SEBI's tasks

You might like to see this video by Skoch from 2006, that featured C. B. Bhave. And, Business Standard had an editorial on 15th about the tasks at SEBI:

Among the different economic regulators, the job of the chairman of the Securities and Exchange Board of India (Sebi) is of more than ordinary importance. The roughly 3,000 firms that are traded have a market value of Rs 57 lakh crore: more than twice the non-food credit of the entire banking system. Taking corporate bonds into account, the market has a value of roughly Rs 65 lakh crore, and the total turnover exceeds Rs.1 lakh crore per day on most days. This market has become the foundation of financing for India's corporations and is thus central to India's growth prospect.

The first task for the new chairman, when he assumes office next week, will be to focus on improving the processes of investigation and enforcement. Sebi's staff needs to be trained on understanding terms like `manipulation' and `disgorgement'. Good-quality investigations should be followed by drafting sound legal documents. An internal quasi-judicial proceeding needs to take place, where some Sebi staff argues the case of the prosecution, the accused are given the opportunity to defend themselves, and an internal bench awards a penalty if it is proved that there is guilt. Such discipline will greatly improve Sebi's quasi-judicial functions.

Recent stock market volatility has brought a fresh focus on the issue of stock market liquidity, which can appear to abruptly vanish. The new Sebi chairman needs to examine the issues of price limits and circuit breakers, the role for a pre-opening call auction, the rules about margins, short-selling based on borrowed shares, derivatives, and algorithmic trading, so as to identify aspects of the market design in India which need to be improved in order to obtain a more resilient market.

Strengthening these processes will have deeper implications for Indias GDP growth. A better-functioning system of financial markets will induce liquidity, not just in the big products like Nifty or Infosys but in smaller products, such as corporate bonds and small companies. Even if a market design is fairly bad, it is not hard to make Nifty futures liquid. But a great deal of sophistication is required in order to make a liquid market in a product with a market capitalisation of Rs 100 crore.

The new Sebi chairman will have to work hard in institution building. This involves attracting high-quality people (who might often be young by government standards), putting them in a meritocratic workplace with open discussion, and establishing transparency and accountability structures so that Sebi becomes not a one-man shop but a genuine institution that will be a key player in India's GDP growth. Committees have recommended merging the Forward Markets Commission into Sebi, for instance. The new chairman needs to build Sebi with an eye to this future.

As was emphasised by the committee that prepared the report on Mumbai as an International Financial Centre, a key story that is now unfolding is India's integration into the world of global finance. The looming challenge for Sebi consists of the global options to Indian financial markets. Many Indian firms are listing offshore; a Nifty futures market at Singapore is gaining ground compared with the National Stock Exchange, and so on. Such competition is, of course, good for improving quality and reducing cost in India exactly as has been seen with Indian manufacturing. Sebi needs to be very mindful of this dimension. It is not enough for Indian markets to look good by domestic or self-set standards; they have to become competitive by global standards.

Fiscal distress ahead

We know that things are going badly on the fiscal front [link, link]. On 13th, Indian Express carried a story about Congress politicians requesting an abandonment of FRBM targets given the coming elections. (See this edit also). And, the politicians haven't even brought up the 6th pay commission.

When I was at MOF, Vijay Kelkar used to endlessly evangelise on the need to `fix the roof while the sun is shining'. While India has made progress on the fiscal crisis, this progress is disappointingly small considering that we have had an unprecedented business cycle upturn over the 2002-2008 period. It will be so much harder to achieve fiscal progress under more challenging macroeconomic circumstances.

In these difficult times, a professional Debt Management Office will help.

How much capital is coming into India?

In continuation of the recent focus on interest rate differentials and their consequences for upholding a pegged exchange rate, Ila Patnaik has an interesting article which makes two points:

1. Remittance inflows seem to be roughly of the same range of values as net capital flows. It is well known that a lot of remittances are actually capital flows: a person working abroad sends money to India to his relatives who get invested here.
2. Eyeballing the time-series seems to show a strong relationship between remittances and the interest rate differential.

This considerably enlarges our sense of how much capital is or can come into India in response to one-way bets. Conversely, if we set out to capital controls, then these will have to extend to remittances also. Else, money that is blocked as capital inflows will merely show up as remittances. Hmm, and if capital controls are placed against remittances, then passangers will need to be frisked at airports, because a kilogram of gold is roughly the size of a box of cigarettes. X-ray machines will detect a kilogram of gold? A cigarette-box filled with one-carat diamonds is worth roughly 2 million dollars.

Here's an amusing aside on Indian monetary policy. At a meeting at the Planning Commission, the policy debate on Indian monetary policy was reduced to the three corners of the impossible trinity:

• Some people favour closing down the capital account, so as to have pegged exchange rate + monetary policy autonomy (e.g. Shankar Acharya)
• Some people favour pegging the exchange rate with an open capital account, saying that the loss of monetary policy autonomy is harmless (e.g. Surjit Bhalla)
• Some people favour an open capital account with a floating exchange rate, which buys monetary policy autonomy (e.g. Suman Bery, Ila).

A remarkable feature of the present situation is: People at all three corners agree on one thing: RBI should cut rates now! :-)

Critical appointments watch

Position	Date	Outcome
Comptroller and Auditor-General	January 2008	Vinod Rai, 17 December 2007.
Secretary, Dept. Financial Services, MOF	January 2008	Arun Ramanathan, 8 January 2008.
Chairman, SEBI. link, Video on 24th Feb	February 2008	C. B. Bhave, but do see this, 14 February 2008.
Two members of SEBI
Chairman, IRDA	May 2008
Governor, RBI. link	September 2008
Chairman and members of Competition Commission. link

Also see:

• Who will fill the hot seats by Tamal Bandyopadhyay in Mint. 4 January, and the associated Experts speak on regulators.

Law and order, the most important public good

Gautam Chikermane reflects on the recent difficulties of law and order in Bombay.

Improving competition in the exchange industry

One of the many clever things that were done in the equity market reforms of the 1990s was a pro-competitive framework for depositories. The depositories legislation explicitly plans for multiple competing depositories. Further, there is an elegant decoupling between the decision of a customer about which exchange to use vs. which depository to use. E.g. it's perfectly feasible for a customer of NSE to use BSE's depository (or vice versa).

I believe competition policy is a very important element of sound government in the area of finance, and such thinking is essential to reshaping the competitive landscape. All too often, such care is not exercised in the formative phase, and we endup being stuck with a monopoly and/or conflicts of interest.

Jayanth Varma alerts us to a proposal of the US Department of Justice which has major implications for competition between exchanges. The document written by DOJ is of top quality - I really admire the human capital they are able to bring into these things - and is well worth reading.

At the essence, it is a proposal to unbundle an exchange business from a clearing corporation business. This would yield orthogonality (as above) where the choice of a exchange and the choice of clearing corporation are made independently. As he points out, this must surely be a good idea for competition, for the CME stock price dropped by 15%:

(Click on the picture to see it more clearly, or click here to see current data from Yahoo Finance.)

The logic here runs well beyond the simple idea of ensuring competitive conditions hold in both sub-industries. The DOJ's reasoning is essentially this:

If exchanges did not control clearing, an appropriately regulated clearinghouse could treat contracts with identical terms from different exchanges as interchangeable, i.e., fungible. The incentives of such a clearinghouse would be to maximize its own profits, and it thus likely would treat identical contracts as fungible. In a world of fungible financial futures contracts, multiple exchanges could simultaneously attract liquidity in the same or similar futures contract, facilitating sustained head-to-head competition. A trader could open a position on one exchange and close it on another. In such a world, a trader could execute against the best price wherever offered without fear of being unable to exit the position because there is insufficient trading interest (or of being forced to exit at a poor price) on the new entrant trading venue when a trader chooses to exit.

In addition, if exchanges did not control clearing, an appropriately regulated clearinghouse could reduce member margin obligations by recognizing offsetting positions in correlated financial futures contracts traded on different exchanges. The ability to offset correlated positions in a futures clearinghouse can significantly reduce the capital required to trade.

Here is a response from CME.

Two interesting documents from the IMF

The IMF released two documents on 4 February: India: 2007 Article IV Consultation, and India: Selected Issues.

Selected Issues

While a quick search on the IMF website shows many `Selected Issues' documents, I had not noticed this product type earlier. It turns out to be a small edited book containing seven papers about India:

1. Competitiveness and Exchange Rate Policy by Hiroko Oura, Petia Topalova, Andrea Richter-Hume, and Charles Kramer;
2. Challenges to Monetary Policy from Financial Globalization: The Case of India by Charles F. Kramer, Helene K. Poirson and A. Prasad;
3. Monetary Policy Communication and Transparency by Helene K. Poirson;
4. Financial Development and Growth in India: A Growing Tiger in a Cage? by Hiroko Oura and Renu Kohli;
5. Developing the Foreign Exchange Derivatives Market by Andreas Jobst;
6. Inclusive Growth by Petia Topalova;
7. India's Social Protection Framework by Andrea Richter Hume.

Of these, three stood out for me.

It has been previously noted that the RBI fares very badly in international comparisons of central bank transparency. Further, while central banks worldwide have improved over the last decade, RBI has stagnated. The paper by Helene K. Poirson is an outstanding how-to manual on how RBI's transparency can be improved. It is sensible, well written and immediately actionable. It reviews the recent difficulties of monetary policy from the viewpoint of communication strategy, and draws on these episodes to propose solutions. I hope RBI is able to implement all this right away. Everyone interested in Indian monetary economics should read this article.

The paper by Hiroko Oura and Renu Kohli was also most interesting to me. There is a vast literature based on the CMIE firm-level database; this one stands out as obtaining interesting answers to interesting questions. Specifically, it sheds light on the areas where the Indian financial sector does or does not deliver the goods in terms of financing of firms.

The paper by Jobst on currency derivatives is an excellent policy paper, one that is particularly timely given that RBI is presently engaged in trying to ensure that a currency futures market does not succeed.

Article IV Consultation document

I am generally cynical about Article IV documents. Too often, they are suffused with bureaucratic triumphalism, with sentences of the form ``Under the steady guidance of the great leader, the peasants and workers reaped a glorious harvest''. The IMF is forced to praise India's deft handling of macroeconomic policy in every alternate paragraph. If your tastes run to `ruthless truth-telling', the result of the Article IV process is often not interesting.

However, this time, the document is well worth reading, particularly if you're able to ignore the platitudes. It gives the reader a good grip of the overall macroeconomic situation, and a sound perspective on the difficulties of both fiscal and monetary policy. It struck me that there isn't an Indian effort of this genre out there.