Three interesting meetings

The 7th research meeting of the NIPFP DEA Research Program

This is 31 August and 1 September; here is the program.

A pair of mini-courses

From 6 to 10 September, we have a pair of mini courses: Sanjay Banerji will teach on financial crises, and Sourafel Girma will teach on the new quasi-experimental econometrics.

NIPFP Macroeconomics Symposium

On 14 September 2010, we have the NIPFP Macroeconomics Symposium.

Understanding the ADR Premium under Market Segmentation

Understanding the ADR premium under market segmentation by Matthieu Stigler, Ajay Shah and Ila Patnaik.

The abstract reads: Capital controls can induce large and persistent deviations from the Law of One Price for cross-listed stocks in international capital markets. A considerable literature has explored firm-specific factors which influence ADR pricing when LOP is violated. In this paper, we examine the interlinkages between Indian ADR premiums and macro economic time-series. We construct an ADR premium index, whereby diversification across firms diminishes idiosyncratic fluctuations associated with each security. We find that the S&P 500 index and the domestic Nifty index influence the ADR Premium Index. Positive shocks to the ADR premium index precede higher purchases by foreign investors on the domestic market, and precede positive returns on the domestic index.

Many practitioners in India believe that net FII flows matter greatly to stock market returns. But this belief is not borne out when you carefully look at the evidence. The VAR in the above paper says this one more time: in the context of the specification used in this paper (aimed at uncovering insight into a different issue, the ADR Premium) you don't see an impact of a rise in net FII flows upon stock prices.

On an interesting story about the ADR Premium for one stock (as opposed to macroeconomic thinking), see: Spike in the ADR Premium on Tata Motors by Anmol Sethy.

You might like to see: the stock of papers from the NIPFP Macro/Finance Group.

Two papers on monetary policy

Monetary policy in an uncertain world: Probability models and the design of robust monetary rules by Paul Levine.

The abstract reads: The past forty years or so has seen a remarkable transformation in macro-models used by central banks, policymakers and forecasting bodies. This paper describes this transformation from reduced-form behavioural equations estimated separately, through contemporary micro-founded dynamic stochastic general equilibrium (DSGE) models estimated by systems methods. In particular by treating DSGE models estimated by Bayesian-Maximum-Likelihood methods I argue that they can be considered as probability models in the sense described by Sims (2007) and be used for risk-assessment and policy design. This is true for any one model, but with a range of models on offer it is also possible to design interest rate rules that are simple and robust across the rival models and across the distribution of parameter estimates for each of these rivals as in Levine et al. (2008). After making models better in a number of important dimensions, a possible road ahead is to consider rival models as being distinguished by the model of expectations. This would avoid becoming `a prisoner of a single system' at least with respect to expectations formation where, as I argue, there is relatively less consensus on the appropriate modelling strategy.

A Floating versus Managed Exchange Rate Regime in a DSGE Model of India by Nicoletta Batini, Vasco Gabriel, Paul Levine and Joseph Pearlman.

The abstract reads: We first develop a two-bloc model of an emerging open economy interacting with the rest of the world calibrated using Indian and US data. The model features a financial accelerator and is suitable for examining the effects of financial stress on the real economy. Three variants of the model are highlighted with increasing degrees of financial frictions. The model is used to compare two monetary interest rate regimes: domestic Inflation targeting with a floating exchange rate (FLEX(D)) and a managed exchange rate (MEX). Both rules are characterized as a Taylor-type interest rate rules. MEX involves a nominal exchange rate target in the rule and a constraint on its volatility. We find that the imposition of a low exchange rate volatility is only achieved at a significant welfare loss if the policymaker is restricted to a simple domestic inflation plus exchange rate targeting rule. If on the other hand the policymaker can implement a complex optimal rule then an almost fixed exchange rate can be achieved at a relatively small welfare cost. This finding suggests that future research should examine alternative simple rules that mimic the fully optimal rule more closely.

You might like to see: the stock of papers from the NIPFP Macro/Finance Group.

Interesting readings

Two striking stories in India's crisis of governance: Sadanand Dhume in the Wall Street Journal on the Commonwealth Games, and Nilanjana S. Roy in the New York Times on the personal safety of women.

The deep determinants of the problems of India's economy lie in the political system, and the deep determinants of the problems of Indian politics lie in the way elections work. One of the many blunders of our Constitution was the use of first-past-the-post in elections. See Anthony Gottlieb in the New Yorker magazine.

Ila Patnaik has four recent pieces: Capital controls and unhedged currency exposure on the new India Policy Forum website; The Mauritius code (in the Indian Express) on a fresh approach to thinking about the Mauritius treaty; concerns about inflation in the Financial Express and a piece on inflation targeting aimed at the white paper readership of the Indian Express.

A while ago, paypal had figured in my list of things that were banned in India. They have announced a workaround : for payments made to customers in India, they will use snailmail and send out a cheque. And so the 20th century payments innovation will be reduced to a 19th century solution.

The frontiers of Nifty, by Ashish Rukhaiyar in the Business Standard.

Mahesh Vyas in Financial Express about criticism of SEBI.

Devika Banerji in the Business Standard about the changing world of the economics think tanks.

Bibek Debroy in the Financial Express on the rupee's new symbol.

Didi Kirsten Tatlow on the struggle to remember, in China. Also see America and China in 2020 by Ian Bremmer.

Jayanth Varma has a chapter in a Robert Kolb book.

I wrote a comment on the `Economics | by invitation' system run by The Economist, on their question: What will it take to convince emerging markets to halt reserve growth?.

Dream-logic, the Internet and artificial thought by David Gelernter, on Edge.

Protests have broken out in France against the government's ban on the `burkha'.

A while ago, I had argued that world food price vol had risen and would rise further. It looks like the evidence is in favour of that proposition. See: What explains the rise in food price volatility? by Shaun K. Roache.

A great piece in the Economist about Europe's future.

Learning about inflation from a box of eggs

Milan Kumar Biswas, General Manager of Keggfarms Pvt. Ltd. knows something about inflation. In a note addressed to his customers, stuffed in a box of eggs, he announced an increase in the unit price of his eggs.

P = (1+markup) MC. To justify the change in P, of course not due to his own greed (the "markup"), Mr. Kumar blames various "exogenous" factors for the price increase, all bunched in what economists call "marginal cost". He tells us about the components of his marginal cost:

1. Input costs for feed: read food grains and other food items.
   
2. Man-power: read wages.
   
3. Packaging and transportation costs: read a mixture of wages, services and fuel prices.

This points to something more than just food inflation. Mr Kumar, just like our RBI Governor, seems to suggest that price pressures are indeed quite generalised.

On 1), we knew about food inflation from the the WPI and the CPI. What is novel is the information on the pass-through to processed food items from unprocessed ones. It is a clear example of the cascading effects of input costs into prices downstream from the production chain.

On 2), unfortunately we have no direct and timely statistical evidence about wages in India. Hence, we, alongside our Central Bank, are left grasping for evidence from anecdotal and piecemeal information. If true, it would be indeed bad news. A input cost increase passed onto wages, i.e. the famous "second round effects". This puts us into something like that classic story of mishandled inflation, the oil shock of the 1970s.

On 3), we unfortunately have no clue what are the developments in services prices. Hopefully CSO will soon release a new CPI so we can start seeing some of this.

Last, but not the least, can we also trust Mr. Kumar that he will not raise his markup in a period of ongoing recovery of demand? Economists have long disagreed on this question. See the seminal papers by Rotemberg and Woodford, and, more recently, Ramey and Nekarda.

Implementing the GST

For many years, India has been in a slow processes of evolving towards a dual centre-state GST. The rough picture is one with two distinct but harmonised taxes, which have an integrated IT system so as to sharply reduce compliance costs. A key dimension is that of properly integrating domestic taxation with international trade in goods and services, by zero-rating exports (thus exempting non-residents) and by charging the GST upon imports (thus taxing the full consumption of residents).

This process has faced two challenges: politics and administration. On the political side, the puzzle lies in having enough states sign up into a system where all taxes other than the GST are abolished, and where firms face an integrated nationwide administration. This would enable a unified Indian common market. Things seem to be going badly on that front.

The administrative challenge is one of project management. The Indian policy landscape contains many important ideas where the political hurdles have been crossed, but where execution has been lacking.
Today there is news of a concete project management strategy for the GST: see this story by Surabhi Agarwal in the Mint. So while there might be many failures on the political side of the GST, atleast we now know that there will be some coherent project management which will yield a working GST system within a year or two.

The idea of bringing NSDL into this problem is not new. Ever since the Tax Information Network (TIN) was built by NSDL for the income tax department, it was well understood that handling of VAT credits is much like handling of TDS. In 2004, the Task Force on Implementation of the FRBM Act, chaired by Vijay Kelkar, had said in the executive summary: ``Hence, the Task Force recommends that the existing TIN and OLTAS systems, developed by CBDT, should be used for the implementation of the GST, both at the Centre and at States.'' We wasted a lot of time in getting to this destination, but while the wheels grind slow, they have ground true. When NSE and NSDL came about in the early 1990s, we had little idea about the far-reaching consequences of what was coming together.

Also see: M. Govinda Rao in the Business Standard.

The push for atleast 25% outside shareholding

The Indian authorities are in the process of pushing listed companies to have atleast 25% shareholding with outside shareholders. I wrote a column in the Financial Express, titled Outside shareholding and market liquidity: Indian empirical regularities where I look at how size and outside shareholding come together to matter for stock market liquidity.