Formalising education in public policy

Writing in DNA, Mukul Asher says that India needs schools of public policy.

Dating exchange rate regimes; the currency exposure of firms

I wrote an article in Business Standard today titled How frail are the firms? about changing currency volatility of a pegged exchange rate and its implications for the currency risk management of Indian firms.

Interview with C. B. Bhave about the recent SAT ruling

There is an interview with C. B. Bhave in Mint where he says:

q: SAT has set aside the Sebi order. So, are you relieved?

a: We are naturally relieved because SAT has ruled in our favour. However, at one level, I am feeling very sad that we had to move SAT. As an institution, NSDL, would be reluctant to take any legal recourse against the regulator, but unfortunately, we were left with no option in this matter.

q: How do you react to the ruling that sets aside the disgorgement order?

a: As I have clarified, we would rather have these matters sorted out with Sebi directly. But if the regulator refuses to hear us and passes an ex-parte order, what do we do? We were pushed into a corner and had no choice.

q: Why is NSDL constantly in litigation with Sebi?

a: You are not fair in your assessment. In this case, very strangely, NSDL along with other entities were asked to pay Rs115 crore without even being heard. It is not possible for any entity to accept such a decision. NSDL was not alone. In fact, all the affected entities moved SAT.

q: Are you suggesting that you were asked to pay Rs45 crore without even being heard?

a: Yes, unfortunately that was the case.

q: Why did Sebi do this? You seem to have lost credibility with the regulator.

a: Frankly, we are surprised that principles of natural justice were violated. In fact, in this country, no authority has the right to violate the basic principle of hearing a party before ruling anything adverse to that party. You must be aware that recently even Parliament on a sensitive issue of contempt heard the concerned party before reaching any conclusion.

q: What do you mean? Cant the regulator ask any entity to disgorge?

a: My reading of the SAT order is that the appellate authority has not ruled on Sebis power to disgorge. SAT has stated that disgorgement can occur if the concerned entity is guilty of violation of law. It should have derived profits out of such violation and should have been given an opportunity of being heard before any disgorgement can occur. In this case, these norms were not followed.

q: What about the order to your promoters to revamp management? I believe your appeal was dismissed?

a: The appeal was dismissed as infructuous. The reason being that Sebi contended that its directives to the promoters were not mandatory. The regulator also contended that the directives in the April 2006 order were only observations in aid of the show cause notice (issued last year). Since the contention was that there was no order against NSDL, we had nothing to appeal against.

q: Can a direction of a regulator be non-mandatory?

a: You have to ask this question to Sebi.

q: How do you plan to celebrate the victory?

a: I dont think there are victories against regulators. I would prefer to look at this matter in a more constructive manner. The SAT has laid down some very valuable ground rules and these would serve the capital market well in future. All market intermediaries, including NSDL, should learn from the episode of IPO allotment scam and correct their systems to ensure similar things do not occur again.

Worsening the PSU banking problem

Privatisation of PSU banks is difficult because 51% of MPs won't support the requisite amendment of the Bank Nationalisation Act. While progress is hard, it would be useful to atleast not make things worse. Further equity infusions into PSU banks by the Ministry of Finance make things worse. As an example, MOF is about to put Rs.16,742 crore into SBI. They didn't need to do that.

Going beyond new money going into PSU banks is the issue of dividend payouts. The average dividend payout for 2006-07 of non-financial firms was 18%. PSU banks paid out 14%. I would argue that far from putting more money into PSU banks, what MOF needs to do is get the payout ratio of PSU banks up. Simultaneously, given the poor HR, risk management and corporate governance of PSU banks, capital requirements for them need to be higher.

Internationalisation of the rupee

Sanjiv Shankaran wrote a two-part article on the internationalisation of the rupee in Mint : Part 1, Part 2. While on this subject, you might like to see this blog posting.

Capital controls impeding trade

Matt Nesvisky wrote (in the December 2007 NBER Reporter) about an NBER paper: Exchange controls and international trade by Shang-Jin Wei and Zhiwei Zhang. This fits into the Indian debate on the costs and benefits of capital controls. This paper figured in this `Capital controls' slideshow done at MOF in July 2007. The quick summary of this paper is: "The experience of the emerging market economies during the late 1990s suggests that controls on capital transactions that are intended to regulate capital flows also tend to harm trade substantially." Nesvisky's text says:

Some years ago, NBER Research Associate and Columbia University Professor Shang-Jin Wei and IMF economist Zhiwei Zhang learned from a top finance official of a certain country that it was common for both companies and individuals to try to circumvent that country's capital account restrictions. A common practice, the source allowed, was mis-invoicing imports, exports, or both. The government naturally reacted by stepping up inspections of goods passing through the customs to make sure that they are not mis-reported to evade capital controls. From this, the economists concluded that attempts to enforce exchange controls most likely raised the cost to firms of engaging in importing and exporting. Just how costly this might be is reported in their study, Collateral Damage: Exchange Controls and International Trade (NBER Working Paper No. 13020).

For their study, Wei and Zhang use data on capital account restrictions collected by the International Monetary Fund (IMF) since 1996 on 184 countries. The IMF's Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER) uses up to 192 indicators to track exchange controls for individual member countries. From this database, Wei and Zhang are able to construct three broad categories of indicators for 1) controls on proceeds from exports and payments for imports, 2) controls on capital transactions, and 3) controls on foreign exchange (FX) transactions and other items not specific to trade or capital transactions.

Wei and Zhang find that countries tend to have more controls on capital transactions and foreign exchange transactions than on trade payments. At the same time, countries with more controls in one category are also likely to have more controls in the other categories. Broadly speaking, the researchers observe that all three indices showed a moderate decline during the years 1996-2005 for countries instituting multiple controls.

There are substantial differences across countries as well as variation over time for many countries. Wei and Zhang illustrate this point with a close examination of the patterns for three developing countries -- Brazil, Chile, and Malaysia -- and one OECD country, Greece. Each of these countries experienced substantial changes in its controls during the sample period.

The researchers conclude that economically and statistically significant evidence exists to confirm their suspicions about the "collateral damage" to international trade brought on by exchange controls. They report that an increase by a single standard deviation in the controls on foreign exchange transactions reduces trade by the same amount as an increase in the tariff rate of 11 percentage points. A comparable increase in the controls on trade payments has the same negative effect on trade as an increase in the tariff rate of 14 percentage points. The experience of the emerging market economies during the late 1990s suggests that controls on capital transactions that are intended to regulate capital flows also tend to harm trade substantially. According to these researchers, the collateral damage of exchange controls should therefore be part of any assessment of the desirability of capital account liberalization.

Wei and Zhang caution that their study is only a first step towards understanding the effects of exchange controls on trade. It is possible, they note, that the effects are non-linear; that is, the same measure in an already restrictive exchange control regime may do more harm than in a less restrictive regime. Moreover, the effects may vary by sectors: exchange controls may raise the cost of trading in more differentiated products more than the cost of trading in homogeneous products; as differentiated products have a greater variance in their unit values over different varieties, it may be more difficult for traders to convince bureaucrats that a particular transaction is not mis-invoiced to evade exchange controls. In such a case, exchange controls imply one more distortion by affecting a country's pattern of specialization.

The effects may also interact with other features of the economy; the same exchange controls may do either more or less damage in a governance-challenged economy, depending on whether corruption primarily weakens the exchange controls or exacerbates the burden of complying with the controls. Such questions, Wei and Zhang suggest, are worthy of further research.

A paper: `New issues in Indian macro policy'

I have a working paper version up on the web, of an article titled New issues in Indian macro policy. This is forthcoming in a book edited by T. N. Ninan that will be published by Business Standard Books in 2008. In this paper, I first highlight the aspects where the Indian economy has changed substantially when compared with a decade ago. I then try to think about what fiscal policy and monetary policy in today's India should be doing, and propose directions for institutional reform. I hope this paper should be interesting to anyone thinking about Indian macroeconomics.