Wednesday, July 23, 2008

Reforms? What reforms?

Now that the UPA government has survived, there is the usual babble about "pushing ahead with reforms". What reforms are people talking about? Can you imagine any government cutting subsidies or changing labour laws in the run-up to elections?

Many reforms require legislative approval and are time consuming. Unless the market rally continues, disinvestment may not be attractive. Not least, the government cannot move an inch if any measure offends one of the numerous small groups whose support it garnered in order to survive.

Even the survival of the government for long cannot be taken for granted. So, talk of a burst of reforms that will lift the stock markets is just hot air. What will lift the markets is the decline in oil prices (which I had predicted) and a return of net FII flows later in the year.

More on the prospect for reforms in ET's debate last Tuesday.

Mayawati gains in stature

One unintended consequence of the PM's insistence on seeing through the nuclear deal is the emergence of Mayawati as the head of a Third Front and contender for the PM's job sooner than most people had thought.

It's fair to say that opposition to the deal came mainly from the Left and Mayawati. The BJP and many of its allies would gladly opt for the deal with some minor changes- or that's the impression they have created. The BJP's lack of determination to topple the UPA also registered- witness Advani's statement in the course of his speech in parliament that the NDA wanted to defeat the government, not destabilise it.

Mayawati made two important points about the nuclear deal: one, it increased the chances of a US attack on Iran with all its implications for India; two, an attack on Iran would see oil prices shooting up further and worsening the suffering of the poor. It does appear that she is carving out a distinctive position for herself. The constituency she is targeting- dalits, upper castes,muslims, the economically backward- is the one that kept the Congress in power for decades after independence. Both the UPA and the NDA have cause for worry.

Monday, July 21, 2008

Why did UPA want a "Confidence" vote?

Tomorrow is D-day. We will know whether the UPA government stays or goes.

I am little puzzled, though, as to the rationale for a "confidence" vote in parliament. As far as my understanding goes, a party or a coalition is required to prove its majority only when it stakes its claim to government and there are doubts that it has the necessary numbers. Then, the president may ask the leader of the coalition to demonstrate its majority on the floor of parliament.

At any other time, it is for the opposition to move a "no confidence" motion. In the present instance, after the Left parties withdrew support, the onus was on them or the other Opposition parties to move a no-confidence motion. At least in constitutional terms, it is not obvious that Congress and the UPA needed to seek a vote of "confidence".

The PM assured parliament that he would seek its approval for the nuclear deal. The right course for the UPA would have been to table a motion on the nuclear deal and seek parliament's approval. The UPA should have done this before approaching the IAEA with the safeguards agreement. Even if the motion had been defeated, the government could have carried on- only a defeat on a no-confidence motion requires the government to quit. The Left would not have had a problem with the UPA government even if the motion was defeated- after all, its opposition to UPA centres on the nuclear deal.

So, why did the PM and the UPA not do the obvious thing? Why seeek a vote of confidence? Was it because they feared that a motion on the nuclear deal itself may not have a great chance of going through? If so, the only way to ensure the success of the deal would have been to stake the survival of the government itself. Then, all members of the UPA and others as well would have had to choose - between the survival of the government and, perhaps, the present parliament and fresh elections. Confronted with such a stark choice, there was a better chance they would back the government- and the nuclear deal.

If the UPA government survives and goes ahead with the nuclear deal, all this may seem clever politics. But it carries with it a heavy price: a fall in standards in politics to new lows and a badly divided nation. The nation would have been better served had the government done what it had promised- come to parliament solely for its approval of the nuclear deal.

Monday, July 14, 2008

What were bank boards doing?

What were bank boards doing as the sub-prime crisis built up? What penalties do they face in banks that has suffered huge losses. Many CEOs have lost their jobs; not many directors have. One fact that took away my breath was mentioned in an FT report: nearly two thirds of bank boards were bereft of banking expertise.

So, who typically sat on these boards? Well, the mighty and the respectable, ex-CEOs of manufacturing firms, faces and names that have wide recognition. Is that good enough? I don't think so. I think it makes sense to have a minimum of finance and banking expertise on board boards. Here, India's Banking Regulation Act gets it absolutely right: at least 51% of board members must have expertise in specified areas: banking, economics, agricultural, small enterprises, etc.

The RBI also has norms for bank governance over and above the norms applicable to listed companies under clause 49. This is entirely appropriate: in many other countries too, governance for banks tend to be stiffer than for other firms or there are separate norms for governance for banks and for other companies.

Is having expertise on boards an insurance against failure? Not at all. Boards are limited by the information that management presents to them and the form in which these are presented. So, the best-intentioned boards may proved ineffective. But there is a more fundamental reason why boards are not as ineffective as one might like.

Most boards are clubby affairs. Those invited to serve as "independent" directors are pals of the CEO, they brush shoulders in the same watering holes and they are often retired people who value the handsome fees that many companies pay these days.

The atmosphere in boards is that of a mutual admiration society. CEOs pay ritualistic obeisance to the "sage guidance and wisdom" of boards in their annual statements- one retired CEO, whom I respect, told me there was not an iota of truth in this. Boards compliment management on their stewardship. Over sumptuous lunches and equally sumptuous snackes, top management and directors share jokes and anecdotes, there is a general air of conviviality. I mention this because, in this atmosphere, it is not done for an independent director to probe or to question. Bad form, old chap.

So, having expertise on bank boards is not enough. We need to ensure that there are enough directors who are independent of management, that is, they are not beholden to the management for their positions. This can happen only if financial institutions with equity stakes in the company and minority shareholders can directly elect a certain number of directors. The present concept of "independent" director, whereby management invites outsiders on to boards, is something of a farce. Alas, I don't see such a revolution happening in the near future.

More on this in my ET column, Banking's governance disaster.

Monday, July 07, 2008

Rating agencies - only a light rap?

Moody's confession of a botched $1 bn securities rating, thanks to a computer bug, is only latest in a series of woes for the ratings industry. Let's face it- rating agencies are not the most popular species in the financial sector today. They had eggs on their face after the East Asian crisis; they seem to have gone and blown it again in the sub-prime crisis.

But it appears the agencies will get away with a mild rap or two. The Economist reported last month that despite half a dozen agencies looking into their role in the recent crisis, the outcomes will be inconsequential: a commitment not permit 'ratings shopping' among clients; more transparency; more disclosure of the collateral; and the like. No fines, no crippling prohibitions.

I guess part of the reason is that it's hard to find an alternative- an independent rating agency promoted by government and funded by investors through the exchanges is a non-starter because governments getting into financial markets is the last thing people want.

The role of rating agencies is poised to get bigger with the implementation of Basel II because, for starters, most banks will rely on the ratings approach- this requires capital to set aside based on ratings assigned to borrowers by rating agencies. Basel II itself is under discussion now. I think there is a case for allowing the better banks to go with their own internal ratings instead of requiring them to go by rating agencies' ratings.

In India, I can't see that the better banks' rating of borrowers is likely to be of lower quality than that of the agencies- most banks, in any case, use the rating models supplied by the agencies and superimpose their own judgement. This probably makes more sense than banks relying entirely on the rating agencies.

Friday, July 04, 2008

Contrarian views on the nuclear deal

The debate on the Indo-US nuclear deal has been reduced to a test of patriotism. Those who who favour the deal want India to be a great economic power with the help of the US and are patriots. Those opposed to it have hang-ups about the US and are not averse to India falling behind China; their patriotism is questionable.

I have found this characterisation utterly puerile given the many nuances to this issue. Remember three top nuclear scientists in the country have come out with a statement expressing their reservations even now.

How refereshing, then, to come across two contrarian views on the deal on the same day. In an interview to Rediff, former diplomat M K Bhadrakumar makes a number of points:
  • The UPA government is guilty of breach of trust in pursuing the matter of IAEA safeguards without the concurrence of the Left. When the Left gave the go-ahead to the UPA government to negotiate safeguards with the IAEA last November, it was on the understanding that the agreement itself would later be discussed and approved by the joint UPA-Left committee on the subject. The Congress has gone back on this assurance.
  • There is lack of transparency on the safeguards agreed with IAEA- the government has not disclosed what these are.
  • The IAEA agreement, once signed, will be 'in perpetuity'; once this agreement is signed, the further course of the nuclear deal is out of India's hands. Even if the form of the NSG waiver is unpalatable to India, it is out of our hands.

In another article, Brahma Chellaney questions the current line that the deal is about reducing dependence on oil and opening up prospects for nuclear power. He points out that India's dependence on oil for electricity purposes is negligible- just 4% of all our needs. Oil is primarily required for transportation purposes whereas nuclear power plants are all about generating electricity! He goes on to blast the case for nuclear energy as a substitute for oil:

If global oil demand is threatening to outstrip supply, so is the case with uranium. Current concerns associated with oil’s price volatility, supply security and geopolitical risks are no different than uranium’s. And if global oil reserves are finite, so are uranium resources, with proven uranium reserves likely to last barely 85 years, according to the Red Book published jointly by the OECD and IAEA.

In fact, in the past five years, the international spot price of uranium has risen faster than that of crude oil, with uranium today trading six times above its $10 a pound historical average. Oil and uranium prices are likely to stay volatile, but the long-term trend for both is surely up. Just as cheap oil now seems fanciful, cheap nuclear power for long has been a mirage.

Chellaney is right. This deal is about a strategic alliance with the US to counter the rise of China, it is merely being presented as an energy proposition for political and diplomatic reasons. The real worth of the strategic alliance lies in the transfer of a whole range of advanced dual-use technologies- these technologies cannot be transferred unless India's status as a nuclear power changes.

The key question is: do we want the strategic alliance at the cost of surrendering some of our freedom of action in foreign policy and in the nuclear field? I do think there is a case for an open national debate and that there is no compulsion to be bound by some artificial time-table.