind peer review.

We built this dataset for cases of debt dispute resolution, using orders collected from the websites of the High Court (HC), DRT and NCLT in Bombay. The analysis was done for a random sample of 200 matters from each of the three courts. In these samples, we selected 100 disposed cases and 100 pending cases for each court. The hearing dates ran between 2018 and 2022.

One difference in how orders are uploaded on the Bombay HC versus the two tribunals is important to take note of: each court follows a different timeline for uploading case life-cycle data. On the Bombay HC website, the case appears from the date of filing. For the tribunal courts, the case appear on their respective websites only from the first hearing date, irrespective of the filing date of the case. Since the sample of cases from each court was drawn at random, there could be cases in the Bombay HC without a hearing, while this is not possible with cases in the sample from the tribunal courts. Further, this makes a strict comparison of hearing characteristics at the Bombay HC and the tribunal courts difficult. These differences impose constraints on how various measures are calculated for each court, in order to enable a balanced comparison across the courts.

Findings: What is the fraction of substantive hearings in the three courts?

Table 1: Fraction of substantive hearings to total hearings in three debt dispute resolution courts

Court	Hearings in full sample			Hearings in disposed cases
	Total	Substantive	Fraction		Total	Substantive	Fraction
Bombay HC*	399	192	0.34*		208	139	0.48*
DRT	575	229	0.40		267	116	0.43
NCLT	1135	258	0.23		365	145	0.40

^{*57 cases at the Bombay HC had zero hearings. The fractions reported for the Bombay HC have been adjusted to account for this.}

Table 1 shows the total number of hearings, the number of substantive hearings and the ratio of substantive to total hearings in the three courts. The number of non-substantive hearings can be calculated as (Total hearings - Substantive hearings). This table shows that the NCLT generates the lowest ratio of substantive hearings among the three courts, while the Bombay HC outputs the highest ratio.

Table 1 also shows the data on the ratio of substantive hearings for disposed cases in the three courts. This indicates two features: first, the court generates a higher fraction of substantive hearings in the case of disposed cases. This means that there is a higher number of substantive hearings among hearings for cases that have been disposed. But, there are still fewer substantive hearings than non-substantive hearings. Less than than 50% of all hearings for disposed cases are substantive hearings. This observation holds for all three courts. This suggests that process improvements that simplify administrative hearings or reduce the incidence of adjournments will have a significant improvement in the experience of the litigant in these courts.

The above finding relates to the outputs generated by the courts as a whole, in relation to each other. The litigant focus will be more on what we observe about hearings per case. We examine these questions next.

Findings: What is the fraction of substantive hearings per case in the three courts?

Table 2 shows the summary statistics of hearings per case in the sample. The values presented include the minimum, median, maximum and average number of hearings per case.

Table 2: Number of hearings per case for three debt dispute resolution courts

Court	Hearings			Substantive hearings
	Median	Average		Median	Average
Bombay HC	1	1.21*		1	0.43*
DRT	3	2.88		1	0.82*
NCLT	5	5.68		1	0.91*

^{*Each court has a different number of cases for which substantive hearings could be observed. The counts are 79 cases in the Bombay HC, 57 cases in the DRT and 60 cases in the NCLT with no substantive hearings}

Table 2 shows two values for each court: the average number of hearings per case, and the average number of substantive hearings per case. We see that the Bombay HC has the lowest average number of hearings per case (1.21). The NCLT has the largest number of hearings per case (5.68). This indicates that NCLT has more than 3 times the hearings per case compared to the Bombay HC. It holds more than 2 times the average number of hearings at the DRT which has 2.88 hearings per case, on average.

When comparing the values of the average number of hearings per case to the average number of substantive hearings per case, Table 2 shows that all courts have less than 1 substantive hearing per case, on average. The NCLT has the highest average number of substantive hearings per case (0.91) but it is less than one. The average number of substantive hearings per case for the DRT is almost the same as the NCLT, despite the number of hearings per case being double at the NCLT. This suggests that for every 6 hearings at the NCLT, one is likely to be substantive, while for every 3 hearings at the DRT, one is likely to be substantive. If the number of hearings can be used as a proxy for the cost of filing a case in court, then NCLT is likely to be the lowest benefit to cost for the litigant.

But, the hearing or substantive hearing per case is often not the sole objective for a litigant who approaches court for the resolution of debt. What is also important is the time within which the substantive hearing can be reached. For this, we next examine what is the expected time to the first substantive hearing.

Finding: Time to first substantive hearing

When the case gets a first substantive hearing is an important milestone for a litigant. It is likely to be a hearing in which substantive oral arguments will be made on questions such as the admission of the matter before the court, questions of interim relief that will operate pending the final disposal of the matter, the impleadment of new parties to the matter, the time schedule for the filing of replies and counter-replies, and so on. Setting an expectation on when such a hearing is likely to be conducted after the case is filed, is therefore an important input to preparing for the case.

We use a survival analysis approach to estimate the time to a first substantive hearing after the filing date (Manivannan et al, 2023). Figure 1 shows two survivor functions for each court. The survivor function can be represented as a curve on a graph, which shows the chances of not getting a first hearing / substantive hearing (on the y-axis) against time from filing the case in court (on the x-axis). When the case is first filed, the chance of not getting a substantive hearing is 1 or 100%. I.e., at the outset, all cases experience no hearing / substantive hearing. As time progresses, this number starts to become lower than 1. The `faster' the curve drops from 1, the higher the chances that the case had a first hearing / substantive hearing. On each graph, the darker line shows the chances of a first substantive hearing, while the lighter line shows the chances of a first hearing.

The graph for the Bombay HC (in red) shows that at the end of one year, 40% of the cases have not obtained one hearing. When we focus on substantive hearings only, 60% of the cases have not achieved this milestone. The dark and light line are clearly separated, which indicates that these two values are distinctly different from each other.

The graph for the DRT (in green) shows that 77% of the cases have not got one hearing at the end of the first year after filing. When we focus on substantive hearings only, this is true for 80% of the cases. This means that only 20% of the cases can be expected to get a substantive hearing by the end of the first year from filing.

The graph for the NCLT (in blue) shows that at the end of one year, a little less than 50% of the cases have not got one hearing. When we focus on substantive hearings only, this fraction goes up to 70%. This means that 30% of the cases are likely to have achieved a first substantial hearing in the first year from filing. The gap between the curves for the first hearing and the first substantive hearing is the largest for the NCLT, among the three venues.

These graphs show that the litigant is most likely to get a first substantive hearing within one year of filing from the BHC.

We have chosen to estimate the chances of getting a first hearing and a first substantive hearing in one year after the case has been filed. But these same graphs can be equally used to estimate the chance of a first substantive hearing for shorter or longer periods of time also. For example, the chance of a first hearing within one month of filing the case is the highest at the NCLT, followed by the DRT, and last, at the Bombay HC. Similarly, the graphs show that the chances of getting a first substantive hearing within one month of filing is the highest at the NCLT, up to three months after filing. But if the case is not heard within this time, the chances of getting either a first hearing or a first substantive hearing are higher for a case which is filed at the Bombay HC.

Conclusion

Unpredictable non-substantive hearings constitute a process failure. In this article, we show that for one kind of matter (debt dispute resolution), at three venues, the fraction of non-substantive hearings is 64%, 60% and 77%. From the litigants' perspective of measuring the performance of courts, if a good measure is the fraction of matters that get to a substantive hearing within the first year after filing, we find that this value stands below 50% for all the courts studied.

There is merit in establishing systematic mechanisms for computing such performance metrics. These findings can help litigants estimate the possibilities of events and expenditures, after a case begins. Such information systems would help improve decision-making about suing, about settling, and the choice of venue, for the litigant. A regular estimation of these metrics can also be a useful guide for changes made in court processes, with the understanding that a change in performance metric will be some complex combination of the process change, along with the change in the response of the people who both make up the legal system, and those who use it.

Finally, this work highlights the difference in objectives for which performance metrics need to be designed. While the producer (court) will find it optimal to use the ratio of aggregate substantive to total hearings, the litigant will optimise based on the metric of substantive hearings per case which can lead to a different choice relative to what the court might expect.

References

Nitika Khaitan, Shalini Seetharam and Sumathi Chandrashekaran (2017), Inefficiency and Judicial Delay: New Insights from the Delhi High Court , Vidhi, March 2017.

Pavithra Manivannan, Susan Thomas and Bhargavi Zaveri-Shah (2023), Helping litigants make informed choices in resolving debt disputes, The Leap Blog, 15 June 2023.

Prasanth Regy and Shubho Roy (2017), Understanding Judicial delays in debt tribunals, NIPFP Working Paper 195, May 2017.

Pavithra Manivannan, Karthik Suresh, and Susan Thomas are researchers at XKDR Forum, Mumbai. Bhargavi Zaveri-Shah is a doctoral candidate at the National University of Singapore. We thank Geetika Palta for data support, and Purbasha Panda for her support in reading through the case orders. We also thank two anonymous referees and Ajay Shah for useful feedback and comments.

Elections in Maharashtra: Have the fires of nativism subsided?

by Naman Pugalia, Renuka Sane, Viral Shah.

The results of the Assembly polls in Maharashtra are anxiously awaited. The four main contenders, the Congress, the NCP, the Shiv Sena, and the BJP have all been part of one of the two principal coalitions, the Democratic Front (Congress and the NCP) which ruled the state for the last 15 years, and the Mahayuti (Shiv Sena and the BJP) that has been the principal opposition alliance.

The battle against the `other'

After these two principal alliances in Maharashtra broke up, ahead of the assembly elections, political parties have been quick to rouse nativist sentiments to secure the Marathi vote. Each political party contesting in Maharashtra, and especially in Bombay, has been vying for the "marathi manoos": the BJP by bringing together Narendra Modi and Chattrapati Shivaji, and the Shiv Sena and the upcoming Maharashtra Navanirman Sena reacting strongly against such a comparison, comparing the BJP leaders as foot soldiers of Afzal Khan, the commander of the Adil Shahi, who was killed by Shivaji. At heart seems to be the idea that the son-of-the-soil will never prefer an outsider as the ruler of the state.

The roots of this angst date back to the Samyukta Maharashtra Movement launched in 1955 in Pune. As Kumar Ketar in the Asian Age says:

the business lobbies, mostly consisting of the Gujarati's and Marwaris wanted Mumbai to be an independent city state or a bi-lingual or autonomous city state. But the mass movement led by Samyukta Maharashtra Samiti foiled that plan. The Marathi angst of the time was one of the reasons for the Shiv Sena's rise, and continues to the reason for the undeclared hostility between the Gujarati-Marwari business community and the Marathi working class.

The Gujarati-Marathi antagonism was mostly restricted to Bombay. In other parts of Maharashtra, it has always been a "Maratha" vote, something that the Congress and the NCP had capitalised on over the last few decades. In the 54 years since Maharashtra was formed, the Congress has ruled the State for 49 years. Of its 17 Chief Ministers, 10 have been Marathas. The outgoing cabinet did not have a single non-Maratha!

By this logic, you would have expected that a national party, with a low support base in Maharashtra in the past, with a Gujarati leader and a Gujarati campaign manager, would not fare that well in the coming elections.

Several commentators, have, however argued that the new Marathi middle class has moved on in its economic and cultural ambitions. It no longer shares the sense of injustice that was the cornerstone of the Samyukta movement, and is in fact, brimming with enthusiasm to participate in the new India. In addition, over the years, migration on a large scale has taken place into Bombay and it's environs, and into Poona, which has created a new set of immigrant voters.

How relevant is the issue of the "marathi-manoos"?

FourthLion Technologies has been conducting message testing polls in the run up to the elections in Maharashtra to tease out voter preferences using its Instavaani. The methodology involves using a control and multiple treatments, and comparing the treatments to the control to get a relative understanding of the persuasion power of different messages.

In a message testing poll, the control is a simple horse-race poll, that asks voters to pick the party or candidate of their choice. The poll on October 1, 2014, showed that 41% of voters preferred the BJP, 11% Congress, 14% Shiv Sena and 11% the NCP. BJP was comfortably in the lead. This is the control.

In each treatment, a particular message is read out to the listener, and then the horse-race question is asked again. Differences from the control give us a sense of the immediate short-term impact of this message on the minds of the populace. These polls are conducted by randomly sampling phone numbers across the entire state. The poll typically strives for 200-400 observations. With assumptions of perfect random sampling of a small sample from a representative population, the margin of error is 0.98/sqrt(n). At 200 samples, the margin of error is 7%, and at 400 samples, it is 5%. These polls are typically carried out as soon as news breaks out, and situations develop in real-time, allowing the observation of the mood of the people within hours after an event.

Here are some results which illuminate attitudes to nativism:

1. `Prithviraj Chavan is a true son of Maharashtra. He went to school in Karad, which is in south Maharashtra. His mother and father, Premalakaki and Dajisaheb Chavan, went to jail because they fought for an independent state of Maharashtra. No other candidate for Chief Minister has the same legacy of fighting for Maharashtra as Prithviraj Chavan'.
   

   Would you vote for	% of respondents
   BJP	31%
   Congress	26%
   Shiv Sena	15%
   NCP	11%
   Others	17%

   This shows that the CM's background matters quite a bit, and led 10 percentage points of voters to switch from the BJP to the Congress. This also explains why Prithviraj Chavan led the Congress' campaign in the state - his popularity is higher than the party's.
2. `In 1960, Gujarati minister Morarji Desai ordered police to fire on activists of the Samyukta Maharashtra Samiti, killing 105 Marathis. The Samyukta Maharashtra Samiti activists won their fight to create an independent state of Maharashtra. Today, the BJP is bringing Gujaratis such as Amit Shah to again place Maharashtra under Gujarati dominance'.
   

   Would you vote for	% of respondents
   BJP	33%
   Congress	14%
   Shiv Sena	25%
   NCP	11%
   Others	17%

   If there was indeed strong antagonism about Gujaratis, this question should have caused a lot of people to switch votes out of the BJP. However, only 8% of the voters seems to have moved away from the BJP, mostly to the Shiv Sena.
   
3. `The BJP has no leaders in Maharashtra who are clean, honest and capable of running the state government. That is why the BJP has to parachute in outsiders like the Prime Minister and Amit Shah to campaign for them. The BJP is afraid to announce who their CM candidate will be because their local leaders, including Devendra Fadnavis and Eknath Khadse, are inexperienced and unqualified to run the second-largest state in India, and also have dozens of criminal charges against them'.
   

   Would you vote for	% of respondents
   BJP	39%
   Congress	15%
   Shiv Sena	19%
   NCP	10%
   Others	17%

   This yielded the least movement away from the BJP: only two percentage points, which is not statistically significant. 39% of voters continue to root for the BJP. It shows there is far greater confidence in the BJP leadership than in that of any other parties.
   

This post is about nativism, so we don't talk about other measurement of how voters feel. But one point must be made. None of these treatments work as well as other treatment messages that talk about construction of roads, public works, anti-corruption, etc. These results suggest that the passions of caste and creed are now less important; that the history of the Gujarati-Marathi antagonism has faded from memory. By this logic, the BJP was perhaps on the right track in breaking away from the Shiv Sena, and focusing on its core messages of development and good governance. This is what voters in Maharashtra seem to care about.

Implications

We may conjecture that three things are going on:

1. Part of the reason for this move away from nativist sentiment is the personal appeal of the Prime Minister. His approval ratings, measured in a survey FourthLion did for Mint on August 16, 2014, were highest in Maharashtra and West Bengal. In the bye-polls, there was very little involvement of the Prime Minister, and the BJP did not do well. It is no surprise then that the BJP is seeking votes under the Modi banner, with messages like "Chalo chale Modi ke saath" ("let's walk with Modi") and "Ab ki bar Modi sarkar" ("this time let's make it the Modi administration").
2. Anti-incumbency against the state government, and the 2 parties (INC + NCP) that jointly governed the state for 15 years, has voters looking for an alternative. Given the BJP's own brand, their assessment of being able to achieve a majority on their own, and the country beginning to taste the benefits of a clear mandate, the BJP has an edge in asking voters in Maharashtra and Haryana to give it a clear mandate in the states too, so that they can work well with the Centre.
3. But most important is the fact that the Indian electorate has moved on. The desire of the voter to look beyond tribal considerations is the reason why Maharashtra might be the first state to throw up a verdict that challenges preconceived notions about the eternal power of old hatreds.

Does this have implications for regional parties elsewhere in India? Many regional parties may have to go in for radical reconstruction if nativist fires are subsiding. Some, like the BSP, have begun doing this. The entire eastern and southern belt, which sees strong regional parties - West Bengal, Orissa, Telangana, Andhra Pradesh, and Tamil Nadu - could see change. While Jammu and Kashmir and Jharkhand will give us some more intuition in the coming few months, Bihar is going to be the next big test in 2015.

One possible argument is that Maharashtra is a better state, with greater exposure to new ideas, low levels of violence, and a successful economy. In contrast, the backward parts of East India may still be trapped in the old nativist ways. But what about the South? The developments in Maharashtra could be particularly portentious for the better states of the South.

The politics of Bombay has long been benighted by the problem of nativism. What was once a great metropolis has been bogged down by decades of nativist politics. These results show a possibility for becoming a normal city, where the political questions that matter are about efficiently producing local public goods.

The rise of high-end finance work in India

by Shashank Bansal.

Until recently, outsourcing by global financial firms to India conjured up an image of commoditised low end services outsourcing: call centres, peripheral systems programming, and testing and maintenance. However, in recent years, there is a new rise of more sophisticated work. This reflects supply and demand factors. Global financial firms are keen to cut costs. Capabilities of operations in India -- both captives and independant firms -- have grown for many reasons:

• The individuals involved in this field in India have gained experience ("learning-by-doing") and credibility.
• New management practices and improved telecommunications technologies have improved the extent to which teams and projects are handled in a more non-local way.
• The Indian diaspora has been rising to senior management levels in global firms, and is better able to envision what can be done in India and to obtain execution.

A European investment bank was among the first to experiment by bringing in teams in India into critical projects. This was a landmark change as a lot of inertia about confidentiality was overcome. Other banks followed suit. New management practices, higher pay, greater meritocracy came in, which helped Indian teams make the transition from low-end work where the HR and management techniques used are quite different. Demand for high skill labour has helped induce greater supply, with a lag, as individuals were more inclined to tool up with advanced degrees and high-end knowledge.

Alongside the developments in finance, parallel developments were taking place in the field of offshoring which have driven up skill levels, and helped create a high skill ecosystem in India. Top tier consulting firms launched `centres of excellence' in India, hiring grads from IITs, IIMs, IISc, statisticians, economists. While education in India has huge problems, the raw talent available in India was of good quality, particularly when we focus on individuals who were able to read on their own and reinvent themselves ("never let your school come in the way of your education"). This process has been helped by globally recognised certification exams such as the FRM and the PRM.

IT firms have have been evolving from core development and maintenance to an entire gamut of IT strategy and consulting for financial firms. Many smaller KPO firms with specialised domain knowledge in finance have emerged, who cater to smaller hedge funds, trading houses, not just outsourcing increasingly complex pieces of work, but also advising them on the entire outsourcing strategy. All this has helped create a pool of high skill labour which is moving between multiple employers in India and able to build knowledge through diverse kinds of experience.

The most impressive development of recent years has been the growth of offshore trading units of global brokerages and trading houses, where people sitting in India take independent trading decisions in international financial markets based on their own skills and judgement. In some ways, this is the highest level of transfer of decision functions to India, albeit at relatively low monetary stakes.

In this fashion, within a period of 15 years, India had graduated from doing repetitive low value tasks to Knowledge Process Outsourcing (KPO) for the global financial system. While these activities are primarily in Bombay, they are also taking place in Gurgaon and Bangalore. The number of high-end finance workers in Bombay has never been greater than it is today. It is estimated that there are now 50 individuals working in Bombay doing work for global financial firms who have Ph.D. degrees in quantitative fields. This is starting to become a big enough number for them to talk with each other and get network effects going. From an employer's point of view, it is now possible to shop in the labour market in Bombay and recruit a 10-man team all with Ph.D. degrees so as to get a new group going. This is a sea change when compared with conditions just a few years ago.

To appreciate this change a little further, it was interesting to take a look at some of the capabilities of finance focussed KPOs, divided mainly into 4 broad categories, catering to Sales and Trading, Middle office and Back office:

1. Quantitative Research and Analytics Support:
   1. Equity and FICC Analytics: Model Validation, Price Verification jointly with clients: these are pretty quant heavy functions which require in-depth understanding of products.
   2. Technical and Fundamental Analytics.
   3. Index and Portfolio Analytics: Index maintenance, design, construction, operations and after sales, Portfolio tracking, decomposition and correlation analysis, performance measurement and attribution support.
   4. Derivatives and Risk Analytics: Measurement of derivatives Greeks, Value at Risk, Tolerance checks.
2. Research:
   1. Equity and FICC Research: Company research, Credit Research, Economics research etc. to augment senior analysts in money centres.
   2. Trade idea generation and back testing: Sales pitches for clients and internal trading desks.
   3. Country, Sector, Company profiling, trends, news and projections: Pitch book generation and support.
   4. 24x7 weather patterns tracking for global energy trading outfits
   5. Overnight trade and market tracking to feed in summary reports, Market Dashboards, news letters, morning meetings and agendas
   6. Market Research: Pre-entry market research and positioning survey for bank's clients.
3. Data Analysis and Modelling:
   1. Data sourcing from multiple heterogeneous sources, refining and maintenance: Static data, Live and Historical market data maintenance. Data research and statistical studies feeding into trading strategies.
   2. Data Mining solutions.
   3. Data modelling, smoothing: Providing data solutions for Algo trading desks.
4. Operations and Control
   1. Derivatives trade processing and documentation: Trade review of structured trades and complex documentation. End to end life cycle management of trades e.g., matching, broker confirmations and fee calculations.
   2. P&L and balance sheet control: Generation and reporting of P&L for vanilla products. Some banks have started moving exotics P&L functions to India. This is quite a significant milestone as such activities require high degree of confidentiality and direct user (e.g., traders) interaction who have zero tolerance for mistakes.
   3. Risk Stress testing, VaR back testing, Risk reporting to senior management.
   4. Auditing: external auditing of valuation marks of trading desks and control processes around it.
   It should be noted here that since the funding crisis of 2008, these jobs have become quite complex as most banks have built more sophistication into their analytics. For example, most yield curves would now have multiple basis spreads (like tenor basis, xccy basis) and not just rates desks but even credit and equities desk have been using such advanced discounting curves.)

What's next

The biggest push probably has been in quantitative middle-office functions with an ever increasing emphasis on valuations and counterparty risk management. Given the way markets have adopted collateral based pricing of derivatives, and the regulatory push on managing counterparty default risk, some captives have started building quantitative teams who will develop and manage CVA, DVA, etc. processes for all trading desks.

The new regulatory climate (Dodd Frank, Basel III etc) has lead to a substantial increase in costs due to additional checks and reporting requirements e.g., centrally cleared OTC trades, real time trade reporting to regulators, exhaustive risk reporting - all of which can are leading to fresh volumes of activity in offshoring.

All high quality banks have a team of techno-quants who work closely with the sales/trading desk, risk managers etc, on their day to day needs as well as on strategic projects. It is now feasible to move such high impact roles to India. It would be possible to have "extended front office teams" where dedicated staff support traders in money centres, doing real time risk analysis and client profiling, while the trade is being dealt overseas.

For a back-of-envelope calculation, if we think of internal billing rates of $100,000 per person per year, and if there are 10,000 persons at this average price, then this is services export of $1 billion a year, which is a sizeable amount. It appears that the early beach-head is in place, and this area will grow dramatically now.

This blog post reflects my experience, which is in investment banking and money management. A similar escalation of complexity of work in India is taking place in retail banking, insurance, etc., reflecting similar compulsions and opportunities.

Constraints

There is a certain tension between the push towards offshoring to India, and the activities that regulators consider `key in-house activities' that cannot be outsourced.

There are serious constraints with education in India. The top institutions are producing some quantitative skills (e.g. fluency with matrix algebra, fluency in numerical computation). On one hand, there are weaknesses of broad intellectualisation that shapes cognition, creativity and malleability. On the other hand, there is essentially nothing in place by way of a finance education in India. A small amount of high-end finance research is taking place (example) but for the rest, there isn't much capacity in the existing academic campuses. New approaches to learning and training need to be devised through which high quality individuals, with strong quantitative skills, can be converted into full fledged participation in high-end global finance work. A mix of public and private initiatives are required in order to jump to the next level.

There are strong synergies between the sophistication of the Indian financial system and the work that is done for global financial firms. There is a two-way feedback loop here: Better domestic capabilities will help do sophisticated offshore work, and the brainpower built for offshore work will strengthen domestic capabilities. The best example of this is found in the equity derivatives market, where India has a world-class market. The individuals with a domestic background here are ready for offshore jobs in fields like algorithmic trading, and individuals with capabilities built in offshore work are useful in the domestic setting. This is where India can set itself apart from Malaysia and the Philippines. To the extent that Indian financial reform makes progress, this will fuel the rise of high-end outsourcing to India.

Acknowledgements

I am grateful to Anand Pai, Paul Alapat and Gangadhar Darbha for useful discussions.

Law and order: How to go from outrage to action

There is fresh rage on the bad state of law and order in India today. That rage is entirely appropriate.

My father was born in 1926 and experienced British rule. One of the high points of his life was participation in the freedom movement. He used to say to me with great regret that under British rule, the Shiv Sena would have never arisen. What has happened in India is a disgrace.

The interesting and important question is: How can the problems be solved?

Moral outrage does not lend itself to good policy analysis. As with the problem of corruption, the problem of law and order requires sophisticated thinking. Just as the young people who got enamoured by Baba Ramdev and Baba Hazare got nothing done in terms of combating corruption, we should worry about what comes next on law and order. Anger and outrage, coupled with low knowledge of political science and public economics, is a sure path to poor policy analysis. What matters is shifting from anger to analysis to action.

As an example, if laws are modified to prescribe draconian penalties for rape, then rapists are more likely to kill the victim. What is required is better quality implementation of the existing law.

What would it take to make the police and courts work better? The three ingredients that are required are incentives for politicians, resources and feedback loops.

Incentives for politicans

The first issue is incentives for politicians. Politicians will deliver law and order if they think that this is what will get them re-elected. From Indira Gandhi's time onwards, politicians in India have felt that the way to win elections was to focus on welfare programs for the poor. As long as this is the case, the narrative that will dominate the Indian State is that of poverty, inequality, and welfare programs.

Economists distinguish between public goods and private goods. Public goods are defined to be those that are `non-rival' (your consumption of safety does not reduce my consumption of safety) and `non-excludable' (it is impossible to exclude a new born child from the environment of safety). The legitimate purpose of the State is to pursue public goods. All citizens gain from public goods, and all voters should respond to these benefits. The first and most important public good is safety, which requires building the army, the police and the courts.

The Indian State has, instead, gone off on the adventure of building welfare programs: of government giving private goods to marginal voters. The first priority of the Indian State is the themes of poverty, inequality and welfare programs. Politicians need to learn that this hurts. Sheila Dixit should realise that her top priority in Delhi is law and order.

There are undoubtedly problems in the leadership and management structure of the police. I believe that once politicians want law and order, this will drive them to recruit the leadership that is required, and undertake structural reforms, so as to get results. As an example, look at how the politicians broke with PWD and setup NHAI, or setup Delhi Metro. The question that matters is : Do politicians want law and order? From the 1960s onwards, the minds of politicians have been addled by welfare programs.

If Rs.X is spent as a gift on a few marginal voters, it makes a certain difference to winning elections. If that same money is spent on public goods -- e.g. better safety for all -- it should make a bigger difference to winning elections since more voters gain. The question is: Do politicans see this and act in response?

Resources

The second issue is resources. India needs much more staffing in the police and the courts. This includes both technical staff (e.g. constables and judges) and support staff (e.g. clerical staff, operators of computer systems, etc).

Courts and police stations need to be high quality workplaces with air conditioning, computer systems, modern office equipment, canteens, web interfaces to the citizenry, lighting, toilets, and such like.

Policemen need to live in high quality housing. If policemen live in high quality housing and work in high quality offices, they will be more civilised both in terms of the quality of intake and in terms of how their behaviour evolves on the job. This will cost a lot of money. The State in India has very little money. To improve the police and courts will require cutting back on welfare programs.

As Robert Kaplan says, underdevelopment is where the police are more dangerous than the criminals. One element of this is the biases in recruitment. As an example, the police in Bombay tends to be male Maharashtraian and relatively low skill. This needs to evolve into a more sophisticated workforce, with gender, ethnic and religious diversity that reflects the cosmopolitan structure of the populace.

At present, in India, spending on police and courts (which are core public goods) is classified as `non-plan expenditure' and is treated as a bad thing. Spending on private goods like welfare programs is classified as `plan expenditure' and grows lavishly year after year. In the UPA period, plan expenditure has gone up by four times in 10 years. These priorities need to be reversed.

The other critical resource, other than money, is top management time. The simple question that I would ask Sheila Dixit or Manmohan Singh is: What fraction of your time do you devote to public goods? My fear is that the bulk of their time is spent worrying about welfare programs. When the top management is not focused on law and order, safety will degrade.

The lack of safety is a regressive tax: it hits the poor more than the rich. The rich are able to insulate themselves at a lower cost. When a policeman faces me on the street, he immediately speaks to me in a certain way once he sees that I come from the elite. Poor people are mistreated by both criminals and the police. Through this, the number of votes that should be affected by improved law and order is large. The people who care deeply about the poor, and would like to focus the Indian State upon problems of inequality and poverty, should ponder the consequences of what they have wrought.

Feedback loops

In order to think about law and order, we need measurement. I used to think that the murder rate is high quality data. Over recent years, I have come to believe that in many parts of India, not all murder is reported to the police. In this case, we are at ground zero about the state of crime: we know nothing about how much crime is taking place out there.

What you measure is what you can manage. I had recently written a blog post about health, and the same issues apply here. Our first priority should be to setup crime victimisation surveys [link].

The most important outcome that I think matters is a question asked in a household survey of parents: Are you comfortable when your teenage daughter is out alone at 11 PM? That's it. That's the end goal. Civilisation is where parents are comfortable when their teenage daughters are out alone at 11 PM.

Once the CPI is measured, and measured well, RBI can be held accountable for delivering low and stable inflation. In similar fashion, the Bombay police can be held accountable once we get a graph updated every month about the crime rate in Bombay, supplemented by quarterly data from crime victimisation surveys. This would generate feedback loops whereby we can judge whether Sheila Dixit has improved law and order in Delhi on her watch.

When Sheila Dixit gets anxious about the lack of progress on publicly visible statistics about the state of law and order in Delhi, she will have the incentives to recruit high quality leadership for the Delhi police, and to resource them adequately, to get things done.

Why are these good things not getting done?

This is the hardest question. I have three opinions about what has been going wrong.

The first lies in the incentives of politicans. Why do politicians pursue private goods for a few when they can instead spend money on doing public goods that benefit all? Why does democracy not push Indian politicans towards the centre? I think one element of the answer lies in first-past-the-post elections.

Today in India, winning elections does not require pleasing all voters; it only requires a base of 30% of the voters. This gives politicans a greater incentive to dole out goodies for the 30% and not work on public goods that please all voters. This reduces the prioritisation for public goods.

The second issue is that of urban governance. The defining challenge for India today is to make the cities work. But our constitutional structure is confused on the location of cities versus states. The feedback loop from the voters in Bombay do not drive improvements in governance in Bombay.
Delhi is unique in this respect in that it's the first city of India where the basic structure is correct. Sheila Dixit is the Mayor of Delhi. She is held accountable for making voters in Delhi happy. Voters in Delhi bother to vote in the Delhi elections. Hence, I am far more optimistic about the future of Delhi than I am with Bombay.

The third issue lies in the intelligensia. Western NGOs, aid agencies and the World Bank are focused on inequality, poverty and welfare programs. This generates incentives for individuals to focus on inequality, poverty and welfare programs, owing to the funding stream and career paths associated with western NGOs, aid agencies and the World Bank. These large funding sources and career paths have generated a distorted perspective in the Indian intelligensia. We need more minds in India who think in terms of first principles economics and political science, without the distortions that come from the worldview of development economics.

We blame politicians in India for being focused on welfare programs. But to some extent, they are influenced by the intelligensia. It is the job of the intelligensia to hold their feet in the fire, and hold politicians accountable for public goods. The politicians were too happy when, from the 1960s, the intellecturals proposed welfare programs, poverty action, socialism, etc.

Acknowledgments

I am grateful to Pradnya and Nandu Saravade who helped me think about all this.

Next big development in the global market for the rupee

The next interesting development after ICE trading of rupee futures: CME will launch rupee futures soon also. See CME follows ICE into rupee futures by Tom Osborn on Financial News.

ICE and CME are the world's top exchanges and they are serious rivals for the global rupee market. These recent developments add up to a substantial change in the outlook for the rupee as an internationally traded currency. The rupee will become more prominent as a globally traded and liquid market. And, ICE and CME are likely to do well, thus accelerating the decline of the onshore market.

Rupee and Real futures at ICE

Intercontinental Exchange has announced cash-settled futures on the Indian Rupee and the Brazilian Real [press release] [Saabira Chaudhuri in the Wall Street Journal]. With this, ICE is the first serious global exchange to start trading in the rupee.

Vimal Balasubramaniam and I have pointed out that the global market for the Indian rupee is adding up to some fairly big numbers. I recently noticed that in 2010, even though China is a much bigger economy than India, rupee trading was 0.9 per cent of global currency trading while RMB trading was at 0.7 per cent. Similarly, it appears that the INR NDF is bigger than the RMB NDF, even though China is a much bigger economy. Something is going right in the growth of the rupee as a big currency by world standards. Rupee trading at ICE would strengthen that process.

The ICE announcement also connects to the issues of global competition for Indian underlyings. The two biggest financial markets in India are Nifty and the rupee. So far, NSE faced serious competition with Nifty futures trading at SGX and CME, but there was no significant rival with the rupee. With the arrival of ICE, the competitive dynamics for the rupee changes, which is a welcome development. NSE now faces genuinely difficult competition from three first-tier rivals: CME, ICE, SGX. At the same time, the outlook for rupee trading in India is hobbled by an array of constraints:

• ICE can pitch for business from non-residents, while NSE cannot, since foreign participation in currency futures is banned. We seem to think that OTC trading of currency forwards requires encouragement from industrial policy operated by RBI.
• ICE is able to start contracts any time it likes on (say) the Brazilian Real while NSE is forbidden from starting any new contracts.
• India has mistakes on tax treatment, lacking residence based taxation, while the world has all this well sorted out.
• India has an array of other policy and regulatory mistakes that hobble local players. The ICE transaction charge is zero. I wonder if litigation will now start at CCI to try to block this.

A process is afoot, at present, through which the Indian financial system is being hollowed out. If this process runs unchecked, RBI and SEBI will be left lording over nothing. There is a need to reverse this  policy framework of reverse protectionism.

The two escape routes away from domestic formal-sector finance

Three problems afflict formal-sector finance in India today: capital controls, taxation, and financial policy. The most important financial products traded in the formal sector in India -- the stock market index (Nifty) and the exchange rate (the rupee) -- are under enormous pressure as a consequence.

One dimension, that has been emphasised in the existing discussions, is the flight to offshore markets. There is another: the trade goes off into underground markets. These come in two kinds. In the field of commodity futures, it appears that important price discovery and liquidity is found on unregulated markets. As an example, in Gujarat, the town of Bhabhar is famous for having a huge oilseeds and edible oil futures market. Babhar is a true market: it has liquidity and discovers the price.

A second mechanism is a class of market mechanisms which leech off the price discovery of a main market, do not really offer liquidity of their own, and let people achieve trades. In Indian parlance, these are called the `dabba market'. Here is how it works:

1. The main market where Nifty trades is NSE. But if a customer goes there, he has to suffer the full burden of the securities transaction tax, the charge by the NSE member firm, etc.
2. The dabba operator (`DO') sets himself up in business offering trading services in Nifty futures.
3. Many individuals place buy/sell trades with him. These are meticulously tracked; their profits and losses are calculated and money is exchanged w.r.t. each customer.
4. Through this, the DO is effectively accepting orders -- like an exchange -- and doing daily mark-to-market w.r.t. the customers.
5. On average, the sum total of trades by many customers adds up to zero. So the net exposure of the DO is roughly 0. If an exposure builds up, he might choose to lay off his risk on NSE.
6. The DO charges much less than the NSE member since he does not pay STT and his establishment costs are lower.
7. He is a big man in the community. He can break your bones. So you will not default on him. So he charges less margin. This is another attraction - but it means that some fraction of customers endup entangling with the underworld.
8. The DO will work with black money (i.e. cash). This is another attraction, compared with the all-cheques-and-PAN-numbers world of NSE. The short-term capital gains tax (or worse, ordinary business income treatment of winnings) is then avoided.

Bhavesh Shah, reporting from Ahmedabad in DNA, tells us that dabba trading has gotten bigger of late. He also points out that the DOs have been doing some system-building to make their business more efficient. Dabba trading is one response of economic agents to the problems of taxation and improper financial policy. It also happens to a varying degree with trading in India of international underlyings (e.g. crude oil or gold), where capital controls prevent locals from accessing the world market.

In summary, when India makes mistakes on three things -- capital controls, taxation and financial policy -- there are two kinds of responses on the part of onshore and offshore users of India-related financial markets. On one hand, users go off to overseas venues. On the other hand, users shift towards informality. In the limit, large scale mistakes on the three fronts will drive the bulk of customers away from the formal sector onshore market venues. RBI, the tax authorities and SEBI will then lord over an insignificant part of the market.

Hollowing out of the Indian financial system

Business as usual, in India, is taking us to a destination where RBI & SEBI & company will preside over a minor and inconsequential financial system. The bulk of India-linked finance will take place overseas, and the overseas market will dominate price formation for India-related financial products.

Why might this happen?

Finance is the business of bits and bytes. Orders being sent to India can be easily switched to other venues. An array of other venues are now springing up:

1. Nifty futures trade in Singapore on the SGX
2. An array of sophisticated derivatives on Nifty trade on the OTC market offshore (also termed `the PN market').
3. Derivatives on the rupee trade overseas on the OTC market (linear contracts are termed `the NDF market').
4. Trading in individual stocks is taking place on the ADR and the GDR market.

Let's focus on Nifty - the most important financial product in India. (The arguments pretty much identically apply to everything else).

The success and survival of the onshore securities markets is fundamentally about NSE. NSE faces an array of problems rooted in domestic policy (example, example, example, example, etc). The overseas market faces no such problems. The CEO of SGX wakes up in the morning and thinks about competing with NSE. The CEO of NSE wakes up in the morning and thinks of an array of weird things.

And then, there is taxation. The fundamental principle worth using in this field is residence based taxation. We, as India, should not tax the activities of non-residents. For a global investor, sending orders to the Nifty futures on SGX is tax-efficient as Singapore follows a residence-based taxation system. Sending orders to India is inefficient today (owing to the STT and the stamp duty) and could get worse tomorrow (if GAAR is used to abrogate the Mauritius treaty).

We think we are comfortable, because India has capital controls, and residents don't have much of a choice on taking their custom elsewhere. Things aren't that simple. First, non-residents can pioneer sending order flow to overseas venues, and make them liquid. The next stage will be about Indian MNCs, who run global treasuries, who can easily patronise the overseas venues. The third stage will be HNI residents, who can take $200,000 per year per person outside India. In addition, the richest 1% of India would systematically shift money out of the country through various means fair and foul [example].

Put these factors together, and suddenly Nifty futures on SGX are a credible option. And this is exactly how things have worked out. Palak Shah in the Business Standard says:

As on date, the SGX Nifty OI is 27 per cent higher than that for Nifty futures on the National Stock Exchange (NSE). The figures are more alarming if one considers the OI in a single month in May as the built-up positions on the SGX are 70 per cent higher than on the NSE. In May, the SGX Nifty OI was worth over Rs 16,200 crore while that on the NSE stood at over Rs 9,250 crore. As far as three-month contracts go, the Nifty futures OI on the NSE is over Rs 12,750 crore.

In 2008, before these troubles had come together, SGX open interest was 59.78% of NSE. By 2012, where all these problems have come together, SGX open interest has come to 101.77% of NSE's. It is astonishing to see that for the biggest Indian product - Nifty - an overseas exchange has got superior open interest.

In the baseline scenario, Indian policy-making will meander on clueless and unconcerned. NSE will continue to lose ground. Why do we care? Is this mere protectionism - what is wrong if the entire India-linked equity index derivatives business takes place overseas?

• A rich and complex ecosystem of finance has developed surrounding the Nifty contracts. Hundreds of thousands of high skill workers are in this industry. A decisive loss of market share for India would endanger their livelihood.
• The tax revenues associated with all these activities, at present, come to the Indian authorities. The Indian tax man earns income tax (on wages and on corporate profit) and VAT (on an array of activities of the firms). All this will go away if the business shifts to Singapore.
• A sophisticated Indian financial system is required if monetary policy is to be effective. The demise of the onshore financial system will damage the onshore monetary policy transmission. It will further take us back towards a world where government is unable to play a role in business cycle stabilisation.
• Prospects of Bombay emerging as an international financial centre will subside. If we can't even hang on to market share for Nifty or the rupee, where is the question of competing against overseas financial firms or markets on things that aren't India-linked?
• Access to finance for firms will tend to split into a two-tier world: the big firms will go abroad to get their corporate finance done. The small firms will face greater constraints since they will not easily access finance abroad (there is a greater information distance between the typical Singapore investor and the typical Rs.1000 crore or Rs.100 crore Indian company), and the local financial system would be weak.

When India started trying to build a mature market economy in 1991, at first, it felt like a sophisticated financial system would emerge, which would both serve India and start competing for the global market. From 1993 to 2001, India achieved a remarkable revolution in the equity market. This increased optimism in the ability of India to understand problems, to achieve change, and to maintain high ethical standards.

It now seems that those hopes were premature. The more likely scenario is one where India-linked finance will happen offshore, while RBI/SEBI/CBDT/CCI/FMC/IRDA squabble over a minor and inconsequential onshore financial system that is riddled with ethics problems. In the short term, onshore Indian finance will suffer from one setback after another.

We are likely to go back to the conflicted arrangements that gave us the Harshad Mehta scandals of the early 1990s and the Ketan Parekh scandals one decade later. I used to think we were finished with those problems. But we are about to restart on that entire story; there is little institutional memory about how those things came about and how dangerous our present path is. Each future scandal, of this nature, will be greeted with joy by overseas financial providers, who will scoop up market share every time India falls into turmoil.

Many years from now, we may one day get to fundamentally superior governance arrangements in finance, and achieve high ethical standards in public life and securities infrastructure. If this happens, we would be able to come back to these questions. As an example, Japan lost the Nikkei 225 contract to Singapore in the mid-1980s and got back into this to a significant extent 15 years later. In the years or decades that will go by until domestic financial governance structures are corrected, a great deal of organisational capital in the onshore financial system will have been lost.

The revolution in the stock market used to be one of the best success stories of economic reforms in India [link, link]. It may well fall apart in coming months and years.

India is losing the market for trading the Indian rupee

The recent order by the Competition Commission of India on NSE and MCX-SX has a bunch of difficulties based on a lack of understanding of new age industries where a pricing of zero is quite feasible and important, a focus on protecting a competitor instead of upholding competition, etc. I wrote about this in the previous blog post.

The most important problem with this order is that it represents a diversion away from the real story. The real story is that trading in the Indian rupee is leaving India.

The rupee is traded on three venues:

1. The onshore exchange-traded market (NSE, MCX-SX, USE)
   
2. The onshore OTC market
   
3. The offshore OTC market (which is called the `non-deliverable forward' or NDF market).

In an article in the Business Standard today, Jamal Mecklai says:

in April 2011, NDF volumes, at nearly $43 billion a day, were more than double those of the onshore OTC market (about $21 billion a day), and nearly 40 per cent higher than the combined OTC and futures onshore volume. Clearly, the bulk of price discovery for the Indian rupee has migrated offshore.

While we are bickering about the valuation of one player in the onshore exchange-traded market, we are losing the plot. The real story is that India is losing the market where the rupee is traded. While we are fussing about NSE's charges on the currency futures market, the OTC market offshore charges zero and has steadily gained market share.

This is part of a larger concern which needs to be more carefully considered. As India internationalises, domestic customers of financial services, and the foreign order flow, will increasingly shift their business to providers abroad when there are problems in the local financial system. These problems fall into three kinds:

1. Non-residents do not like to send orders to India given that India as yet lacks a residence-based taxation framework; they would rather send their orders to Singapore or Dubai or London which do.
   
2. Indian capital controls hinder orders from non-residents: E.g. RBI prohibits FIIs from trading on the exchange-traded currency futures market (the only edge that India has in the trading of the rupee).
   
3. An array of mistakes in regulations in India hinder the emergence of a capable domestic financial system (e.g. the CCI order, prohibition of options trading on INR/EUR, mistakes in how RBI will compute the INR/USD reference rate which must be used in the functioning of the exchange-traded contracts, etc.)

Our mistakes in policy on these three fronts generate a genuine possibility of a hollowing out of the domestic financial system in coming years.

The overseas market is the real source of competitive pressure. Unless overturned, the CCI order is working to reduce the market share of the onshore market.

Financial policy has two goals in this field. First, we'd like for more business to be on the transparent exchanges instead of the OTC market. This goal is assisted by a price of zero at exchanges. Second, we'd like for more business to be in India rather than the overseas market. This goal is also assisted by a price of zero at exchanges.

Two unconventional ideas in breaking with bad governance

Jumpstart a city

Cities are the heart of civilisation and growth. A well functioning city is a great opportunity to obtain economic growth and social change. The best thing that we can hope for, in thinking about the lives of poor people or those facing discrimination in rural India, is for them to escape to a city. We in India don't have a single well functioning city. As an example, governance in Bombay is deeply broken.

How could a poor country kick start the emergence of one or more good cities? Paul Romer has an idea : To walk down the Hong Kong route, to create `charter cities'. See Two paths to good cities. Writing on CFR.org, Sebastian Mallaby reports some big events. Last year, Madagascar came close to signing onto a charter city, but it did not work out. And last month, Honduras approved a Constitutional Amendment which will make this possible. So Paul Romer's three-year crusade appears to be going from a wild idea to the zone of possibility. If it works, it'll score bigger impact than Romer, 1986, which is in Nobel Prize range.

I personally think it would be a much better use for aid money, to go down this route, instead of the conventional development economics that aid agencies emphasise. I feel these existing strategies range from useless to counterproductive. In contrast, it seems that under the right conditions, a charter city could work, and if it works, the upside is phenomenal. So even if 10 charter cities are attempted and one works, it'd be a huge contribution.

On a related theme, you might like to see: What if India had a Hong Kong?

Elect a foreigner

Raghuram Rajan has been talking about another line of attack. He has a recent paper titled Failed States, Vicious Cycles and a Proposal. The blurb reads:

...examines the problems of failed states, including the repeated return to power of former warlords, which he argues causes institutions to become weaker and people to get poorer. He notes that economic power through property holdings or human capital gives people the means to hold their leaders accountable. In the absence of such distributed power, dictators reign.

Rajan argues that in failed states, economic growth leading to empowered citizenry is more likely if a neutral party presides. He proposes a unique solution to allow the electorate to choose a foreigner, who would govern for a fixed term. Candidates could be proposed by the UN or retired leaders from other countries; they would campaign on a platform to build the basic foundations of government and create a sustainable distribution of power.

Rajan emphasizes that this is not a return to the colonial mode: the external candidate (like all the others) would be on a ballot and the electorate would choose whether he or she was their best chance to escape fragility.

Each country is unique and we have to ask ourselves what might work where. In India? Bangladesh? Sri Lanka? Pakistan? Afghanistan? Libya?