Interesting readings

The Anna Hazare silliness is depressing. Writing in the Indian Express, Shekhar Gupta has an interesting angle on why there is so much interest in this snake oil.

India's $2 trillion economy means we have to reform faster by R. Jagannathan on FirstPost.

Meera Subramanian has a beautiful story about how Diclofenac, fed to cows, is killing off India's vultures. We're down from 50M vultures to 60k. The consequences are bigger than we think.

Former Sebi member Abraham?s claims under CVC lens by Appu Esthose Suresh in Mint.

China's port in Pakistan?, by Robert D. Kaplan, in Foreign Policy.

The 10 most corrupt Indian politicians.

A promising band: Menwhopause. Listen.

The decline of Asian marriage, in the Economist.

Vinayak Chatterjee on ten projects that matter in India today.

The new draft Microfinance Bill. Back story.

Nirvikar Singh in the Financial Express on the CCI order about NSE.

Think again: War by Joshua S. Goldstein in Foreign Policy.

Hegemony with Chinese characteristics by Aaron L. Friedberg, in the National Interest. Arab Spring, Chinese Winter by James Fallows, in the Atlantic. The South China Sea is the future of conflict by Robert D. Kaplan, in Foreign Policy.

The problems of dogs in Iran.

Household financial choice of the hapless households of India

by Ajay Shah.

In February 2010, I had the opportunity to visit Pudhuaaru KGFS in Thanjavur. This is a remarkable project which helps us see the interface between households and the financial system in a wholly new light.

What a difference 17 months makes! On that visit, I had found a little tenuous Reliance CDMA cover at one place in Thanjavur city. On this visit, I found 3g or Edge cover in many remote places. On that visit, the ride from the airport at Tiruchirapalli to Thanjavur took two hours. This time, it got done in 30 minutes on the new NHAI road, with a peak velocity of 110 kph. While there are many reasons to be gloomy about the problems that India faces, some things are moving along merrily.

The KGFS approach to households and finance

KGFS emphasises the very important idea that for households to correctly engage with the financial system, this relationship must be (a) rooted in high quality advice, (b) which is grounded in a state of strong information about the household. The first is achieved by focusing on the incentives of the front line staff, by pushing them to think about household financial choice in its entirety instead of thinking about one product at a time, and by having no sales commission.

The removal of asymmetric information matters in many ways. On one dimension, if credit is extended to the household, a state of high information helps ensure better credit decisions. But more generally, across an array of financial products, when the advisor knows a lot about the household, the advisor would be able to synthesise an appropriate mix of sophisticated financial products which add up to an improvement in household welfare. In time, the advisor will increasingly lean on an expert system to help him do this better: it's a good approach today and it will get better in coming years.

I think there is enormous value in this approach. I believe that KGFS is doing a great job of building this kind of information about households in their present rollout (which involves going into really small villages at three locations, in Thanjavur, in Uttarakhand and in Orissa).

The typical KGFS front-end is a three-man branch in a village, where the three employees live in that very village. Remote villages in India are an environment of radical transparency. The households are relatively trusting. The three people in the outlet know an incredible amount about the households that surround them. Households and dwellings in small villages are rather stable: there is relatively little action through migration / change in financial conditions, etc. If there was ever an environment where asymmetric information is being removed, it is this.

The line between household finance and small business finance cannot be drawn. An adaptation of the KGFS approach can be quite effective with small business also: the KGFS branch would obtain a full picture of the firm, and deliver a portfolio of financial services to it.

A nice feature of the places where KGFS branches are being rolled out is the lack of alternatives. At a time when Indian financial regulation does not do much to check the behaviour of conventional financial distribution, a few high pressure sales agents can queer the pitch for the KGFS staff. By being in remote places that are being ignored by distributors, the KGFS staffpeople have the luxury of dealing with households without the households being tugged by various high pressure sales tactics of rival sales agents.

Urban households are being mistreated by finance

I also realised some limitations of this approach. Looking forward, India is urbanising. At first blush, it may appear that there is a big problem with the utilisation of finance in rural India. But there are big problems with the utilisation of finance in urban India.

The urban middle class and upper class is deluged with sales pitches by a variety of sales agents of financial firms. But these agents are almost always mis-selling, given their drive to push a product (through commissions) and given their lack of knowledge about the household's overall financial problem. Almost all financial products that are pushed in India (i.e. sold and not bought) seem to be mis-sold. I also feel that when the conversation between a sales guy and the household is about a product and not the overall household financial choice, it is almost always leading to the wrong answers. It's tantamount to a salesman who sells a drug without knowing anything about the patient.

What is out there, in urban finance, is a scandal, and I am embarassed to be an accessory to the crime (in however peripheral fashion). While in Thanjavur, I got the odd sense that at its best, a rural household that's well connected to a local KGFS outlet is doing better on utilising the power of finance, when compared with most urban households who are victims of the sales practices that are mainstream in Indian finance.

In this sense, the real problem for India is not the tawdry state of financial inclusion of the very poor in remote places. The real problem for India -- one that influences the bulk of Indian GDP and the households that matter greatly for India's growth -- is the tawdry state of financial planning of the typical urban household.

The KGFS approach is valuable and important to the places where it's being rolled out. But the burning challenge is that of fixing the mainstream. The mode of India is not brutally poor and isolated; it is middle class urban. Improving the interface between middle class and urban households, and the financial system, matters on a GDP scale.

An unrelated rumination: How important is rural deprivation in thinking about India?

The discussion above is a recurring theme in Indian economics. A variety of incentives (development journals, first world aid agencies, government rhetoric) make it fashionable to emphasise rural deprivation. But India is changing and the sweet spot has shifted. The emphasis on poverty and rural is increasingly off-centre. To stay relevant, and do the most important things in today's India, we have to keep our eye on the ball.

To fix intuition, it's useful to look at the distribution of annual household income, over April 2010 to March 2011, from the CMIE household survey of 143,000 households:

Percentile	Household income
10	45,700
20	59,900
30	72,800
40	90,000
50	112,200
60	142,500
70	180,000
80	240,000
90	348,500

As an aside, I think it's useful for anyone who thinks about India to memorise these nine numbers. Or atleast memorise these three numbers: the 25th percentile is Rs.66,000; the median is Rs.112,200 and the 75th percentile is Rs.208,500.

Middle India today has a household income from Rs.66,000 a year (at the 25th percentile) to Rs.208,500 a year (at the 75th percentile). The old-style Indian story of rural deprivation is (roughly speaking) about the 20% of households who are below Rs.59,900 a year (and the size of that group is shrinking). The main story of India is about the remainder.

An emphasis upon exotic poverty is as misplaced, in thinking about today's India, as an emphasis on designer clothes. Perhaps a bit worse, looking forward, since the extremeties of deprivation are being extinguished by growth, while designer clothes are a superior good.

Urban households are a much harder problem

So it's natural to ask: How can the KGFS approach be applied to urban India? When dealing with the urban poor and middle class, it seems that things are much harder.

Rural households tend to be more trusting, particularly in an environment of ethnic homogeneity and the repeated game that prevails in the village setting. But in urban India, households are more skeptical given the lack of ethnic ties and given the greater experience with people who have finked in prisoner's dilemmas.

Rural households tend to be a stable household in a stable dwelling place. Urban households tend to be physically mobile with greater fluctuations in the household composition.

Until deeper reforms on consumer protection take place in Indian financial regulation, urban households will be constantly tugged by unscrupulous sales agents of financial firms pushing products based on high pressure tactics Even if a KGFS tried to be patient and thorough, the very presence of such high pressure sales tactics would contaminate what a KGFS and its ilk can do.

It is relatively easy to construct information about the economic environment of a farming household (though seasonality and revenue volatility is a serious concern). I feel it may be relatively hard to even put together a picture of an urban household, particular when there is informality of labour supply coupled with entrepreneurship. This makes it difficult to do financial planning for such households.

On the other hand, in urban India, the revenue per household would be higher, and perhaps households could be persuaded to pay for advice qua advice. Or, the government could move on giving out advice vouchers to households, thus spurring the rise of an unconflicted advice industry.

Summary

I think KGFS is a great approach and it will be fascinating to watch them execute their agenda in the really remote places of India. What they are doing is path-breaking and important. This should help us set our sights higher on the problems of urban India. I have traditionally felt gloomy, in the knowledge that most households in India are being scammed by the agents selling financial products. As I look at KGFS, I find myself thinking: Can't we do something like this in mainstream India? I think this is an important question to ask. At the same time, there are some visible hurdles which suggest that this will be hard.

Credits

I am grateful to Bindu Ananth, Ramesh Ramanathan, S. G. Anil Kumar, Kshama Fernandes and K. P. Krishnan for many conversations which helped in improving this post.

Mythbusting: Balance of payments edition

by Jeetendra.

Imagine a world with two countries. If one country has a current account surplus, the other must have an equal and opposite current account deficit. More generally, the sum of the current account balance, of all countries, is zero.

But what about the world's balance of payments? Many economists assume these must also sum to zero. For example, one often hears the claim that if one country is running a balance of payments surplus then others must be running deficits. Another argument often heard is that the RMB cannot become a reserve currency until China stops running a balance of payments surplus, because otherwise other central banks will not be able to acquire RMB assets.

This is wrong. In fact, if the right conditions come together, every country of the world can simultaneously run a balance of payments surplus.

Once a country starts trading on the currency market, the identity between the current account and the financial account breaks down. As an example, China runs a surplus on both the current and capital accounts. (That's how it is piling up so much reserves). Thus, when even one country in the world is trading on its own currency market, it is no longer the case that the balance of payments of the world have to add up to zero.

Does the accumulation of reserves by one country imply a loss of reserves by another? Consider the following two country example. Let's say the two countries are the US and China, and lets assume that the RMB and dollar are both reserve currencies. Let's say that the currencies are pegged at 1:1, so it doesn't matter if you are talking about RMB or dollars. And let's say that trade is balanced, so we can ignore it.

The US government now sells a 100 bond to the PBOC. And the Chinese government sells a 100 bond to the Fed. This yields a balance of payments surplus of 100 in both countries. Reserves went up by 100 in both countries. In both countries the economy (outside the central bank) has imported 100 in capital by selling bonds. So, the financial account in each country shows an inflow of 100, creating a surplus of 100.

What is going on? In this example, the central banks are inflating reserves by exchanging assets -- I buy your government's bond and you buy mine. But we call this a balance of payments surplus (in both countries) because we draw an arbitrary line, above which we record the government part of the transaction (inflow of fx from the bond sale) and below which we show the offsetting central bank transaction (outward investment). Since the assets are accumulating to the central bank in each case, we say that both nations are running BOP surpluses.

When countries do this, all countries can run a balance of payments surplus at the same time. Admittedly, this will be difficult for countries running current account deficits and facing capital outflows. But it is, technically, possible. That's why, say, China has been able to build up $3 trillion in reserves without any major country losing reserves at all.

Interesting readings

The frontiers of Nifty.

Next steps on the SEBI story: An interview with U. K. Sinha, by Puja Mehra and Rajiv Bhuva, in Business Today. Mobis Philipose in the Mint. Uproar over I-T raids on SEBI members, in Business Today. In probing SEBI board members, go by CVC rule: Abraham, by Sunny Verma, in the Financial Express. Sebi may stick to its guns in MCX-SX case by N. Sundaresha Subramanian in the Business Standard. Sebi's Abraham emerges front-runner for FMC top job by Ashish Rukhaiyar & Sanjeeb Mukherjee in the Business Standard. An editorial in the Business Standard. Sunil Jain on the problem of recruiting a UTI Chairman, in the Financial Express. SEBI looks to amend law to protect officials from investigative agencies by Reena Zachariah, in the Economic Times. SEBI seems to have not backed away in the high court on MCX-SX.

Static on the FM channel by Puja Mehra, in Business Today.

That seventies feeling by Pratap Bhanu Mehta, in the Indian Express.

Shubhashis Gangopadhyay in the Business Standard on land acquisition.

We should be learning from these Afghans!

A difficult patch in the Indian IPO market.

Saurabh Kumar in the Mint on the extent to which IPOs from certain investment bankers are more exciting for investors than others.

Demystifying Swiss banking by Priti Patnaik, in the Financial Express.

Imagine there's no central bank.

Steven Levy has a great story of how Google built Plus, in Wired magazine. And, PC World magazine on where and why Google Plus is better.

Sebastian Mallaby in Foreign Affairs on how emerging markets should play the appointment problem of the IMF MD.

Cash-settled futures on the 91-day treasury bill

It took a while, but here they are!

37 minutes into the life of the market, here's the order book:

New BOP data -- a reminder of the paradigm shift that is required in our heads

Recently, India released BOP data. Many people, writing about this new data, wrote text such as:

The current account deficit (CAD) moderated to 1.1% of GDP in Q1 from 2.2% in Q4 2010, due to an improvement in the trade deficit and a sharp rise in the invisibles surplus.

Net capital inflows moderated sharply to 1.7% of GDP in Q1 from 2.9% in Q4, due to a steep fall in equity inflows and a moderation in debt capital inflows.

This is wrong.

Under a floating rate, the current account deficit is the same as net capital flows. Net capital flows finance the current account deficit. The exchange rate is moving constantly so that the two are equalised. It's no longer the case that each of these have a distinct and unrelated causal story.

Under a fixed exchange rate, such decoupled thinking was okay! You would look at the trade side and talk about why the CAD moved. You would look at capital flows and talk about why the net capital inflow moved. The two stories would take place on their own without a tight connection. That intuition has to be jettisoned once a country grows up into a market determined (i.e. floating) exchange rate, where there is a new macroeconomics which shapes both pieces.

On this theme, see Mythbusting: Current account deficit edition, on this blog, 20 December 2010.

Most of what we knew about Indian macroeconomics in 1993 has become obsolete. The good news is that standard undergraduate textbooks in macroeconomics, which are used internationally, are now much more useful in understanding India when compared with the way things used to be. And, you might like to read this integrated kit of four papers -- one, two, three, four -- which will give you a modern framework for thinking about Indian macroeconomics. If I had to teach a class in macroeconomics in India, I would teach these four papers (along with some other material).

India is losing the market for trading the Indian rupee

The recent order by the Competition Commission of India on NSE and MCX-SX has a bunch of difficulties based on a lack of understanding of new age industries where a pricing of zero is quite feasible and important, a focus on protecting a competitor instead of upholding competition, etc. I wrote about this in the previous blog post.

The most important problem with this order is that it represents a diversion away from the real story. The real story is that trading in the Indian rupee is leaving India.

The rupee is traded on three venues:

1. The onshore exchange-traded market (NSE, MCX-SX, USE)
   
2. The onshore OTC market
   
3. The offshore OTC market (which is called the `non-deliverable forward' or NDF market).

In an article in the Business Standard today, Jamal Mecklai says:

in April 2011, NDF volumes, at nearly $43 billion a day, were more than double those of the onshore OTC market (about $21 billion a day), and nearly 40 per cent higher than the combined OTC and futures onshore volume. Clearly, the bulk of price discovery for the Indian rupee has migrated offshore.

While we are bickering about the valuation of one player in the onshore exchange-traded market, we are losing the plot. The real story is that India is losing the market where the rupee is traded. While we are fussing about NSE's charges on the currency futures market, the OTC market offshore charges zero and has steadily gained market share.

This is part of a larger concern which needs to be more carefully considered. As India internationalises, domestic customers of financial services, and the foreign order flow, will increasingly shift their business to providers abroad when there are problems in the local financial system. These problems fall into three kinds:

1. Non-residents do not like to send orders to India given that India as yet lacks a residence-based taxation framework; they would rather send their orders to Singapore or Dubai or London which do.
   
2. Indian capital controls hinder orders from non-residents: E.g. RBI prohibits FIIs from trading on the exchange-traded currency futures market (the only edge that India has in the trading of the rupee).
   
3. An array of mistakes in regulations in India hinder the emergence of a capable domestic financial system (e.g. the CCI order, prohibition of options trading on INR/EUR, mistakes in how RBI will compute the INR/USD reference rate which must be used in the functioning of the exchange-traded contracts, etc.)

Our mistakes in policy on these three fronts generate a genuine possibility of a hollowing out of the domestic financial system in coming years.

The overseas market is the real source of competitive pressure. Unless overturned, the CCI order is working to reduce the market share of the onshore market.

Financial policy has two goals in this field. First, we'd like for more business to be on the transparent exchanges instead of the OTC market. This goal is assisted by a price of zero at exchanges. Second, we'd like for more business to be in India rather than the overseas market. This goal is also assisted by a price of zero at exchanges.