What Arjun Singh needs to focus on

The two planks of education policy of Arjun Singh and the UPA government seem to be: Fan the flames of the conflict on quotas, and put more money into Sarva Shiksha Abhiyaan (SSA). In today's Indian Express, Ila Patnaik has an article questioning the consensus about SSA. I have written about education and SSA a few times : one two and three.

Ila argues that the consensus behind SSA rests on higher enrollment rates and growing literacy rates. But standardised tests show that kids seem to come into school for a meal and don't learn much. She asks why giant expenditures on SSA did not plan an evaluation by an independent agency which would conduct randomised tests. She also links up to a fascinating Centre for Civil Society working paper which compares private "unaided" schools, private "unaided" schools and public schools. Update: Ila has another article on entry barriers faced in starting a school.

SEBI report on regional stock exchanges

Just when you thought regional stock exchanges were safely dead and buried, a new SEBI committee report has brought the issue back to prominence. (The SEBI website is bad; here's the report.) It isn't a good report, by SEBI standards, but it needs to be tracked because it can be raw material for doing some damage. As usual, India excels at outstanding editorial commentary: read the edits in Business Standard, Economic Times.

One key proposition that seems to be getting a free pass is the idea that "Regional stock exchanges are good for SMEs". I think this statement is wrong. If a stock has the size, asymmetric information, equity vol, and ownership structure required to achieve significant trading, then it will do so on NSE anyway. NSE does not have a physical floor - there is no limit to the number of firms that can get listed on NSE. If a stock lacks these characteristics, then switching from NSE to (say) Delhi Stock Exchange will certainly not do the trick. If anything, NSE has the eyeballs: if an SME firm has a hope in hell of gaining the attention of investors, this is likely to happen more on NSE than on dinky exchanges.

Thus I believe that there are some interesting policy puzzles about liquidity for SME stocks, and I believe that we aren't doing enough to address these questions. But linking up the goals of RSEs with the dream of greater stock market liquidity for SMEs is just analytically incorrect.

Individuals in currency trading

On an international landscape, speculative price discovery is dominated by `institutional investors', particularly hedge funds. India is unusual in two respects. First, we have speculative price discovery in only two areas: equity and commodity futures. In all other areas, the government is either a major market manipulator or has simply banned speculative trading.

The second unusual thing about India is that in these two markets, price discovery is dominated by individuals. Institutional participants - whether domestic or foreign - are but minor participants on the equity market and the commodity futures market. At every stage of financial innovation in India, my experience has been that individuals pick up new instruments and new trading mechanisms first, they build the liquidity, and then (much later) the institutions might join in the party. As an example, see the miniscule numbers for institutional trading with equity spot and equity derivatives trading in the most-recent Economic Survey or the most-recent NSE Derivatives Update, which shows that in March 2006, institutional investors made up a princely 7% of trading on the equity derivatives market.

The currency market is arguably the world's biggest market. It has been dominated by institutional trades on OTC markets. Basically, the big boys talk to each other. Leo Melamed tells the story of currency futures as originating from an opinion piece in a newspaper by Milton Friedman, who wanted to short the GBP but was told by the big banks that they wouldn't deal with him because he was just Milton Friedman, a mere individual and not a big OTC market participant. This thought process led to a great innovation - financial futures - which makes possible safe trading between strangers, and permits a gigantic scale of entry into speculative trading. While exchange-traded derivatives worked out very well, currency futures didn't really click all these years, until some very recent signs of growth.

In this context, I found a fascinating article in The Economist which talks about the rise of individuals in currency trading in Japan. It makes me wonder how currency trading in India will shape up, once we get out of the present control raj. Some excerpts:

... Japanese savers have sought greater risk - notably in foreign exchange. They started with foreign-currency bank deposits, then moved on to investment trusts denominated in foreign currencies. In the past year or so, they have taken a further step, by piling into high-risk, high-return margin trading of currencies. So keen have they been that collectively they have become important actors in the yen foreign-exchange market.

Retail currency trading on margin was largely unmeasured until last year, when many intermediaries joined the Financial Futures Association of Japan (FFAJ), the industry watchdog. For the first time, the FFAJ, which does not allow members to solicit business, has been able to release figures on individuals' margin trading. In the three months to December, over-the-counter trading involving its members came to $280 billion. Experts believe that a new trading system called click365, run by the Tokyo Futures Exchange, and trades through non-members could bring the total near to Y40 trillion.

The size of Japan's foreign-currency market is hard to gauge, but experts put it at Y130 trillion-200 trillion, making individuals' share 20-30%. Retail investors have, in effect, acted like mini-hedge funds, using carry trades to buy American, Australian and New Zealand dollars, euros and sterling that give them yields of up to 7%, by leveraging their principal. Gaitame.com, the top foreign-currency retail intermediary, says that on some days its retail business beats its parent broker's wholesale transactions. Gaitame.com's retail accounts have grown two-and-a-half times over the past year (see chart), a trend reflected across the industry.

Analysts are used to believing that Japan's currency is moved by banks and brokers. Yet individuals are becoming more powerful. According to the FFAJ, they held a net long position in foreign currency of Y15 trillion at the end of 2005 - almost as big as Japan's current-account surplus and more than foreigners have in Japanese stocks.

Guns don't kill people; distorted wheat markets kill people

I saw an amazing article in Economic Times, by Nidhi Nath Srinivas, about the present situation with wheat "procurement" by the government. This year, for once, the wheat procurement price is lower than the market price. Under normal circumstances, that should be just fine - government procurement is only supposed to kick in when the market price has collapsed. But in India, the bureaucracy that runs the system is most displeased - they have a "target" of buying 2,400 tonnes. So, in the district of Sitapur in Uttar Pradesh, they are offering a freebie if you sell 25 tonnes of rice to the State - a free gun licence! You can add a decline in law and order to the long list of consequences of distorted policies in agriculture. But then, the gap in prices multiplied by 25 tonnes seems to be too large to justify utilising this offer, given the market price of a gun licence. As the ET article says:

“Initially our offer was that any one who delivers 500 quintals to us will be offered a revolver, rifle or pistol licence. But we did not receive a single application. Farmers told us that they would be willing to consider the offer if the quantity was halved to 250 quintals. So we have agreed to that,” said a senior district official in Sitapur. Ironically, despite guns as a carrot, farmers are saying no deal. There is a price difference of anything between Rs 170-Rs 225 per quintal between FCI and open market prices. That works out to a loss of Rs 50,000 on 250 quintals if farmers choose to supply to FCI. “People say that as they can pick up a gun licence by spending Rs 15,000 in speed money, why should they undergo a loss of Rs 50,000 for it. So the scheme has been a damp squib,” said a leading local businessman.

Was a rate hike required?

A few weeks ago, there was a great deal of focus on whether the RBI should have raised rates. I wrote an opinion piece in Business Standard where I argued that in response to the recent spike in CPI growth, and in response to the expected inflation of coming months, there is a need to raise rates now.

My reasoning is based on the `Taylor Principle' which suggests that monetary policy has to respond by more than one-for-one when there are changes to expected inflation. The trouble is: we don't measure inflation well, and there is no secondary market for inflation indexed bonds using which we can infer inflation expectations. So the question really turns on your views about inflation.

My view is that the CPI is the best inflation measure in India (and the WPI is worse than useless - your understanding of India goes down if you listen to the WPI). And, lacking either the models or the inflation-indexed bonds, I fall back on mere extrapolation. The acceleration of CPI is clear, and further oil-induced inflation is likely.

Of course, none of this makes much sense as long as we have a pegged exchange rate, for the RBI doesn't really run an Indian monetary policy as long as the exchange rate is pegged to the USD. I guess my point is that we need to bring a new monetary economics to bear on Indian monetary policy, instead of giving over the job to a mechanical currency peg.

How bad are Indian ports, and how badly does it matter?

Everyone in India is envious of the labour-intensive, export-oriented manufacturing exporft of China. The gap between India and China is caused by 4 problems: Small scale sector reservation, labour law, lack of GST and superior Chinese infrastructure.

I recently came across some striking data which suggests that Chinese ports are roughly as bad as ours. I wrote an opinion piece in Business Standard on these issues. On one hand, this raises questions about the port reforms in India - we haven't yet obtained low-cost ports by world standards.

But equally, this makes one question the importance of infrastructure as the explanation of why India lags China on manufacturing exports. Perhaps the other 3 problems are more important. You wouldn't start a factory with 100,000 employees with Indian-style labour law, which critically impedes the economies of scale that are attainable in India.

Good effort on combining maps with economic data

In the EPW of 22 April 2006, I wrote this book review of Social & Economic Profile of India by Peeyush Bajpai, Laveesh Bhandari and Aali Sinha. It is published by Social Science Press, 2005.

In the old days, there were the fascinating established disciplines of `regional economics' or `economic geography'. These lost ground over the decades, and well-trained contemporary economists have typically not studied these fields. The typical modern economist is highly conscious of time-series econometrics, but has only a rudimentary grasp of handling spatially organised data. In recent years, however, economic geography has come to enjoy a renaissance, through three factors.

The first is the new work by Paul Krugman and others which seeks to link up geography into the core questions of economics. For example, while classical trade theory focused on gains from trade through differences in factor endowments, contemporary trade theory is greatly concerned with geographical distance. The second factor at work is the heightened interest in spatial distributions of income and purchasing power on the part of the marketing fraternity, which has brought new kind of interest in learning about these questions as also an impetus for improving the informational foundations. The third factor at work has been the remarkable marriage of computers and maps with economic data, which has made it easy to visualise spatial data using interactive software systems which go by the fancy name of `geographical information systems' (GIS).

Bajpai, Bhandari and Sinha have come out with a volume titled `Social & Economic Profile of India'. In my knowledge, this represents a first effort at marrying computers, maps and economic data to produce an economic atlas of this fashion. So far in India, there are some strong GIS systems, and there are strong spatial databases. This book is the first time these have come together in a satisfactory fashion.

The authors must be commended for scouring the statistical system for spatial data. In some cases, the unit of observation is the state. In some cases, the unit of observation is the district. A very wide range of sources have been tapped to put together this volume. In some cases, the `standard sources' do not offer a certain kind of information, but the authors have reduced NSSO or NFHS data into summary statistics organised by location.

Every page of the volume is a map (in colour). Social Science Press has done an equally remarkable job of bringing world-class paper and printing to bear on this problem. As little as five to ten years ago, it was not possible to envision a book like this about India, but this has now become a reality.

The content of the book is organised as sections on Demography, Geography, Poverty and hunger, Health, Education, Water and sanitation, Employment, Fiscal analysis, Mass media, Safety and justice, Economic profile and Decentralisation. This is a fair depiction of what the Indian statistical system offers in the field. I was particularly impressed at the effort that the authors have taken to obtain data on issues of law and order and the judiciary, which tend to be ignored by the economics profession. Problems of law and order are increasingly shaping up as a central task of the State in addressing the poverty traps in the country, since participation in markets, investments in human and physical capital, and the equalising-differences of the price system cannot come into play until safety of life and property is assured.

I wandered through the book from end to end several times. Such such unstructured browsing is strongly recommended for the intelligent layman, and I am sure that each reader will take away different insights from this material. If there is one thing that I am struck by, it is the extent to which the stories are correlated. There is a powerful single factor called economic growth, which appears to affect a diverse array of spatially organised data.