Monday, March 30, 2015

Remaking RBI: Rushing changes is unwise

Moves are afoot to diminish the role of RBI in the financial sector. Whatever the theoretical merits of the different proposals, the government needs to hasten slowly. It's not as if financial regulation or the RBI in particular is an obstacle to growth today. There are plenty of other things the government needs to do more urgently in terms of the economic agenda - it's hard to see why remaking the RBI should be a priority at the moment.

It may be well that the political establishment, including the bureaucracy, has been upset over the years over the RBI's stand on interest rates.Some of its frustration is understandable but the solution is to cut the RBI to size but to engage more vigorously with the RBI governor on interest rates.

More on the differences between the finance ministry and RBI in my piece here.

Sunday, March 29, 2015

Manufacturing: China's loss may not be India's gain

India's manufacturing sector has disappointed in the past- it has failed to create the large number of jobs India needs. Many think that, with the right policies, India can grab a big share of manufacturing jobs out of China and into other Asian countries. This may not happen, as an article in the Economist points out.

One reason China is expected to lose is that wages in China have been rising rapidly. But China is offsetting this through use of greater automation- it has stepped up use of robots- and by massive investment in infrastructure. If productivity gains keep ahead of wage rates, Chinese manufacturing will remain competitive.

Secondly, the jobs that are moving out of China are moving into South-East Asia, which has close linkages to China. In other words, China is emerging as the centre of the Asian supply chain, with South East Asian countries on the periphery.

Thirdly, China is a big consumer of manufacturing goods, so locating production close to China reduced transport costs.

The article correctly points out that India does need to create more jobs in manufacturing. But job creation cannot happen merely by replicating the Chinese low-cost manufacturing strategy. Both services and agriculture will have to contribute to the process. As many have pointed out, India's strengths may well lie in knowledge-based manufacturing, not the light engineering that has been China's forte.

 There's one point the Economist overlooks. The revised GDP figures show that the share of manufacturing in GDP has been understated in the past. It's not 16% as thought earlier but around 25%. If these figures are to be believed, the 'challenge' of raising the share of manufacturing does not exist- it has already happened!

Wednesday, March 25, 2015

Global banks no longer make money

As readers of this blog would know, I have always been sceptical about size in banking. It's not that the bigger you are, the more money you make; or the more spread about you are across nations, the more money you make.

Today, three Cs- the costs of capital, compliance and complexity- overwhelm the size effect, as the world's top banks are discovering. The Economist tried to see what sort of return on equity the big global banks would make under the new Basel 3 capital requirements (they assumed equity capital requirement or core tier I equity would come to 12-12%). They stripped out one-off costs that these banks have incurred, such as fines for violation of regulations. It turns out that the best case ROE is a little above 10 percent for HSBC, 10 percent for JP Morgan Chase and below 10 percent for Stanchart, Deutsche Bank, Citigroup and BNP Paribas.

Why has global banking turned out to be unprofitable of late? The Economist offers explanations:

First, these giant firms proved hard to manage. Their subsidiaries struggled to build common IT systems, let alone establish a common culture. Synergies have been elusive and global banks’ cost-to-income ratios, bloated by the costs of being in lots of countries, have rarely been better than those of local banks...

Second, competition proved to be fiercer than expected. The banking bubble in the 2000s led second-rate firms such as Barclays, Société Générale, ABN Amro and Royal Bank of Scotland (RBS) to expand globally, eroding margins. In 2007 RBS bought ABN in a bid to rival the big network banks. It promptly went bust, proving that two dogs do not make a tiger. The global giants also lost market share in Asia to so-called “super-regional” banks, such as ANZ of Australia and DBS of Singapore. 

Bank supervisors, meanwhile, have imposed higher capital standards on global banks. Most face both the international “Basel 3” regime and a hotch-potch of local and regional regimes. A rule of thumb is that big global banks will need buffers of equity (or “core tier one capital”) equivalent to 12-13% of their risk-adjusted assets, compared to about 10% for domestic firms. National regulators increasingly demand that global banks ring-fence their local operations, limiting their ability to shift capital around the world. The cost of operating the systems that keep regulators happy is huge. HSBC’s compliance costs rose to $2.4 billion in 2014, 50% higher than the year before. JPMorgan is spending $3 billion more on controls than it did in 2011.

Compare Indian banks with these global giants and you find that we are much better placed. Private banks had an average return on equity of 16 per cent in 2013-14, SBI and its associates over 10 per cent and nationalised banks just under 8 per cent. These are under unusually stressed conditions, given the problems in infrastructure related lending. Combine these returns with credit growth of 15-20% in the next few years, with  a high retail component with low risk and high yield and you realise why Indian banks are sitting pretty. Global fund managers who believe in India should be putting their money in a big way into Indian banks.

China's Infrastructure Bank can't be thwarted

The US is miffed with the UK for agreeing to join China's proposed Asian Infrastructure Investment Bank. India too is expected to be among the 35 countries that will join.

Infrastructure in Asia needs enormous funding. The World Bank cannot meet its needs nor the ADB. The IMF/ World Bank have refused to change their governance structure in line with the changing realities of the world. China is sitting on foreign exchange reserves of $ 3.8 trillion. The AIIB is inevitable under the circumstances.

The AIIB will be dominated by China, unlike the proposed Brics Bank where all the founding shareholders will have equal votes. There's every prospect that China may reserve veto powers for itself. Still, Martin Wolf of the FT thinks the rest of the world should join- he spells out his reasons for saying so:
First, the US, Europeans and Japanese treasure a degree of influence on global financial institutions that is increasingly out of line with their position in the world. Moreover, they have failed to exercise that stewardship as well as they ought to have done. Not least, they have insisted on the right to appoint leaders who have been far from consistently excellent.
Second, it is five years since the Group of 20 leading economies agreed on new quotas that would moderate their outsized influence at the International Monetary Fund. The world is still waiting for the US Congress to ratify the changes. This is an abdication of responsibility.
Third, the world economy would benefit from larger flows of long-term capital to developing countries as well as from a bigger insurance fund than the IMF can offer to countries exposed to “sudden stops” in capital flows. 

Monday, March 09, 2015

Women on board in Germany- two cheers!

The big news on international women's day yesterday was Germany's decision to mandate 30% of board seats on listed companies for women. One report says that the move will affect 100 listed companies. That's a small number but these are the biggest names in business, so the move is indeed significant.

The move came after it's become clear that women are heavily under-represented in top Germany companies and that the only way to get these companies to change is to shove quotas for women down their throats. Germany is only following in the footsteps of other European countries. Norway, Spain, France and Iceland all have 40% board quotas for women. Italy has a one-third quota, Belgium 30% and the Netherlands and non-binding quota of 30%. Interestingly, the UK does not have such quotas.

Gender diversity is, of course, necessary and useful. I happen to think that, by pushing gender diversity, we will be able to get diversity of other kinds- class, ethnic and professional diversity. Why? Because, it will be difficult to fill the positions with women with only a certain background or class- say, high income, corporate types. Companies will be forced to cast their nets wider and, in the process, will have to break out of the closed club from which board members now come. They will have to look for women with varying backgrounds.

How does diversity help? Well, it's established that diversity of viewpoints contributes to better decisions. Boards need this badly because today they happen to suffer from group think. It's interesting that a study , done by MSCI, has found that companies with more women on the board are less likely to be hit by scandals. As one asset manager correctly points out, this has less to do with women per se than with women bringing in diversity, a different way of looking at things:
I don’t think this is because women are inherently more ‘moral’ than men. And it’s difficult to tease out cause and effect — are better companies more likely to embrace diversity or does diverse leadership make for better companies?
What we can say with certainty is that gender diversity is a good proxy for more general cognitive diversity, and we know that cognitive diversity leads to better problem solving and outcomes.

This would be the argument for pushing for such quotas in India as well. It's shameful that companies are huffing and puffing to fill the one seat mandated for women under clause 49. Even more shameful that promoters have chosen to fill the sit by appointing their wives, mothers and daughters on to the board. This is not genuine diversity at all.

I know the I run the risk of getting lynched but I would argue for quotas for SCs/STs and OBCs as well on boards- and for the same reason, namely, that it brings in more diversity. It will also go a long way towards making companies more tuned to the bottom of the pyramid if somebody from that segment is on the board. So, you see, boardroom diversity is not about affirmative action or correcting wrongs in society. It is simply about making boards more effective.

Setting quotas is one way of getting diversity but this will be fought and resisted. Another way is to introduce proportional representation boards- allowing all stakeholders, not just the promoter or dominant shareholder, to select board members. Today's boards are stuffy, boring places where there's no genuine debate or active questioning. We need to shake them up. Setting quotas and introducing proportional representation will make boards and companies more vibrant. 

Saturday, February 28, 2015

Goodbye big bang reforms, hello economic growth

One of the most striking points of this year's Economic Survey relates to 'big bang reforms'. For years, commentators have been bemoaning the lack of political will to push through such reforms. IN the run-up to the budget, they have been warning the government that it will be judged on how well it does on this account. The Survey pours cold water on such hopes and explains why:

Given the expectations surrounding the upcoming budget, one question needs to be addressed head-on: Does India need Big Bang reforms?Much of the cross-country evidence of the post-war years suggests that Big Bang reforms occur during or in the aftermath of major crises. Moreover, Big Bang reforms in robust democracies with multiple actors and institutions with the power to do, undo, and block, are the exception rather than the rule.India today is not in crisis, and decision-making authority is vibrantly and frustratingly diffuse.

This is refreshingly candid stuff- and one hopes it will put an end to the 'big bang reform' cottage industry. It's not just that such reforms are not politically feasible. One could argue that the past pace of reform is perfectly consistent with rapid economic growth in India. Over ten years of the UPA regime, few major reforms occurred- and we saw among a period of the highest growth ever.  In the slow growth period of the last three years when the world was still feeling the impact of the financial crisis, India grew at 6.7%. The Indian economy is now set to grow at over 8% in 2015-16. We should not be surprised. Reform or no reform, we can expect an investment rate of 32% or more. This should translate into growth of around 8%.

The Survey should have spelt out the implications for fiscal policy of  the imminent return to the high growth path. Whenever the economy is growing at over 7% and 8%, the fiscal deficit problem tends to disappear- the fiscal deficit to gdp begins to decline and fall within an acceptable range. The debt to gdp ratio also declines. If we are looking at double digit growth in the medium term, we can tolerate a fiscal deficit to gdp ratio of over 3%. The finance minister need not have been apologetic at all about deferring the year for meeting this target by one year, as he has in the budget. He might have been bolder on the spending front and given a greater boost to public investment than he has.

More on the growth and India's fiscal problem in my article here.

Wednesday, February 25, 2015

Raghuram Rajan on free markets and political freedom

Rajan's most recent speech on democracy, inclusion and prosperity has drawn attention for quite the wrong reason: the reference to Hitler and the perils of strong government. Since Modi was being likened by the Congress to Hitler in the run-up to the last elections, the reference is liable to be misconstrued and, indeed, the highlighting of this particular point in sections of the media appears mischevous.

It's the larger point in the speech that deserves highlighting, namely, that liberal democracies rest not just on three pillars- rule of long, strong government and political accountability- as Francis Fukuyama has said but also on a fourth one, free markets.

Rajan sees competition in the market place as the counterpart of competition in politics. The two tend to support each other. However, he points out, there is a difference. In politics, every citizen has one vote. In the marketplace, the richer guy has more votes than the poorer guy. He then poses the question: why would voters not use the power of their votes to disenfranchise the rich? Because they see the owners of property or resources as spreading prosperity and benefiting the voters. Also, they don't mind richness as they long as they see a certain fairness about the acquisition of wealth. As long as these two conditions are met, voters will tolerate free markets and a measure of

Well, well, the conclusions appear rather sweeping. It's not as if voters can disenfranchise the rich if they wanted to. The people who get voted in do support with the money power of the rich behind them. They are beholden as much to the rich as to the voters. And their natural affinity is towards the rich rather than the voters.

As for the fairness of the process, we do know that upward mobility has fallen in the US. And, we have one book (The son also rises) that claims that mobility has changed very little in the west over hundreds of years. In India, upward mobility has been made possible more by the political process rather than the markets. By grabbing political power, the backward classes and the scheduled castes have been able to advance. They have also advanced through government jobs. Markets and enterprise haven't contributed as much.

There isn't much fairness or legitimacy to the system we have. Political accountability has largely meant substituting one set of crooks supported by businessmen with another set of crooks supported by businessmen. The victory of Aap in the Delhi polls shows that people are still looking for a fix to the crooked political and economic system we have. A Nandan Nilekani emerging on the landscape doesn't mean much of a change in the Indian system. Inequality is more of an issue, perhaps, in Indian than in the US where it has emerged as an important issue.

In the long term, genuine democracy or political freedom does not seem compatible with deep inequality. How to get the political system to address such inequality will remain the fundamental challenge in the years to come.

Monday, February 16, 2015

Government mustn't get fixated on the fiscal deficit.

Should the government stick to its fiscal road-map- 4.% for fiscal deficit/GDP in the current year and a lower deficit the next year? Ruchir Sharma argues in today's TOI that it should. He gives instances, such as China, where an increase in government spending has been followed by lower growth rate.

I disagree. China is over-invested in infrastructure. We are under-invested. Without infrastructure investment, it's hard to see investment in general reviving. And the private sector is in no position to get into infrastructure now. So, the government should go ahead and spend on infrastructure- and it doesn't matter if it's about half a percentage point away from its fiscal deficit targets. Here's my case.

India's debt to GDP ratio of around 65% today is among the lowest in the world today. So, considerations of sustainability of debt need not deter us. The only case can be that higher spending will spur inflation which will undermine our currency. The inflation rate has declined sharply, our external account has improved considerably and quantitative easing in Europe and Japan can be expected to offset somewhat the effect of any rise in the interest rate in the US. So, concerns about the impact of the rupee are not a factor either.

Whichever you look at it, this is the right time for Jaitley to go out and spend boldly.