Friday, September 16, 2022

Ukraine escalation spells gloom for world economy

 The escalation in sanctions against Russia, including a price cap on oil and a possible cap on gas prices, means more trouble for the world economy and especially for the economies of Europe. On top of that, Ukraine has launched counter-offensives against Russia in the north and the south. The Russians cannot be expected to take that lying down.

So, the outlook for the world has worsened in recent days. But it doesn't look as though the world's leading stock markets have noticed. Do they know something that the world's leading agencies, including IMF and World Bank, have missed.

My article in BS today, Global outlook grows murkier after Russian setback


FINGER ON THE PULSE
T T RAM MOHAN

Global economic outlook grows murkier after Russian setback

As Ukraine escalation raises the risk to global economy, it is time to hunker down for the rough ride ahead

“We are at war”, says French President Emmanuel Macron.” German Chancellor Olaf Scholz sounds only a little less sombre. “We live in serious times… but we are prepared”. After more than six months of relatively low-intensity warfare in Ukraine, there is the prospect now of a substantial escalation on both the economic and military fronts. That bodes ill for the world economy. India’s policymakers need to brace for a rougher ride than thought until recently.

Russia has shut down the Nord Stream 1 gas pipeline that supplies gas to Europe. Last year, the pipeline provided an estimated 35 per cent of Europe’s gas imports from Russia. Russia says that Western sanctions against it make it difficult to ensure effective maintenance of the pipeline. Nord Stream 2, which was due to start supplying gas to Europe in early 2022, faces sanctions from the US and the EU, which make it a punishable offense to utilise the system.  

Russia’s decision to shut down the Nord Stream 1 pipeline came soon after the G-7 countries agreed to impose a cap on Russian oil prices. The G-7 intends to apply the cap to all countries purchasing oil from Russia. How to enforce a price cap in the case of non G-7 economies? The idea is to deny insurance and finance to oil cargoes that are priced at above the price cap that the G-7 will impose.   

. The EU is contemplating a cap on the price of gas imported from Russia as well. The West contends that it has little alternative given the steep rise in gas prices. Speaking at the East European Economic Forum earlier this month, Mr Putin explained that the West had only itself to blame for the spiralling price of gas. 

Mr Putin said that Russia had long tried to persuade the EU and other buyers to enter into long-term contracts for gas— at one point, Russia was negotiating the supply of gas at $100 per 1000 cubic metres. After the Ukraine conflict erupted, Ukraine chose to shut down one of the two gas pipelines passing through it. Poland sanctioned the pipeline passing through Poland. For these and other reasons, gas prices have climbed to $3,000 per 1000 cubic metres. 

The EU now thinks price caps on Russian gas are the answer. Mr Putin has warned that price caps would amount to violation of contractual obligations and Russia would not hesitate to cut off all energy supplies — gas, oil, coal and fuel oil — if that happened.  

As though the escalation in the economic war was not bad enough, there has been a change in the military situation on the ground. Until a few days ago, the general sense was that the war of attrition of the past several months would continue. The Ukrainian counter-offensive in the Kharkiv region in the north and in the south has changed perceptions. Ukrainian claims about territory regained need to be taken with the proverbial pinch of salt —the government in Kyiv is known to make exaggerated claims in order to sustain the flow of arms from the West.

Nevertheless, it is clear that Russian forces have been dealt a blow in the north. This has triggered nationalist outrage in Russia and scathing comment from sections of the Russian media. Russia has responded by pounding the eastern region of Ukraine with missiles, causing power blackouts in several parts.  

Russia has thus far contented itself with launching what it calls a “special military operation”, intended mainly to protect lives in the two provinces in eastern Ukraine that have declared independence. But increased Western military support to Ukraine and setbacks on the ground for Russia have prompted calls for a radical change in  Russia’s approach. Mr Putin is under pressure to deliver a knock-out blow by bringing the full might of Russia to bear on Ukraine. Prospects of a negotiated peace have seem very distant now.

These developments render the global economic outlook murkier. The International Monetary Fund (IMF) had projected global economic growth of 3.2 per cent for 2022, down from 6.1 per cent last year, and at 2.9 per cent in 2023. That was the baseline scenario. 

The IMF had also looked at an alternative scenario in which Russian oil exports fall by 30 per cent relative to baseline, Russian gas exports fall to zero and inflation expectations become more elevated. Global growth in that scenario drops to 2.6 per cent in 2022 and 2 per cent in 2023.  The EU would bear the brunt of the shock with growth in the EU being near zero.

That scenario, which would place global growth in the bottom 10 per cent of outcomes since 1970, does not appear far-fetched now.  The changed outlook will increase uncertainty over the conduct of monetary policy in advanced economies —to hike or not to hike policy rates will be a difficult call (except, perhaps, in the US).

How does India respond to increased uncertainty about  global growth prospects? First, it is unrealistic to expect exports to be a key driver of growth in today’s troubled environment. The decision to walk on two legs — to push exports where possible and also promote indigenous production through modest protection and subsidies — is an experiment worth persisting with.

Secondly, it is not advisable to allow the exchange rate to depreciate too steeply and bear the full impact of the shock in the hope of benefiting from a rise in exports. In a crisis such as the present one, the dollar is the default option for investors. Net foreign institutional investor (FII) flows have turned positive in July and August. Too steep a depreciation in the rupee with respect to the dollar could lead to a swift reversal of this trend. The Reserve Bank of India must continue with careful management of rupee depreciation. 

Thirdly, embarking on “big bang reforms” at this point, as many urge, would be unwise. We do not need political turmoil in the country to add to the grim global outlook. We need instead to hunker down for the rough ride ahead. 

 

 


Sunday, August 28, 2022

Management consulting firms hike pay for new MBA hires

 This item should tickle the present batches at the top IIMs.....

 McKinsey, Bain and Boston Consulting Group have unveiled one of the biggest rounds of pay rises for new hires in more than two decades, as inflation, booming demand for advice and a tight labour market force the trio of consultancies to compete harder for talent. The firms, which do not publicly disclose their pay scales, will increase annual base salaries for MBA graduates in the US from $175,000 to between $190,000 and $192,000, according to people familiar with the matter. Top performers will be in line to receive more than $250,000 in their first year when performance-related and signing bonuses are included.

 The hope must be that these firms will want to likewise hike pay for recruits in India.

Freebies: Supreme Court frames questions

The Supreme Court has decided to refer the freebies matter to a three-judge bench. Earlier, it had been inclined to constitute a committee of experts on the subject. Now, that is one of four questions put to the three-judge bench. The questions:

  1. What is the scope of judicial intervention? 
  2. What should be the composition of the expert panel to examine the issue? 
  3. Can the court pass any enforceable order? 
  4. Whether Subramaniam Balaji vs Government of Tamil Nadu judgment needs reconsideration?

In Subramaniam Balaji vs Government of Tamil Nadu, the petitioner had challenged the decision of the DMK government in Tamil Nadu to distribute colour TVs to identified individuals. The petition was dismissed by the Madurai High Court in 2007. In 2011, the same petitioner approached the High Court with a prayer to restrain the AIADMK government from distributing freebies such as mixies, grinders, electric fans, etc. The case was transferred to the Supreme Court. In 2013, the Supreme Court dismissed the case saying it had no grounds to interfere.

Question no (3) above was, in a way, addressed by the Supreme Court then. The honourable Court decided it could not issue any guidelines in respect of freebies.

I guess the larger issue that has arisen now is whether political parties can provide freebies in ways that undermine public finances. That seems to to the point addressed in questions (1)  and (4) above. While the grounds on which the SC had ruled in 2013 may be valid, is there a further ground, fiscal responsibility, on which Subramaniam Balaji can be revisited? It's going to be a tough call. 

 

Tuesday, August 23, 2022

RBI and government of India differences?

The RBI put out a paper on bank privatisation in the RBI Bulletin..  The paper argued that public sector banks (PSBs) have done better on financial inclusion that private banks. It also found that counter-cyclical policy happens better through PSBs, no surprise as they are subject to broad government direction.

On these grounds, the paper argued that 'big bank' privatisation is not desirable, we must hasten slowly. Somehow, the seems to have got interpreted in some quarters as anti-privatisation. The RBI was constrained to issue a clarification. The RBI said the paper does not reflect the views of the RBI. It also said that "instead of a big bang approach, a gradual approach as announced by the Government would result in better outcomes", which is correct. 

Any controversy over the paper is entirely avoidable. 

There is another issue, however, on which there appears to be a difference. The RBI put out a discussion paper seeking views on the question of charging for UPI payments. The government clarified promptly that "UPI is a digital public good with immense convenience for the public and productivity gains for the economy. There is no consideration in Govt to levy any charges for UPI services.".


Privatisation of PSBs: why 'big bang' is not feasible

 

Those pushing for aggressive privatisation of public sector banks (PSBs) in India must keep three points in mind.

One, the evidence on the superior performance of private sector banks over PSBs over a long period is not unambiguous- indeed, there was a trend towards convergence in performance until the first decade of the 2000s.

Two, the sale of PSBs is fraught with practical problems given RBI’s norms for private and foreign ownership.

Three, as a recent paper put out by RBI points out, ‘big bang’ privatisation of PSBs is not desirable as it could create a void in financial inclusion.

My article in EPW focuses on points one and two.

Comparisons between PSBs and private banks are distorted by the fact that the comparisons do not eliminate “survivorship bias.” The PSB sample includes more private banks that have failed (25) and have got merged with PSBs than the number of private banks that failed (11) and were merged with other private banks (Ghosh and Kumar 2022).  

Secondly, the divergence in performance between PSBs and private banks happened after the global financial crisis (GFC) of 2007–08 and became glaring only post 2011–12. In 2010, the gross NPAs/gross advances ratio were 2.3% at PSBs and 3% at private banks. By March 2020, the position had changed dramatically: the respective numbers were 11.3% and 4.2%.

The divergence happened because PSBs lent massive to infrastructure (power and telecom) and related sectors, namely, mining, iron and steel, textiles, and aviation. These five sectors accounted for 29% of all advances at PSBs and 14% of advances at private banks. Such lending was not on account of poor underwriting skills at PBS. The Economic Survey of 2016–17 noted,

the vast bulk of the problem has been caused by unexpected changes in the economic environment: timetables, exchange rates, and growth rate assumptions going wrong.

As to the mechanics of privatisation, we need to be clear answers to the question: whom do you sell the PSBs to? You can't sell them to corporate houses, RBI policy does not allow corporate ownership in banking. Foreign banks are either not interested or are not willing to enter the country via the subsidiary route as mandated by RBI. The larger private banks have large enough networks and don't want to be saddled with the legacy issues at PSBs.

That leaves you with FIIs, including private equity. The RBI is willing to allow only a maximum stake of 15 per cent for such entities. They will want a controlling stake, preferably 51 per cent and with zero government presence. That is not a condition that can be easily met.

Then there are the legislative amendments needed to the Bank Nationalisation Act, on which Parliament has to sign off.

So, you see, in the very nature of things, PSB privatisation can't be accomplished in a hurry.


Saturday, August 20, 2022

Debate on freebies: no easy answers

The debate on freebies- handouts or subsidies of one kind or another by the central and state governments- is getting shriller by the day. Everybody thinks freebies should be curbed because they wreak havoc with the government's finances. The solution is not as obvious as many think.

One of the most common answers is: subsidise items that generate positive externalities such as health and education. Clamp down on those that do not, such as power.

Former RBI Governor D Subbarao points out in an article in ToI today that it's hard to measure the welfare effects of a given subsidy, so it's hard to determine what are 'merit' and 'merit' subsidies. He proposes that we abolish the classification. Let politicians agree on a cap on subsidies. An independent fiscal council must vouch for the integrity of budgetary numbers. 

Dr Subbarao is right on the measurement issues. MGR's now-famous Mid-Day Meal scheme for school children was decried by many as simply giving away food for free. We know now that school attendance went up sharply, with the ensuring benefits. Politicians, with their acute understanding of realities at the grassroots, may have a much better sense of the welfare effects of a given subsidy than economists. So, many freebie schemes may not be as perverse as economists think. Any sensible Railways minister will include a junction in his constituency in the Railways budget- he knows how a rail junction can transform the local economy.

I am not sure that Dr Subbarao's suggestion for a cap on freebies will work. It may well go the way of the limits on the FRBM caps. Politicians will find ways around limits.

It is important to recognise that jobs in industry or services go to the relatively privileged, that is, those who have access to education and the means to afford it. A big chunk of freebies goes to those who will not be able to access the jobs created by productive expenditure. 

So, how much to spend on freebies relative to productive expenditure is a question of equity. It is a question that can be answered only by the electorate. Expenditure on freebies will fall only the potential beneficiaries of these diminish relative to the potential beneficiaries of job-creating expenditure- the votes will no longer be as strongly in favour of freebies. Politicians understanding this better than economists, so they will go on spending on freebies until this condition is met. 

Wednesday, August 17, 2022

HBS announces tuition waiver for low income students

Harvard Business School has announced waiver of tuition ($76,000 for each of the two years) to the lowest income students for about 10 per cent of its annual intake or 200 students. Students will still have to incur living costs of approximately $35,000 per year. 

HBS is known to offer limited scholarships based on merit. Th expansion of scholarships to those who satisfy certain socio-economic criteria is a huge leap forward. It will make it easier for talented students who lack the means to access one of the most reputed business schools in the world.

The move should make IIMA and some other leading schools in India sit up and think. IIMA used to offer scholarships to the needy but these have been more or less phased out over the years. IIMA argues that the placement salaries on offer at the school are good enough to help students pay back students loans for the two-year programme. So those who gain admission should simply take loans to pay for the programme.

This argument is flawed. Several of the most disadvantaged students would be deterred by the uncertainty factor: what if they ended up with a  below-average placement salary so that it took them very long to repay a student loan? A typical student from a poor family would have to take care of the burden of several family loans. The prospect of having to take another loan could prove a deterrent to his or her accepting admission or even applying. 

For years, the leading IIMs would declare in their Admissions ad that no student would be denied admission for want of funds, meaning the IIM would take care of funding. They need to go back to that noble affirmation. 

Friday, August 12, 2022

Should central banks prioritise inflation or growth this year? No easy answers

Central banks in advanced economics cannot make up their minds whether they should priortise growth over inflation in the months to come. That is because it's hard to predict how the Ukraine conflict will shape. 

At the moment, they have prioritised inflation. But if the conflict worsens, growth will be the bigger problem. My column in BS today, Central banks haven't got it wrong.

FINGER ON THE PULSE

Central banks haven’t got it wrong

TT RAM MOHAN

Central banks in advanced economies are today in thrall to the conflict in Ukraine. Emerging market central banks, in turn, are in thrall to the actions taken by the US Federal Reserve. Those who fault  central banks for their response to inflation in recent months seem to gloss over these facts.

During the global financial crisis of 2007, central banks knew what they had to do- loosen monetary policy and keep doing so. Likewise, during the pandemic. Now, the course is nowhere as clear.

The conflict in Ukraine has rendered the conduct of monetary policy extremely difficult. There is still no knowing how the conflict will pan out. Western sanctions against Russia are unprecedented in their scope and severity. And it’s hard to say how Russia will respond as the conflict rages on. 

The US Federal Reserve faces an unenviable task.   With the inflation rate in the US at 9.1 per cent in June, analysts warned  that a recession was imminent.  Some claim that the US is already in recession. This would imply that the Fed should go slow on rate hikes to fight inflation.

Hold on. After the last meeting of the Federal Open Markets Committee, Fed  Jerome Powell poured cold water on talk of a recession. US unemployment rate in July was 3.5 per cent, which was the level before the pandemic set in. This meant that the Fed should tighten more aggressively, not less so, as the recession school contended.

If that is not confusing enough, the conflict in Ukraine is a huge imponderable. Do we know whether or not the impact of Ukraine on the world economy is played out? If central banks reckon that the oil price will stay in the range of $100-110, they would be justified in concluding that inflation is the bigger threat at the moment. However, if Russia moves to cut supplies drastically, all bets on oil prices are off and growth is seriously threatened.  

JP Morgan Chase has warned that, in an extreme scenario, Russia could slash dramatically oil supplies in response to the oil price cap imposed by the West. Oil prices could then surge to $380 dollar a barrel. At that price, global growth will collapse and inflation will cease to be the priority for central banks.

So great is the uncertainty created by Ukraine that, after the last meet, Mr Powell refrained from providing forward guidance, that is, any indication of exactly what rate hikes to expect in the coming months. Nor is the Fed in a hurry to return to the inflation target of 2 per cent for the US. It seems quite happy to return to the target by end 2023.

If the task for the Fed is so complicated, the challenge for central banks in emerging markets, including the RBI, can well be imagined. In addition to factoring in the outlook for growth and inflation, they have to keep a wary eye on the exchange rate. Coping with the “spillovers” of Fed policy is testing the mettle of emerging market central banks.

That should explain the stance taken by the Monetary Policy Committee (MPC) of RBI earlier this month. The MPC made no change to its forecasts for growth and inflation in 2022-23. Nevertheless, it thought fit to increase the policy rate by 50 basis points. The MPC argued that the increase was needed to anchor inflation expectations and to bring the inflation rate closer to the target of 4 per cent.  

That does not sound very convincing. With the actions taken so far, the RBI can at best hope to bring the inflation rate down to the target only by end 2023, exactly as the Fed intends to. The RBI, like the Fed, has chosen not to provide forward guidance.

The more plausible explanation is that the RBI is keen to manage the exchange rate of the rupee after the Fed’s rate hike of 75 basis points. The real effective exchange rate of the rupee against a basket of currencies has been steady over the past year. Analysts have argued that we could do with a depreciation in the real effective exchange rate in order to boost exports.

However, when it comes to managing capital flows, it is the exchange rate with respect to the dollar that matters. The dollar is the safe haven for funds. In order to stem the outflow of capital, it is important that the rupee not depreciate too much with respect to the dollar. If portfolio investors sense a steep depreciation with respect to the dollar, they will flee the rupee. The RBI’s policy rate moves are thus substantially dictated by the Fed’s own.  One wonders whether the RBI would have thought it necessary to raise the repo rate if the Fed itself had settled for a more modest increase.

On a broader note, critics of central banks say that central banks failed to catch the impetus to inflation post the pandemic. Many believe central banks have laid the ground for stagflation similar to the one witnessed post the oil shocks of 1973 and 1979. As the annual economic report of the Bank for International Settlements (June 2022) makes clear, the critics are off the mark.  The behaviour of commodity prices this time has been different from that in the 1970s. So are the economic backdrop and monetary policy regimes.

First, the oil price shock has been less severe this time around. Oil price have increased by 50 per cent since mid-2021 and are around their long-term averages. In 1973, oil prices doubled in a month and touched historic highs. Secondly, higher energy prices impact growth to a less extent today because of the reduced energy-intensity of GDP. Thirdly, the 1973 rise in prices happened on the back of several years of rising inflation. In contrast, today’s episode follows years of low inflation. Lastly, the institutional frameworks for monetary policy and for anchoring inflation expectations are far more robust today.

Forecasts of economic doom in the year ahead are premature and central bank-bashing is misplaced. Central banks are not behind the curve on inflation nor is a soft landing inconceivable  in the US. To be sure, things could change dramatically if the conflict in Ukraine worsens. But that is hardly something central banks can prepare for.

(ttrammohan28@gmail.com)

 

 


Tuesday, August 09, 2022

IIM salaries and fees: what are the larger implications?

TOI carried a story saying IIM placement salaries had not kept with rising fees for the two year  MBA programme. 

The story quotes a director as saying that the rule of thumb was that the fee should not exceed the average annual salary. The fee seems to have exceeded the average salary at only two IIMs. But that is not the correct measure.

The correct measure is how many years it takes to repay student loans. Taking into account costs in the large cities, I was told this takes seven to eight years-  using average salaries. For those earning less than average, which would be half the cohort, the time taken would be a lot more. 

Moreover, one should not confine the analysis to the leading IIMs. The leading IIMs' fees are the benchmark for lesser IIMs and non-IIMs. At the latter, the pain felt by students would be more.

There are a few fundamental points about IIM fee pricing that tend to get overlooked.

First, what is the basis for the fee charged? IIMA used to charge Rs 4.8 lakh until 2007. Surely, costs cannot have multiplied five-fold since! The fee clearly is not based on cost-plus pricing but simply what the market can bear. If 450 students can pay Rs 25 lakh or more, why not charge that much?

Is that responsible pricing? At top B schools in the US, the fee typically does not even fully recover the cost. So there is an element of subsidy in the fee. On top of that, the schools offer a few scholarships based on merit and financial need. B schools in the US bear the cost of subsidy through large endowments, consultancy, executive programs and the rest. In other words, the fee at US B Schools is not intended to include a profit margin.

At the IIMs, there is not only a profit margin but the margin but must be obscenely large. What are the profits used for? The IIMs are structured as non-profit, non tax-paying trusts. So, they can have a surplus of only 20 per cent over cost. Any surplus above that has to be used. Typically, they have been using the surplus for infrastructure- more and better buildings, better facilities for faculty and students, etc.

The IIMs have also introduced variable pay for faculty (and, to a lesser extent, for non-faculty staff). Some of the surplus goes towards that. A portion of the fee is thus a straight transfer from students to the pockets of faculty. 

Secondly, the fee at IIMs has implications for the choice of employer or jobs. If students take out a large loan for the MBA program, they will be under pressure to take up only the highest paid jobs. That rules out most of the public sector, where there is a crying need for superior managerial skills. It could also preclude entrepreneurial ventures on the part of graduating students- risk-aversion amongst students will be the norm. Is that what the economy needs? Are the IIMs intended solely or mainly to produce talent for Big Tech, the international consulting firms and the top Indian business houses?

Thirdly, the fee have implications for the student profile. It is reasonable to expect that steep fees would deter the disadvantaged sections from applying, given the risk that repayment of loans could stretch out over a very long period when the family looks to the MBA candidate to take care of it. In other words, steep fees dis-favour inclusion.

There is a more important consequence of high fees at IIMs. Many of the graduates at IITs and NITs have offers from the same companies that go to the IIMs. They also have other opportunities such as going abroad from higher studies in engineering or management. High fees create incentives for students at IITs and NITs to pursue alternative opportunities instead of applying to the IIMs. This is certainly happening because the proportion of graduates from IITs and NITs has been falling over the years at the leading IIMs. The IIMs no longer attract the "cream of the cream" although they like to parroting that. Does this not have implications for the brand equity of the IIMs in the long run?

Unfortunately, there seems to have been  no discussion of the larger implications of high fees at the Governing Council or among the faculty. The IIMs keep rubber-stamping five per cent increases in fee ostensibly "to cover the cost of inflation"! So much for research-based policy making at the IIMs!

Unfortunately, after the IIM Act of 2017, the government has let go of all monitoring of IIMs. It seems happy that it does not have to fund many of the IIMs any more. The IIMs are accountable to Parliament, so government needs to shed its hands-off approach and look carefully into the functioning of the IIMs.