Awash in liquidity

The rise in the Sensex beats anything we have experienced in the recent past. I mean, we are supposed to be in the midst of a serious international financial maket crisis. Some think the probability of a US recesssion is still pretty high and that global economic growth will be dragged down in consequence.

If the Sensex has taken note of these, it's not showing. For some reason, funds continue to pour in. The statistics I saw on TV are: FII inflows of $1 bn in the past week, net inflows of $ 3 bn in September. And the best annual score thus far has been around $10 bn!

Deepak Parekh was on one of the channels a couple of days ago. He suggests that whole new classes of investors are waking up to India: US insurance and pension fund investors (as distinct from mutual funds and hedge funds, thus far the prominent US investors in India), Japanese retail investors, the newly set up sovereign wealth funds. Then, you have huge oil surpluses looking for alternatives to US and Europe. A tiny percentage allocation to India turns out to be a flood so far as we are concerned.

The biggest surprise to me is the rebound in IT stocks. I thought they were headed relentlessly southwards in the wake of an appreciating rupee. But, this week, the stocks are up again. I asked a street corner broker whether he had an explanation. He said Infosys' Nandan Nilekani had indicated on TV from New York that Infosys was in a position to weather the impact of the rising rupee. That did the trick this week. Whether this will last we will know when the first quarter results start pouring in from October 5.

Tough justice in Scandinavia

An investment bank in Sweden inflates profits by overstating trading positions. When the truth is revealed, it has to write down profits by a huge amount.

The price for this sort of behaviour? The regulator asks the entire board to step down, not just the CEO. That's the sort of tough justice you find in Scandinavia- it's hard to think to sounder corporate governance norms elsewhere in the world. FT reports:

Carnegie in May said its net profits from 2005 to 2007 would be cut by SKr227m after three employees had inflated profits by overstating trading positions. The bank eventually took a SKr315m write-down as a result of the scandal.

”All this is very serious. We could have pulled their licence, but we see that there is hope that their measures are sufficient,” said Ingrid Bonde, director general of the regulator.

”We demand that the board replaces the CEO who must not be allowed to remain a board member either. The guidance and control which we have criticised involves the entire bank and the bank management,” Ms Bonde said at a news conference.

Containing "moral hazard"

Much has been written about "moral hazard" created by central bank intervention in times of financial crises- the danger that such intervention encourages market players to take undue risks in the knowledge that the central bank is always there to help them out.

In my posts on the subject, I have been sceptical of this line of reasoning. When you are faced with a financial crisis that threatens to impact the real economy- note, not just a crisis that is confined to the financial sector- you don't sit around twiddling your thumbs. You don't use the possibility of "moral hazard" to justify inaction. That is because the costs of systemic failure can be huge where banks are involved- in the East Asian crisis, the countries there were set back by years when it came to economic growth.

I also believe that another criterion is valid: has intervention by central banks or governments actually led to increased moral hazard? Are banks more prone to failure today than before? Impressionistic evidence suggests this is not the case. In the US, banks are better capitalised than before, their risk management practices have improved hugely and they are better placed to present a crisis than before.

Larry Summers' article in Business Standard today makes clear why moral hazard cannot be allowed to come in the way of timely intervention. Summers provides three good reasons for this.

First, ......... the prospect that people may smoke in bed is not usually taken as an argument against the existence of fire departments. Moreover, if there is “contagion” as fires can spread from one building to the next, the argument for not leaving things to the free market is greatly strengthened.



Second, ......moral hazard and confidence are opposite sides of the same coin. Financial institutions can fail because they become insolvent, as misguided lending or borrowing causes their liabilities to exceed their assets. But solvent institutions can also fail because of illiquidity simply because creditors rush to withdraw their funds and assets cannot be liquidated fast enough. In this latter case the availability of external support averts needless panic and contagion.



Third,.....much of what financial authorities do in response to crises does not impose any costs on taxpayers and may actually make them better off. In the much criticised LTCM case no taxpayer money, except perhaps the cost of a lunch, was spent. ....Monetary policies that prevent deflation of the kind that cost Japan a decade of growth in the 1990s are another example of how a policy can respond to stress without imposing costs on taxpayers or the economy.

Summers goes on to spell out the conditions under which central bank intervention would be worthwhile:

First, are there substantial contagion effects? Second, is the problem a liquidity problem where a contribution to stability can be provided with high probability or does it involve problems of solvency? Third, is it reasonable to expect that the action in question will not impose costs on taxpayers? If the answers to all three questions are affirmative, there is a strong case for public action.

Harish Salve on Mid-Day case

In my post yesterday, I indicated that I had doubts as to whether the media had gone overboard on the Justice Y K Sabharwal case. My doubts were about the manner in which the case was reported, the point on which the Delhi HC based its decision to hold the journalists concerned in contempt of court.

In today's Indian Express, Harish Salve goes further. He is dismissive of the allegations themselves and he also makes the point that Sabharwal's judgement in the sealing case must be viewed in the broader context of several bold judgements he had made:

Every judge has his “foot print”. Justice Sabharwal’s footprint is that of a judge who took on controversial cases and dealt with them squarely. This is reflected in his judgments in the case relating to the expulsion of members of Parliament, the office of profit controversy, Bihar Assembly dismissal, the forest matter, and the Ninth Schedule matter.

His decision in the sealing case follows the same trend. There is nothing odd or curious about his decision in the sealing cases — and the bench hearing the case after his retirement continues to pass orders in the same direction notwithstanding the hamhanded attempt by the government to browbeat the court manifested in the intemperate (and rehearsed) outburst of one of its law officers.

The allegations against him that sought to cast aspersions on his motives in deciding the sealing cases, pursued after his explanation, ought to have been treated with contempt rather than in the contempt jurisdiction.

Salve, however, argues that the judiciary might show greater consideration to the media in such instances, especially where media reports may be well-intentioned. Stringent action against the media, while perhaps defensible on technical grounds, may have the effect of weakening the institution of a free press. And, after all, when it comes to enforcing accountability, the media and the judiciary are on the same side.

In a perfect world the intrusive methods of the Indian media would be an intolerable invasion of privacy and an unbearable encroachment on a citizen’s reputation. In contemporary India these methods have gone a long way in serving a larger cause of the fragile democracy of this nascent republic.

The action of the newspaper in publishing these allegations was clearly ill-devised. But in the circumstances, stern action of the kind taken by the court may have a “chilling effect” and may turn out to be a remedy worse than the disease.

Mid-day contempt of court case

Mid-Day's three journalists and one publisher have been sentenced to four months in jail by the Delhi High Court for contempt of court. They were sentenced in the case relating to the reports the daily had carried about Y K Sabharwal, former Chief Justice of the Supreme Court, and the Delhi sealing drive. The Delhi High Court had taken suo moto cognizance of the Mid-Day stories.
The media is understandably incensed. It believes that this is an attempt on the part of the judiciary to shield itself from scrutiny and accountability. Senior journalists have said that the Delhi High Court should have gone into the veracity of the allegations made by Mid-Day against the former CJ. This view has been echoed by some eminent lawyers- TOI quoted Prasant Bhushan as saying that the judgement was an "attempt to muzzle the media".

The SC will now decide on the contempt issue. It is important, however, not to miss the nuances to the Delhi HC ruling, whatever opinion one may have about the actions of former CJ Y K Sabharwal. I caught some of the nuances only in one report, that in the TOI of September 22.

The Delhi HC was not pronouncing on the merits of the Mid-Day story. The HC bench headed by Justice R S Sodhi is quoted in TOI as saying:

"The nature of the revelations and the context in which they appear, though purporting to single out former Chief Justice of India, tarnishes the image of the Supreme Court."

How so? Because "by imputing motive to its presiding member, (it) automatically sends a signal that the other members were dummies or were party to fulfil the ulterior design (of Justice Sabharwal)." Besides, Soli Sorabjee, among others, has expressed the view that the cartoon carried by the paper was contemptuous.

In other words, the report had the effect of casting asperions on the SC as a collective, hence the veracity of the report was irrelevant to the issue of contempt of court.

Ordinary people may find it difficult to digest such nuances but those with a nodding acquaintance with the law will know that technicalities such as these can have a crucial bearing on the outcome of a case.

The question then arises: how does a paper report on the actions of a judge or former judge that raise doubts in the minds of the public without in any way appearing to cast aspersions on the Court as a whole? Does it merely highlight the actions of a judge without in any way questioning a given judgement, especially where other judges are involved?

In other words, is there a proper way of reporting such matters in the public interest without inviting action under contempt of court? One hopes that the SC ruling in the matter will shed light on this subject so that the ground rules for media reporting in such matters are clear to all concerned.

More on the ongoing sub-prime saga.....

My latest thoughts on the sub-prime saga in my ET column, More solid than Rock. I think the risks to the world economy are still manageable, that central banks will bring it off. I also discount the possibility of a US housing crash triggering a similar crash in India- the two markets are quite different in character.

Will the Bernanke 'put' work?

I suggested yesterday that there was a Bernanke 'put' in operation out there in the markets, much like the much-maligned Greenspan 'put'- when push comes to shove, nobody wants plummeting markets to drag down the larger economy. A commentator in FT today endorses this view but suggests that the Bernanke 'put' may not solve the underlying problems:

The positive response of global equities highlights how the move was both unexpected and welcome. Now that the Fed cites “developments in the financial markets” as influencing their policy assessment, investors have good reason to believe in the “Bernanke put”.

........The problems in credit markets stem from unsustainable financial structures brought on by many years of unregulated financial innovation. It would be naive to think that these structural problems could be spirited away by a 50bp rate cut.

Well, the Fed's response may or may not work but, as I argued yesterday, no central bank can fail to respond to market conditions as bad as the ones we are seeing now- this it not some unpleasant invention of Greenspan's.

Bernanke vs Greenspan

The Fed cut its benchmark rates by 50 basis points yesterday. Those who liked the move called in 'bold'. Those who didn't like it called it 'risky'.

Earlier, when Bernanke had held out against a large cut in interest rate, people had called him 'bold' and compared him favourably with the supposedly trigger-happy Greenspan. Greenspan, they said, was Wall Street's central banker, only too happy to cut rates in order to appease the financial markets. Bernanke was the academics' central banker, guided by larger theoretical considerations.

Greenspan's interest rate cuts, the critics said, had fostered moral hazard in the financial markets, they had caused firms to take up excessive risk. Now, we were all paying the price for those excesses. Bernanke was diferent, they said. He was out to make a point to market players: if you take excessive risk, be prepared to pay the price for it.

Much of this gets blown away by yesterday's interest rate cuts. A trigger point, perhaps, was the collapse of Northern Rock, a mortgage lender, in the UK, with the Bank of England rushing to its rescue. No regulator anywhere wants crowds queueing up outside banks and the prospect of a similar run on banks in the US, caused by protracted uncertainty in the markets and a sharper downturn in the US economy, no doubt helped focus minds in the US Fed.

So where does that leave us in terms of policy? Is Bernanke going the Greenspan way? Is the 'Greenspan put' , the floor on asset prices caused by interest rate cuts, now a 'Bernanke put'? Are central bankers obliged to take steps to prevent steep falls in asset prices that impact on financial institutions and especially banks? The answer to the last question at least does appear to be in the affirmative. The consequences of not responding are just too fearful for central bankers to contemplate.

Does this mean that Greenspan and Bernanke are abetting 'moral hazard' and we are bound to be swept by excesses of the kind that led to the present crisis? That would be too sweeping a judgement. There is a difference between some of the earlier financial crises and the present one.

In the present crisis, it is non-bank financial institutions that are primarily involved. Banks are involved indirectly either through lines of credit they have extended to troubled institutions or because they are holding securitised assets. Banks are much better capitalised today than before (especially US banks) and they are well placed the absorb the losses to which they are exposed.

The markets are jittery because it's hard to put a precise figure on the losses, given the accounting and valuation issues involved. The resolution of the crisis will take time and markets will remain jittery. But the financial system is better equipped to absorb the shock than on many earlier occasions. You can't argue that central banks have caused moral hazard to worsen through their actions.

Ah, Calcutta!

This news item from FT may not gladden the comrades in New Delhi but they are sure to boost Buddhadeb Bhattacharya's standing:

Starwood Capital and Walton Street Capital, two US real estate investment firms, have teamed up to invest in a $1.25bn property development in Kolkata, India, that will rank as one of the largest private equity deals in the country.The buyers will team up as equal partners with Shriram Properties, an Indian developer, to launch the project on 20m sq ft of land previously occupied by a Hindustan Motors plant. It will be classified as a “township” including residential, retail and commercial real estate properties designed by HOK, the architecture firm.

....People close to the deal, which is expected to be announced on Tuesday, said it reflected India’s ability to absorb a new supply of property developments and the business-friendly nature of Kolkata’s regional government.It also highlights the attractiveness of deals in emerging markets such as India for private equity and real estate groups whose opportunities have been dramatically reduced in their home markets by the global credit squeeze

Making the judiciary accountable

Magsaysay winner Arvind Kejriwal has a hard-hitting piece in today's TOI on the absence of accountability in the Indian judiciary.

It was news to me that the Delhi High Court had initiated contempt proceedings against Mid Day journalists for publishing a story questioning the acts of former chief justice of India (CJI) Y K Sabharwal. Kejriwal is highly critical of this move:

If the inquiry concludes that Mid Day journalists were wrong, they could be proceeded against. But by gagging the media, the Delhi high court is only lending credence to the allegations against Justice Sabharwal. The Delhi high court in its judgment against Mid Day journalists said that they were guilty of lowering the dignity of Supreme Court in the eyes of the public. If the voice of the media were to be gagged, the dignity of the Supreme Court would be lowered for ever.

Exposure of corruption in any institution might seem to lower it in the eyes of the people but in the long run strengthens the institution by allowing it to take corrective action. Suppressing exposure increases suspicion and indeed the people's 'contempt' for such institutions. Complete transparency and honest efforts to bring truth out in the public domain enhance the dignity of individuals and institutions.

Kejriwal makes the point that the Campaign for Judicial Accountability called a press conference in New Delhi and "released more damaging facts against Justice Sabharwal than what appeared in Mid Day." Justices JS Verma and V R Krishna Iyer, both former Supreme Court judges, called for an independent enquiry. Why then single out Mid Day journalists for contempt proceedings, Kejriwal asks.

Kejriwal then makes the case for greater accountability in the judiciary:

The judiciary lacks accountability. One needs the CJI's permission to file an FIR against a judge, which effectively rules out an FIR. One cannot publicly discuss the conduct of judges for fear of contempt. No agency has the powers to enquire into charges against them. Of late, the judiciary has expressed its desire to be kept out of RTI.

Contempt powers of the court should be subject to scrutiny. We have a right to hold the courts accountable. If there is a prima facie case of wrongdoing against any judge, it ought to be inquired into through a fast and effective mechanism. It is time that we asserted our right to discuss the conduct of judges and courts, the way we discuss that of any other democratic institution. Only then would the dignity of the courts rise in the eyes of the people.

And now a bank bail-out in UK

Today's papers noted with some sorrow that the Sensex came off the day's high and took a dive towards the end of the day following news about a bank failure in the UK. The culprit was Northern Rock, one of the smaller British banks. The bank could not get finance to service its liabilities and had to be rescued by the Bank of England.

Is the Bank of England merely providing liquidity or this is a bail-out of a failed bank? We do not know yet except that the line of credit provided is said to be large. Indications are that the bank may have turned insolvent - FT reports that market capitalisation is below thevalue of Tier I equity. If so, the Bank of England has really eaten humble pie- its Governor has been very vocal about central banks not rescuing institutions that made imprudent business decisions.

The Bank's predicament is made worse by the fact that Northern Rock is a small bank and its failure would not pose a threat to financial stability. Inevitably, there is talk of political pressure- Gordon Brown does not want a financial mess on his hands so early in his tenure.

FT's Lex column summarises the cause of failure at Northern Rock:

Should the end come, the rise and fall of Northern Rock will become a case study in failed alternative banking models. Compared with the UK banking average of 7 per cent, Northern Rock used wholesale market securitisation for 43 per cent of its funding. Eschewing customer deposits kept down costs – the bank has just 72 branches – and facilitated a rapid expansion of the loan book. But this over-reliance on one form of funding now looks foolish, irrespective of exceptional credit market conditions.

The Bank of England will soon look for buyers for Northern Rock- among the possible suitors being mentioned are Lloyds TSB and HSBC.

One cannot help noting that India's commercial banks provide a study in contrast to the likes of Northern Rock- not only are they well capitalised, the retail deposit to total liabilities ratio is among the highest in the world and a big chunk of liabilities is low cost current and savings account.

With a business model of that sort, you are likely to be pretty stable. Then, on the asset side you have a large slice of housing loans (with among the lowest default rates in the world) and corporate loans in a time of 8-9% economic growth. Retail is the key to stability in banking- it makes for stable liabilities and it provides for stability in income streams as well.

This must explain why foreign banks are positioning themselves for the retail market post 2009 when barriers to foreign entry will come down. Foreign banks have been making big money on fees on cross-border transactions but they refuse to take their eyes off the retail segment. Northern Rock's failure tells you why.

India Sparkling!

A government-owned power transmission company launches an IPO for around Rs 3000 crore. It gets bids worth Rs 190,000 crore. And these are said to be troubled times for financial markets! This is not India Shining, it is India Sparkling.

PowerGrid Corporation has nearly 45% of the share of power transmision in the country. But that in itself is not what is attracting institutional investors (this segment is said to have been oversubcribed 115 times). Investors are attracted by earnings growth. Investors see earnings growth potential in PowerGrid. That clearly means they expect to see more transmission, which means more power generation.

This perception is signification because the power sector has long been one of the areas of failure in the reforms era. Now, with mega-power projects going ahead, this sector is also poised for a sea-change. That would complete the overhaul we are seeing in every other segment of infrastructure- airports, ports, telecom, railways, roads. Investment in infrastructure and broader investment demand driven by infrastructure investment and improvements in infrastructure will be the key element in the India growth story in the next few years.

How NOT to promote financial inclusion

Financial inclusion is the talk of the day- everybody wants it, nobody knows how to make it happen.

In today's BS, Christopher Butel puts forward the sort of non-solution that market players often favour. He says that banks don't have much of an incentive to invest in branches and ATMs in under-served areas because the transaction volumes don't justify these investments.

I am not very sure. Banks really don't collect charges for volumes - issue of cheques or usage of ATMs of banks where they have accounts- unless volumes exceed a certain level. Even in urban areas, most people would tend to stay within the limit. I don't see how increasing transaction volumes hold the key to greater income for banks.

Suppose we grant this. How are we to increase volumes? Butel has two ideas. Let employers change the payment cycle- hand out pay in two instalments instead of a single payment every month. But wouldn't this increase transaction costs for employers and for employees? Are they to bear more costs so that banks can benefit?

Secondly, Butel wants some of the post office infrastructure to be made available to banks. That would help banks reach out without having to make big investments in infrastructure. Sorry, but India Post is planning to offer banking services itself, so why would it fall for such an idea?

One cannot help telling the corporate types: get real.

C Rangarajan on bank consolidation

Former RBI Governor and Chairman of the PM's Council of Economic Advisors, C Rangarajan, takes stock of the Indian banking sector in the first R K Talwar memorial lecture instituted by SBI and the Indian Institute of Finance.

R K Talwar was the legendary chairman of SBI in the seventies and must rank among the most respected figures in Indian banking. Rangarajan rightly refers to his pioneering role in the financing of small firms.

Talwar was just as respected for his integrity. He fell foul of the Indira Gandhi regime during the Emergency. The story goes that Sanjay Gandhi wanted SBI to grant a loan to one of his cronies. Talwar was not willing to oblige. The SBI Act was amended to permit the removal of the SBI chairman before his tenure had ended. Talwar did not wait to receive marching orders: he proceeded on leave and subsequently resigned.

To come to Rangarajan's views on bank consolidation. I note that Rangarajan is guarded on the subject. Yes, there will be possibilities for mergers but these should be driven by the market, not by government dictat, nor should banks consider themselves doomed if they don't go in for bigger size through mergers.

As the bottom lines of domestic banks come under increasing pressure and the options for organic growth exhaust themselves, banks in India will need to explore ways for inorganic expansion. This, in turn, is likely to unleash the forces of consolidation in Indian banking. However, there are two caveats.

<>First, any process of consolidation must come out of a felt need for merger rather than as an imposition from outside. The synergic benefits must be felt by the entities themselves. The process of consolidation that is driven by fiat is much less likely to be successful, particularly if the decision by fiat is accompanied by restrictions on the normal avenues for reducing costs in the merged entity. Thus, any meaningful consolidation among the public sector banks must be driven by commercial motivation by individual banks, with the government and the regulator playing at best a facilitating role.

Second, the process of consolidation does not mean that small or medium sized banks will have no future. Many of the Indian banks are of appropriate size in relation to the Indian situation. Actual experience shows that small and medium sized banks even in advanced countries have been able to survive and remain profitable. These banks have survived along with very large financial conglomerates. Small banks may be the more natural lenders to small businesses.

Market players try to estimate losses

One reason nervousness is rife in the international markets is that market participants do not have a clear idea of what their assets are worth- and how much losses they have incurred because of the turbulence in the market. This uncertainty, more than anything else, underlies the panic in the markets and the aversion to risk.

Incredible as it may seem, nearly a month after the problems began, banks and investment banks are yet to get a reasonable fix on their losses. Partly, this could be because they believe that disclosure could undermine market confidence. Partly is because the players themselves do not know what their assets are worth.

The latter is especially true of complex derivative portfolios. But banks and investment banks are also in a fix about valuing debt finance they had committed for takeovers and other purposes. Banks are stuck with large amounts of these debt- and interest rates have shot up. On a mark to market basis, these would entail huge losses. But banks are also trying to renegotiate rates with clients, so would like to delay the valuation.

Another issue is whether market players should be subject to uniform valuation norms. Central banks are inclined to believe this should so for banks. But the SEC, FT reports, would leave it to investment banks to use their discretion.

The SEC, which stepped up checks of how five of the largest US investment banks are valuing mortgage-related securities, is comfortable with valuations being different between firms – as long as their valuations are consistently applied and checked. “We don’t substitute our opinion for our firms’,” said one senior SEC official.

John Dugan, Comptroller of the Currency, regulator for some of the top US banks, gave a warning last week that banks should use market prices, rather than “models”, to value securities even if trading volumes were far below normal

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As John Gapper notes in the FT, the market will soon provide solutions to these overhanging problems. There are funds being created to buy distressed debt at huge discounts. Historical experience suggests that returns on such purchases can be attractive.

There is probably a huge weight of money building up to clear the debt overhang that banks are now suffering. The reason the market is not already clearing is that banks are wary of selling off mortgage-backed debt at a huge discount now, only to watch the prices trade upwards again after a few months.

This game of chicken between wary sellers and astute buyers is bound to end at some point and, when it does, I suspect that liquidity will return to the debt markets as abruptly as it vanished this summer.

We should see plenty of action on this front once the first flush of panic subsides. I remain optimistic about the resolution of the present market crisis and the outlook for the global economy.

Economists who left a lasting impact- and who didn't

There's a terrific article by John Kay in the Financial Times on the two economists who last a lasting impact on their times- Keynes and Friedman, others- Schumpeter, Galbraith- who didn't and yet others- Sen and Stiglitz- who won't. No student of economics should miss it.

In a nutshell, Kay argues that academic leadership is not just about scholarly ability, it requires sustained effort in creating a school of thought and the ability to draw followers- in other words,
perseverance as well as human qualities. Otherwise, you remain a renowned scholar, not the founder of a school of thought.

Here's Kay's take on Schumpeter and Keynes.

Schumpeter rivalled Keynes in range of experience and subtlety of thought, and surpassed him in breadth of scholarship. But his impact on intellectual life and practical affairs was slight compared with that of his English rival......

Schumpeter knew that his rival’s work had far greater influence. His critical essay on Keynes in History of Economic Analysis both displays his bitterness and identifies the reasons for Keynes’s greater success. Schumpeter expresses genuine admiration for the courageous publication of The Economic Consequences of the Peace. Keynes was, Schumpeter recognises, a natural leader who gave others confidence and inspiration.

Schumpeter would observe of himself: “I singularly lack the quality of leadership – with a fraction of my ideas a new economics could have been founded.” That new economics did not happen. There would be a Keynesian school, a Keynesian economics, but no Schumpeterian school, and really no Schumpeterian economists.

As for the contest between Friedman and Galbraith, in terms of lasting impact, there was no contest- Friedman has won hands down.

In the generation that followed Keynes and Schumpeter, John Kenneth Galbraith (born 1908) and Milton Friedman (born 1912), were the two most prominent public intellectuals among economists. If Schumpeter is more admired than read, Galbraith is more read than admired.....

Like Schumpeter, Galbraith never had time or inclination for the university and the gift for dry, academic observation which was his stock in trade was best deployed in perpetual opposition. If Schumpeter lacked qualities of leadership, Galbraith chose not to exercise them.

The method of dissemination of the Chicago school (led by Friedman) was similar to that of the Keynesians: a relatively simple ideological message for communication to the world outside; a new, difficult, yet extensive theoretical framework; and a dedicated band of supporters who would entrench the doctrine in other economics departments.

What about Amartya Sen, Joseph Stiglitz and Paul Krugman, today's reigning gurus?

Sen is, in a natural sense, the Schumpeter of our times. He shows a breadth of erudition and subtlety of mind unparalleled among other economists. But, like Schumpeter, Sen is an isolated figure. There will be no Sen school. Nor, it would seem, will there be a school of Stiglitz: a generation of students looks for a counterweight to Chicago, but the school’s potential leader has not found the application to develop a coherent and comprehensive critique that such a leadership role would today require, or the aptitude or inclination for academic
politics. And the dissonance between Paul Krugman as polemical columnist at The
New York Times, and his professional work at Princeton, seems too great.

"Solutions" to the market crisis

You may not guess it from the buoyant state of the Sensex but international markets are still gripped by fear and uncertainty. There are some who believe that the most obvious solution- interest rate cuts effected by central banks- will not suffice, although central banks, and especially the Fed, have been careful in using this instrument.



I see two other solutions being tossed around:

• Fiscal intervention, that is, government bail-outs of distressed institutions, not just banks. This is based on the premise that interest rate cuts will not be adequate. In the US, the government-backed agencies such as Fannie Mae have been asked to step in to save mortgage institutions.


• A rescue of distressed institutions by private banks and investments a la the rescue of the hedge fund LTCM in 1998. An article in FT proposes the creation of something akin to an asset reconstruction corporation for various credit instruments for which there is no market at present.

What do we make of these solutions? First, I don't believe that the situation is so bad that fiscal intervention will be widely required. As for private institutions doing a rescue act, don't forget that LTCM was rescued under "moral suasion" exercised by the Fed, it wasn't entirely voluntary. For banks to do so now, they would have to be convinced that this is a profitable exercise. As the FT article makes clear, there is a problem in making this determination: it's very hard to put a fair price on many of the distressed credit assets.

I don't see private banks, accountable to shareholders, undertaking this task. The first order of business, really, is for all concerned parties, to come clean on their distressed exposures. Only then can central banks get a fix on the magnitude of the problem. Central banks must make liquidity available. Some banks may have to be bailed out.

That's about it. For the rest, we should wait for some of the panic to subside- and like grief, it will over time. Then, private parties will swoop on attractively valued distressed assets and the clean-up will begin. There is enough capital sloshing around to do this job. Governments are not required to do this. And private firms need not be mandated to do so.

As you can see, I'm rather more optimistic about the resolution of the present uncertainty than many others.

Analysts back in favour !

Analysts were in the doghouse after the American stock market bust of 2001. There were sweeping changes in the leading investment banks relating to research (including the much-trumpeted separation of analysts from investment bankers). Now, the Economist reports, analysts are back in demand. For various reasons:

• In bad times, analyst calls and research in general are more valued than in good times- in good times, everybody is just focused on piling on to the usual stocks.
• Analysts performance is better monitored and rewarded at investment banks with bold (and correct) calls earning high bonuses.
• Quantitative models have performed badly of late leading to a revival of "fundamental analysis".

The Economist contrasts the improved performance of analysts with the miserable performance of the rating agencies.

The audacity of some analysts stands in contrast to the spinelessness of Moody's and Standard & Poor's, which showered complex structured products with top-notch ratings and then twiddled their thumbs until they could no longer avoid downgrading them. By growing too cosy with their paymasters in structured products—the banks that package them—the rating agencies have ended up hopelessly in knots. A bit like equity analysts during the dotcom boom, in fact.

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Chinese firms vault to the top!

The dizzying rise of the Chinese stock market has propelled Chinese firms to the top in terms of market capitalization, according to the Economist.

China has three companies now in the world's top ten- Industrial and Commercial Bank of China, Petrochina and China mobile. All but two of the rest are American. ICBC has overtaken Citigroup as the world's largest bank.

The Economist, however, sounds a warning:

In 1989, just before its bubble bust, six of the world's ten biggest banks were Japanese. Look at what happened to them.

Defining the 'basic structure' of the Constitution

'Judicial overreach' has become a vexed issue for the political class and even those outside it will agree that the judiciary sometimes goes overboard in its activism. More than anything else, the Supreme court's ruling in 2007 ( IR Coelho vs state of Tamil Nadu) has the potential to create big waves on this subject.

In that case, the SC ruled that the power of judicial review extends to the Ninth Schedule of the Indian constitution. Under the Constitution, as amended in 1951, legislations inserted into the Ninth Schedule cannot be challenged on the ground that they violate the fundamental rights of the Constitution. In the 2007 ruling, however, the SC pronounced that it had the power to review legislations in the Ninth Schedule if they violated the 'basic structure' of the Constitution. The doctrine of 'basic structure' was propounded by the SC in the now famous Kesavananda Bharati case in 1973.

In the EPW (August 4-10), Madhav Khosla notes that following the ruling in the Coelho case in 2007, it is now open to the SC subject all legislations incorporated into the Ninth Schedule post April 24, 1973 to judicial review. One immediate implication, as others have pointed out, that the provision of quotas upto 69% in Tamil Nadu can now be challenged.

Khosla believes that, given the record of judicial activism in the recent past, such 'unbridled power of judicial review' is not desirable. He suggests that the SC clearly define what it means by 'basic structure' instead of preferring to apply the test of 'basic structure' on a case by case basis.

I am no legal expert but I doubt that it is possible or desirable for the SC to define the 'basic structure' to encompass all possibilities. Situations could arise that are incompatible with the spirit of 'basic structure' but that had not been taken into account in any definition. It is far more preferable for the courts to exercise judicial restraint and, of course, to push ahead with proposals to usher in greater accountability in the judiciary in general.

Was Jinnah secular?

I suppose this is one of those questions that will be never settled like the one about partition being inevitable. People will keep coming up with answers based on whatever new information is unearthed.

In EPW (August 11-17), Pervez Hoodbhoy tries to answer the question: was Jinnah only in favour of a Muslim majority state (where non-Muslims would have equal rights) or did he want an Islamic state?

Much is made of two speeches where Jinnah is seen as expressing himself against a theocratic state. However, sifting through Jinnah's various pronouncements at other times, the charitable conclusion that Hoodbhoy comes to is that Jinnah preferred to maintain ambiguity on the subject. He was not beyond declaring that Pakistan would be governed by the fundamental principles of the Shari'ah when it suited him.

Hoodbhoy contends that Jinnah's ambiguity was aimed at retaining leadership in Pakistan- had he been entirely forthright in his views, he may not have been able to do so. More interestingly, Hoodbhoy argues that even if Jinnah favoured an Islamic state, that would not be saying much given that the true nature of the Islamic state has been highly contentious in history.

I am surprised that Hoodbhoy does not state the obvious. Having propagated the two-nation theory, it would have been difficult for Jinnah to argue wholeheartedly in favour of a secular state. If such a secular state was possible, why create a separate nation in the first place?

Hoodbhoy concludes:

He (Jinnah) certainly did not want a theocracy or a Taliban state, nor
one in which the non-Muslim minorities would be persecuted and harassed (as they are today). But Jinnah's statements at different times and circumstances are far too widely spread out to conclude anything substantial beyond these
truths.

An exit tax for IIT/IIM products?

I wouldn't have thought brain drain would be a big issue today, seeing that we are seeing a modest return of highly qualified NRIs. Apparently, it is.

Outlook magazine has a story on the parliamentary standing committee of the HRD ministry considering an "exit tax" or IIT/IIM graduates leaving the country:

The panel's report, submitted to Parliament last week, has sparked off a heated debate within government and academic circles. Some feel students who enjoy the benefits of a highly subsidised education should serve the country—or be penalised. Others find the proposed tax impractical, impacting only poorer students who may be unable to pay up even though they get lucrative job offers or scholarships from abroad.

............ an IIT graduate pays Rs 40,000 per annum as fees while the state spends nearly Rs 1.50 lakh on him for the period. The state subsidy for an IIM student is higher at Rs 3.5 lakh per annum. Interestingly, almost a year before passing out, students from these premier institutions are wooed by companies with annual salaries of at least Rs 6 lakh—it's higher for those going abroad. So, isn't the state fair in asking for its share, runs the argument.

These arguments are not new. But the implementation issues have been formidable. At what point is the tax to be collected? Is a candidate expected to make a declaration to the Income tax department that he or she is an IIT/IIM product and leaving the country and, therefore, wishes to have a clearance certificate? What if the compensation is understated? Is the passport supposed to carry a stamp saying the candidate is from IIT/IIM? In the case of fresh graduates leaving immediately after graduation, they may not have the resources to pay the tax. So, are they expected to raise a loan? Will banks provide loans to departing individuals? And what about graduates who return after a few years' experience? Are they eligible for a tax refund? And why only IIT/IIM products?

Get the idea? The more you think about it, the more you realise the problems in implementing such a scheme. And what would the total collection amount to? Would it serve any purpose other than satisfying some people that a 'penalty' has been imposed on those betraying their 'lack of patriotism'?

I must mention here that there is already a means available to the IIMs to recover some of the subsidy incurred on their products. There is a fee that is levied on recruiters and the fee has risen steeply for foreign recruiters. Perhaps, this can be jacked up even further. The graduate does not pay out of his or her pocket but the institution does recover some of the subsidy. The calculation of the subsidy itself is a vexed issue and there is reason to believe that the figures tend to be inflated.

Some of those interviewed by Outlook think the answer is to phase out the subsidy through higher fees. That is clearly not the way to go, in my view. The IIMs accepted this when they agreed to take care of a portion of the costs of those coming from families with an income of less than Rs 2 lakh. Any increase in fees at the IITs and IIMs will mean an increase in fees in all other institutions and this will undoubtedly go against the idea of greater inclusion in higher education. It will not just not fly with the political class- so forget about higher increase in fees.

I also think that we can afford to be a little more relaxed about the issue of 'brain drain'. Indian professionals who go abroad contribute in various ways: they send remittances, they create networks between foreign firms and Indian firms, they play a role in getting foreign firms to invest in India and, over time, there is diffusion of the intellectual wealth they create abroad. So the "loss" on account of brain drain, it turns out, is not as high as was previously supposed.

Not least, the departure of these brains has not come in the way of India touching a growth rate of 9%- so what are we fretting about? Let me put it this way. When India was trapped in a growth rate of 3.5%, we didn't do anything about the emigration of highly qualified professionals. It does seem a little odd to think of an 'exit tax' at at time when the Indian economy is doing much better and professionals are also thinking twice about leaving.

I say: tax the recruiters through stiff fees at the campuses- and leave it at that.