Discussion of my book RETHINC at Kindle Lit Fest

Kindle Lit Fest features my book RETHINC on October 27 at 5:45 -6:15 pm. Please feel free to join.

Why would Indian educational institutions want to go abroad?

Amity University plans to be in 50 countries in the next ten years, the Economist reports.  It has already set up shop in  America, Britain, China, the UAE, and Singapore.There are others such as BITS and Manipal University that have also spread their wings overseas.

Why would Indian institutions want to go abroad when there's a huge untapped market here? And surely, they can't expect to compete with foreign institutions for foreign students?

Well, here's the answer to the puzzle. These universities do not in general cater to the local market abroad. There are plenty of quality institutions overseas to take care of the local market. What the typical Indian institution does is cater to rich kids from India. These kids can't get into, say, Amity University in Delhi. But they can get into the same university in Dubai or Singapore. They are happy to cough up more than what they would pay in India and they either can't get into top schools abroad or don't want to pay the fees of foreign universities.

So, there's a perfect market segment arising from basically the Indian market. Why would Indian institutions not expand their institutions here and take in more students? Because that would dilute the quality of their products in India and affect placement and their brand image. Many do take in some via capitation fee or donations but, taken beyond a limit, this carries risks. Better to cater to Indian students who can't make it here by setting up operations abroad. Then you grow your revenues without compromising on quality in the domestic market.

I daresay this makes for a great case study in market segmentation and pricing.

Bloomberg interview

A Bloomberg crew landed up at IIMA the other day and did an interview with me on the Indian economy and Indian banking.

Nato hypocrisy on Syria

The US and its Nato allies have no strategy on Syria, they only have outrage over Russian actions. That's because a year's bombing by Nato has produced no results on the ground other than bringing Syria closer to disintegration. The reason is simple enough. Nato has been bombing ISIS and it has also been weakening the Syrian regime headed by Assad. Naturally, the outcome is a draw- and untold suffering for the people of Syria.

Enter Russia with a clear agenda, namely, to shore up Assad against all jihadists, ISIS, Al Nusra whoever. This is the only approach that can resolve the crisis in Syria, if at all.

Read this excellent article by a British military expert.

Putin's masterstroke- for now

I happened to watch CNN and BBC the other day and was transfixed by the press conference on Syria given by Sergey Lavrov, Russia's foreign minister to the press corps at the United Nations. It was a brilliant performance. Lavrov was polite, firm, combative and, above all, came across as principled and honest. It was the performance of a man who is a diplomat to his fingertips. 

Lavrov left behind a memorable quote on why the  Russians were not confining their bombing to ISIS and instead targeting some other groups:

If it looks like a terrorist, if it acts like a terrorist, if it walks like a terrorist, if it fights like a terrorist, it’s a terrorist, right?”

Yes, right, indeed. The US-led coalition's strategy of bombing ISIS while at the same time undermining the one force in Syria that can put up a fight against it, namely, the Assad government, has produced nothing but chaos and unimaginable suffering to the people of Syria. As Lavrov put it, the idea that if Assad were made to disappear, the fight against ISIS would be successful was not "serious". Lavrov's plea for "some honest journalism" was also appropriate- the western media's demonisation of Assad has simple not helped the cause of fighting ISIS. Nor its willingness to turn a blind eye to the western coalition's decision to undertake bombing in Syria without a mandate from the UN.

Russian president Vladimir Putin's spirited address to the UN helped place the Syrian problem in perspective:

We must look at the situation in the Middle East and Northern Africa already mentioned by the previous speaker. Of course, political and social problems have been piling up for a long time in this region, and people there wanted change. But what was the actual outcome? Instead of bringing about reforms, aggressive intervention rashly destroyed government institutions and the local way of life. Instead of democracy and progress, there is now violence, poverty, social disasters and total disregard for human rights, including even the right to life.
I’m urged to ask those who created this situation: do you at least realize now what you’ve done? But I’m afraid that this question will remain unanswered, because they have never abandoned their policy, which is based on arrogance, exceptionalism and impunity. 

Putin's decision to intervene in Syria- with aircraft, tanks and other arms to the Syrian government plus 2000 Russian military advisors- is, perhaps, the first decisive action we have seen in the bloody war. The intention is to help shore up the legitimate government in Syria, reduce opposition from terrorist groups other than ISIS and get the world to focus single-mindedly on the threat posed by ISIS. There are, of course, other objectives. Russia would like to maintain its foothold in the Middle East. It would like to project itself as a global power. And it would like to move western attention away from sanctions imposed in the wake of its intervention in Ukraine.  However, the primary objective undoubtedly is stem the chaos and suffering in Syria. To quote from Putin's address again:

We should finally admit that President Assad’s government forces and the Kurdish militia are the only forces really fighting terrorists in Syria. Yes, we are aware of all the problems and conflicts in the region, but we definitely have to consider the actual situation on the ground.
Dear colleagues, I must note that such an honest and frank approach on Russia’s part has been recently used as a pretext for accusing it of its growing ambitions — as if those who say that have no ambitions at all. However, it is not about Russia’s ambitions, dear colleagues, but about the recognition of the fact that we can no longer tolerate the current state of affairs in the world.

The US is mightily upset- President Obama has warned that Russia will get trapped in a 'quagmire'- but much of Europe has maintained an eloquent silence (with the exception of Britain's PM). Europe is being swamped by refugees from Syria. It has every interest in any action that carries the promise of stemming the inflows into Europe.

There are, of course, imponderables in the situation. If the US and its allies in the Gulf were to attempt to shore up the non-ISIS opposition to Assad at all costs, the fighting would drag on interminably. Any extended intervention would pile up costs for Russia and any loss of Russian lives would erode domestic support for Putin. For now, however, Putin's decision to intervene is a masterstroke that holds out the possibility that Syria will not disintegrate as Iraq and Libya did.

What explains RBI's surprise rate cut?

The RBI's rate cut of 50 basis points was a huge surprise to everybody. I would have thought the market reaction would be ecstatic. It hasn't quite been that although the market indices have risen. I argued for a 50 bp cut in an article in the Hindu (Hemmed in by the safety net) on September 28 but did not expect the RBI to oblige.

So, what caused the RBI governor to change his mind?

Many analysts point to the global economy, the inflation rate being within the 6% target for January 2016 and the downward revision in the growth rate for India to 7.4%. And yet, none of these was seen as influencing the RBI in the run-up to the budget. It's also hard to buy the contention that the RBI has tilted in favour of growth: the governor is sticking to the glide path for inflation and is setting his sights on bringing inflation down to 5% by 2017. That being the case, the RBI would have been more comfortable delivering a cut of just 25 bp. Why a 50 bp cut?

My guess is that the steep cut has to do with the NPA and capital position of public sector banks. The woes of the steel industry have been added to those of the infrastructure sector and there's no let up in pressure on the NPA front. There's only so much additional capital the government can provide. However, banks are holding to excess SLR securities- around 29% of liabilities against the mandated 21.5%. A rate cut boosts the value of these holdings and gives capital gains to banks. This helps them make provisions against growing NPAs. In the process, the rate cut does provide  a stimulus to the economy and especially to retail credit.

If the market response has been somewhat tepid, it could be because it's hard to conclude that this is the beginning of a round of rate cuts. Instead, as the governor mentioned, the RBI has front-loaded rate cuts, delivered these at one go. It's unlikely that there is much more to look forward to in the year ahead, especially if the Fed rate hike comes through.

We need to get growth over 8%. It would have helped if the governor had reiterated his commitment to the 6% target for January 2016 and omitted any mention of a target for 2017. That he did not do so suggests that bringing down inflation further remains the priority.

Reining in megalomaniacal bosses

Power corrupts and absolute power corrupts absolutely. We've all heard Lord Acton's famous dictum. And we have seen it happening all the time, whether in politics or in a corporation. The trillion dollar question is: what do we do about it?

Many, if not most, management gurus think sermonising or indoctrination is the answer. Exhort managers to live up to "values". Train leaders to be  "caring". Tell those at the top that being "selfless' or "service-oriented" is the secret of true leadership. And so on. And how do we do this? Well, by talking about the "lessons in leadership" to be learnt from Gandhi or Mandel. Or the Gita and the Mahabharata.

In other words, the emphasis is on turning people at the top or those headed for the top into evolved souls. The entire leadership industry thrives on this sort of stuff. It's amazing how popular leadership programmes are. I guess that's because they generate a 'feel-good' factor in participants at least for a short while before reality catches up.

It should apparent to the meanest intelligence that this is a load of rubbish. If sermons could have created a better world, we should have had paradise on earth by now. I point out in my recent book, Rethinc: what's broke at today's corporations and how to fix it, that the whole idea that people get corrupted after they get into positions of power is a mistaken one. Would-be leaders have all the hallmarks of corruption before they get into positions of power. Leadership is acquired through the single-minded and ruthless pursuit of self-interest. It's acquired by discarding "values", setting aside compunction or guilt and focusing on the big prize that people get to the top (leaving aside a few exceptions). So, to expect leaders of corporations to be something different, once they assume power, is sheer delusion.

As Schumpeter puts it in a recent column in the Economist, there is a Donald Trump in every leader, meaning that egomania is to be expected at the top. The answer to that is not try to change leaders into something different- that would require some feat of genetic engineering. It is to take it as a given that leaders will have a dark side to their personalities and to create checks and balances that limit the damage they can do.

One common way is to split the post of chairman and CEO (and to make sure it's not the CEO who brings the chairman on board). Another, which I propose in my book, is to have independent directors appointed by different constituents: institutional investors, large lenders, employees, etc. A third is to foster dissent within the organisation by actively rewarding people who speak up. (The CEO may not like this but the board must find ways to do it). I propose the use of prediction markets as a way of letting diverse views influence decisions instead of having the big boss take all of them.

I also think term limits are a great idea. The US, by law, limits presidents to two terms. It doesn't matter how wonderfully a president has performed or how young he is.(Presidents in recent years have faded into retirement even before reaching their sixties). IIMA, by convention, limits the director to one term of five years.

Do not for a moment think that leaders can be changed into wonderfully balanced, compassionate people. Take it as a given that those at the top will tend to abuse their powers. Find ways to limit such abuse.

Central bank independence: India does better than Turkey and Brazil?

Well, that's what an article in the FT claims. Both Turkey and Brazil have inflation targeting as the objective of their central banks, as India does now. But both countries have missed their targets- thanks to political pressures, according to the article:

Recep Tayyip Erdogan, Turkey’s president, has repeatedly tried publicly to bully the central bank into cutting interest rates, calling its governor a “traitor” and evoking the peculiarly paranoid notion of an “interest rate lobby” that was damaging Turkey by demanding high borrowing costs.

In Brazil, the central bank is still part of the finance ministry, and its head is answerable to the president. Its governors are also appointed by the president and have no fixed terms. In last October’s election, Marina Silva, the Brazilian Socialist party candidate, argued strongly that the central bank had done too little to control inflation in an election year because of political pressure from Dilma Rousseff, the president.

In India, in contrast, the author contends, the RBI has managed to get on with its job of containing inflation, thanks to a determined person at the top. So it's best to leave inflation targeting to technocrats free from any political interference.

Well, matters are not that simple. Inflation targeting is not the norm amongst central banks. The Fed does not follow inflation targeting nor does the Bank of England. Secondly, if we even believe in inflation targeting, leaving matters entirely to the RBI is not a great idea. There is always need for an external input. And government nominees are not necessarily handmaidens of the government. Economists nominated by the government have their own reputations to protect. Indeed, one could argue that they are, perhaps, better placed to act independently that some of those inside RBI, as the latter would have their own career ambitions to worry about and have every incentive to stay on the right side of the government.

Lastly, what constitutes 'optimal' or 'threshold' inflation is not easily determined. The RBI has set itself a target of 6% for January 2016. A recent paper in EPW points out that there is a wide range for inflation thresholds, as estimated by various studies. One study, which covered 127 countries in the period 1960-92, found that the inflation threshold is as high as 20% if outliers (those with hyperinflation of over 40%) are excluded from the sample. The EPW paper itself places the threshold at 11% for Asia, 23.5% for Latin America and the Caribbean, and 23.6% for sub-Saharan Africa.

There could be costs - in terms of lost output- to keeping inflation below a threshold if the the threshold is incorrect. Given the difficulties in estimation, there is a good chance that the threshold is indeed incorrect. That's why being fixated on inflation targeting may not be a good idea. Politicians, including those in Turkey and Brazil, may have a point when they complain about the monetary polices of their central banks.

Indradhanush gives Nayak committee report a wide berth

Former Axis Bank CMD P J Nayak thinks the government is not serious about banking reform. He thinks Indradhanush, the plan announced by the finance ministry recently, is inadequate:

Indradhanush is inadequate… While it is not necessary to privatise Indian banks, it will be desirable to do it. It will be greatly helpful if government’s (equity) share in banks comes down to less than 50 per cent. A lot of the unlevel-playing field will immediately disappear....Reforms will begin when the government decides to rollback the laws.” (The Bank Nationalisation Acts of 1969 and 1980, the State Bank of India Act, and SBI (Subsidiary Banks) Act.

One can understand Nayak's disappointment. Indradhanush makes no mention of the Nayak report. There's been some indication that stock options for top management of PSBs is being considered. But the level playing field in terms of compensation that the Nayak committee had urged is nowhere in sight. Perhaps most galling for Nayak, the government has appropriated the agency the committee had suggested for making top appointments at PSBs- Bank Boards Bureau- without embracing the essence of it, namely, that the Bureau should be distanced from government and should entirely comprise professional bankers.

One should not be surprised. Repealing statutes related to public sector banks is quite out of the question in an environment in which the government cannot even get the GST bill passed. Parity in pay between PSBs and private banks will undermine the economics of PSBs. As for making appointments to PSBs, it is unrealistic to expect the government not to want to have a say when the government is accountable to parliament for the PSBs.

Indradhanush does not make radical changes to governance of PSBs. Its centrepiece is infusion of capital into PSBs. Whether the capital infusion is adequate for all banks one is not sure but it is certainly an improvement over their existing situation.

I have a detailed analysis of Indradhanush in my EPW article, Can Indradhanush help revive PSBs' fortunes?

All eyes on the Fed tomorrow

Will she, won't she?

We shall know tomorrow whether Janet Yellen intends to hike interest rates, right  away or in the near ftuure?

Emerging markets face turmoil but some emerging markets think the Fed should go right ahead; at least, it will end the uncertainty they have been facing. On the Fed itself, opinion is divided. Gavyn Davies, writing in the FT, outlines the options:

The first and more likely option is a “hawkish postponement”, under which she explains that the conditions have not quite been met, but that the bulk of the committee believes this will happen by December. I am not sure that would do much to clear the air.
The second is the so-called “one and done” option, under which the FOMC raises rates by 0.25 per cent (or even conceivably by 0.125 per cent), and the “dots” show that no further rate rise is expected in October or December, except by a small handful of hawks.
This option seems to be gaining ground in the public commentary, on the grounds that it would get the bad news out of the way. But the markets know from past experience that they should take the first rate hike seriously as a guide to the Fed’s underlying attitude, and they would probably reprice short rates in 2016 upwards.
A final, more dovish, option — to keep rates unchanged, and also to eliminate the expectation of a rise in December — is probably not one that Ms Yellen could guide through the committee, even if she wanted to do so.

Financing higher education: ideas from the US presidential poll

Tuition fees in the US have doubled in real terms in the past 20 years, partly because universities have felt no compulsion to curb costs. Student debt is soaring. How to make higher education more affordable? The US presidential poll is throwing up interesting ideas, the Economist reports.

Hilary Clinton's solution: Cap repayment of college loans at a maximum of 10% of income over 20 years. Any shortfall in loan repayment made on these terms would be made good by the government. The cost to government is estimated at $350 bn. As for curbing college costs, Clinton would link government subsidies to reduction in college costs.

Another candidate Marco Rubio wants online programmes to be actively promoted. This is easier said than done. The problem is not lack of information on these programmes, it is that online degrees do not have anywhere near the same acceptability in the market as resident programmes. Rubio has a bold proposal for financing of education: opt for equity financing provided by private investors instead of loans from banks. This would link repayments to earning capacity. To ensure that successful students do not overpay, one could limit the tenure over which repayment happens.

The problem with equity financing, as the Economist points out, is that if a candidate should opt for a low-income career after an expensive education, the private investor loses out. Moreover, those who think they will do well in college and thereafter would prefer to have debt finance to equity as repayments are limited.

One thing is clear: simply leaving it to the market to set fees and trying to fund higher education through loans is creating serious problems. In India, we are aping the American model, especially in respect of management education. We need to think again.

Resurgence of the left in UK and US

Political pundits are watching with some astonishment the resurgence of the left in the UK and- of all places- the US.

In the UK, Jeremy Corbyn is positioning himself for the leadership of the Labour party on September 12. That doughty champion of market forces, The Economist, does not approve one bit:

For him no policy is too dog-eared, no intellectual dead-end too futile. Public spending? Yes, please. Higher taxes? Soak the capitalists and the landlords. State ownership? Nationalise the railways and utilities, get the private sector out of public services and reopen the coal mines. If that were the secret of prosperity, Britain would never have fallen apart in the 1970s and Tony Blair would not have won three elections at the head of a modernised centre-left Labour Party.

In the US, Bernie Sanders stands a slender chance of emerging as a shock Democratic candidate. He may end up getting pitted against Donald Trump, the Republican's own shock candidate who leads the ratings. An article in the Economist describes Sanders' broad political position:

A typical Sanders speech resembles a 90-minute sermon on modern America’s ills, delivered in the growling tones of his native Brooklyn. Hunched over a lectern, snowy hair aquiver with emotion, the 73-year-old’s usual targets include the “greed, recklessness and dishonesty” of Wall Street bankers, the malign influence of billionaire political donors, and the “abysmally low” wages that blight the lives of working families. Change will be hard, Mr Sanders warns audiences, and will require a “political revolution”. He is not joking (the senator rarely jokes). His proposals include moving towards a Canadian-style health system with publicly funded care for all, free tuition at public universities and a trillion-dollar infrastructure plan intended to create 13m jobs.

...Mr Sanders detects a chance in 2016 to lead a national uprising, drawing strength from the millions of working Americans who loathe mainstream politicians, news outlets and the economic status quo. Paraphrasing Franklin D. Roosevelt, he told the rally in Boone: “If the Koch brothers and the billionaire class hate my guts, I welcome their hatred.”

The Economist doesn't think that either Corbyn or Sanders can actually emerge as leaders of their respective parties.

BJP leader Varun Gandhi has a comment on this in the Hindu. He ascribes the resurgence to rising inequality. Gandhi's prescriptions for inequality would, perhaps, find easier acceptance in the Congress than in the BJP:

To cut inequality, we need to raise the level of minimum wages, strengthen collective bargaining, and improve employment benefits. Women need equal wages, flexible work environments and better childcare facility. We need better regulation of business, especially for rent-seeking sectors. Climate change requires a systemic response, with enhanced environmental protection.. With new demands for reservation based on economic criteria, the old politics of ethnic, racial and caste based reservation or affirmative programmes will soon die. 

Well, I am not sure the issue is just inequality, although it is an important factor. There is widespread discontent about the economy, for one thing. More importantly, perhaps, a profound dissatisfaction with mainstream candidates and parties and a yearning for something very different. Trump's appeal is precisely on the latter count, although I cannot fathom how he appeals to black voters.

Some of this is reflected in Indian politics as well. Aap undoubtedly has won out because of its anti-establishment orientation. The resistance to reforms reflects a growing realisation that a disproportionate chunk of the economic pie has gone in favour of business and corporate interests.  The BJP's retreat from the Land Bill and its reluctance to privatise government banks are acknowledgements of the realities on the ground. It's hard to think of any party moving decisively to the right in the near future. 

1965 war: a Pakistani view

I read and re-read this assessment of the 1965 war in Pakistan's Dawn newspaper with some amazement. It is scathing in its comments on the handling as well as the outcome of the war on the Pakistani side:

In fact, the war was started when we launched Operation Gibraltar in early July 1965, infiltrating thousands of Pakistani soldiers into India-occupied Kashmir under the assumption that Kashmiris would rise in revolt against the Indian forces. That never happened and within weeks the entire operation had collapsed. Meanwhile, the Indian forces launched a counteroffensive occupying parts of Azad Kashmir.
Subsequently on Aug 30, we launched Operation Grand Slam that was meant to capture the strategic town of Akhnur and to cut off held Kashmir from India. But it was too late. Another disaster happened when halfway through Grand Slam, the command was changed giving more time to the Indians to recoup and gather reinforcements. As a result this operation too ended in a fiasco.

About the Indian offensive on the Lahore front, the writer says:

...the persons most surprised were the president and the army chief when the Indians launched the attack on Sept 6. Ayub was woken up at four in the morning and given the news of Indian advances towards Lahore by an officer of the air force on reconnaissance duty. Ayub telephoned Gen Musa who said he had also heard the news but was waiting for confirmation!

 The author concludes:

Air Marshal Nur Khan, who led the air force, achieving complete superiority over the Indian air force, called it a wrong war that was planned “for self-glory rather than in the national interest”. History has to be put straight so that the mistakes are not repeated.

On the 1967 war, have you come across anything half as self-critical and objective in the Indian media? If the leading newspaper of a country can carry such an article, I would submit that there is something very right about that country. It cannot be a failed state, indeed, it is a country steadfastly battling any descent in that direction.

I have been an admirer of Dawn for many years now. Its liberalism is not confined to India-Pakistan relations. It has a thoroughly modern and reformist view on matters internal to Pakistan as well. Those who want Pakistan to be a vibrant democracy, free from the taint of terrorism, and also want that India and Pakistan should live together in peace must make it a point to read Dawn.

Who's afraid of the Seventh Pay Commission?

The Seventh Pay Commission looms. This is already giving rise to serious apprehensions about the impact on the fisc and negative comments about a government workforce that is said to be overpaid at the lower levels. Here are the standard comments and my responses to these:

i. SPC award will damage the fisc: Total pay of central and state government employees is 5% of GDP. The government projects a pay increase on the average of 16%. This translates into an impact on the fisc of 0.8%. Amortised over five years, the impact is 0.16%- hardly something to get worked up about.

ii. Where is the need for a Pay Commission every 10 years when government employees get DA increases? : Well, over a ten year period, after taking into account DA increases as well the annual increment of 3%, pay typically rises by less than 50%. This is less than the rise in nominal GDP of around 100%. After the Pay Commission hike, we get an increase in 10 years that is slightly below the nominal GDP increase (so pay and allowances as a proportion of GDP have fallen). The increase is way below what happens in the private sector. If the Pay Commission hike were not there, it would become difficult for government to compete for talent at the top, even after taking into account non-pay benefits such as job security, prestige, etc

iii. Government workforce is bloated and needs pruning: It has got bloated in recent years mainly on account of increases in police and paramilitary forces. We need more doctors, teachers, engineers, etc. Pay and allowances as a proportion of total government revenues has been falling by 1% every year. This is not downsizing as conventionally understood- that is, reduction in numbers of personnel. But, in financial terms, it is certainly downsizing. Wages are becoming less and less of a burden on government revenues, which is to be expected when central government revenues grow at 17% and the rise in annual wages is way below that.

The explosion in pay in the private sector is creating huge inequalities in Indian society. Pay in government should be seen as a sort of corrective to private sector excesses. It is not as much of a problem in fiscal terms as it used to be (although you could always argue that savings in wages can be used for other purposes).

It would best to accept periodic pay rises as a given and to focus instead on training and capacity building in the work force. Don't fret about the cost, instead get the best out of the workforce in terms of service delivery.

More in my article in the Hindu, Seventh Pay Commission is no ogre.

Inflation, deflation and Raghuram Rajan

Chief Economic Advisor Arvind Subramaniam thinks the Indian economy may now be in deflation territory. Deflation is a fall in prices. The WPI has been in decline. Subramaniam's remarks are seen as a broad hint to the RBI to cut interest rates.

But trends in WPI have little bearing on the RBI's policies given the monetary policy framework within which the RBI is now operating. In this framework, the focus is resolutely on CPI and the objective is to bring the CPI down to 6% by January 2016.

Those want a rate cut make two arguments. CPI is below 4%, which is below the 6% target, hence there is a compelling case.Two, a cut in the rate will stimulate growth. In a recent speech, Rajan addresses both arguments:

 To take the first argument first:

The statement “Inflation is low, you can now turn to stimulating growth” also perhaps reflects a misunderstanding of how central banking works. Monetary policy works with a lag of 3 to 4 quarters. So in deciding policy today, we need to predict how inflation will look approximately a year ahead. Today’s inflation therefore matters only in informing us about future inflation. However, today’s inflation measured on a year on year basis may be low because there was an unexpected price spurt last year – the so-called base effect.

So we need to take out base effects before we even assess the information from current inflation, something many observers fail to do. Also, there may be many sources of uncertainty that cloud the future inflationary picture and disconnect it from current inflation – the strength and distribution of the monsoon, the extent and persistence of low commodity prices, the effect of external disturbances on the exchange rate, etc. In practice, we use models to project how all this might play out on inflation, and we overlay the models with the subjective assessments that our internal committee and its advisors offer, to ultimately arrive at a policy decision.

Our model based assessments of the inflation path are almost surely going to differ a little from the realization, given that the world is uncertain, but they are our best professional assessments, and we set policy based on those assessments. As information comes in, monetary policy is adjusted – for instance, the substantial disinflation from November 2013 gave us confidence about the persistence of low inflation into the future, allowing us to cut the policy rate three times.

What such an approach rules out is what might best be described as “inflation following policy” that some populist commentators on monetary policy advocate.

In other words, the policy rate is set based, not on past inflation, but on expected inflation. Given that the RBI is committed to an inflation target of 6 per cent and has to explain any failure to meet the target, the tendency will naturally be to err on the side of caution- and any number of indicators can be found in the future to support such caution. The inflation targeting framework thus creates a bias against rate reduction.

As for the second argument, Rajan has this to say:

Modern economic theory suggests there is indeed a short run trade-off between inflation and growth. In layman’s terms, if the central bank cuts the interest rate by 100 basis points today, and banks pass it on, then demand will pick up and we could get stronger growth for a while, especially if economic players are surprised. The stock market may shoot up for a few days. But if the economy is supply constrained, we could quickly see shortages and a sharp rise in inflation. The central bank may then be forced to raise interest rates substantially to offset that temporary growth. The boom and bust will not be good for the economy, and average growth may be lower than if the cut had not taken place. This is why modern economics also says there is no long run trade-off between growth and inflation – the best way for a central bank to ensure sustainable growth is to keep demand close to supply so that inflation is moderate.

This is true when the economy is operating at its full output potential. Today, the Indian economy is not because projects are stalled on the ground, partly for want of funds. Cutting the interest rate impacts the supply side as well, not just the demand side. How? By increasing retained earnings, it improves the debt to equity ratio of companies. Some companies can access debt, some can access more equity. Projects can be completed and supply can increase. Further, the rate cut increases the value of securities held by banks and is a clever way of recapitalising them. With more capital at their disposal, banks are more ready to make loans and take risks. A rate cut thus can have important supply-side effects in the situation we are in.

A cut in the interest, of course, provides a stimulus to demand. it lowers the cost of capital and makes some fresh investment feasible. It stimulates demand for housing from consumers and allows housing stock to sold, making cash flows available to builders. 

Axis Bank: Irena Vittal and conflct of interest

Irena Vittal has quit as independent director on the board of Axis Bank. The reason is said to be that her husband is CEO of Bharti Airtel, which won a license for a payments bank to be set up in partnership with Kotak Bank, a competitor of Axis Bank. There was a perception of conflict of interest in this situation.

The implication seems to be that Vittal was placed in a situation where she could share information about Axis Bank with her husband and this would not be in the interests of Axis Bank. This suggestion has drawn fierce criticism from many who see the suggestion as proof of gender bias, implying that we in India cannot believe that a lady can separate her family life from her professional obligations.

What do we make of this situation? Well, I doubt that anybody would want to cast aspersions on Vittal, a professional of repute. But the point is that it is best to avoid a situation that has potential for conflict of interest. There are lots of competent lady professionals out there. If Axis Bank can find somebody who is not placed in a conflict of interest situation, why not do so?

Of course, you could say that since conflicts of interest are par for the course in boardrooms, why get worked up over this one? One situation is where A sits on B's board and B sits on A's board and they happily scratch each other's backs. Independent directors on most private boards are drawn from the same cosy club of CEOs, retired bureaucrats and chartered accountants. Even if there's no technical conflict of interest, independence is the last thing one would expect from the members of this cosy club.

The central issue in boardroom reform is not conflict of interest but having directors who are capable of acting independently of management or the promoter. I have said this before- and I argue at length in my recent book RETHINC (Random House), that the long-term answer is to have proportional representation on boards, with various constituencies other than the promoter and management - institutional investors, minority shareholders, large lenders, emloyees, etc- also been given the right to appoint independent directors.

Then, we have independent directors answerable to those who have put them there, not 'independent' directors who are beholden to  management or the promoter for their seats and fat fees and who will happily nod their heads to whatever management or the promoter wants done.

I spy

James Bond is passe. The spy of the 21st century is more likely to be software secretly smuggled into your computer which enables somebody to know exactly what you are doing with your PC or laptop. Or it could be a drone drifting into a cave harbouring Afghan militia.

The Economist has  a fascinating article on how spying has evolved.  In the old days, the thing to do was to smuggle in a smart guy- preferably from an elite institution, such as Oxbridge- into the target country with a fake identity, visiting cards and plenty of cash. Today, with biometric identification, this has become difficult. The other form of 'humint' - or human intelligence- is simply paying people on the other side for passing on information. This is, of course, alive and well. But, targeting the right people who will spy for you is becoming more sophisticated- it's no longer a matter of accosting people at clubs or parties.

The thing to do is to get data on a whole lot of people and look for weaknesses- medical problems, financial problems, hints of scandal. That's what the people who hacked the site of America's Office of Personnel Management were looking for. I am surprised people didn't think of hacking Ashley Maddison for this reason.

This gives us an idea of what the focus of spying game will be: electronic communications and materials stored on PCs and laptops. One begins to understand why the NSA and other intelligence agencies are so keen on scrutinising email and related traffic. By combing through this, one can lead a treasure of information. The equivalent of this is listening into phone conversations, including mobile conversations.

One problem for spy agencies, the Economist mentions, is encrypted messages. Since it is the receiver and the sender who hold the keys- and not the channel that allows them- spy agencies want the channels to insist that users give them the keys. But this may not be necessary. You don't have to crack an encrypted message. It's enough if you can track what the sender is typing or what the receiver is typing- and there's plenty of spyware available for this.

The flip side is that spy agencies that store information are themselves vulnerable- as the Snowden episode highlighted in a big way. How to steal somebody's else data while safeguarding your own is the central challenge of modern spying.

All of this seems pretty clear. Still, some doubts remain. Electronic spying may be effective when it comes to spying on official agencies. Will it work with terrorists or criminal groups? Such groups are more likely to rely on passing messages on a slip of paper or by word of mouth. Electronic spying can't help here. Since, James Bonds can no longer be smuggled in to mingle with such groups, it's just possible that spying on terrorists and the like has been weakened in recent years.

Making sense of crashing markets

Markets have crashed all over the world, including the US. It's not easy to make sense of this phenomenon. The glib explanation is that it has to do with the inability of Chinese authorities to stem the crash in markets there and the devaluation of the yuan. Both point to clear slowdown in Chinese growth and falling Chinese demand for imports. China is a big source of incremental global growth, so this is bad news for the world economy.

All of which is true. But what's new in that? Why should markets crash instead of declining in an orderly way? How does that explain the panic? One possible explanation is that the slowdown in China will be more severe than thought- growth won't be even 7 per, it would be, say, 6 per cent. But, again, why would markets latch on to this virtually overnight?

The other suspect is the impending Fed rate hike. But this has been long in coming. Also, it's not as if the Fed will press ahead regardless of what's happening to markets worldwide. An article in Business Insider highlights these points very well but does not come up with a plausible alternative. So let me stick my neck out and offer one.

Might worsening geo-politics be a factor? There's been news in recent days that both Russia and Nato have carried out exercises that military analysts see as a clear preparation for war. Then, there's been news that the US is moving some of its most advanced aircraft to its European allies. Oil prices have fallen to close to $40 and there's been another run on the rouble. This adds to Russia's economic woes and puts Russian president Putin under further pressure.

It could well be that the flight of funds from emerging markets is a sign of a full-blown global crisis that is not just economic in nature. I read in the Economist recently that Russia will find it difficult to hold on to Chechnya and other states in the federation the moment it runs out of cash. Any impending turbulence in Russia, with all the uncertainties it carries, would certainly frighten the life out of investors.

Worsening ties between the west and Russia are part of worsening geo-politics in general: think the situation in West Asia, China- Japan, India- Pakistan, etc. Don't get me wrong. I don't see any of these crises playing out in the near future. But worsening geo-politics makes it difficult to get the necessary focus on the economic situation. Indeed, crashing asset prices, notable that of oil, which is crucial to Russia, may just suit the  agenda of the western powers.

My sense is that the US and its allies under-estimate Russia, as it has been under-estimated by others in the past. When this becomes clear enough, the geo-political situation should improve and panic should dissipate. However, this learning could be a long and painful process. Until then, however, risk aversion will be high. It's the combination of a weak economy and worsening geopolitics that, perhaps, explain the current panic.

(Updated on August 27, 2105)

Indradhanush: a fortune for PSBs at the end of the rainbow?

The government has unveiled a plan for revamping PSBs titled Indradhanush. One thing is striking: the government is implementing the recommendations of the P J Nayak committee in form but not in content. The Nayak committee wanted a radical departure in the way PSBs are run. Its model for PSBs was Axis Bank, the former UTI Bank in which the government allowed its stake to fall below 51% and let it be run like a private bank, with a professional board and with private sector scales.

Well, it doesn't look as though any of this is going to happen with PSBs under Indradhanush. The centre-piece is the infusion of Rs 70,000 crore over four years, with Rs 25,000 crore being infused this year itself. This marks a turnabout in the government's position on recapitalisation. In its first budget, the government took the view that capital infusion would be a reward for performance.

The departures from the Nayak committee report are striking:

• There will be a Bank Board Bureau that will make top appointments in PSBs, including appointments of independent directors. But this is not going to be manned entirely by professionals as the Nayak committee wanted. Some reports say half of the six members will be government appointees. One report quoted the banking secretary as saying he will be the sole representative. Either way, the government will make the final call on appointments. It cannot be otherwise as long as the public sector character of the banks continues. I have always thought that the idea of government distancing itself from control of PSUs and PSBs was hogwash- it just can't happen.
• Two of the five appointments have been from the private sector. But the finance secretary has assured PSBs that hereafter there will be no more appointments from the private sector- EDs at PSBs will be given a chance.
• Performance-linked pay and private sector pay scales: If this happens, it will be in a restricted way. The basic framework of government, defined by the Pay Commission, won't go away.
• Bank Investment company: The Nayak committee wanted government equity to be transferred to a BIC with the BIC dropping its ownership in individual banks below 51%. The BIC won't happen in a hurry. And when it does happen, government will not drop its ownership below 52%. That means, CVC and CAG will stay.

So, nothing changes with respect to the UPA? I won't say that.  The government has moved to separate the roles of chairman and managing director (about which I have my reservations). The
appointments process has been more rigorous than what we say in UPA-II.

More in article in Quartz, Slow, steady and sensible: Modi's new approach to reviving banks

Land Bill setback could be a blessing in disguise

The Modi government has had to backtrack on the Land Bill. Industry is howling but, on a longer view, this may not be such a bad thing.We need an approach that farmers regard as fair. Perhaps, parliament can now consider a fresh set of options.

It's not enough to say glibly that farmers should not complain as long as they are compensated and that twice the market value in urban areas and four times the market value in rural areas is good enough. The problem very often is that the market value is not easy to determine. Simply looking at recent land sales may not help, as the Economist points out, because these may distress sales made by farmers to other farmers or because the sale price may have been under-reported to dodge stamp duty.

The fact of the matter is that the true value, in acquisition for industrial use, becomes known only after the industries are set up. This means that farmers should have a 'call option' on the property that is sold to industry. The approach taken by AP Chief minister Chandrababu for the construction of a new capital for AP may well be the way to go. Naidu has offered to give back to farmers 30% of the land pool they have together contributed once the city is constructed. This is a way of providing  a call option to sellers.

The problem of dealing with holdouts- people who simply refuse- may still be there. The Economist cites a suggestion made by two economists. Ask for bids for plots close to the ones being acquired and offer these as compensation to those unwilling to sell in the acquired area.

Land acquisition is a hugely emotive issue and more so at a time when farmers are in distress. Forced and unfair acquisition is a factor underlying insurgency in many parts of the country. We need to think of new solutions. So the setback to the government on the Land Bill may well be a blessing in disguise.