Friday, March 30, 2007

SC on OBC quotas

The media and some politicians seem to be over-reacting to the SC judgement on OBC quotas.

As the SC's judgement in the Mandal case shows, it is not against affirmative action. Indeed, it has said that reservation upto 49% is okay subject to the exclusion of the creamy layer. Out of 49%, 22% is the constitutional provision for SC/ST. But this does not mean that the balance is automatically open for OBCs. The government has to make out a case for any particular percentage that it wants to reserve for OBCs- to my mind, that is what the SC is saying.

In other words, the SC is not against the concept of reservation for disadvantaged groups. It is saying: please have a clear basis for identifying who these groups are.This, of course, means evolving criteria for backwardness and carrying out a census that will determine who exactly satisy these criteria.

The political class is up in arms against the SC judgement. It needs to realise that government has an obligation to take decisions that are administratively sound. Reserving 27% for OBCs on the basis of a 1931 census is, in the eyes of the SC, not a sound administrative decision.

While supporting reservation for OBCs, I had argued that the government should make a modest start- say, reserving 10% of the seats. It should then monitor OBC representation in centrally administered educational institutions. It could well be that a certain percentage makes it on the strength of merit alone. I had said that reservation should be 27%-x%, where x% represents the proportion that is able to get into these institutions on the strength of merit.

How does the government resolve the present situation? The minister for education has said that all legal options would be explored. One way would be to ask the SC to allow Phase I of the Moily committee roadmap to go ahead (out of a total of three pahses). In Phase I, the IIMs, for instance,are committed to 6% reservation for OBCs. The government could represent to the SC that OBCs are reasonably certain to constitute 6% or so of the population, hence the SC should allow Phase I to go ahead. That gives the government a year's time in which to come up with hard data that the SC has asked for.

Expansion of capacity in education institutions and budgetary allocations for these are welcome. So, there is merit in proceeding with Phase I of the Moily committee roadmap. That would also serve to buy peace for the time being.

Thursday, March 29, 2007

LIC eyes UTI Bank

Business Standard reports:

Life Insurance Corporation (LIC), the public sector life insurer, wants the government to provide it the first right to purchase the 27.47 per cent stake held by Specified Undertaking of Unit Trust of India (SUUTI) in UTI Bank, a mid-sized private sector bank.

A senior LIC official said, “It makes sense for an insurance company to own a bank or a bank to own an insurance company. LIC should be given the first right (to buy SUUTI’s stake) as it was the co-promoter of the bank.” LIC already holds 10.39 per cent stake in UTI Bank and also about 27 per cent in public sector Corporation Bank.

...“The government has to take a decision on how they wish to divest SUUTI’s stake in UTI Bank. We have given our suggestions which include divesting the stake to LIC and other financial institutions, selling it to the public, or a combination of domestic public offering and overseas offering. It’s a decision the government has to take,’’ said S B Mathur, administrator, SUUTI.

Will LIC get UTI Bank? I doubt it. LIC's interest in the deal is obvious: it can merge UTI Bank and Corporation Bank in due course and become a force in the banking sector. But it is unlikely to get the government's nod.

UTI Bank is a "private bank" originally promoted by UTI, a public sector entity. Ever since UTI ran into problems, it has become more of a private entity with only notional control by the government directly or indirectly. The pay scales, for instance, are totally private sector- the CMD gets a package that public sector bank chairmen cannot dream of.

My guess is that the government would like it to stay that away. It is not able to privatise public sector banks; the least it would like to do is not to add to the public sector stable, which would be the result if LIC took it over. That is part of the reason the government has prised UTI Bank away from UTI, its promoter.

Moreover, Corporation Bank in which LIC has a big stake has a salary structure and culture that is very different from that of UTI Bank. LIC will not find it easy to merge the two.

The chances are government will offer SUUTI's stake to a combination of domestic and overseas investors through a public offer. That means UTI Bank will emerge as a professionally-run bank with a diversified base of investors. Rather like ICICI Bank.

UTI Bank wants to foray into asset management. It had wanted to acquire UTI Mutual Fund which now has four public sector banks as sponsors. The government has not favoured the idea. It would rather have UTI Bank rebrand itself. This is best done if UTI Bank is not linked to any particular institution, domestic or foreign.Which again means the ICICI Bank model is the one that is likely to prevail.

Ninth Schedule: Judiciary versus legislature

The Supreme Court ruled recently that laws placed in the Ninth Schedule of the Constitution were open to judicial review if they were violative of fundamental rights and infringed the basic structure of the Constitution. This has been taken to mean that the Tamil Nadu Reservation Act, for instaance, that provides for 69% reservations (that is, in excess of the 50% permitted by the SC) could come up for review.

Rakesh Shukla, writing in EPW (February 17-23) has some interesting comments on the SC judgement. He makes two points. The SC has not really stood up for fundamental rights on crucial occasions. Its objections relate to attempts to enforce directive principles, which enforcement is seen to violate fundamental rights, notably the right to property.

The constitutionality o fthe first preventive detention law of independent India allowing for detention without trial was challenged by A K Gopalan, a leading member of the communist movement. The Supreme Court held that the detention law need not satisfy the test of reasonableness and upheld the legislation.

In the Emergency era of 1975-77, the apex court upheld the suspension of the most fundamental of rights and declared that habeas corpus petitions could not be filed for the deprivation of life and liberty. The Terrorism and Disruptive Activities (Preventive) Act (TADA) making confession to the police admissible was upheld in 1994. The Armed Forces (Special Powers) Act (AFSPA) giving the power to shoot to kill with impunity was declared constitutional in 1997. The Prevention of Terrorism Act (POTA) was upheld as valid in 2004. Notwithstanding the stated concern for liberties in judgments, the judiciary seems to have failed the people on
every occasion that called for a verdict upholding fundamentalrights in the face of a draconian law

...Directive principles requiring the state to secure adequatelivelihood, equitable distribution of material resources and prevention of concentration of wealth and Part III dealing with fundamental rights, are both part of the Constitution and are best interpreted harmoniously.It is the court which seems to have chosen to create a conflict between directive principles and fundamental rights. The nationalisation of banks was done with the object of public control of national finance.The Supreme Court struck it down as discriminatory. The abolition of privy purses to erstwhile rulers of princely estates,a move clearly in tune with
a democratic polity, was held to be a violation of fundamental rights

On one of the TV channels, I read that the SC is due to pronounce on reservation for OBCs in central universities today. The petitioners have questioned the basis for 27% reservation. If the SC upholds the challenge, we are in for interesting times.

Wednesday, March 28, 2007

Bloggers' fatigue

Today's TOI reports that 200 million blogs have shut down. Experts think the blogging phenomenon may have peaked in October 2006 when nearly 10,000 blogs were being created everyday. Some analysts believe that the total will level off at 100 mn in 2007; others think the number will drop to 30 mn. No surprises about the closures: people simply run out of things to say.

I hope to solider on......

Banks' Q 4 profit to slow down

Most public sector banks are anticipating a much slower growth in net profit in the fourth quarter of 2006-07, Business Standard reports. Net profit is expected to decline by about Rs 50 crore per bank because of the increase in provisioning requirements from 1% to 2% on standard loans to capital market, real estate, personal loans and credit card receivables mandated by the RBI in credit policy statement for the third quarter. This will be offset to some extent by interest on CRR balances leaving a net impact of around Rs 30 crore.

That's pretty small for most banks. Banks are realising gains on recovery of stressed assets (on which they had made substantial provisions). Credit growth continues to be strong. Fee income is rising. Expect banks to sustain profit growth in line with the past two or three years in 2007-09.

IIM (B) hikes fees, others to follow

IIMB has raised its fee for the PGP program by Rs 75,000- from Rs 175,000 to Rs 250,000, rediff reports. Presumably this is the total charge (including lodging and boarding). IIMC is set to raise its fee from Rs 1,75,000 to Rs 200,000. I don't know whether this includes mess fees. Other IIMs are to follow. I think it would be a good idea if the IIMs follow a common format in declaring fees and fee increases. They should indicate which component of the total charge has been raised and how much the total charge goes up.

In other news, the Distance Education Council has allowed the IITs and IIMs to offer online courses. I'm a little surprised to hear about this "approval" because, to my knowledge, IIM- Kozhikode has long had such a program. IIMA offers a distance learning program in collaboration with NIIT. I don't know what the "approval" given is all about.

Tuesday, March 27, 2007

Indo-US nuclear deal

The Indo-US nuclear deal seems to have disappeared from the news in recent weeks. The charitable view to take is that much hard work is being done behind the scenes to work out a deal that would satisfy both sides. But could it be that, in some matters, the gap is unbridgeable?

Today's Business Standard has an edit that suggests that on two issues, the gap is pretty wide. One is the issue of reprocessing spent fuel- the US wants such fuel to be returned to preclude its being used for bombs. India would like to keep the fuel. Another is stockpiling of fuel for civilian nuclear plants. The paper feels that too much energy is being invested in the deal and that Indo-US cooperation can flourish even without it.

Maybe. But there's one other issue the edit overlooks- Iran. American plans for regime change (and about this there should be no doubt) cannot possibly have India's support. A big irritant at the moment is the Indo-Pak-Iran gas pipeline. The US Energy secretary recently made it clear that the US could not countenance the construction of such a pipeline at a time when the US was tightening the squeeze on the Iranian regime.

However, on NDTV yesterday, India's foreign minister, Pranab Mukerjee, said categorically that the pipeline is on. I liked the steely determination on Mukerjee's face when he made that statement. If the Indian government sticks to that position, we can forget about the Indo-US nuclear deal going through- unless the US puts in motion its plans for regime change in Iran in the near future.

Monday, March 26, 2007

Placement at IIMA

You know it's placement time at IIMA when you see men and women striding along briskly in suits- a refreshing change, I daresay, from the rather shoddy attire on display in normal times. You can also tell from the upmarket taxis you see in the parking lot. We faculty are on the old campus. All the placement action has moved to the new campus. So, we catch a lot less of the buzz than before.

Wondering what is placement time at IIMA? Good question. Placement happens in two lots: lateral placement (for people with more than a year's work experience); and final placement (for the majority). We now have three programmes running: our flagship, PGP, PGP-ABM (the agriculture program) and PGP-X (the one year program for executives).

Lateral placement for the first two happens in January and February and final placement in March. For PGP-X, the process starts in December. Then, there are the privileged few who land PPOs- pre-placement offers. These are people who are offered permanent positions on the strength of their summer internships. This year, there were 81 PPOs, although not all got accepted: some of the recipients participated in placement in the hope of doing better. In the lateral placement category, there were 28 acceptances this year.

Ah, I mustn't forget. We have Summer placement as well. That happens in the middle of the second term- sometime in September/October, I would reckon. Also, placement is not just about the final interviews. We have pre-placement talks and presentations, which start well ahead of the placement interviews. Effectively, you could say that the Institute is now in placement mode for half of any academic year- this is a subject on which there is some muttering from the faculty. Too distracting, they say.

Salaries at IIMA keep soaring. It's the international offers that grab the headlines. This year, top salaries (based on minimum bonuses) were of the order of $225,000. The highest domestic salary for Rs 60 lakh. The average international compensation was Rs 115,300 and the average domestic salary Rs 13.6 lakh.

A key question for us is: are we on par with the top b-schools in the world when it comes to placement? The Financial Times' list of b-schools shows that the top three b-schools in the US had an average placement salary of $160,000. Ours, as I mentioned above, is $115,300. I have a few observations to make on this:

  • The average salaries at IIMA and those at US b-schools can't be directly compared. The typical b-school product in the US has at least three years' experience. The majority of our students have less than a year's experience. On the face of it, it appears that on an "experience-adjusted" basis, our average international salary of $115,300 would not compare unfavourably with those in the US b-schools.
  • However, I am not sure whether the compensation package is counted in the same way here and abroad. Our package includes the cost to the company, including sign- on bonus and year-end expected bonus. Going through the FT list, I get the impression that US b-schools include sign-on bonus but not year-end bonus. But I could be wrong. We need to do some research on this.
  • Suppose, we assume that the composition of the package is the same at IIMA and in top b-schools in the US. Are we then equal after adjusting for work experience? Not quite. The average international salary at IIMA is for 61 students or less than a quarter of the batch. Harvard Business School's average is for a batch of over 900. We would equal the top US b-schools only when those looking for international placement (at least 150 in a given batch) all get placed internationally and at an average of around $120,000. By that yardstick, we still have some distance to go.
  • One gratifying sign for us is the level at which some of our grads with experience are getting placed. Some international firms (such as Deutsche Bank) are offering the Associate level to IIMA grads with, say, two or three years' experience. That is the level at which a US b-school would join. Other investment banks absorb our products at the Analyst level. Goldman Sachs won't compromise and puts our grads at the bottom of a three-year Analyst program after which they become Associate. Lehman Brothers takes people at the second or third year level. And so on. The consulting firms mostly take our products for their India offices on Indian salaries.
  • A better direct comparison might be between our PGP-X placement salaries, rather than PGP salaries, and those abroad. But this comparison too is flawed to some extent because PGP-X is a one-year program. Moreover, the top investment banks, who really determine the average international salary, have not shown themselves receptive to the PGP-X product. Once that happens, IIMA will have achieved a breakthrough.

Cheating in MBA programs

The Harvard Business Review (March 2007) has an interview with Howard Gardner, professor at the Harvard Graduate School of Education on "The Ethical Mind". It has this nugget:

A study conducted by Duke University recently found that 56% of students in the United States pursuing a master's degree in business administration admit to cheating- the highest rate of cheating among graduate student groups.

No doubt, the MBA students go on to fine-tune their skills at cheating after they enter the corporate world.

The interview is worth reading. I liked the professor's uncompromising approach towards confronting wrong-doers in authority. He quotes the seventeenth century French playwright Moliere: It is not only for what we do that we are held responsible but for what we do not do.

Prof Gardner remarks:

As for confronting superiors, if that is impossible, you are not in the right organization. Of course, it is helpful to consult with others, to make sure that your perceptions are not aberrant. But if you are not prepared to resign or be fired for what you believe in, then you are not a worker, let alone a professional. You are a slave.

Saturday, March 24, 2007

India's banking sector will see strong growth

Banking stocks have declined sharply in recent weeks. While the Sensex has declined from its high of February The BSE Bankex has fallen by 14%, the BSE Bankex has fallen by 18%.

That is to be expected. Bank stocks are considered riskier than the broader market, which is why they typically trade at a discount of 15-20% to the market multiple. But once the present correction has run its course, expect bank stocks to revive strongly.That is because the outlook for profit growth in the banking sector remains strong, as I argue in my recent column in ET.

Many analysts think credit growth with decelerate strongly because retail credit will heavily impacted by rising interest rates. I think they are wrong, for reasons I spell out in my column.

Analysts also think that banks' net interest margin, the difference between interest income and interest expense as a proportion of assets, will decline sharply with rising interest rates. That is because banks are heavily dependent on short-term deposits. Deposit costs will go up but banks won't be able to pass on these to borrowers.

This is only partly true because in retail loans, the floating rate component of loans is quite high today- many banks offer home loans with a mix of 50:50 fixed and floating rates. But, even if the spread on loans is squeezed, banks stand to gain because the proportion of loans in assets is rising relative to government securities. Rates on loans are typically higher than on government the overall yield on the portfolio of assets can be expected to go up.

Then, banks are seeing a sharp rise in fee income as they are able to cross-sell mutual fund, insurance and other products.

Overall, banks will see high loan growth with the net interest margin being maintained or decreasing narrowly. Revenues will be boosted by fee income. Non-performing assets will continue to decline or at least will not increase. Intermediation costs will decline as banks continue to scale up. All this translates into robust profit growth. No surprise, there. Banks are a play on the economy. If you believe the India story, you must believe the banking story.

Wednesday, March 21, 2007

Fatter pay packets for bank bosses

After some humming and hawing, the finance ministry has sanctioned performance bonuses for public sector bank chairmen-and-managing directors and executive directors. Chairmen will get bonuses of Rs 0.6, 0.7 and 0.8 mn depending on whether they meet 60-80%, 81-99% and 100% of targets. For executive directors, the bonuses will be Rs0.4, 0.55 and 0.65 million against meeting targets.

I think that the scheme is a bad idea. I oppose it on conceptual grounds, on grounds of implementation and on the ground that selectivity in giving rewards is not in an organisation's interest.

The conceptual grounds: Banks are highly leveraged institutions. We know from finance theory that the existence of debt creates extra incentives for taking risk on the part of management. That's because if a risky bet fails, it's debt-holders who will mostly be left holding the can. It does not make sense to create further incentives for risk-taking through performance-linked bonuses.

Yes, you can create additional incentives for risk-taking provided you are in a position to track the extra risk taken and ensure that capital is provided against risk- as is intended in Basel II. Then, you measure returns on risk-adjusted capital (RORAC). Indian banks are far from that stage. I say: if you can't track the risk that management is taking, don't create rewards for risk-taking.

The implementation grounds: Measuring performance at the best of times is a difficult proposition. The finance ministry proposes a slew of quantitiative parameters (weight of 85%) and qualitative parameters (15%). The quantitative parameters relate to meeting targets. This can easily lead to "gaming" of targets- bank chiefs can set targets that are easily attained. Measuring qualitative parameters such as leadership or customer satisfaction bristles with problems.

It would be much better to measure relative stock performance (relative to the Banking index as well as the market index). It would also be useful to measure improvements in the price-earnings multiple of public sector banks, given that these banks enjoy very low multiples at the moment. The measures proposed by the ministry are unsatisfactory.

: I don't know how many public sector banks have performance-based incentives at all levels. Giving performance-based rewards only to people at the top is not the best way to motivate those lower down.

I understand where the ministry and the banks are coming from. Top management compensation in public sector banks is hopelessly out of sync with market realities. But so is compensation at senior management levels. The answer is to revise the compensation structure in banks.

But this means three things. One, public sector banks cannot have a common compensation structure: pay must be related to capacity to pay. Bank unions must accept this and abandon their insistence on banking sector-wide compensation settlements. Two, increases will be related to market compensation for a given position. This means, higher increases in some cases and lower increases in others. Unions must accept this well.

Third- and by no means the least important- the bureaucracy must accept that public sector pay cannot use bureaucrats' pay as the starting point. Bank chairmen may get more than secretaries at the centre.

I hope the Sixth Pay Commission brings some fresh thinking to bear on the subject of pay at public sector enterprises. Otherwise, HRD is going to be a serious problems for PSEs in the years ahead. Maybe that's what some people want? Then, they have a ready excuse for pushing ahead with privatisation, no?

Tuesday, March 20, 2007


Britain marks the 200th anniversary of the abolition of slavery. With its penchant for doing offbeat items every now and then, the Economist (February 24) carries a detailed report on the slave trade.

The sheer scale of the slave trade is mind-boggling: some 20 million Africans were shipped across the Atlantic between the 15th and 19th centuries. The question for researchers is similar to the one that those investigating the holocaust the Nazis perpetrated on the Jews asked themselves: how could decent people accept that sort of thing?

One answer, as in the case of the Nazis, is clever concealment. There was no slavery in England itself; it all happened in distant plantations. Those who campaigned against slavery later had to fight hard to produce evidence to convince the public. But that was not all. Another was the use of euphemisms to aid denial.

The means by which sugar lumps arrived on tables in polite society were carefully hidden. The young officers of the African Service who volunteered to man the slave forts and oversee the dungeons were children of the age of enlightenment. They saw themselves as well-endowed with all the refined feelings and sensibilities that could be expected of a gentleman.

Those fine feelings were spared from reality by careful euphemisms. There were no slave-traders; only “adventurers” in the “Africa” or “Guinea” trade. Prints of the gleaming white Cape Coast Castle made it look like a European palace; there was no hint at its real role. Shackles used to string captives together were just “collars”. The “Company of Merchants”, which ran Britain's slave trade, had on its logo an elephant and a beehive—denoting Africa and America—but nothing about slaves.

Of an evening, officers of the African Service might peruse a new work of history or philosophy: an eerie precursor of the Nazi officers who relaxed to the sound of Beethoven after a day in the gas chambers.

But there was still a pervasive feeling that, despite all the evasions, those involved in the trade were doing something deeply wrong. In the courtyard of Cape Coast Castle lies the tomb of Philip Quaque, the chaplain to the officers and men of the castle for 42 years in the second half of the 18th century. During all that time he failed to bring a single officer to the Christian rite of Holy Communion. In a letter he reflected that this had nothing to do with his (black) skin-colour, and more to do with a mood of shame: “The only plea they offer is that while they are here acting against Light and Conscience they dare not come to that holy Table

All the leading nations of the time were involved- Britain, America, France, Denmark, Portugal. For the Africans, some of whom are demanding compensation of one sort or another, the painful part of the story is the role played by their compatriots. The slave trade could not have happened without the active participation of African tribes. Most of the slaves sold were men and women captured in battles between tribes. One of the most notorious slave emporiums, Cape Coast Castle in today's Ghana, stood on land rented to the British by a local chief.

The Economist piece leaves you numb with horror. But, hang on, slavery did not quite end in the nineteenth century. A report in the Financial Times(March 17) tells us that slavery is still alive and kicking. Only, it goes by a more modern name, "human trafficking".

In this 200th anniversary year of the abolition of the slave trade in the British empire, slavery is turning up in surprising places. The trade may have been outlawed, but the practice still reaches into our homes and businesses, perhaps more than we realise. Most of us learn about modern slavery from the bottom up, in the heart- wrenching stories of individuals enslaved in the developing world or trafficked into forced labour in the west. But there is a larger, historic, top-down account that is only now becoming clear as activists and scholars explore the role of slavery in the global economy. With the end of the cold war, human trafficking and slavery have bounced back as businesses.

The United Nations reports that human trafficking is now the third largest moneymaker for criminals, after drugs and weapons. No one is sure how many people were enslaved 50 years ago, but the number is thought to have grown rapidly with the population explosion to an estimated 27 million today. The increase in slavery is also linked to globalisation. But this is not about sweatshop workers existing on miserly wages. Slaves are under the complete, violent control of another person; they are economically exploited, and get only enough food and shelter to keep them alive. For millions of victims, their experience differs little in hardship from that of slaves hundreds of years ago....

With the growth of global markets, some of these slaves are used to produce many of our basic commodities. In Brazil, for example, slaves cut down forests and burn the wood into charcoal to be used to make steel. The European Union imports nearly a million tonnes of Brazilian steel each year to produce everything from cars to buildings to toys. Slavery is in fruit bowls and fridges too. There are documented cases of slaves being used to harvest or produce coffee, sugar, beef, tomatoes, lettuce, apples and other fruit. The list goes on: shrimp and other fish products are suspect, as are cocoa, steel, gold, tin, diamonds, jewellery and bangles, tantalum (used in mobile phones and laptops), shoes, sporting goods, clothing, fireworks, rice, bricks....

In south Asia, hereditary "debt bondage slavery" is common. Loans are made to families in a financial crisis - for example, crop failure - and since they have no assets, all the work they do must serve as collateral until the loan is repaid. The debt is passed from one generation to the next; up to 10 million people are thought to be held in hereditary debt bondage slavery in India, Pakistan and Nepal.

The silver lining, as the report points out, is that slavery is illegal in almost every country and hence can be ended. The only requirement is that the public and governments make ending slavery a priority.

Whatever goes up.......

The Indian stock market, along with the other BRIC economies (Brazil, Russia and China), has hogged the lion's share of portfolio flows into emerging markets in recent years. That has sent the markets rocketing up. The downturn, when investors get jittery and pull out, can be as severe as the upswing. ET (March 20) reports:

China, India and Russia are losing their allure for stock investors because corporate profits are showing signs of flagging, even as their economies grow at some of the fastest rates in the world.

Stock markets in the three countries are among the 10 worst performers this year. Together with Brazil, they’ve fallen twice as much as developing nations as a whole. In the past five years, each market has at least tripled, helped by an economic boom that exceeds 10% a year in China. Now, growth is stoking inflation and straining production. .....

Russia’s ruble-denominated Micex Index has surged at an average annual rate of 48% for the past five years, the best performance of the four. The Hang Seng China Enterprises Index, tracking shares of mainland companies that international investors can buy and sell freely in Hong Kong, posted average gains of 37%, and India’s Sensitive Index added an average 34%. Brazil’s Bovespa index had an annualised advance of 27% during the same period....

By comparison, the MSCI emerging-markets index rose 26% each year on average, while the Standard & Poor’s 500 Index in the US climbed at a 3.8% rate. Last year, BRIC-related stock funds garnered a net $18.7 billion. The net inflows equaled 83% of the record $22.4 billion for all emerging markets and the most since Emerging Portfolio Fund Research started compiling figures in 1995.

BRIC markets were the hardest hit during a global sell-off, sparked by a plunge in China’s mainland markets on February 27, which wiped away $3.3 trillion in value worldwide in a week. “In the short term, what people want to do is to reduce risk, and these markets are definitely going to be punished,” said Rudolph-Riad Younes, who helps oversee $58 billion as head of international equities at Julius Baer Investment Management in New York.

Is this kind of volatility bad? Well, ups and downs in the stock market do not by themselves pose any systemic risk in well regulated financial markets, such as India. The wealth effect of stock prices also tends to be small. But volatility in portfolio inflows causes volatility in exchange rates. This can be unsettling for firms.

In India, the RBI has had to intervene to limit rupee appreciation caused by inflows because it is not sure whether the inflows will continue. Whenever foreign portfolio capital exits, it causes rupee depreciation. RBI intervention increases money supply. This has to be neutralised by open market operations which causes interest rates to rise. Managing money supply and interest rates in the face of large and uncertain capital flows is a big problem for emerging market regulatory authorities.

Greenspan the bear

As Chairman of the Fed for 18 years, Greenspan was said to be responsible for creating for more than one asset bubble. He was bullish about on many subjects: a breakthrough in productivity in the US, sustained high growth rates of the US economy, soaring property and stock prices, the health of the financial sector. The Economist magazine held him squarely responsible for too much money sloshing around the markets when he quit.

Now, he seems to have turned bear He thinks the sub-prime market problem in the US will worsen and he also sees a recession setting in by the end of the year. That is making a whole lot of people livid, including people who went along with his bullish views. His detractors say that the markets are not taking him seriously- the same markets that hung on to his words when he was Fed Chief. A Bloomberg story in ET (March 19) has the following quote:

"Its definitely true that his influence is waning," said Hayes Miller, who helps oversee $38 billion at Baring Asset Management in Boston. "He may be over-playing his position in the world, even as an ex- Fed chief."

Friday, March 16, 2007

Three big banks run into rough weather

Interesting. Three of the world's top banks have run into rough weather. HSBC is having to cope with the problems created by its acquisition of a mortgage finance company in the US (See my post, Shocker from HSBC, March 8). Rising defaults in the US sub-prime market have caused HSBC to issue its first profit warning in decades.

HSBC is in good company. Citigroup's CEO, Chuck Prince,has been facing flak for sometime thanks to the stock's underperformance for the past five years. Citigroup, the world's biggest bank, has faced regulatory problems in different parts of the world and tightening compliance has been one of the priorities for its CEO. Most recently, it has faced a probe by the SEC regarding tax matters related to one of its acquisitions.

Under Prince's charismatic predecessor, Sandy Weill, Citigroup powered ahead through a series of acquisitions.Digesting those acquisitions has proved a problem for Prince. So, he has focused on growing the bank organically. For a bank of Citigroup's size, this is not easy. Citigroup's growth must come from its international operations- Prince wants to raise the share of international revenues from 45% to 60%. But this must be done without inviting fresh regulatory problems.

Citigroup's latest gamble is the planned acquisition of Japanese broker, Nikko Cordial, a firm that is caught in an accounting scandal. At twice the book value, Citigroup will pay through its nose. Besides, Citigroup and other foreign banks have had regulatory problems in Japan. Citigroup's readiness to plough ahead is a measure of its desperation to produce results.

Elsewhere, Dutch bank ABN Amro is facing demands from a leading hedge fund investor to get its act together. ABN Amro again has to sought to grow through acquisition in Europe but it is having problems with its purchase of an Italian bank. That acquisition is in line with ABN's strategy of being a strong regional player rather than a global player. But, like Citigroup, it is finding that making acquisitions work is not easy. There are already rumours of ABN Amro becoming a takeover target itself- with Citigroup as a possible contender.

You can see what is common to the three banks: they judged that they could not grow fast enough organically and tried to grow through acquisition. But such growth is not delivering shareholder value. There is one place where growth through acquisitions may make sense for banks such as HSBC and Citigroup: emerging markets. Trouble is, the two biggest markets, India and China, are not open to such possibilities.

The lesson? Beware of the lure of growth through acquisition unless there are huge gains that are easily had. It also follows that when organic growth is possible, there is nothing like it. That's why I've been wary of the clamour for consolidation among the larger public sector banks. In the last few years, these banks have seen very good growth. If such possibilities begin to shrink, then- and only then- should they think of consolidation.

Thursday, March 15, 2007

Where's the Sensex headed?

Citigroup unveils its forecast (ET, March 15):

Announcing their target values, Citigroup’s regional equity strategist, Markus Rosgen, has set a target of 14700 to 16000 for the Sensex as of December 2007.

This is based on a fair value of 13300 for Sensex and 10-20% premium on account of higher ROE’s(return on equity) and expected upgrade momentum for earnings estimates.

......Citigroup expects earnings growth of its Indian universe at around 15-20% and expects growth rates to trend downwards from current cyclical peak of around 25%

Err.... could we have Citigroup's forecasts for the past three years?

What's wrong with SEZs?

Nandigram in West Bengal is boiling. At least 11 protesters were killed in police firing yesterday. Nandigram, where the state government plans to acquire 10,000 acres of land for Indonesia's Salim group, has been out of bounds for the police for the past few weeks and yesterday's violence erupted when police attempted to enter the area.

Nandigram is grabbing headlines. Another project that has not been in the news but is also facing trouble is Reliance's proposed SEZ in Jhajjar district in Haryana. In the past week, locals have held demonstrations to protest planned land acquisition in the area.

Land acquisition is the most controversial part of SEZs and I have touched upon this in earlier posts. But from an economist's standpiont too, SEZs pose problems, as Nitin Desai points out in a well-argued article in today's Business Standard.

The primary problem is not just the tax concessions extended to SEZs and potential loss of revenue to the government. As the Commerce ministry has pointed out, this loss is temporary and can be more than made up over time once the tax-free period ends. The problem, as Desai points out, is that SEZs take us back to the era of discretionary government powers and lobbying by industrial houses.

The SEZs involve discrimination and discretion. The discrimination is between the policy regimes that apply to producing units within the domestic tariff area and those within the SEZs. The discretion lies in the case-by-case approval of proposals to set up these SEZs. Both of these involve a significant departure from a market-friendly system. Sooner or later they degenerate into what we politely call rent-seeking by politicians, bureaucrats and their business cronies. In some ways the SEZ policy marks a reversal of a trend towards non-discriminatory and non-discretionary regulatory regimes that started in 1991.

The SEZs are meant to drive rapid export expansion. But export production and production for the domestic market should not be separated in a sensibly-run economy. In an open trade regime with low tariffs there is no essential distinction between the two.

SEZs, Desai says, are "business-friendly" but they are not "market-friendly". In a market-friendly policy regime, any businessman would be able to avail of the facilities and regulations that apply to SEZs- infrastructure, low tariffs, relaxed environmental and labour regulations, etc. Government is not able to make these generally available. So, it makes these available at select places- and to select businessmen.

But doesn't China have SEZs? Desai addresses this favourite argument of those who want to push through their schemes. China has six large SEZs- Shenzen is 50,000 hectares in size. We plan to have SEZs in hundreds, many of them quite small, some only 40 hectares in size.

Secondly, China's SEZs were meant to confine economic liberalisation to a few pockets; for the most part, the public-sector dominated economy was to be protected. That is not our idea of liberalisation. Our objective is to liberalise across the board but gradually. The two approaches are not comparable.

The bottom line is that the SEZs do not address and in fact work against what is really needed—an economic policy that promotes competition, innovation and growth throughout the economy, an urban policy that focuses on affordable housing and services for all, a social policy that actively expands opportunities for all regions and classes and a political policy that bridges the divide between those who support continuing reform in the role of government and those who fear the rigours of liberal capitalism.

Wednesday, March 14, 2007

Winds of change at Harvard

Harvard university is revisiting its undergrad curriculum. This is happening after three decades! Shows just how slow the best of universities can be in ushering in change.

FT reports (March 14):
Harvard, the richest, oldest, and arguably most influential university in America, is on the verge of overhauling its curriculum for the first time in three decades – and in doing so, helping redefine what it means to be an educated person in the 21st century.

A recent report by a panel of professors tasked with revamping the school’s general education programme calls for courses designed to help prepare students to contribute to civic life, respond to change in society, and grasp the ethical implications of their actions. Because everything that happens at Harvard sends ripples throughout the academic world, university officials throughout the US are watching the report closely. “Our aim was to help students try to draw connections between what they are learning in the classroom and their 21st-century lives,” said Alison Simmons, co-chair of the task force and a professor of philosophy.

“We’re not trying to say that an educated man or woman needs to know this, that and the other.

“What we’re saying is that an educated person should have a certain set of capacities: inter­pretive capacities, problem-solving capacities, reflective capacities and critical capacities to help them through the world,” she said. Harvard’s current core curriculum, which was designed in the 1970s, has been faulted for allowing professors to teach whatever narrow and obscure subjects interest them and for placing too little emphasis on the quality of undergraduates’ academic experience.

The new curriculum design would be any educator's dream:

Under the new curriculum, each student would be required to take one course in each of eight categories. These include: science of living systems; science of the physical universe; societies of the world, which will cover ethnic identity, statehood and government; empirical reasoning, which will include courses on evaluating data; and ethical reasoning, which will cover philosophy, political theory and religion.

The three other areas are: aesthetic and interpretive understanding, which focuses on cultural expression, such as literature, art and music; culture and belief, which would place those works in context; and the US in the world, which is meant to give students a “nuanced understanding of American society”.

The report also promotes an initiative in “activity-based learning” that would link academic work with students’ Harvard-sponsored extra-curricular activities, such as writing for the student newspaper or performing in a dance troupe, as well as pursuits outside the university, such as volunteering for a political camp­aign or taking a placement as an intern at a company

You can see the committee's thinking. Identify the skills needed. Then, identify the courses that would provide the skills.

Biology and physics/chemistry would be part of any existing curriculum. Ethics and philosophy would not be uncommon, as also literature, art and music and data evaluation.

What is new, as I see it, are the elements that help the young student relate to the world at large and understand the sources of conflict in the modern world: ethinic identity and statehood; culture and belief; and the US and the world, especially important because Americans are amongst the most insular people in the world today.

In a word, the revamped curriculum is all about helping students relate to globalisation. That is as it should be. "Internationalisation" of programmes is something of a buzzword today but, like many buzzords, it is in danger of being trivialised.

Too many institutions, especially business schools, think "internationalisation" has to do with students visiting foreign lands or having foreign students come over- "exchange programmes" are the flavour of the day. There is, of course, a place for travel but there is more to "internationalisation" of programmes than globe-trotting. After all, tour operators can do a decent job of travel, we don't need universities to do that.

No, "internationalisation" must be primarily about changing the curriculum to reflect changes in the world at large, it must be about bringing in the international dimension to learning.We need to develop citizens who have basic skills and knowledge and who can also intelligently relate to what is going on in the world. That is what Harvard is attempting with its new curriculum.

There's just a little footnote I would like to add. Larry Summers, the distinguished economist and former US treasury secretary who was President of Harvard, tried his damndest to ring in changes at Harvard. One of his main concerns was the undergrad curriculum. He was defeated by a faculty body that was resistant to change and that was also resistant to anybody telling them they needed to improve. It must be gratifying for Summers to see that faculty have had to respond, after all, to the clamour for change, even if somewhat belatedly.

Tuesday, March 13, 2007

Sub-prime market woes deepen

Will the sub-prime mortage market in the US prove the trigger for the correction in financial markets that many analysts have long been predicting? I flagged this issue in an earlier post (Shocker from HSBC). At the time, it seemed the problem might just be manageable. But with each passing day, doubts grow. The Financial Times (March 13) reports on the latest collapse in this market:

Trading was halted in New Century Financial on Monday with the second-largest US subprime lender teetering on the edge of bankruptcy, sparking fresh fears about whether turmoil in the sector could spread and damp US economic growth.....

The rapid decline of New Century, the latest problem at US subprime lenders, raised concerns that problems could spread in the $8,000bn mortgage industry and to other parts of the capital markets.

The problem is two fold. One, as the sub-prime lenders go under, they drag down banks who have lent to them and those in the derivatives market who have positions on sub-prime loans. Two, as sub-prime loans dry up, property prices tumble, dragging down more players and creating further problems for those exposed to sub-prime lenders. A further decline in housing prices will mean further decleration in the US economy and an increase in non-performing assets in other sectors as well. So, the billion dollar question remains: can the problems in the sub-prime market be contained?

Lalu Yadav is going places.......

The re-branding of Railway Minister Lalu Yadav is gathering steam.

Today's Ahmedabad Times reports that in April, Lalu has speaking engagements in three top business schools in the US: Harvard, Stanford and Chicago. Students from Harvard and Wharton have already met him while on a tour of India. More b-school students are scheduled to do so. I suppose IIM-A can take credit for having started it all by inviting Lalu over.

The turnaround of the Indian Railways (IR) is a big story because many rail systems in the world are in trouble. As I wrote in an earlier post (Lalu Yadav is no liberaliser), Lalu has succeeded by eschewing the coventional reformist route. Today, in TOI, Lalu makes the point that he has made IR commercially successful without privatising or downsizing. Very true. But, I repeat, one must not get carried away and ascribe the turnaround to one man. It is IR's formidable technocratic strengths that have created the turnaround.

Monday, March 12, 2007

This year's budget is about 2008-09, not 2007-08

Anyone commenting on the budget more than ten days after it has been presented risks being thought a bore. But I am going to be brave. I think there's a case for a relaxed view of the budget after the frenzied coverage on and around budget day.

The Union budget has become something of a spectator sport- like the World Cup one-dayers. There is a huge build-up of interest ahead of the event. You have saturation coverage in the visual and print media on the day of the budget and a couple of days thereafter. Then the budget vanishes from view.

Is this a problem? I think so because it's hard to get a handle on the budget without spending a little time on the budget papers. The sort of hurried analysis and comment we have now can be misleading- and, in fact, it gives finance ministers a chance to manipulate public opinion.

The budget analysis in some ways illustrates the classic problem of the information age: too much data and too little understanding. We were,perhaps, better off in the old days when there was no Internet and no business channels on TV and the budget papers were available as hard copy. The newspapers then dissected the budget over several days and it was possible to have an informed assessment. Now, we have instant judgements delivered on budget day- and zero analysis thereafter.

This is not going to go away. Finance minister P Chidambaram has been quoted as saying that the budget should be regarded as no more than a statement of government accounts. I doubt that the media is in a mood to listen and tone down its coverage. The budget is big bucks for the media, so they have an interest in perpetuating the hype.

I touch upon this problem in my latest ET column. This budget was supposed to be all about aam admi. The finance minister was supposed to have failed on reforms but succeeded in doing a lot for the social sectors. Look carefully at the budget numbers and you find very little to support this claim.

Read my full article in ET here.

But that begs the question. If the finance minister did not push reforms- especially in terms of reducing tax rates- and if he did not do much on the expenditure side either, what did he do at all in the budget? Not much, I am afraid. That may seem strange considering that the economy is booming and so are tax revenues. Surely, the FM could afford to cut tax rates or spend more?

The answer to the puzzle lies, I think, in the revenue projections for 2007-08. The FM shows tax revenues rising by just 17% in the coming year compared to 28% in 2006-07. That does seem too conservative. Assuming tax revenue growth just a little lower than in the current year- say, 25%- would have placed another Rs 28,000 crore the FM's disposal. He could then have allocated a great deal more for Plan capital expenditure, an item greatly neglected in budgets in recent years.

For those not familiar with the jargon, Plan capital expenditure is public investment of the sort that will have payoffs in future (as distinct from capital expenditure for maintenance purposes or in areas such as defence). How can you expect agriculture to do better if you don't invest in a big way in irrigation, dryland development, extension services, etc? You can't say you care for aam admi and then ignore public investment in agriculture.

So, if he has revenues at his disposal, why on earth did the FM not spend where required? Here's my explanation. I believe Mr Chidambaram is looking ahead to his next budget for 2008-09. The Sixth Pay Commission recommendations will be out in 2008. In his next budget, the FM will have to make a significant provision for higher salaries in government. Besides, elections will be round the corner and higher spending on various social heads will be required.

In other words, the FM will have step up expenditure significantly next time. While doing so, he has to meet the FRBM Act target of 3% for the fiscal deficit for 2008-09. For 2007-08, the deficit is projected at 3.3%. I suspect it will be lower- closer to 3%. But, to keep the fiscal deficit at 3% in the following year, he needs the cushion in revenues that he gets by not spending heavily this year. He keeps expenditure in check this year by simply under-estimating revenues.

For Mr Chidambaram, the FRBM targets are sacrosanct. He would like to go out next year in a blaze of glory as the FM who kept the nation's tryst with the FRBM target for 2008-09. That would explain the numbers we are seeing in the budget this time on the revenue as well as expenditure side.

Thursday, March 08, 2007

OBC Reservation - not a done thing yet

The IITs and IIMs are gearing up for the first of the three phases in the introduction of OBC quotas but at this point, the fate of the 27% OBC reservation proposal still hangs in the balance. A two-judge bench of the Supreme Court is hearing a writ petition seeking a stay on the Central Educational Institutions (Reservation in Admission) Act, 2006.

The petitioners oppose the implementation saying the 27% figure is based on a 75 year old census; unless we have updated figures on the caste-wise distribution of population, they say, we cannot decide what is the quota. Fali Nariman, representing the petitioners, argued in court yesterday that he was not asking for the Act to be set aside; he was only asking that implementation be delayed until criteria for establishing backwardness had been spelt out. He also pointed out that, under the Act, the creamy layer had not been excluded.

The Court has reserved its decision.

My point is a little different. There is already a certain percentage of OBCs that makes it to elite institutions. We need to get a handle on this percentage- say x%. The quota must be set at 27%-x% even if it is accepted that 27% is the right figure for reservation. Otherwise, you will have x% getting in through the general list and 27% through the quota, making for a total in excess of 27%. To my mind, this aspect has not been clarified so far.

Shocker from HSBC

The world's leading stock markets have tumbled over the past week. The markets are nervous. Why? You will hear analysts mention the Japanese "carry trade"- borrowing cheaply in yen and investing at a higher rate abroad. This could hit arbitrageurs if the yen moved against them. Then, there is the sharp fall in the Chinese stock market and its impact on international investors.

One other factor that is mentioned is the "sub-prime mortgage" market in the US. This is the segment of the home loan market comprising loans to those with poor credit histories. Nearly 25 sub-prime lenders, firms that specialise in lending to this market, have collapsed in a matter of months. But it is the impact on a leading bank, HSBC, that comes as a shock.

HSBC is exposed to the sub-prime mortgage market on account of its acquisition in 2003 of Household, a US consumer finance firm. Sub-prime mortgages are popular with those who cannot access loans from mainstream banks. A typical sub-prime borrower would be somebody with an unsteady source of income but with a house against which he could borrow. When housing prices were rising and interest rates were low, it was possible for such borrowers to raise loans and repay them- or use such loans to repay earlier loans. With the rise in interest rates over the past two years, repayments have become dicey. The slowdown in the housing market has undermined the value of the collateral.

In addition to the sub-prime mortages with Household, HSBC bought large amounts of risky loans from the market. It did so in the confidence that it had the analytics to price the associated risk accurately- more accurately than others. But, all analytics go out of the window in the face of two years of rate rises.

HSBC has taken a bad debt charge of $10.6 bn, up 35% over that for the previous year. If things don't worsen in the housing market, analysts reckon the charge will be adequate. Inspite of the charge, HSBC managed to grow profits by 5% in 2006. But its troubles in the US -and its first profit warning in years- have called into question the quality of its top management and its risk management system. Nearly half of HSBC's profits come from emerging markets and that's where the growth has been in recent years. Why would HSBC abandon its areas of strength and head for a risky business segment in the US? That's the question.

HSBC management had contended that the expertise built up through Household could be applied to emerging markets. That is a little hard to buy. Emerging markets are not known for excellent credit histories, so applying fancy models there would be difficult. HSBC would be bettter off simply expanding into normal housing loans in those markets: India's default rate of under 1% on housing loans is a dream for international banks. The question now is whether HSBC can cap its problems in the US and direct its energies to emerging markets.

To return to the point I started off with, why is the broader market apprehensive about sub-prime mortgages? These loans are said to be only 8% of the total and so will not bury banks by themselves. The problem, as John Authers points out in the Financial Times, is different:

Mortgages are packaged by banks in instruments known as collateralised debt obligations. These include a range of loans. Investors can buy different slices – or tranches – of the entire package that have been put together. Losses will first affect the most junior tranches, and must be severe before they affect the senior tranches.

Most people, even with bad credit histories, repay their loans. So the most “senior” tranches can qualify for triple-A credit ratings, encouraging risk-averse institutions to get involved. But the underlying collateral is still subprime debt.
The synthetic derivative market means that the same portfolio of risky loans might show up as collateral for many different instruments. Thus bad defaults in the subprime sector, even though it accounts for only about 8 per cent of US mortgage-lending, could force defaults on instruments that investors thought were almost as safe as Treasury bonds. And that way would lie the much-feared systemic collapse.

Get the idea? As in LTCM, the problem is that financial institutions are exposed in a bigger way than the direct exposure to sub-prime mortgages would suggest.

Tuesday, March 06, 2007

Budget and education

(pl double click on image to see figures clearly)

Finance minister P Chidambaram has been exceedingly generous to the ministry of education- no question about that.

  • As the table shows, the allocation for education is up by nearly 34%.
  • Within education, technical education is a big gainer- the increase in allocation is 123%!. More than a quarter of the increased allocation for education is for technical education.
  • The IITs get Rs 879 crore more
  • The IIMs get an additional Rs 70 crore.
  • The allocation for AICTE (All India Council for Technical Education) is up by Rs 702 crore

The increased largesse for IITs and IIMs, no doubt, has to do with the expansion in seats to accommodate the reservation of 27% for OBCs. Whatever the reason, Mr Chidambaram's munifence is welcome.

Basel II drags on

Basel II, the new rules for bank capital that align capital requirements better with risk, was supposed to happen in 2007. It is indeed happening in much of Europe. But not in the US. In the US, regulators have proposed amendments that would delay implementation until January 2009. Here in India, the date has been pushed back to 2008.

The Economist (February 22) reports:

Banks in America, on the other hand, are glum. Their regulators have taken fright over studies showing that banks' required capital could fall by an average of 16% if they embraced the new accord. European regulators are inclined to let regulatory capital fall (subject to the discretion of national authorities). American regulators are not. They have now proposed changes in America's version of Basel 2 that will delay its implementation until at least January 2009. Under their proposals American banks will be subject to a number of “safeguards” that keep capital cushions plump. These include the “leverage ratio” (see chart), a blunt measure of a bank's lending exposure that is not linked to the riskiness of its activities.

The accord was intended as a single worldwide standard. But it now threatens to be qualitatively different in Europe and America. International banks that straddle the Atlantic are in a bind and America's large banks are especially irritated. On February 7th four of them, including Citigroup and JPMorgan Chase, wrote a letter of complaint to regulators. These extra restrictions, the banks wrote, give foreign competitors an edge, because they can hold less capital for identical assets.

....In fact, each side (Europe and America) can learn from the other. The Europeans should add clarity to Basel 2. The Americans should add a bit of urgency to implementing it. No doubt the accord has flaws, but these can be fixed later.

Thursday, March 01, 2007

Goodbye growth ?

Finance minister P Chidambaram's latest budget has brought him brickbats aplenty from foreign observers and commentators. Joe Leahy in the Financial Times:

The window of opportunity for contentious economic reforms, the key to sustaining the 8-9 per cent growth rates India so badly needs, has now closed

There it is: no more reforms, no more growth. I would have bought this readily except for one thing. We weren't supposed to get to 8-9% growth in the first place. Through the nineties and especially after the Left-supported UPA government came to power in 2004, we were told that India's reforms had lost momentum, so we must bid goodbye to our hopes of attaining higher growth. Don't forget that the rating agencies placed us below investment grade until recently.

The sceptics have been proved dead wrong. We have clocked 8% or more for four years in a now. So, why should we believe them now?