Fiscal fundamentalism

The pundits on TV made a big deal about the stock market going up on budget day- by about two hundred points. The market had gone actually declined in the run-up to the budget and, even otherwise, movements one way or another on budget day are of no great significance when the Indian market is so closely linked to global market trends.

The big item for the market was said to be fiscal consolidation. The pundits said this had compensated for 'big ticket' reform. Other than Manmohan Singh's first budget, there has been hardly any budget that measured up on this count, so you have to wonder what it is that pundits dream about. Leaving that aside, what do we make of the achievement on fiscal consolidation in Mukherjee's latest budget?

He has budgeted a fiscal deficit down of 5.5% in 2010-11, below the 7.9% and 6.9% of the two preceding years. Some of this is automatic- the pay commission arrears don't apply, farm loan waiver has got pruned. Then, there is the disinvestment effect and the sale of 3-G spectrum, some cutting of subsidies. But, the figure of 5.5% is lower than the Thirteenth Finance Commission's recommendation of 5.7%. Besides, nominal growth for 2000-10 will be higher than the budgeted 10.2% because of higher inflation, so the fiscal deficit will be lower than 6.9% and the deficit for 2010-11 will be even lower than 5.5%.

Is this appropriate when government needs to spend a lot more- on railways, roads, education, health care, irrigation, etc? We need to factor in rising government expenditure and we need to push for a higher tax/GDP ratio- we have just edged past 10%, which is lower than even the 12% we had in 2008-09. We need agriculture to grow at 4% if growth is to be truly inclusive.

Alas, there seems to be a sense that if get to growth of 9% and we meet FRBM targets, we have reached heaven. Not at all, we need 9% growth that is sustainable and inclusive- and these conditions will be met only when agricultural growth is boosted and when we spent a lot more on the social sector. Fiscal consolidation should not be confused with fiscal fundamentalism.

Purpose of business

Why does business exist? For many the answer is obvious: to make money or, let us say, profit. But this is not a definition that is operationally useful, quite apart from the fact that it's not seen as palatable. If you say profit, is it in the short-run or the long-run? And how much profit? 'Maximisation' of profit is again not operationally useful because businesses are all the time doing that may not maximise profit in any meaningful time horizon.

If we accept that in a competitive market, business cannot make super-normal profit, then business can only make profit that is equal to its cost of capital. That is why Drucker did not accept the idea of business existing to make profit. He defined the purpose of business as: to create a customer. Only this, he argued, is operationally defensible.

FT columnist, Michael Skapinker, introduces a slight wrinkle to Drucker's definition. He says businesses, no less than people, crave for respect. He says that is what banks lost in the present crisis although here he confuses respect with trust. He says businesses exist in order to make profit and serve customers by doing things they can be proud of. Here again, I sense some confusion. Pride, respect, trust are the means to profit and customers. Are they ends in themselves? Perhaps they ought to be. You can bring out your best in people when there is pride in what they are doing.

So, here is a plausible, alternative definition of business purpose: creating customers and making profit so that people who do these things have a sense of pride and well-being. In this definition, you place the employee at the centre of things, not the customer or the shareholder. But this can only be a start. How do we tackle the measurement issues?

Don't overdo fiscal consolidation

That's the title of my latest ET column. Yes, fiscal consolidation must happen but thee's no need to rush it until a full recovery has taken place.

In the long run, we need to take a fresh look at what level of consolidation of desirable.First, we need an accutate target for the fiscal deficit, one that factors in the off-budget deficit elements as well. Secondly, the target needs to be realistic- it must take into account the very real expenditure needs that will arise in the years to come, the prospect of the Indian economy moving onto a growth trajectory of 8-9% and the ups and downs of business cycles.

My sense is that the present limit of 3% for the fiscal deficit/GDP ratio, each for the centre and the states, is not realistic.

Return of the traditional bank?

FT carries a profile of Handelsbanken, an old style Swedish bank, that is expanding in the UK branch by branch. It has 62 outlets as of today. Two things make the bank stand out:

• Its belief in the traditional branch banking model, focused on the retail branch. This means key decisions are taken by branch managers, not by the central office, and customers contact the local branch, not some call centre.
• Its belief in organic growth rather than growth by acquisition.

Its CEO, Per Boman, refutes any suggestion that the branch model is uncompetitive:

Conventional wisdom suggests such a bottom-up approach should be more costly to run than the standardised, mass market operations of bigger banks. Mr Boman insists that the opposite is true and points to returns on equity and cost-to-income ratios that compare favourably with peers. “It’s not branches that cost money, it’s the headquarters,” he says

There are lessons here for Indian banks. Many public sector banks have moved away from their
their branch model and towards centralised processing- in essence, apeing ICICI Bank. But ICICI Bank was a late entrant with limited branches and it needed to do something different to quickly attain scale. For PSBs to imitate this made little sense. Anyway, ICICI, under its present CEO, has declared that it will revert to a focus on branches. So what do PSBs intend to do?

Secondly, be extremely wary of growth by acquisition- a point I have made ad nauseum in this blog. Managing and digesting acquisitions is a tall order. It requires very high managerial capabilities, which many PSBs may not have. There is also profound truth in what Boman says about bank acquisitions:

“It’s more or less impossible to find a quality bank at a discount price. And we do not think bad banks are cheap enough.”

Slow going for NATO forces in Marjah

Operation Moshtarak ("togetherness"), Nato's most ambitious military operation in Afghanistan to date, has run into rougher weather than thought. The operation is intended to clear Marjah city in Helmand province of the Taliban. Four days into the operation, the Nato forces control only a small portion of the 155 sq mile area.

The city's total population is 80,000. Nato has committed 15,000 troops, including the famed US marines. But, with all their firepower and air back up, they have not found the going easy. The invading force has been surprised by the tactical skill and training of the other side. Moreover, the Taliban has thus far not lived up to the assumption that he will melt away in the face of the onsalught. The insurgents have shown a determination to stand and fight.

FT's correspondent has an exciting eye witness account:

Marine commanders remain optimistic that their initial efforts at establishing bubbles of security around key commercial areas will have a catalyzing effect on the population and will result in residents identifying Taliban fighters, bomb locations and arms caches.

Thus far, however, most residents seem to be opting for a wait-and-see approach. Most roads used by the Marines have been devoid of people, save for a few curious gawkers. The bazaars are similarly abandoned, some so hastily that merchants left their onions and potatoes sitting atop wooden carts.

Diluting RTI

Looks as though the government is determined to dilute the provisions of RTI. Amendments to this effect are being contemplated, Outlook reports:

The DOPT proposed seven amendments, including the addition of a clause that would define some applications as “frivolous and vexatious requests”. If introduced, this will give the public information officer liberty to reject applications. This, crucially, would increase the workload of the commissions, where final appeals are heard. The other worrying proposal is to have a bench of two commissioners for every appeal. With commissioners struggling with the present workload, this will ensure further delay. Barring two information commisisoners, all rejected these amendments outright.

You can be pretty sure that information officers will use every opportunity to dub applications as "frivolous and vexatious". The applicant will have to appeal to the CIC, which involves a fair bit of work and, these days, a long wait. This would be the bureacracy's way of denying justice- delaying justice to a point where the appellant simply gives up.

Yes, we could have a provision for "frivolous and vexatious" requests provided that the CIC is empowered to impose punitive fines where the contention is rejected. The penalties for non-compliance with the RTI provisions today- Rs 250 per day subject to a maximum of Rs 25,000- are too trivial to have any bite. Even these small penalties are challenged by large organisations in courts of law- after all, the legal expenses are borne by the shareholder, not management.

The RTI is one of the great initiatives in our post-independent history and it has the potential to transform Indian democracy for the better. Here are some suggestions to make the RTI Act more effective:

• Increase the penalties to levels where they become a deterrent- there could graded penalties in the range of Rs 1000- Rs 10,000 per day
• Impose compensation where the appellant has suffered on account of non-provision of information and also get the institution to reimburse costs of travel when it loses the case
• Make it mandatory for management of organisations to report violations and rulings against it to the Board or to the appropriate higher authority.
• Where an organisation accumulates more than a certain number of rulings against it in a specified period, impose substantial penalty

Pune blast: Al Qaeda arm claims responsibility

I haven't seen this reported in our papers yet. Asia Times online reports that 313 brigade, an arm of Al-Qaeda has claimed responsibility for the recent Pune blast. Asia Times received a message that read:

“We warned the international community to play their role in getting the Kashmiris their right of self-determination and preventing India from committing brutalities in Kashmir, especially in Badipuar, raping the women and behaving inhumanly with Muslim prisoners.

“We warn the international community not to send their people to the 2010 Hockey World Cup, IPL [Indian Premier League - a cricket competition involving international players] and Commonwealth Games [to be held in Delhi later this year]. Nor should their people visit India - if they do, they will be responsible for the consequences.

"We, the mujahideen of 313 Brigade, vow to continue attacks all across India until the Indian Army leaves Kashmir and gives the Kashmiris their right of self-determination. We assure the Muslims of the subcontinent that we will never forget the massacre of the Muslims in Gujarat and the demolition of Babri Masjid [a Muslim mosque destroyed by Hindu militants in 1992]. The entire Muslim community is one body and we will take revenge for all injustices and tyranny. We again warn the Indian government to compensate for all its injustices, otherwise they will see our next action.

"From 313 Brigade"

America's Af -Pak strategy

The US vowed revenge following the daring suicide bomb attack that killed seven CIA operatives in Khost in Afghanistan. They were true to their word. Taliban commander Hakimullah Mehsud was taken out in a drone attack.

The Americans had been after Mehsud for a while. They did not have any luck. If they succeeded recently, it must have been because of high-quality intelligence. That could have come only with the cooperation of Pakistan's security apparatus. It must have been one of those situations where, as they did following 9/11, the American told the Pakistanis: deliver or else.

If this is what happened, then American resolve and the tacit Pak cooperation do suggest that, perhaps, talk of America planning an exit at all costs, following the London conference on Afghanistan is overdone. That is because the implications of a Taliban takeover of Afghanistan are far too serious for the region- and for the US itself. The recent US-led offensive on Marjah city in Helmand province, which involves 15,000 troops, suggests that the US is not inclined to follow the line of least resistance in Afghanistance. Rather, it wants to neutralise and stabilise before it exits.

Security expert K Subrahmanyam believes that there is some misreading of US intentions and is reluctant to take the view that US will just cut its losses in Afghanistan and run:

Professional analysis of the Obama strategy will focus on what will happen in the next three months as the surge gets completed and the forces take action, instead of being obsessed with the beginning of the withdrawal some 18 months later. The latest US QDR says, "The first (objective) is to prevail in today's wars" in Afghanistan and Iraq the first time this objective has been stated in a QDR. "America's ability to deal with threats for years to come will depend...on our success in the current conflicts." In other words, the US doesn't have the option of losing the war and withdrawing from the Af-Pak area.

..........CIA director Leon Panetta said one of the greatest concerns was a possible al-Qaeda attack on the US in the next 3-6 months; the threat was the prime reason the US has undertaken to dismantle terror infrastructure. A media report recently suggested that the US National Security Council has downgraded the intelligence priority of China. The speculation is that intelligence effort is concentrated on Af-Pak. In his State of the Union speech, Obama, referring to the war, said he was no quitter. He has designated five terrorist organisations as enemies to be dismantled, disrupted and defeated. He has also warned that, when actionable intelligence is available and Pakistan does not act, the US will do so.

Fighting corruption with notes

In Tamil Nadu, an expat physics professor has come up with an unusual way to fight corruption: handing out phoney R 50 notes with a photo of Gandhi, the Economist reports:

The idea was dreamt up by an expatriate Indian physics professor from the University of Maryland who, travelling back home, found himself harassed by endless extortion demands. He gave the notes to the importuning officials as a polite way of saying no. Vijay Anand, president of an NGO called 5th Pillar, thought it might work on a larger scale. He had 25,000 zero-rupee notes printed and publicised to mobilise opposition to corruption. They caught on: his charity has distributed 1m since 2007.

One official in Tamil Nadu was so stunned to receive the note that he handed back all the bribes he had solicited for providing electricity to a village. Another stood up, offered tea to the old lady from whom he was trying to extort money and approved a loan so her granddaughter could go to college.

Well, one is all for any initiative that can make a difference. But, one should be careful not to get carried away. Such strategms may work in the case of petty corruption. For bigger things, alas, only genuine notes will do. Remember, also, that the biggest forms of corruption do not involve handing over notes, they are all about transfers to Swiss banks, giving contracts to firms run by the kith and kin of corrupt officials and politicians and so on. There is not even a theoretical possibility of fighting the real thing with tokens.

In defence of business

Business has got a bad name in recent years thanks to the collapse of financial firms and, earlier, the jailing of celebrated business leaders, such as the CEO of Enron. Businessmen defend themselves with two arguments: they have concerns that go beyond business; and they have done much to advance prosperity.

Not enough, says the Schumpeter column of the Economist. The columnist advances three better arguments in defence of business:

The first is that business is a remarkable exercise in co-operation. For all the talk of competition “red in tooth and claw”, companies in fact depend on persuading large numbers of people—workers and bosses, shareholders and suppliers—to work together to a common end......

....Another rejoinder is that business is an exercise in creativity. Business people do not just invent clever products that solve nagging problems, from phones that can link fishermen in India with nearby markets to devices that can provide insulin to diabetics without painful injections. They also create organisations that manufacture these products and then distribute them about the world.

.... A third defence is that business helps maintain political pluralism. .............Companies have a difficult enough job staying alive, let alone engaging in a “silent takeover” of the state. Only 202 of the 500 biggest companies in America in 1980 were still in existence 20 years later.

These are all plausible defences. But, it would be idle to suppose that hostility towards business exists only amongst common folk, including those who are not employed by large businesses, or by the political class. Business- or, rather, businessmen or top management- today lack legitimacy within their own firms. Many are not liked or even respected by their own employees.

One reason could be that top management walks away with a disproportionate share of pay- inequality within firms has widened in recent years. Another is that so-called improvements in efficiency come at the expense of those down the line, in the form of lay-offs or reduced benefits. Thirdly, for all the talk of empowerment and enfranchisement, management and businessmen are seen as highly autocratic

Goldman Sachs bonuses

Goldman Sachs CEO lloyd Blankfein has settled for a bonus of $9 mn this year, way below the $69 mn he made in 2007 and the $100 mn that he could have claimed but for the tide of popular anger against bankers. The firm chose to keep its bonus pool at around $16 bn which works out to $500,00 per employee. The earlier betting was that bonus plus salary would hit the $1 mn mark.

The top five employees of GS will all get $9 mn but others down the line are taking home more. But I think it's the top execs pay and the total bonus pool that matters from the PR angle- and my sense is that what GS has done has calmed down tempers a bit or at least kept them from spiralling out of control.

Not that CEO Blankfein will starve- as one commentator puts it, his bonus is down to the utterly enormous from the utterly obscene. And one doesn't exactly see a flight of talent of GS or elsewhere because of the reduced bonuses.

SBI's technological razzle-dazzle

I was in Mumbai last Sunday to attend SBI's 'Technology concert'. It was intended to celebrate SBI's achievement in core banking- some 9000 branches connected, said to be the largest in the country, and accomplished with the collaboration of TCS and Cisco.

The event itself was a technological achievement. It was held at Brabourne stadium, with around 600 invitees. Even in the dark, I could spot several bigwigs of business and finance. The show was conducted against a screen that ran for several hundred feet, the largest screen ever put up in Asia, I was told. The screen as well as the rest of the area were packed with hardware. The event was heralded with spell-binding fusion music, followed by various luminaries and SBI officials coming on screen tell us what it took to get the core banking job done.

SBI chairman O PBhatt himself anchored the event. There followed a panel discussion figuring Mukesh Ambani, Sunil Mittal, Mohandas Pai, S Ramadorai, Jeffrey Sachs and the India head of Cisco. Pranab Mukerjee delivered the chief guest's address.

Next, the stage and sky alike were lit up by a laser dance. This was followed by an electrifying Kathak dance performance by Shovana Narayan and her troupe. The execution was immaculate throughout and the effects terrific- great acoustics, fantastic colours lighting up the screen and huge flames popping up all over the stadium.

It was the sort of thing one associates with Filmfare awards nite or the Oscar awards. Certainly not something one would associate with the public sector. If the intention was to demonstrate SBI's technological prowess, the message could not have been better conveyed.

Reining in large banks

The contours of Obama's plan to deal with the problems posed by large banks are slowly taking shape. Three elements have been spelt out:

• A levy of 0.15% on banks with assets of more than $50 bn
  
• Keeping banks out of proprietary trading on their own account, hedge funds and private equity
• Limits on bank size other than the present restriction of 10% of deposits

What will be the impact on bank size of all these put together? For now, US officials say it will prevent banks from growing larger. But that is just the immediate effect. When banks find they cannot grow earnings by growing bigger, that increases the incentive to sell off some of the assets and shrink. It also creates incentives against consolidation in banking.

So, yes, a modest beginning has finally made towards serious reform of banking instead of just increasing capital requirements. My own preference is to have regulatory limits on bank assets- say, 5-10% of GDP. We may get there eventually at the present rate but I would go for it without too much delay.

Secondly, I think it may not be advisable to ask banks to eliminate risky activities such as hedge funds and private equity. Instead, we may be better off setting exposure limits. More on all this in my ET column, At last, the remaking of banks?

India's unemployable engineers

India produces more engineers every year than the US but that's not necessarily a matter for rejoicing. A large number of Indian engineering graduates are unemployable, according to a report in the Economist, which quotes a study done by an Indian firm, Aspiring Minds:

According to the company, only 4.2% of India’s engineers are fit to work in a software product firm, and just 17.8% are employable by an IT services company, even with up to six months’ training. A larger share could cope in business-process outsourcing (call centres and the like). These findings are even gloomier than the 25% figure for employability that has been bandied about since 2005, when McKinsey released the results of a survey of international companies.

For this reason, Indian firms, including IT firms, find it convenient to confine their recruitment to the top 100 colleges. But this is a soft option and one that cannot help meet Indian firms' huge demand for engineers in the coming years. The challenge is to locate the small percentage in the large pool of engineers outside the top 100 colleges that is fit for employment. Apparently, Aspiring Minds has developed standardised tests that helps locate that small percentage.

If this works to the satisfaction of employers, it will be a huge gain. There is only so much extra capacity you can create in higher education. We have to make the best of the existing capacity- locate the quality in a large pool. Next, firms must invest in training. We see this happening already in banking and insurance where, again, the demand for people is going to be huge. Waiting for colleges to produce graduates who are readily employable will mean a long wait indeed.

Management consultants and the public sector

The Schumpeter column in the Economist has interesting thoughts on the role of management consultants in the public sector. Can they contribute? The evidence is damning:

They have frequently left devastation in their wake and have treated the public sector as dumping grounds for airy-fairy ideas such as “transformation” that have been rejected by the private sector. They have built overly elaborate management structures that make it harder for people to do their jobs. And they have demotivated people who like to feel that they are working for the public good. The government has wasted huge amounts of money on botched IT projects designed by consultants. The worst example, a £12.7 billion project (in the UK) to improve the health service’s systems, has now been partially abandoned; but the Ministry of Defence is still struggling with a project that is currently £180m over budget.

But Schumpeter finds some virtues in the public sector using them:

Civil services are congenitally inward-looking organisations, led by people who are plucked from elite universities and shielded from the rest of the world in government palaces; it helps to expose them to innovations from the private sector. The private sector routinely introduces reductions in costs and improvements in performance that are almost unknown in the public sector....

......the people who are ultimately responsible for the debacles are not the hired hands but their political masters. Gordon Brown and Tony Blair were suckers for flashy but insubstantial ideas about transformation. Lower-level politicians were lazy managers. In 2006 the National Audit Office provided a devastating list of ways in which the government had failed to make the best use of consultants—ranging from failing to appreciate what could be achieved with their own staff to refusing to learn from what the consultants were telling them.

I think it's important to identify where management consultants can be useful. In specialised areas, such as IT and improvements in efficiencies in particular operations, yes, they could be useful. But, giving them a broader mandate- putting in place performance measures or incentives in government, judging the necessity of particular tasks in government- would be ill-advised. That is because the ethos of the public sector is fundamentally different from that of the private sector and it is difficult for those with a private sector orientation, such as management consultants, to appreciate the difference.

On a broader note, I would be wary of relying on outsiders for solutions. There are plenty of ideas within organisations, including government, but you have to provide opportunities for these to surface. Once a set of ideas is available, it may be useful to get an outside assessment of which make more sense.