Sunday, December 30, 2007

Mao the management guru

The Economist year-end issue is a delight with its collection of articles on several topics other than economics. This year's issue has articles on, among other things, life in the Dharavi slum, the Koran and the Bible and the state of the Mormons. The piece that caught my eye is the one on Mao Zedong as management guru.

The Economist contends that Mao is the sort of guru that mediocre or non-performing CEOs might want to emulate- after all, not every CEO can aspire to be an Alfred Sloan. Most management books talk about how to emulate the peaks attained by the likes of Sloan. But the run- of- the-mill CEO needs something more practical to survive and prosper. Mao fits the bill.

The four key lessons that "under-performing, overcompensated" CEOs might learn from Mao are:

1. A powerful, mendacious slogan: Mao's slogan was "Serve the people". He hardly lived up to it, says the Economist, but that's not the point- he was able to justify everything he did in relation to an attention-grabbing slogan.

2. Ruthless media manipulation: Promote yourself ruthlessly- it may termed "personality cult" but it " is hard to distinguish from the modern business practice of building brand value."

3. Sacrifice of friends and colleagues: Don't let people stay close to you for too long- they may want your job. Also, do not hesitate to blame failures on others and get rid of them. Mao practised this dictum faithfully- and this is what sensible superiors at investment banks do after a bad quarterly result.

4. Activity substituting for achievement: Think big and keep coming up with plans and initiatives- they may flounder in the long run but you will be gone by them.

How true is the above description of Mao? It is true but it not the whole truth. Mao may have been a bad leader once he came to power but he was capable of sacrifice, heroism and genuine achievement on the way to the top- the Long March was not a delusion and he did succeed in toppling a discredited regime. His early achievements were also not inconsiderable- land reforms, for instance.

It is the record of substantial achievement with an element of personal sacrifice, however collosal the failures, that must explain why Mao has a standing in China today that Stalin lacks in Russia. Stalin too faithfully acted on the four lessons but he is a reviled figure in Russia today. He was not bereft of achievement- his successful defence of the Soviet Union against Hitler, for instance. But he lacked a comparable record of sacrifice- he is seen merely as a grabber and wielder of power.

That said, the Economist's lessons certainly hold true for non-performing CEOs in the corporate world. An individual may have earned the CEO's job or may have hacked his way to the top. But, once there, he can get away with non-performance and worse if he faithfully sticks to the four lessons. Sloganeering, projection in the media and creating an illusion of results are undoubtedly useful in making one's stay at the top productive- for oneself.

Friday, December 28, 2007

Ethics or self-interest?

Tarun Das of CII has a piece in today's TOI in response to Swaminathan Aiyar's column earlier in the month. Aiyar had faulted the Tatas for their pusillanimity in not favouring hostile takeovers - the context was Rata Tata's comments about not wanting to force a deal on Orient Express Hotels, the international hotel group in which the Tatas have a minority stake. The management of Orient Express had stirred up a controversy with what are believed to be racist comments about the desirability of having an Indian group as owner for an international hotel brand.

Das takes Aiyar to task for not appreciating that Indian business groups are driven by values , not just commercial goals.

On the business and commercial side, Tatas follow the practice of negotiated mutually acceptable acquisitions and mergers. They have said it repeatedly that hostile takeovers are not their policy for growth and expansion. This is a value system of the group, which earns it respect, not hostility. Therefore, Aiyar’s opinion that these values and traditions be dropped is unfortunate. This is not what Indian industry should be known for. In fact, his advice leads one to think of trying to evolve an informal code to be followed by Indian corporations with regard to mergers and acquisitions, the cornerstone of which should be: No hostile takeovers.

........Business is not only about accumulating wealth and glory. It is not about growth for the sake of size. It is about being a good corporate citizen. This is the model to follow for corporate India. Orient Express may come and go, but the Tatas will go on forever. So, too, will responsible Indian companies.
Das protests too much, methinks. Hostile takeovers are a means of getting rid of inefficient management and creating value for shareholders. Management will want to hang on to companies for their own reaons which may not be in the interests of shareholders. Hostile takeovers and the market for corporate control are an excellent cleansing mechanism.

Now, there may commercial reasons why the Tatas or any business group may not want to go down the hostile takeover route in a given reason- they may think, for instance, that they will generate too much ill- will in a given community or they may not have the cooperation of senior managers. But to tout opposition to hostile takeovers as a 'value' is a bit thick.

I don't think a company or a business group is at all being a 'bad corporate citizen' by using hostile takeovers- it is making an important contribution to the efficient utilisation of society's assets. Students of corporate finance would take this as a given.

Das's outburst and his suggestion that the Indian corporate sector should adopt a code against hostile takeovers makes me wonder: is it about values or about protecting Indian business groups? After all, if the Tatas use hostile takeovers today, they and other business groups cannot oppose such takeovers aimed at them tomorrow.

Room for optimism about the world economy

I know I'm sticking my neck out on this but I do believe that the world economy will ride out the present storm, bruised but not knocked out. I believe central bank intervention combined with fiscal policy will help limit the damge of the sub-prime crisis.

The critical problem today is banks' unwillingness to lend to each other because no bank is sure how badly damaged the other guy is. They will know pretty soon- once the first and second quarter results are in and the losses are accounted for. After that, things should be more normal in the banking sector and for the world economy. Remember, there is no generalised threat to world economies (of the sort posed by, say, a huge oil shock). There is a downturn in the US caused by factors specific to the US economy. That is part of the reason the impact on the world economy, I believe, will be limited.

See my relatively bullish views in the ET, Cheer up, the outlook is not so bad.

Wednesday, December 26, 2007

The Chinese are a-coming!

Am back from a longish trip, hence this gap in my blog writing.

Bear Stearns, Citigroup, UBS, Morgan Stanley.... the list of American firms offering equity stakes to Chinese and Asian firms is growing. Another troubled firm, Merrill Lynch, is getting an infusion from Temasek, the Singapore investment firm.

What does this mean? First, large overseas investors clearly think that the world's investment banks, although in trouble at the moment, are a good investment bet. The sub-prime crisis will end sooner or later- in my view, sooner rather than later- and banks with a fundamentally sound franchise will bounce back.

Secondly, the absence of hostility towards acquisitions by Chinese or Asian firms in blue-blooded western financial firms is striking. That's clearly because large funds are required- and the Chinese seem to have the filthy stuff. Considering how closed China's own financial market is to foreign firms, it is interesting that Chinese funds are now in a position to breeze into western firms. Remember, they acquired an over 10% stake in Barclays during the year and also a stake in Blackstone, the private equity firm.

We are clearly seeing sovereign wealth funds flex their muscles. They are sitting on assets of around $3 trillion and this is expected to rise to $10 trillion soon. Should India too follow suit? There are a couple of issues that economist Gary Becker has highlighted. One, these funds lack transparency and hence monitoring of performance becomes difficult. Secondly, being goverment-owned, they may not deliver the sort of performance one associates with private sector funds.

Becker thinks the funds should simply return some of the excess they have to their citizens as a national dividend or the government should cut taxes. Individuals will then be left with more surpluses which they will manage more efficiently than sovereign funds will manage theirs.

I am not sure about the second proposition, that government ownership is necessarily inimial to efficient fund management- UTI Mutual Fund has done pretty well in recent years. Lack of transparency is the real issue. In India, we do have excess forex reserves but nowhere near what China has. These excess reserves are better spent on developing infrastructure. China has first-rate infrastructure, so it can think of other uses for its reserves. For us, infrastructure spending should be the priority, not passive fund management.

Wednesday, December 19, 2007

Dangers of rupee appreciation

In today's ET, Swaminathan Aiyar pooh-poohs the claim that rupee appreciation is causing job losses in millions. He says he toured Gujarat and found little evidence of big job losses in its export oriented sectors. He is right.

But the big problem posed by rupee appreciation to date is not an export slowdown and the resultant job losses. The problem is that it entrenches the belief among market players that the rupee has become a one way bet. Combine that with higher interest rates in India compared to other countries and you have a recipe for Big Trouble- there will huge capital inflows in expectation of windfall gains and this will cause the sort of rapid appreciation in rupee that could spell serious trouble for the real economy. Then, you will have a serious export slowdown, the possibility of overheated assets and, finally, a sharp reversal in capital flows that could cause the economy to collapse.

Central bank blitzkrieg

Central banks showed what sort of fire power they are capable of on Tuesday when the European Central Bank injected a massive Euro 350 bn into the markets. This follows coordinated injection earlier by various western central banks and the US Fed in a bid to ease liquidity fears. Banks have been shy of lending to each other because they don't quite know how creditworthy the counterparty is and they are also hoarding cash to deal with the deepening impact of the sub-prime crisis. This has caused the inter-bank rate to rise sharply over central bank's bechmark rates.

Will it all work? Well, the intervention is certainly better than sitting idle. It reduces the possibility of bank collapse arising from liquidity problems in the short-run. Long-run, conditions will return to normal only when there is clarity about where a given bank stands in terms of losses. Over the next two quarters, once accounts are finalised and released, a measure of clarity should return.

The criticism against these moves and also against any cuts in interest rates is that these increase moral hazard- they benefit traders who are eyeing their year-end bonuses. There is merit in this criticism but this is not a problem we can focus on for now- it should be dealt with at the firm-level by restraining bonuses for people who took foolish risks. The costs to the wider economy from doing nothing are huge. But central banks should certainly tighten regulation once conditions in the world economy stabilise.

Friday, December 14, 2007

Remembering Ravi Mathai

December 11 is Institute Day on the campus. The community foregathers at Louis Kahn Plaza. Awards are handed out to those who have completed 20 years of service, to children of staff and faculty who have done well in studies or in other activities. There is an entertainment programme with contributions from campus kids as well as students. There is a certain vibrancy in the air. In its 46th year, IIMA retains a spring in its stride. My thoughts drifted towards the man who made much of our success possible, IIMA's legendary founder-director, Ravi Mathai. I devoted my last ET column to him.

There's a puzzle I haven't been able to crack. How on earth did Vikram Sarabhai zoom in on Mathai as the first director? He was a BA from Oxford who had then joined the corporate world. Only two years prior to joining IIMA, he had switched to IIM Calcutta. He was all of 38. And he was called to preside over the collection of dons Sarabhai had already assembled. (IIMA was founded in1961, Mathai was appointed director in 1965). Says something about Sarabhai's talent spotting abilities.

When Mathai came in, he had a bit of a student revolt on his hands. The PGP had been started in 1964 and discontent was brewing amongst the students. Every evening, he would sit with the students in the open ground for hours, listen to them patiently and reason with them. The revolt died down. This is one of many nuggets about the man in a two volume collection of tributes to Mathai that is available in our library.

Amongst MBA students, there is insufficient appreciation of the 'soft' aspects of management. It is much easier to relate to the number crunching part. If you want proof that the 'soft' aspects matter, that culture and process have a lot to do with an institution's success, IIMA is proof. Mathai thought through these aspects carefully and he came up with something that can be called truly world-class. How to run an organisation of knowledge workers is an art- management guru Peter Drucker wrote a great deal on this subject. Academic institutions represent an extreme in the class of knowledge workers, so if you can make things happen there, you have achieved something. That is what Mathai achieved.

My column mentions some of the elements. I did not have a chance to mention how Mathai went about grooming talent. That was a time when it was not easy to bring in too many doctorates in management. Mathai's solution was to find people with a basic aptitude for academics and then send them over to Harvard Business School for a doctorate. They signed a bond, came back and served and, of course, had the option of leaving thereafter. C K Prahalad (a PGP product who joined IIMA as faculty thereafter) was one of the beneficiaries. Mathai reckoned that some people would leave. But even if a few stayed backed, that would be a big gain. And a few did stay back.

As I mention in my column, one of the astonishing things Mathai did was to step down a little after completing seven years on the job. He had everything going for him. Age was on his side. His record had been spectacular. He had terrific equations with all the major stakeholders. Kasturbhai Lalbhai, then chairman, and Sarabhai pleaded with him to continue as director. He could have been director until retirement. Yet the man chose to walk away from the job. Because he had thought through the governance implications very carefully.

Mathai had been careful to distance the Institute from government. This he did by making government one of many stakeholders with local businessmen and the state government being other stakeholders. IIMA is nominally accountable to the IIMA Society and it has an MoU with the government. That's how autonomy was ensured. He also made sure that the Board of governors did not dictate matters nor, for that matter, the director himself. He devolved power to the faculty by making the Faculty Council the principal instrument for decision-making. All key matters (even today) have to be brought to the Faculty Council for deliberation.

Which is all fine as long as there is a Ravi Mathai in the saddle. But not every director can be expected to be an angelic Ravi Mathai. In the present scheme of things, it is possible for a director to concentrate powers in himself with little accountability to anybody in particular since both the Ministry and the Board have been distanced from the decision-making process. Mathai found an answer to this problem: a single term for the director, after which the director reverts to a faculty role. This substantially addresses the problem of checks and balances on the office of director. All this is clear as crystal today. But for Mathai to have thought of it over three decades ago at the height of his success!

In relinquishing his job, Mathai lived up to the highest traditions of self-abnegation so greatly revered in this country. In many other ways, he set almost impossible standards of conduct. He instituted a rule (since waived) that the director should not be involved in consulting. He declined to seek reimbursement of his travel and medical bills. He never projected himself, it was always the Institute that got projected. I have heard that he was rather reclusive, locking himself in his house at the end of the day and mentally reviewing the events of the day.

The great thing about people like Mathai is that not only do they create the foundations for durable success, they also set standards for those who follow. It is impossible for anybody sitting in the director's chair to escape comparison with Mathai.

Monday, December 10, 2007

Bengalooru Bangalore-d

These are not the rosiest of times for IT companies. Their profits are being squeezed by a rising rupee, they face high rates of employee attrition, they have come in for sharp criticism from the Health minister for the working conditions to which BPO employees are subjected and their stocks have lost some of their sizzle.

Now, they are coming for in flak from the city with which they have come to be associated and which they claim to have placed on the international map, Bengalooru. Outlook magazine has an interesting story by Sugata Srinivasulu on how IT companies and their employees are being viewed with disfavour by many in Bangalore.

The world's most celebrated IT city is now considering that privilege to be a curse. Infosys and Wipro are no longer considered gateways to heaven, but more as roads to hell. When Infosys's Narayana Murthy was charged with showing 'disrespect' to the national anthem, there was a glaring absence of sympathy for the IT czar in the public domain, whereas earlier there would have been a tidal wave of support. Likewise for Wipro, when it was charged by a government panel of encroaching upon Bellandur lake to build its guest house. Another time, when the state government proposed to set up an education training and management institute with the Azim Premji Foundation, there was a letter campaign against it. There is now a perceptible change in the way the public in Bangalore looks at Murthy and Premji, the two most revered symbols of its IT industry—that they're no different from other businessmen who merely make profits for their company and their shareholders.

Well, well. What precisely are the grievances that people in Bangalore have against IT folk? The litany of complaints includes: rising property prices thanks to the IT employees' purchasing power, grabbing of prime land by IT companies, the bar and disco culture and IT employees being preferred in the bridal market.

There is a clear divide between other middle-class professionals, including the many in the public sector, and the IT employees. Those on the former side resent the rise to prominence of the latter.

The feature set me thinking. There are other professions that pay even more- the financial services sector, for instance. How come we do not see a similar resentment towards investment bankers and private equity people in Mumbai? I guess that's because partly the city is not yet identified with these professionals, they are not that numerous and, besides, in Mumbai, there are other sectors that absorb people and pay well.

IT dominates Bengalooru in a way in which other sectors do not dominate any metropolis and, also, the disparity between a dominant sector and other sectors in any city is not as great. If the proposed International Finance City materialises in Mumbai, we can expect an even greater backlash than what we are seeing in Bengalooru today.

A second reason could be that IT does not have the same linkages with the domestic economy. Finance professionals create prosperity in companies they take public, the stock market benefits thousands of shareholders. IT is seen to benefit only the people in the sector and nobody else. True, as Subroto Bagchi points out, IT creates benefits (such as declining telecom costs) but these effects are indirect and not as visible, hence the resentment.

Thirdly, to some extent, the prosperity of IT and its employees is seen as coming at the expense of the economy. IT companies have benefited from huge allotments of land at concessional prices, they benefited from an undervalued rupee for over a decade and they benefited from tax concessions as well. The charities made by some IT personalities are seen as poor compensation for the benefits earned.

So, what do we do? Throw IT out? Not at all. Can greater philanthropy help? To some extent, maybe- for instance, a classy university run at affordable prices on IT endownments might help assuage popular sentiment.

But the biggest corrective, I reckon, will come from the very economic environment that created IT's prosperity- no more concessional land, a decline in profitability from a rising rupee and its attendant costs (including layoffs in the IT sector) and a greater focus on the domestic economy on the part of IT firms in the face of a rising rupee.

Thursday, December 06, 2007

Goldman's success

I had a post yesterday on Goldman's success. I said it wasn't just luck or skill but the uniqueness of its business model that explained its success.

In today's FT, John Gapper argues that the firm benefits from the edge it gets by engaging in activities that involve conflicts of interest:

Big investment banks run advisory, securities and investment businesses but keep them walled off from each other to avoid conflicts of interest and trading on inside information. Goldman has been more aggressive than any other bank in putting the three together – it often advises a company on a transaction, finances it and invests its own money.

That regularly puts Goldman in delicate spots. It swaps from advising on a sale to bidding for the property, or its private equity arm co-invests with another fund in a company its bankers have found for sale. It often faces accusations of conflicts of interest over its overlapping roles but it brushes them off by saying that its job is to “manage conflicts”.

It has got away with this because it is too powerful to ignore. Private equity firms grumble that Goldman advises them on deals and competes with them but they accept it because it has such a big network of corporate clients that they cannot cut it off. One day, however, this balancing act will blow up in its face.

Goldman’s skill, luck and edge have combined this year to produce its great escape. The three will not always align so well.

This is an argument that others have made, notably Philip Augar in his book, The Greed Merchants. Point is: such conflicts of interest are not unique to Goldman. Perhaps the conflicts are more acute in the case of Goldman because of its higher involvement in activities that entail its own capital.

Maybe Goldman benefits more from the access to information it has as a giant investment bank. But how come the others are not seeing such benefits? Because they are not as much into proprietary activities or have not developed as much expertise in these.

Wednesday, December 05, 2007

Does better governance explain Goldman's success?

Goldman Sachs is one firm that has defied the meltdown in the financial sector. It has sub-prime exposures but it hedged these by shorting mortgates, so it has come out of the present turmoil smelling of roses. What explains Goldman's success at a time of widespread risk management failure?

John Plender, writing in FT, contends this is because of superior governance:

Much of it is down to culture. Until recently, Goldman was a partnership, which is one of the best risk-control mechanisms invented. The culture of partnership, which entails a high degree of mutual surveillance in the common interest, still survives in spite of Goldman’s status as a listed company.

......Most importantly, Goldman ascribes as much status, prestige and pay to people engaged in control functions as to those running businesses. It constantly rotates human capital back and forth between risk control and business operations.

...The structure of boards is also relevant. In the US governance model, the chairman and CEO roles tend not to be split, while the boards are dominated by non-executives who too often lack expertise in risk. Over the recent credit cycle, these non-executive directors permitted a huge escalation of risk across the banking system. They also sanctioned pay deals for CEOs, complete with rewards for failure, that encouraged risk escalation.

....In contrast, Mr Blankfein (CEO of Goldman) is accompanied on the board by two other executive directors, together with Stephen Friedman, a former senior partner of the firm. So there is a core group on the board steeped in the disciplines of risk. And Goldman’s managing directors include Gerald Corrigan, a former head of the Federal Reserve Bank of New York, who is regarded as the pre-eminent expert on financial plumbing.

I am not entirely persuaded. The risk management systems and structures that Plender associates with Goldman are to be found at other Wall Street firms as well- and yet they have done badly. I should know: I have worked for a Wall Street firm myself.

Assigning as much importance to control functions as to managing businesses, for instance, is not unique to Goldman although rotation between the two may be. I also doubt that a superior quality of board has to do with better risk management: it's next to impossible for a board to assess and monitor risk at a large investment banking firm.

What, then, is the explanation for Goldman standing out- apart from the luck factor? My guess is that Goldman's business model may have something to do with it. It is more heavily into deriving income by using its own capital than many others and it has the advantage of long experience in these - proprietary trading, hedge funds, private equity, etc. At a time when the global economy has been booming, private equity especially has a huge upside. Merrill's drive into these businesses is relatively recent and this may explain why it has stumbled badly.

Having a unique business model may help at the margin more than better governance. Macquarie Bank is a fabulous success. That is because its business model was unique- I doubt that better governance is the factor.

Monday, December 03, 2007

Wall Street bonuses- skewed against shareholders?

Goldman Sachs will be handing out huge bonuses even in what is a miserable year for Wall Street. No question, Goldman has done well. It has hedged subprime risks, has reported healthy profit for the third quarter and is expected to do well in the last quarter as well. Enough reason for its CEO to walk away with something in excess of the $54 mn he earned last year.

But people at the top at Goldman know that huge payouts in times such as these are bound to attract hostility. They have sought to preempt it by announcing the creation of a charity, Goldman Gives., to which senior executives will contribute a part of their compensation. Each contributing partner will have his or her own account in the charity and will have say in determining beneficiaries.

In this, Goldman people are doing what the Narayana Murthys and Aziz Premjis have done long back as also Bill Gates and Warren Buffet (although both Gates and Buffet seemed to need some prodding). It helps if you are seen to give back to worthy causes; it also helps if you are seen to have a not very flamboyant lifestyle.

The problem arises with bonuses at firms that have not done well. How do you justify bonuses at firms that have seen an erosion in shareholder value? I address this in my latest ET column, Sorry, you can't touch my bonus.

There are two reasons why Wall Street might think this is justified. The first is that variable pay is a big piece of compensation on Wall Street - and this has to do with individual, not firm performance. If you don't have variable pay, then base pay will have to go up - and Wall Street firms would like to avoid that. The second reason is that performance is easilly measurable unlike in non-financial firms.

Fair enough. However, in financial firms, including banks, there is an issue of rewards not taking into account losses to the firm down the road. Firms pay when the individual performs but don't expect him to pay back when he inflicts losses on the firm. This does seem to be a problem given the scale of bonuses.

True, stock options that vest over a longish period go some way towards addressing the problem. But several problems remain. What if options vest in the third year and the individual
causes a loss in the fourth? What about payments that are made in cash? And what about rival firms taking care of options that are yet to vest when they poach a high performer?

Banks and investment banks are highly leveraged and banks enjoy a security net at the expense of the taxpayer. High leverage can result in high returns to equity and high bonuses when the going is good. It can result in bankruptcies when the going is bad. Incentives in financial firms seem to be skewed in favour of the individual and against the shareholder. The problem needs to be addressed.

Wednesday, November 28, 2007

Private equity disclosure

Opacity in private equity is a vexed issue. We don't know much about returns that private equity firms make out of businesses they run, who are the ultimate owners, how value is created.

Private equity justifies this lack of transparency essentially by saying: returns and other financial information are for owners, others have no business to demand information. Following criticism of the ways of private equity firms, the industry in UK responded recently with a voluntary code of disclosure.

In an analysis in FT, Chris Higson, a professor at London Business School, says the disclosure offered is inadequate. In particular, the industry is willing to disclose how value was created in the aggregate but is unwilling to do at the level of a particular unit. That would have meant shedding light on which stakeholders lose out when shareholders gain hugely.

Higson is scathing about the industry's stand that financial information is meant for owners. Not so, argues Higson. Almost any business has an obligation to practice a certain level of transparency because several stakeholders are involved, not just owners or shareholders:

As a matter of fact, both US Generally Accepted Accounting Principles and international accounting standards emphasise that financial statements are aimed precisely at those people who do not have the close and easy access to the business that private equity partners do; also, that investors, creditors, managers and employees all have similar information needs since they all make risky investment decisions. Moreover, the entitlement of all to receive its financial statements is long-established in UK law, whether a company is public or private.

....Of course, privacy concerns apply with equal force to acquisitions by sovereign wealth funds, private individuals or families. The working assumption in the 20th century was that most businesses of any importance would be public, with the disclosure and scrutiny that brings. But the eclipse of public equity markets challenges those assumptions. Critics talk about companies “going dark” after private equity acquisition. Unless we understand the importance of transparency, and unless there is political will to protect it, more business activity will pass into shadow.

Sunday, November 25, 2007

Homeopathy- cure or delusion?

Lancet, the British medical journal, is set to place itself firmly in the anti-homeopathy camp, a British GP, Margaret McCartney writes in FT.

“There are five homeopathic hospitals in the National Health Service, 40 per cent of GPs refer patients for homeopathic treatments,” he (Richard Horton, editor-in-chief, Lancet) told listeners, “and there’s not one shred of evidence to support homeopathic efficacy for any disease.”

McCartney herself is forthright in denouncing homeopathy:

The bottom line, and no homeopath with half an eye on the evidence can ignore it, is that homeopathic remedies are no better than taking a placebo. Homeopathy does not work. We should accept this and move on.
McCartney argues that homeopathic hospitals under the NHS must be closed down. However, that the placebo effect of homeopathy- the effectiveness of treatment that is chemically inactive- is worth focusing on. Homeopathy doctors tend to give more time and attention to a patient than their allopathic counterparts. This 'caring' factor itself may have beneficial effects and should be captured in some way in allopathic treatment.

How can this be achieved under NHS? McCartney has one concrete suggestion: ensure that patients meet the same GP on a continuing basis instead of being bounced from one GP to another.

When I read stuff like this, I thank heavens for the quality of medical care in India. Most of us have GPs we stay with for years. They know our ailments inside out, the treatments they have prescribed- and, not least, are willing to come home at short notice.

Tuesday, November 20, 2007

Banks' losses and gains in sub-prime crisis

Goldman Sachs estimates that financial institutions will take a hit of $400 bn due to the turmoil in financial markets. But the impact varies widely across institutions. Goldman, Lehman and Morgan Stanley have come out relatively unscathed while Bear Stearns, Merrill, Citigroup and Bank of America have suffered big losses.

For some banks, there is a big offset coming from stakes in Chinese banks. The increase in market value of the stakes of top international banks in Chinese banks - FT's Lex column places this at $70 bn- exceeds the sub-prime write-offs that banks have announced so far.

The difficulty, as Lex points out, is that international banks will be able to augment their capital only if they actually sell their stakes in Chinese banks. So far, they have been reluctant because they view these as strategic investments that will help them gain access to the Chinese market. But, as capital is progressively impacted by sub-prime exposures, the case for selling these stakes will become strong.

Two pieces of good news from the above. One, the banking system as a whole is better placed to weather the impact on capital of sub-prime losses than many would suppose. Capital may shrink but it is not likely to turn negative- in other words, a generalised banking crisis appears a remote prospect. That augurs well for the world economy.

Two, because there are good performers among banks, the bonus pool for 2007 is estimated to be slightly higher than for 2006 even though shareholders have seen their value eroded. How to explain this?

Well, there is an asymmetry in rewards and penalties in banking. In all banks, including underperforming ones, the divisions that have done well need to be rewarded generously. Those that have done badly will be penalised through job losses but there will be no negative payments, so to speak, for employees. Heads you win, tails you don't lose- that's the story for employees.

Monday, November 19, 2007

Om Shanti Om

I saw OSO. The first half is entertaining, especially the spoofs on Bollywood. Had the film remained a spoof throughout, one could have related to it. The trouble arises because there is a
more serious part to it. That makes the second half a drag.

The degeneration towards the end is precipitous. As though it's not bad enough that Shah Rukh and Deepika both appear in a reincarnation, there is a lookalike of Deepika who rescues Shah Rukh. She then disappears into nothingness. It's a bhoot, you see, not the reincarnated Deepika! That really got my goat.

OSO simply does not deserve the hype surrounding it. There are a couple of decent songs. Deepika has the makings of a superstar but she's under-utilised. The film is all about Shak Rukh- his endless baring of his chest is not funny at all, not least because he shows clear signs of ageing.

I believe OSO is a box-office success. That tells me what clever marketing of films can achieve. You build a brand out of a film- everybody wants it, never mind the content. Will this work in general? I doubt it. You can't fool all the people all the time. Ultimately, the test of a film is: do you want to recommend it to somebody? With me, OSO fails the test.

Saturday, November 17, 2007

Drumbeat on Iran grows louder

Western experts warn that Iran could be in a position to develop nuclear weapons way ahead of the 2010-2015 period estimated earlier. Some believe that Iran may be just 12-24 months way, according to a report in the FT.

“It looks like they could be there in a year,” said Richard Garwin, one of the designers of the US’s first H-bomb, referring to the possibility that Iran could build up a sufficient stockpile of enriched uranium in the next 12 months. That would mean it could produce enough weapons-grade material for a bomb at a few further months’ notice.

Prof Garwin said the IAEA report showed that Iran was stepping up uranium enrichment. The report says that between February and November this year Iran fed 1,240kg of uranium feedstock into its enrichment facility in Natanz, south of Tehran, up from 690kg between February and August.

This means that in the last three months Iran has pushed almost as much uranium through the system – 550kg – as it did in the preceding seven months. It also indicates that Natanz has not only expanded in size but may also now be operating more smoothly.

Prof Garwin said the figures signified that Iran would now have more than 100kg of fuel-grade uranium, which could be fed back into the system to produce weapons-grade material in a matter of months.

I don't know what to make of these reports- remember also those warnings about WMD in Iraq? I do know one thing: the appearance of such reports makes a US attack on Iran more likely. I had thought that such an attack would happen in 2007. I think the probability is even higher in 2008. That is part of the reason oil prices inched up to the $100 mark recently. They receded after a top US general warned against the risks of such an attack.

Defence experts have been saying that the US would lauch a comprehensive air attack on Iran's nuclear and physical infrastructure with as many as 1500 targets. Very few ground troops would be involved. The idea would be to bomb Iran back into the stone age.

Friday, November 16, 2007

Customer service in Indian banks

I quoted from an ET story sometime back about the poor quality of services in London, including in banking. Why would a competitive, modern banking system deliver shoddy customer service?
You get an answer when you look at the Indian banking system. After having opened up to competition in a big way over a decade and a half ago, we are getting serious complaints.

That's because customer service is not just about speed or promptness, nice-looking branches or even a choice of diverse channels such as ATMs and internet. Pricing and charges are always an issue- and it hurts when you find that the marble interiors in bank branches are being paid for by extortionate lending rates, hidden charges and lack of transparency in pricing.

One other item in customer service that is in the news is the methods used by banks to effect loan recovery. Private banks mostly use recovery agents and these agents do not hestitate to use force and intimidation to effect recovery. Bankers say this is necessary when borrowers wilfully resort to default. But, I argue in my ET column,A fair deal for bank customers, that problems in recovery often have to do with bad lending practices and that tighter regulation is needed. Credit information bureaus and better rules for repossession will also help.

But, under no circumstances can the regulator allow banks to resort to coercion. The ordinary citizen already has a sense of living in a lawless environment where he has little recourse against powerful individuals and institutions. Imagine what would happen as banks fan out further into the smaller cities and towns. The cooption of the underworld into the banking system is the ultimate nightmare.

Wednesday, November 14, 2007

IIMs through FT's lens

I read the story on IIMs in FT by Della Bradshaw with a sense of disbelief. The FT's correspondent seems to have bought whatever a few people in positions of authority at the IIMs told her especially about lack of autonomy at the IIMs and the government's "counter-productive intervention".

Let me take up some of her key statements one by one:

1.After five years as director of IIM Ahmedabad, in Gujarat, Bakul Dholakia had to step down from the top job, in spite of the hopes of many at the school that this forward-looking figure would be allowed to serve a second five-year term.

It is a time-honoured convention at IIMA for directors to serve only one term. This convention owes to the legendary founder-director of IIMA, Ravi Mathai, who chose to step down after one term after a spectacular record and despite fervent entreaties from the board as well as the IIMA community to stay on. If Prof Dholakia had indeed been given another term, that would have come as a shock to the community. I do not know who the "many at the school" are whom the FT correspondent refers to.

2....under the Indian system of academic appointments, it is the Indian prime minister who decides who will be the next director and the politically controversial Prof Dholakia had spent much of his time in office spearheading the IIM campaign against government dictates.

Only on paper does the PM decide the next director. The choice of director was left to a search committee of which the IIMA Chairman was member. The IIMA Chairman had extensive interactions with IIMA faculty on the basis of which he drew up a three person short-list. The search committee seems to have gone by the short-list given to it by the Chairman and it proposed two IIMA faculty for consideration by the government. It is a travesty of the truth to suggest that it was the PM's office that decided who would succeed Prof Dholakia.

3. On a practical level, it (the method of choosing the director of IIMs) has hampered the IIMs in their efforts to become world-class business schools

Not true. Prof Dholakia himself emerged through the same selection process the last time.

4."We've been arguing - with not much success - that as we don't take money from the government, we should be able to decide salaries," he (Rishikesha Krishnan of IIM Bangalore) says. "What we're hoping for, but seems unlikely to happen, is that we will get more autonomy for deciding salaries."

IIMs are part of a much broader fraternity of government sponsored institutions- and the list includes such heavyweights as SBI, ONGC, BHEL and BSNL- whose salaries are part of the government framework.

There is room for improvement in salaries in these institutions but it is a moot question whether greater autonomy for IIMs will translate into superior salaries. Do IIMs have the capacity to pay a lot more? I am not sure. At IIMA, which leads the others by a wide margin in revenues, there is concern today over the impact of the Sixth Pay Commission, leave aside paying anything more!

5. Trying to attract new faculty is one of the biggest issues affecting the six IIMs - located in Ahmedabad, Calcutta, Bangalore, Lucknow, Indore and Kozhikode. (A seventh IIM has been created in Shillong, near the Chinese and Burmese borders.) And the biggest problem in faculty recruitment is salaries. ......"Attracting international faculty? You can forget it," says Prof Krishnan.

I have said this before in my blog: the notion of attracting international faculty on the strength of superior salaries at IIMs is bogus. Universities in Europe, Hong Kong and Canada offer a premium to those in the US and are yet unable to draw the best faculty. The IIMs cannot hope to get anywhere near those packages whatever the improvements they effect. When IIM faculty say, 'please let us make salaries more attractive', they do not seriously mean they can attract better faculty. They mean: let us get richer.

Note, however, that at IIMs salaries for many faculty are only a small part of the total compensation. Dholakia is quoted as saying that his top faculty earn seven or eight times the government stipend. If that is true, them comparing the salary alone with corporate salaries
(the ratio is said to be 1:10) is incorrect. One should compare average total compensation for IIMA faculty with corporate salaries.

6. With India's top business schools eager to establish themselves as leading global brands, government control is hugely restrictive, says Prof Dholakia.

This statement is often made but without substantiation. Government intervention is felt mainly in respect of salaries for faculty. As I have said earlier, this is only notional because it's not clear IIMs have the capacity to pay a great deal more. Other than this, I am not aware of anything the government does that comes in the way of developing a global brand.

Developing such a brand is not just about globe-trotting- pitching a tent in Nigeria or Oman- but developing teaching and research capabilities that can compare with those in the top schools abroad. There are hundreds of business schools in India, including the Indian School of Business, that are free from government interference. Not one of them has been able to attain even the level of the IIMs.

The limitations are inherent in our situation. The top B-schools in the US have had a head-start and their financial and academic strengths today are overwhelming. It makes as much sense to talk of the IIMs catching up with them as it does to talk of India catching up with the US in defence capability- not even China or Russia harbour such a delusion.

FT, I am disappointed, one expects a better critical sense of a world-class daily.

Sunday, November 11, 2007

Accountability of the judiciary

How to make the judiciary accountable is undoubtedly one of the most important questions in governance today. Whether it is the media or the IIMs or the medical fraternity or the judiciary, one key principle should be upheld: self-regulation is simply not the answer. The merchant bankers used to say the same thing: leave it to us, we will set standards. Stock exchanges used to say that. Accountants in the US claimed it worked for them. Every body of professionals would rather not have somebody from outside looking closely into what they are upto. Sorry, this cannot be permitted.

In an article in EPW, Prashant Bhushan lays out the case for judicial accountability. Today, the only recourse against an errant judge is the process of impeachment. To initiate this requires the signature of 50 MPs. For this, in turn, to happen, there must be conclusive evidence against a judge; and the evidence must be published so that it assumes the proportions of a scandal. But because the media is afraid of publicising charges against a judge and politicians do not wish to invite the wrath of the judiciary, these conditions are almost impossible to satisfy. Bhushan adds that it is virtually impossible to register an FIR against a sitting judge because, under a 1991 Supreme Court judgement, no judge can be prosecuted without the written consent of the CJI.

On top of this, Bhushant points out, courts have been trying to insulate themselves from the Right to Information Act. The application fee in many courts is Rs 500 instead of the Rs 10 that is normally required. Many courts have framed rules that prohibit the disclosure of information on administrative and financial matters. They have done this in the knowledge that any petition that challenges these rules will have to come up before the judges themselves!

The response to the rising clamour for accountability is the Judges Inquiry Act Amendment Bill 2006 under which an in-house procedure will be created for taking cognisance of charges against errant judges. Bhushan argues this won't work because it requires complainants to disclose the source of information for charges and it also provides for action against complaints that the judges believe are mala fide.

Bhushan argues in favour of a National Judicial Commission. The chairman will be selected by the judges of the Supreme Court. Other members will be selected by each of several groups: judges of high courts; the cabinet; a committee comprising the speaker of the Lok Sabha and the leaders of the Opposition in the two houses of parliament; and a fifth member selected by the chairman of the National Human Rights Commission, the CVC and the CAG.

Curbing ECBs- some new proposals

The hottest topic in policy debate today is curbing capital flows into India. Amazing. Barely five years ago, people were talking about the things we should do to attract capital! One item in capital flows that has ballooned is external commercial borrowings (ECBs), foreign loans obtained by Indian companies. This is worrisome because, given the interest differential between India and the industrial economies, it makes sense for Indian companies to raise loans abroad. The appreciation of the Indian rupee makes this even more attractive.

ECBs can become unmanageable if not curbed. The government announced several measures last August, such as limiting the use of such loans in India to $20 mn, the rest of the borrowing having to be spent abroad. The government also has in place a ceiling on the spread over LIBOR that Indian companies can borrow at- this means companies that do not have high ratings will be automatically restricted from raising ECBs.

There is a sense that these measures are not enough and some new proposals have been mooted: auction of ECB loans among corporates and a sterilisation tax that will be borne by companies.The latter is meant to compensate the government for the cost it incurs on sterilising foreign inflows- the government sells securities at Indian interest rates when it sterilises inflows; the foreign exchange that it buys fetches it foreign interest rates. The difference in rates is the cost to the exchequer.

I contributed to a debate in ET on the subject. I don't believe these measures will be effective enough. The government should have a better capacity to sterilise. For this, it needs to have a bigger war chest of market stabilisation bonds and it also needs to bring down domestic rates. It must also act to make returns to investment in India less attractive through, for instance, introducing long-tax capital gains tax on equities.

Tuesday, November 06, 2007

ICICI Bank cops it again

ICICI Bank has been slapped with a cost of Rs 5.5 mn in a consumer dispute. The Delhi Consumer Commission levied the penalty in a case involving the use of goons to recover a vehicle financed by the bank. As happens often in such cases, the wrong guy got beaten up- not the owner of the vehicle but his friend's son and ended up in hospital.

Only a few weeks ago, ICICI Bank was in the spotlight when a home loan borrower in Mumbai committed suicide- the bank entered into a settlement with the deceased borrower's family on that occasion.

Banks must beware- the RBI has warned that banks that attract strictures from a court will not be allowed to use recovery agents.

Rediff reports:

"No civilised society governed by rule of law can brook such kind of conduct," the Commission's president Justice J D Kapoor said, adding the violent methods adopted by the recovery agents were serious violation of "human rights".

Holding the ICICI Bank guilty of "unfair trade practice," the Commission termed such miscreants as "yahoos" and said they are boorish and a brutal lout, who care a fig for legal and judicial authorities, including the Supreme Court. While taking to task the leading bank, it vented its anger on ICICI for flouting the apex court's direction that restrained all the financial institutions from employing musclemen to recover a loan amount or possession of a vehicle.

The Commission, also comprising member Rumnita Mittal, issued notices to the collection manager of ICICI Bank and the CEO of the recovery agency, seeking their explanations over blatant violation of the direction of the highest court of the nation.

Friday, November 02, 2007

Fear not the Sixth Pay Commission

Some sort of panic has gripped economic commentators as the Sixth Pay Commission award draws nearer. There is talk that this will again deal a crippling blow to public finances.

I don't think so. I think the improvement in both central and state finances has been sufficiently impressive that we can withstand the impact of any SPC award. But, also, as I point out in my
latest ET column, Booming Sensex, smiling GoI, the government could easily mobilise the extra funds needed through disinvestment.

True, the unions and the Left oppose disinvestment. But this opposition can be overcome. I argue, by linking a generous award with: a. approval for disinvestment and b. assurance (if necessary by legislation) that government equity in PSUs will not be allowed to fall below 51% consequent to dinsvestment.

By holding on its to investment in PSUs and public sector banks, the government has ended up a big winner from the rise in the Sensex- and don't forget it was the Left that forced the government to hold on!

Tuesday, October 30, 2007

A primer on leadership for Wall Street CEOs

Stan O'Neal, CEO of Merrill Lynch, has had to exit his job following huge losses on the sub-prime portfolio. It wasn't just the magnitude of the writedown- $ 8bn- that appalled the board and analysts. O'Neal was seen to have failed to provide the right guidance- the estimate only a few weeks earlier was of $4.5 bn. This was seen as a poor reflection on risk management at the firm.

O'Neal was also faulted for having approached Wachovia Bank for a possible merger without prior discussion with his board.

These are both failures, all right, but are they big enough to cost a CEO his job? Wall Street's standards, you might say, are exacting. You earn big money as the CEO of a Wall Street firm and you must expect the margin for error to be narrow.

However, as former star analyst Abigail Hoffman points out, others have got away with failures of the same order.

I find it odd and odious that Mr O’Neal has been hounded from office while other chief executives linger on. At Citi, Mr Prince has presided over third-quarter fixed-income losses and a lacklustre share price performance; Bear Stearns, under James Cayne, has stumbled badly; and Ken Lewis, Bank of America’s chief executive, had the wrong people in charge of the investment banking division, where net income fell by $1.33bn in the third quarter.
Hoffman notes that O'Neal had conspicuous success at Merrill:

Mr O’Neal changed Merrill and, in my opinion, he changed it for the better. He diversified the business away from its traditional retail broking focus and oversaw significant profit growth. Net earnings rose 47 per cent last year to a record $7.5bn.
So, why was O'Neal singled out for heavy punishment? Hoffman says the problem was not the failures he ran up recently. It is just that he antagonised people through his cost-cutting and, more critically, failed to pack the board with supporters. As a CEO, you need to perform, of course, but there are other things you need to keep in mind:

Mr O’Neal’s departure was not inevitable. Nevertheless, this squalid incident has lessons for us all. Chief executives must be careful to keep the board on side. And the maxim: “On your way up, be cautious who you step on because you may meet these people on the way down” remains true.

Thursday, October 25, 2007

Service quality in London

London. Financial capital of Europe? Yes. Throbbing metropolis? Yes. Great amenities and services befitting an advanced economy? NO- says Sudeshna Sen in today's ET.

there’s nothing I can do to be politically correct about the fact that average customer service standards in London - across the spectrum from banking, hospitality, utilities, telecoms, retail, internet, IT et al - is, to put it mildly, appalling.

And yes, to make another sweeping generalisation, it’s much worse compared to what you get in urban India today — even more in higher end services like telecom or banking. It can take up to two months to set up a bank account, another three weeks to three months for an internet connection, a week to check a faulty phone line, an hour for an order to be delivered in some of the poshest restaurants.

What could be the reason for such poor quality of services? Sen has her hypotheses:

From what I’m able to make out, it has little to do with employees - more with corporate attitude. Service providers here seem to have business models that are all carved in stone, possibly invented in pre-Thatcherite times, and no real new competitors in decades to drive innovation in any segment. Another reason, I’m told, is the European obsession with employee rights has pushed customer rights completely off the map.

I don't believe this is the whole of the explanation. I think the privatization of key services has been a disaster- government monopolies have given way to quasi-monopolies in the private sector. Whereas there is a certain accountability in government, thanks to parliament and the media, the private sector is free to operate as it pleases. No amount of regulation seems to help.

I shudder to think of what we can expect when we in India too make a wholesale shift from government to the private sector in respect of education, health, telecom, banking and the rest.

No certitudes in bank regulation

In today's BS, Shankar Acharya has an article that shows how the certitudes underlying bank regulation in industrial economies have been shaken by recent events. The certitudes were:

first, a nation’s central bank should be accorded statutory independence from government; second, the central bank should be charged with the single (or primary) target of keeping inflation low; and third, all financial trading and intermediaries should be brought under a separate single regulator.

Following the collapse of Northern Rock in UK, the Bank of England could not fend off pressures from government to effect a rescue of depositors. This was after all the tough talk from Bank of England Governor Mervyn King. So much for central bank independence.

As for focusing on inflation alone, the US Fed found itself obliged to cut interest rates in order to maintain financial stability. As for having a single regulator, Acharya rightly points out that there cannot be a uniform prescription for all contexts- you have to see what will work in a given context.

Acharya has some kind words to say about the criticism that RBI has attracted for its efforts to contain rupee appreciation:

Against this background it should be easier to sympathise with the Indian authorities’ recent and somewhat untidy efforts to grapple with the unprecedented surge in foreign capital inflows and their destabilising consequences. The shrill and simplistic critiques of over-zealous “market fundamentalists” are not very helpful. Nor, of course, is blind defence of any and all public regulatory interventions.

Wednesday, October 24, 2007

A swipe at risk management techniques

Naseem Talib, a former trader, is something of a maverick when it comes to risk management. He has produced articles and books that question the value of many modern tools of risk management. In FT, he takes another swipe at these:

MPT (Modern Portfolio Theory) produces measures such as “sigmas”, “betas”, “Sharpe ratios”, “correlation”, “value at risk”, “optimal portfolios” and “capital asset pricing model” that are incompatible with the possibility of those consequential rare events I call “black swans” (owing to their rarity, as most swans are white). So my problem is that the prize is not just an insult to science; it has been putting the financial system at risk of blow-ups.

I was a trader and risk manager for almost 20 years (before experiencing battle fatigue). There is no way my and my colleagues’ accumulated knowledge of market risks can be passed on to the next generation. Business schools block the transmission of our practical know-how and empirical tricks and the knowledge dies with us. We learn from crisis to crisis that MPT has the empirical and scientific validity of astrology (without the aesthetics), yet the lessons are ignored in what is taught to 150,000 business school students worldwide.

.......The environment in financial economics is reminiscent of medieval medicine, which refused to incorporate the observations and experiences of the plebeian barbers and surgeons. Medicine used to kill more patients than it saved – just as financial economics endangers the system by creating, not reducing, risk

Caste discrimination in Indian industry

Indian industry claims it has no caste bias and that its hiring policies are entirely meritocratic. It uses this claim to oppose caste-based job quotas. The Economist had a feature on the subject largely supporting industry's contention and arguing that quotas would hurt industry while doing little for the underprivileged. Much of the discrimination, the feature suggests, may have to do with class rather than caste:

There is no strong evidence that companies discriminate against low-caste job applicants. Upper-class Indians, who tend also to be high-caste Hindus, can be disparaging about their low-caste compatriots. “Once a thicky, always a thicky,” is how a rich businessman describes Ms Mayawati. Yet this at least partly reflects the fact that low-caste Hindus tend also to be low class; and in India, as in many countries, class prejudice is profound.
Two academics, Paul Atwell, Professor of sociology at City University of New York and Katherine Newman, Professor of sociology at Princeton, contest these claims in a letter to the editor. Their empirical study bears out what those who favour quotas have been saying: caste discrimination may not be overt but it exists and improving the educational credentials of lower castes alone will not be enough.

Our two-year study, which we will soon present, found widespread discrimination against highly qualified low-caste individuals. We sent out 4,800 applications in response to advertisements for graduate jobs in Indian and multinational companies. These applicants bore distinctively upper-caste names, Muslim names and dalit surnames, but were otherwise identical in educational qualifications and work experience.

The odds of a dalit being invited for an interview were about two-thirds of the odds of a high-caste applicant with the same qualifications. The odds of a Muslim applicant being invited to an interview were even worse: only one-third as often as the high-caste Hindu counterpart.

The evidence is solid. Serious policies, coupled with an overhaul of India's education system, a required to overcome this pernicious form of social exclusion. Maybe then the widespread relegation to the bottom of the barrel of India's poorest castes will begin to diminish.

The difficulty I see with quotas in industry is that they will be hard to implement- bureaucrats and politicians alike will be bought off by businessmen and anybody who leans too hard on industry will find it hard to survive in politics- he or she will not be able to access the kind of funds that political surivival requires these days.

Thursday, October 18, 2007

A more stable world economy

The world economy is more stable today in the past, it is growing faster than at any time except the 1960s, deep recessions have disappeared in the industrial economies and emerging markets have grown stronger since the east Asian crisis. Facts worth emphasising when there are long faces over the sub-prime crisis in the US and its possible impact on the world economy.

The IMF's World Economic Outlook makes the point that better economic management has helped in a big way- monetary management especially, based on the insights developed in monetary theory, has had huge pay-offs. The WEO does not mention the role of central bank coordination in dealing with economic crises- I believe this too has been a big factor. As a result, central banks are better placed today to deal with the fallout of crises in financial markets of the sort we are facing now and to limit their impact on the real economy.

More on this in my ET column, Good times last longer.

Craze for emerging markets

Investors have rediscovered emerging markets after being burnt in the east Asian crisis. But net inflows into emerging markets as a whole are still lower than their historical highs. That is because the rise in gross inflows has been matched by outflows from emerging markets into other economies.

That was the position until last year. Things may have changed dramatically after the sub-prime crisis. Money is flooding the emerging markets on an unbelievable scale. FT reports:

Brad Durham of EPFR Global, which tracks fund flows, says that of the $29bn (£14bn, €20bn) in net inflows to emerging markets so far this year, 82 per cent has arrived over the past seven weeks, “which is astounding”.

By contrast, during the same period, US equity funds tracked by the group saw outflows of $6.3bn, European equity funds (excluding east European funds) surrendered $6.9bn and Japanese equity funds gave up $3.9bn.

There you have it. Funds are being switched out of industrial economies and into emerging markets. As a result, the price-earnings ratio in emerging markets is at a small premium to that in industrial economies. Macroeconomic conditions in emerging markets are today seen as sounder than before- growth is strong, 50% of global growth was contributed last year by China, India and Russia and foreign exchange reserves of emerging economies exceed inflows into emerging markets, making these economies net creditors for a change.

India is particularly favoured among emerging markets and that must explain the dizzying rise in the Sensex in recent weeks.

Wednesday, October 17, 2007

Restrictions on capital flows- Sebi proposals

Not to sound boastful but I wasn't perturbed at all when I learnt this morning that trading had been halted after a steep fall in stock prices triggered the circuit breaker. I was awaiting "clarifications" from official sources that would calm the markets. That's exactly what happened. After the PM and the SEBI chairman came on the air, the market recovered to end the day around 400 points lower- a considerable recovery from the fall of 1700 points earlier.

The draft regulations circulated by Sebi, which will become law with or without some minor modifications by October 20, are intended to curb capital inflows into the country. It will do so by curbing the volume of Overseas Derivative Instruments (Participatory Notes), instruments through which foreign investors can invest in India even if they are not registered as Foreign Institutional Investors.

PNs constituted 51.6% of Assets under Custody (AUC) in August 2007, 30% of which had derivatives as the underlying. The RBI has long been in favour of phasing out PNs but the finance ministry was resisting because it didn't want the stock market run to stop. With the kind of rise in the Sensex we have seen in recent weeks, the ministry, no doubt, reckons that a correction is affordable.

Sebi's proposals are as follows:

1) FIIs and their sub-accounts shall not issue/renew ODIs with underlying as derivatives with immediate effect. They are required to wind up the current position over 18 months, during which period SEBI will review the position from time to time.
2) Further issuance of ODIs by the sub-accounts of FIIs will be discontinued with immediate effect. They will be required to wind up the current position over 18 months, during which period SEBI will review the position from time to time.
3) The FIIs who are currently issuing ODIs with notional value of PNs outstanding (excluding derivatives) as a percentage of their AUC in India of less than 40% shall be allowed to issue further ODIs only at the incremental rate of 5% of their AUC in India.
4) Those FIIs with notional value of PNs outstanding (excluding derivatives) as a percentage of their AUC in India of more than 40% shall issue PNs only against cancellation / redemption / closing out of the existing PNs of at least equivalent amount.

So, the idea clearly is to limit investment in the Indian market through PNs. There has always been a problem about the identity of investors holdings PNs. For that reason alone, restrictions on PNs are welcome. But will it help meet the objective of curbing capital inflows? In the short run, yes. In the long run, no, for the simple reason that the volumes waiting to enter India are enormous. Once PNs are barred, we should see an increase in those wanting to register as FIIs.

I am sure the finance ministry and Sebi recognise this. But a breather on the capital inflows is welcome- and the present proposals will provide just that. JP Morgan estimates that the ouflows on account of the unwinding of PNs with derivatives as underlying could be $4-7 bn; the unwinding on account of PNs issued by sub-accounts of FIIs will be even larger. Of course, all this will happen over a 18 month time horizon although it may not be evenly spaced out over that period.

Forex additions this year have been $50 bn- the addition considered comfortable was around $25 bn. In relation to overall capital inflows, the outflows that will be triggered by the Sebi move
will be a minor speed-breaker. International factors remaining the same, it will slow the rise in the Sensex over the next few months. But it does provide some breathing space for RBI in terms of managing the exchange rate- the way things were going, it appeared the rupee would soon touch Rs 35 to the dollar.

In macroeconomic terms, the Sebi move does not amount to much over the long term. It does little to alter the trend towards rupee appreciation. But, as I said, it gives a little time for adjustment to appreciation- and that is exactly what Indian industry needs and can expect at best. Rupee appreciation can be managed, not eliminated.

The combination of a rising stock market and rupee appreciation would have meant capital inflows on an uncontrollable scale. That would have had a severe impact on the Indian economy. The speed-breaker imposed by Sebi is good for the economy. It is also good for the stock market. I think the market will recognise this - and continue its climb.

Monday, October 15, 2007

"Overpaid" US executives

Many think US executives are overpaid but not many would expect the executives to say so. Well, in a poll carried out by the National Association of Corporate Directors, four out of six CEOs or presidents polled acknowledged this was the case, FT reports.

Four out of six chief executives or company presidents polled by the NACD in July and August said the compensation of top executives was high relative to their performance.

Only 2.2 per cent of the nearly 70 chief executives and presidents involved in the survey said compensation was too low, while a third deemed it “just right”.

Their views were backed up by outside directors, with more than 80 per cent of them saying chief executives were overpaid.

“There is an overall realisation that executive compensation is an area that boards and management are struggling with,” said Peter Gleason, chief operating officer of the NACD.

The issue is particularly sensitive because the gap between rich and poor in America has reached its widest point in more than 60 years.

Figures released last week showed the share of national income claimed by the wealthiest 1 per cent of Americans had reached 21.2 per cent – a postwar record – partly because of booming company profits.

This is not a problem that can be addressed by "restraint" among corporate executives- I can't see these guys practising self-denial. It cannot also be solved by boards of directors as they are constituted at present.

There is a fundamental problem with corporate boards- and this includes corporate boards. The "independent" directors are, in fact, chosen by CEOs and are beholden to them for the fat fee and commissions they get these days- in the US, $100,000 is pretty common. The figures I have seen in the papers for Indian boards are an average of Rs 9- 10 lakh. A CEO requests you to join the board and he pays you Rs 10 lakh - do you think many people would question the CEO or oppose the CEO in the knowledge that that would be the end of the goodies they get? Not a chance!

We will have truly "independent" directors only when institutional shareholders get to nominating directors on boards. Then, we will have directors independent of management. Today, the word "independent" is construed to mean anybody who does not have a pecuniary relationship with management. That's not enough- to be independent, a director must not owe his job to management.

Friday, October 12, 2007

A peep into IIM-C's board room

Ajit Balakrishnan, Chairman of IIMC's board, has a piece about a recent board meeting. The board was reviewing proposals for a revamp of the PGP course curriculum.

The interesting thing to me is that not the comments made at the meeting. It is that Balakrishnan has thought fit to share some of the proceedings with his readers. This is hardly typical of boards. The agenda item itself would be "secret". The proceedings would be "confidential". So much that even at supposedly "faculty-governed" academic institutions, faculty have little clue as to what is discussed in their own boards. True, there are faculty nominees on these boards but try eliciting information from them!

I concede that not all matters discussed in the board of an IIM can be shared with a wider audience. But many matters can. And matters related to the strategic direction of the Institute certainly should be shared.

Changes in MBA curricula are a matter of intense discussion worldwide. What IIMC board members and what IIMC faculty have to say on the subject is certainly a matter of public interest. Balakrishnan has rendered a valuable service by giving us a peep into IIMC's board room. Congrats, Balakrishnan- and more power to those who favour greater disclosure rather than less.

Thursday, October 11, 2007

Lack of Ph Ds threat to IT industry

Microsoft MD Ravi Venkatesan thinks the shortage of computer science Ph Ds threatens the future of the IT industry, FT reports. I was taken aback at the figure mentioned in the report- just 35 Phds in a year in India compared to 1000 in the US !

“It’s an incredibly urgent and important issue,” Ravi Venkatesan told the Financial Times. “It affects the pipeline of future talent because the teaching institutions aren’t getting enough qualified faculty and, of course, if you really want to do cutting edge innovation in computer science, you’re restricted by the pool of talent out there.”

While Indian companies have until now relied on the difference between Indian wages and those in developed markets to attract business, the strategy is not sustainable, Mr Venkatesan said.

“It’s inevitably a matter of time before these wage disparities disappear and the only thing that’s going to matter is the quality of ideas coming out of an employee,” Mr Venkatesan said.

Wednesday, October 10, 2007

Fashions in bank regulation

Until the other day, the ruling wisdom was that it makes sense to separate the conduct of monetary policy from bank supervision. Combining the two roles, as the RBI does, is folly, we were told - among other things, there could be lack of focus and conflict of interest in doing so. The British separation of the Financial Services Authority from the Bank of England was held up a role model and the RBI was portrayed as being cussed in resisting any separation of roles.

That wisdowm is being turned on its head in the wake of the collapse of the British bank, Northern Rock. Now, we are told that the collapse could have been averted but for the fact that three players were involved- the UK Treasury, the BoE and the FSA- and none of them regarded as its primarily responsibility to avert disaster. Here is a sample from a comment in FT

It is, incidentally, worth noting that compared with the problems of mounting and co-ordinating a last resort lending operation to a big multinational bank, a Northern Rock bail-out should have been child’s play. But the tripartite division of responsibility between the Treasury, the Bank of England and the FSA has become the Bermuda triangle of the British financial system.

Evidently, fashions in bank regulation keep changing as they do elsewhere.

Lean times for Indian economy gurus

Swaminathan Aiyar has a piece in today's ET on how the mystery underlying the growth of the Indian economy. He says it is not clear why India should be growing at an average rate of 8.6% in recent years when there are still so many negatives in the scenario.

A different way of putting this would be to say-as I have been saying for long- that economic pundits have simply been wrong about the Indian economy. They warned us that there was no way the Indian economy could grow at 8% plus without "reforms". Many of these reforms have not been implemented or implemented in full. But that has not kept the economy from growing.

Aiyar mentions several hypotheses that attempt to explain the Indian economy's performance- "tipping point" or the cumulative effect of past reforms, steady improvement concealed by external shocks such as the east Asian crisis or the IT bus, the revival of manufacturing, the global boom. He is not sure they adequately explain the outcome. In particular, governance remains weak and the fiscal deficit is disconcertingly high.

I have never bought the governance thesis- that shifting coalitions or even political instability can be a growth inhibiting factor. Look around and you will find countries wracked by insurgencies doing quite well in terms of economic growth- Sri Lanka is a striking example. The fiscal deficit may be high in absolute terms but the trend towards improvement is unmistakeable.

I happen to think that the biggest factor in the improved performance of the Indian economy is the increase in savings and investment rates. The savings rate has risen by nearly 10 percentage points over the past decade. Fiscal improvement has been an important factor underlying the increase in the savings rate. Fiscal improvement, in turn, has been made possible by falling interest rates. And lower interest rates are the result of huge foreign inflows.

Why have foreign inflows risen so fast? Remittances have risen sharply after the exchange rate became market determined and hence it made sense to remit money through official channels and not through the havala route. FII flows have shot up as the stock market was modernised and foreigners realised that here was an economy that had grown at over 6% for two decades and would grow even faster. FDI has risen for the same reason. Falling interest rates have also boosted corporate profitability and corporate savings.

When an economy of India's size shows sustained growth, it becomes a magnet for global savings. Once the savings start pouring it, domestic savings rise because of the impact on the fisc and corporates of falling interest rates. The momentum imparted to the economy is sufficiently strong that it does not require "second generation" reforms. That's bad for economic pundits- they are left with little to preach. But it's just fine for the economy.

Would we have been even better off with a further dose of reforms? No- and here I think the political class got it right in preferring to move gradually. More reforms would have been socially disruptive- vocal segments would have been alienated and that would have created serious governance issues. The trick was to recognise the trend towards improvement and let the economy be. In this the politicians were right, the pundits wrong.

I have said this before: the performance of the Indian economy is ultimately a tribute to the democractic process and a warning against setting too much store by experets.

Sunday, October 07, 2007

Why can't the media get its facts right?

Today's Indian Express carries an interview with outgoing IIMA director Bakul Dholakia. The report carries the following item in a box:

No three-month extension for Bakul

IIM-A directors have always been given three-month extension after the expiry of their term. This was done to facilitate the handing over of the charge process to the next director, as the selection process for the same is a time-taking affair. For Prof Bakul Dholakia, however, October 9 is the last day of his term as also his last day in office. Sources in IIM-A said the chairman of the governing body of IIM-A, DrVijaypat Singhaniya, had written to Union HRD Ministry seeking an extension of Bakul's term until the next director is appointed.

It has been learnt that an "explicit" communiqué has been issued to Dholakia to hand over the charges on the last day of his term

The report is factually incorrect. In 2002, the then outgoing director too was asked to hand over charge the day his term expired. If the suggestion is that Prof Dholakia is being single out for special treatment by the MHRD, that is completely erroneous.

In previous rounds, yes, there were occasions when the director's term had got extended until the appointment of his successor but not all the time.

Leaving aside the historical record for the moment, isn't it a good idea to have fixed terms for such positions? Is it not a healthy practice for the director to step down when his term expires and for somebody else to hold temporary charge till the new director takes over? IIMA and its governing council should have instituted this practice on their own in the interests of good governance- that is the least one expects of the nation's top business school, many of whose faculty have made careers out of preaching governance to the rest of the world.

If they failed to do so and if the MHRD has now instituted an altogether healthy practice- of adhering strictly to the a director's term limit- then the ministry surely deserves bouquets, not brickbats.

Friday, October 05, 2007

Illusory surge in FDI

I remember an interview with P Chidambaram sometime ago- as I recall, he was being interviewed by an Indian business channel and the interview was in London. He was asked whether the opposition to reforms was not coming in the way of greater foreign direct investment (FDI) into sectors such as insurance. Chidambaram said he wasn't too worried because largely flows of FDI were happening anyway. If lack of progress on reforms made it difficult for foreign investors to enter some sectors, "so be it".

There is a certain smugness, I notice, about FDI since the official figures place FDI at $16 bn. As a proportion of GDP, FDI in India would today not compare unfavourably with China's. I have been taking a close look at the numbers and I find that nearly $ 8bn of FDI is private equity. Now, private equity is not the same as firm- or MNC- related FDI. It is in the nature of secondary market investment, with no immediate addition to capital stock or jobs.

Now, it's true that FDI from MNCs is also mostly of the secondary market variety, as it happens through mergers and acquisitions. But there is always the prospect of additions to capacity down the road, infusion of technology and export linkages with the parent. With private equity, you have a ruthless focus on efficiency- and this often takes the form of asset-stripping and paring of jobs- but the other benefits that arise from MNC FDI are not there. Much of the private equity flowing into India has gone into the services sector,including real estate. It is more akin to stock market investment with the prospect of additional gains from an appreciating rupee.

Take away the private equity component and changes in accounting practices in relation to FDI and the figure of FDI in 2006-07 falls to $5 bn. It does seem that the hype over FDI in India is misplaced. More on this in my latest ET column, Are FDI flows into India for real?

Thursday, October 04, 2007

Investment banking losses

Banks and investment banks are unlikely to go under in the present market crisis but their earnings are bound to take a hit.

Deutsche Bank and Merrill Lynch are the latest additions to a growing list of investment banks hit by losses in fallout of the sub-prime crisis. Earlier, Citigroup, UBS and Credit Suisse all had issued profit warnings. Lehman is among the few banks to have weathered the storm better than expected. The losses are in billions of dollars and heads are rolling merrily.

The sources of loss in banking are the following:
  • Direct losses from exposure to sub-prime securities
  • Loans for takeovers that have ended up on the books of banks- this will require higher allocation of capital and the terms on which these were negotiated are unfavourable in the changed context in which interest rates have shot up
  • Fee income from structured products will decline
  • Private equity income will be hit
  • Interbank financing costs are higher, this will impact margins

How to ride out the storm? Having a large retail base helps. Also, equities have risen and this may compensate for weaker fixed income markets. Banks will also look to boost income from emerging markets- this may well explain the surge in flows into markets such as India and the boom in the Sensex in recent weeks.

Wednesday, October 03, 2007

Celebrity woes!

I read this with some disbelief and I hope the report I saw is correct. Newly crowned Vishwanathan Anand was quoted ( sorry, I forget which paper or website) as saying that he wanted to see what sort of crowds he would attract when he returned home. He said he had heard about the rapturous welcome accorded to the Indian cricket team after their T20 win and he wanted to see how he would be received. (Reader Guru has since provided the link to TOI-,prtpage-1.cms)

I am sympathetic to the hockey players being deprived of cash rewards after their Asia Cup win but I thought Anand's remarks were rich! Anand takes home $400,000 as prize money, so he isn't exactly financially deprived. As for the crowds any winner draws, doesn't that have to do with the popularity of a sport? Like so many Indians, I rejoice in Anand's win but, sorry, I am not going to be able to show up at the airport when he arrrives.