Interesting readings

My collection of links on the transition at SEBI from C. B. Bhave to U. K. Sinha.

How India's banks killed the future of commerce on the Cleartrip blog.

The defining problem of the Indian State is the tension between spending on program that benefit the few (e.g. the typical UPA welfare program) versus programs that benefit all (i.e. public goods). This problem even extends to skimping on resources for the judiciary. See Dhananjay Mahapatra in the Times of India.

Greasing our shock absorbers by Ila Patnaik in the Indian Express, 3 February 2011. And watch her talk about the economy.

There is quite a bit of debate in India about big government versus small government. On this subject, Blanca Moreno-Dodson and Nihal Bayraktar have a note How Public Spending Can Help You Grow: An Empirical Analysis for Developing Countries. They compare a set of fast-growing developing countries to a mix of developing countries with different growth patterns. Considering the full government budget constraint, the empirical analysis shows that public spending, especially its `core' components, contributes to economic growth only in countries that are capable of using funds for productive purposes. In addition, those countries must have an adequate economic policy environment with macroeconomic stability, openness, and private sector investments that are conducive to growth. Unfortunately, their definition of `productive and core sectors' reflects World Bank ideology, and does not focus on public goods.

IT strategy for the Goods and Services Tax.

A great article on Saudi Arabia by Laurence Wright.

Tunisia and Egypt continue to be incredibly important and riveting. I really enjoy the thought, however fatuous, about every strongman across the world sleeping a little less easy. See Why Egypt should worry China by Barry Eichengreen on Project Syndicate. On the East Asia Forum, Peter Beck tells the story about how the dictatorship collapsed in Korea. Robert L. Tignor on Project Syndicate locates the present discussion in Egyptian history.

Read this interview with Andreas Wesemann.

The wonderful world of Android: link, link.

Is Your Job an Endangered Species? by Andy Kessler in the Wall Street Journal.

Abrupt change in authoritarian regimes: Gary Becker, Richard Posner.

Reliance ADAG consent order

I have long had a complaint that the fines imposed in India for violations of law are too tiny. In SEBI's entire history, big fines - of more than Rs.10 million - have seldom arisen. The economic reasoning suggests that fines have to be way bigger than mere disgorgement, in order to reflect the imperfect probability of getting caught. Fines have to be big enough to really hurt the key decision makers. Only then will they exert an influence on the behaviour of the entire market.

SEBI recently came out with a consent order on certain irregularities in the trading of shares of Reliance Communications. Some of the penalties imposed are eye-popping. Applicant companies shall not make investments in listed securities for calendar 2011 and 2012. Individual applicants shall not trade in the market in calendar 2011. The individuals involved -- Anil Ambani, Satish Seth, S. C. Gupta, Lalit Jalan, J. P. Chalasani -- have paid a settlement amount of Rs.0.5 billion.

Are these penalties big enough to hurt? The corporate treasuries have been shut off from the secondary market for 2 years, the individuals from trading on the market for one year, and a payment of Rs.0.5 billion: I think this is big enough to hurt.

I applaud this development, of moving towards bigger penalties that are big enough to pinch the immense resources commanded by individuals and firms in modern India. At the same time, consent orders require immense regulatory capacity in government. It would have been all too easy for Dr. Abraham and others at SEBI to agree to a penalty which was one-tenth as large, in the negotiation that leads up to the consent order. Nobody in India would have criticised the SEBI leadership if the size of the settlement amount had been Rs.0.05 billion. But that would have made all the difference in shifting from a penalty that hurts, to a mere minor cost of business. It requires immense resources of integrity and toughness to do what SEBI has done.

We must move in this direction, of tough orders. These developments underline the criticality of the appointments process for SEBI and for other financial regulators. In an environment of unprecedented gloom about corruption in India, SEBI's progress on being a tough regulator with the highest ethical standards is noteworthy. It shows us something about the human energies that continue to be found in the Indian State, where some teams and individuals stubbornly stand up against the malpractice and corruption which is increasingly becoming the norm, despite the considerable firepower that crooks are able to command.

This order is one more pillar in the body of case law of C. B. Bhave's SEBI. I think of Bhave's achievement at SEBI as being a series of remarkable orders. SEBI is a quasi-judicial organisation and the technical quality of this organisation is all about the quality of orders that they are able to come up with. Alongside other famous orders -- Sahara, MCX-SX, HDFC AMC front running, ULIPs, Bank of Rajasthan, Pyramid Saimira -- this is a major achievement of SEBI in nailing wrong-doing and (more importantly) scaring off other would-be wrongdoers. For each firm that is visible as having been caught trying to violate rules, there are ten other entrepreneurs who have been dissuaded from similar business strategies by watching these events unfold.

Reliance ADAG consent order

by Shubho Roy and Pratik Datta.

The SEBI Consent order under discussion has garnered wide media attention. The total settlement amount sounds very large. Certainly, it is the largest `settlement amounts' ever collected by SEBI. One could argue that the settlement amount is large enough to deter such behaviour and prevent recurrence. However, if we are skeptical about the functioning of any government agency (as we all should be) we have to wonder. Whenever you consider the size of a fine, the most important thing to remember is that it is always relative. US$150 million sounds like a large amount for a fine. If I were to tell you that this is the total fine Union Carbide paid for the bhopal gas disaster, it does not seem very large.

The traditional method of enforcing laws/regulations in most regulators is through an enforcement action. The regulator sets up an investigation, collects evidence and then places it before an adjudicating body. The adjudicating body then gives the opposite party an opportunity to defend its actions. After both parties are heard, the adjudicating authority is required to record its decision along with the reasons for arriving at such a decision. This process is long and requires large amount of resources to be spent by all parties involved. In most cases the decision of the adjudicating body can be challenged in a court of law. This leads to another round of litigation and delays. Despite these drawbacks the judicial process has one important facet: transparency. The evidence presented, the reasoning and the decision are all open to scrutiny. Any person can look at the facts and decide whether the decision was fair or not. Consent orders are not the same. They function differently.

How do consent orders work? Going by the existing SEBI regulations:

1. The concerned entity offers the terms for a settlement, by itself, to SEBI.
   
2. This offer is considered and debated amongst an Internal Committee (IC) of Division Chiefs of SEBI.
   
3. If the IC accepts the terms it is forwarded to the High Powered Advisory Committee (HPAC) which is headed by a former judge of a High Court and other wise men.
   
4. The HPAC considers the terms and recommends whether they should be accepted, declined or modified.
   
5. Two Whole Time Members of SEBI take the final decision.

These different bodies are created to prevent collusion between the officials of SEBI and the entity offering the terms of settlement. The system is quite similar to the system of consent orders used by the Securities and Exchanges Commission (SEC) in the United States.

On one hand, it appears that SEBI has imported global best practices. At the same time, it is important to remain skeptical about this area. Global best practices often do not work when mechanically transplanted: each institutional arrangement needs to be analysed from scratch, with an aim of understanding how incentives and maximisation generate behaviour under Indian conditions.

The actions that SEBI has taken in the recent months show strong signs of integrity and a tough approach towards wrongdoing irrespective of the size and nature of the entities involved. However, consent orders by their very nature are dependent on other strong institutions. These include reasonable anti-corruption agencies and a general faith in the system of governance. Each of us will have to decided whether in the Indian context the system set up for consent orders can be considered safe or not. Consent orders are a positive part of the present environment, but at the same time all of us must apply the maximal skepticism in watching how consent orders are being produced.

Author: Shubho Roy

Shubho Roy is a researcher at the National Institute for Public Finance and Policy.

On this blog:

• The consequences of criminalising cheque bouncing, 24 February 2024.
• What ails public procurement: an analysis of tender modifications in the pre-award process, 26 November 2020.
• Does India need a public procurement law?, 19 August 2020.
• Pricing education: An example from Uttar Pradesh, 21 July 2020.
• India’s low interest rate regime in litigation, 11 March 2020.
• Delays in deposit insurance, 9 April 2019.
• The rise of government-funded health insurance in India, 21 January 2019.
• Concerns with Delhi Metro, 14 December 2018.
• Diagnosing and overcoming sustained food price volatility: Enabling a National Market for Food, 6 August 2018.
• Building State capacity for regulation in India, 17 July 2018.
• Fair play in Indian health insurance, 30 April 2018.
• Estimating the impact of the draft drone regulations, 19 March 2018.
• Analysing the NMC Bill #1: Composition of NMC, 29 January 2018.
• Cost of compliance for clinical establishments, 2 September, 2017
• Concerns about how the Medical Council of India thinks about medical malpractice, 1 July, 2017
• Understanding judicial delays in debt tribunals, 16 May, 2017
• Replace voice votes, 11 April, 2017
• Drafting hall of shame: A mistake in the Reserve Bank of India Act, 1934, 30 March 2017
• Sustainable strategy to eliminate vector-borne diseases, 28 February 2017
• The RBI board: Comparison against international benchmarks, 24 January 2017
• Methods for measurement of delays in the bankruptcy process, 25 November 2016.
• Questions of law in demonetisation, 18 November 2016.
• Runs on real estate companies?, 16 November 2016.
• Constitutional law, Brexit and the Bhopal encounter, 6 November 2016.
• India needs drones, 23 June 2016.
• Understanding judicial delays in India: Evidence from Debt Recovery Tribunals, 18 May 2016.

• The regulatory difficulties of NBFCs in India, 24 December 2015.
• Payment bank entry process considered inconsistent with the rule of law, 1 September 2015.
• Reducing delays in litigation by reshaping the incentives of litigants, 7 August 2015.
• Bureaucrats in business: The tension between rule of law and commercial considerations, 16 March 2015.

• Difficulties with Special Guidance and General Guidance in the IFC, 11 February 2014.

• From clubs to States: The future of self-regulating organisations, 19 December 2013.
• The saga of criminalising and then decriminalising cheque bouncing, 15 June 2013.
• Investigating ponzi schemes: A malady, 30 April 2013.

• Evaluating responses to India's macroeconomic crisis, 28 May 2012.
• Movement at SEBI towards principles-based regulation, 11 March 2012.

• Policy and legal review of the Micro Finance Institutions (Development & Regulation) Bill, 12 October 2011.
  
• Solving the problem of black money in real estate, 5 May 2011.
  
• Legal process in rule-making: A success story in an unexpected place, 15 April 2011
• Rule of law: A pair of stories, 14 March 2011.
• Reliance ADAG consent order, 18 February 2011.

• Transactions between banks in bad assets: An interesting legal drama, 7 October 2010.
• SEBI, IRDA & ULIPs: Hurried solutions lead to poor law, 24 June 2010.
  

Watching markets work: Bad move, Nokia

I have long marvelled about how quickly the world of mobile phones has rapidly moved through four paradigms. My first mobile phone was a Nokia and they seemed to rule. But then Blackberry won because Nokia did not get the importance of email. And then Apple won because Blackberry did not look beyond email. And then Google Android seems to have won because Apple did not understand the problems of a closed system. At each stage, it looked like there was a dominant solution, but the pace of change was brutal and the king of the heap was rapidly unseated. What an amazing pace of creative destruction.

So when I heard that Nokia was now going to be quite wedded to operating system from Microsoft [press release], I thought to myself ``That can't be so bright''. Then I looked at the stock price and it said:

So the market seems to have knocked Nokia down by 18% for wanting to run with a loser like Microsoft. And what's more funny, the market seems to have knocked Microsoft down 4% for this contract too (which I don't understand - compared with being wasteland, it seems that it is good news for Microsoft to have the support of Nokia).

How to measure inflation in India

Ila Patnaik, Giovanni Veronese and I have a paper titled How to Measure Inflation in India?. The abstract reads:

What is the best inflation measure in India? What inflation measure is most relevant for monetary policy making in India? Questions of timeliness, weights in the price index, accuracy of food price measurement, and inclusion of services prices are relevant to the choice of measure. We show that under present conditions of measurement, the Consumer Price Index for Industrial Workers (CPI-IW) is preferable to either the Wholesale Price Index or the GDP deflator.

You may like to see our stock of papers.

Inflation measurement in India may just get significantly better, with the release of the new CPI. The paper should help in evaluating this new CPI and in evaluating its applications.

The extent to which reform of the capital account is or should be irreversible

This blog post is joint work with Jeetendra.

One important part of capital account decontrol is commitment. If there is risk that capital controls will be brought back in the future, this can have a variety of unpleasant effects. If there is a fear of fresh restrictions coming in on inflows, a surge of money will rush into the country. If there is a fear of fresh restrictions coming in on outflows, a surge of money will rush out of the country. A long-term commitment to openness is required, in order to rule out such behaviour.

As a consequence, when a country moves to full convertibility, this requires not just the removal of restrictions. It also requires the removal of bureacratic process including reporting requirements. As long as forms have to be filled up for `automatic approval', this can easily swing back and become a capital control through breakdowns of rule of law (as has happened in India). See the MoF Working Group on Foreign Investment on issues of rule of law in India's capital controls. It is important to pour concrete on the decontrol so as to give confidence that the controls are gone.

We don't have the exact facts, but in the UK, when they moved to convertibility (back in the late 1970s) this was accompanied by dismantling of reporting requirements.

Korea is very open; there are no restrictions on capital flows. But Korea has kept the reporting requirements and through this, they have retained controls in a certain sense. The reason is that people fear that if they report transactions, then the government may come and investigate, and ask why they are doing it. They might also ask where the money is coming from. So, even though the rules may allow capital transactions, people -- especially individuals, but also small businesses -- remain very wary of these, and refrain from wiring large amounts in and out of the country, apart from some outward investments via mutual funds, where the government can't actually see who is sending the money out. Through this, reporting requirements perpetuate home bias and inhibit international economic integration.

Today we became aware of one mechanism through which some countries have committed themselves to an open economic system: When the US signs free trade agreements and bilateral investment treaties, there are provisions which limit the extent to which capital controls can then be brought back.

A curious letter has brought this to our notice. It says: Under these agreements, private foreign investors have the power to effectively sue governments in international tribunals over alleged violations of these provisions.. How interesting. So that locks down the possibility of a reversal of reforms in countries where the US has free trade agreements, and quite a few more where the US has bilateral investment treaties.

It makes sense for investment and trade treaties to mention capital controls. Trade and finance cannot really be separated: finance follows trade, and enhanced de facto integration in each feeds the other.

Trade requires currency risk management. When an Indian firm signs a long-term contract to buy/sell with invoicing in Yen, the Indian firm needs to be sure that Japan will stay open so as to enable INR/JPY hedging in the future.

If an MNC makes a direct investment in a country, it needs some assurance that it can bring in funds (equity and loans) to finance the investment, take them out when it wants to run down its operations, and repatriate profits in the meantime. It also needs to be able to hedge its currency exposure.

Hence, entering into trade/investment contracts today is assisted by confidence that liberalisation put in place today will still be there tomorrow.

More generally, there is a big difference between (a) a move today and (b) a move today + a commitment about behaviour tomorrow. Permanent tax cuts yield a much greater consumption response. Permanent capital account liberalisation leads to more FDI and trade. A variety of mechanisms need to be found through which reforms can be given stronger commitment so as to rule out risk of reversal in the future.