Is higher capital the answer in investment banking?

There is a sense that investment banks too will become subject to requirements of regulatory capital- at present, only commercial banks are subjected to the requirements imposed by Basel I (and hereafter Basel II). FT doesn't think this is a great idea:

There will now be renewed calls for more regulation, and understandably so. But it is naive to think that the right regulatory response is obvious. From poor governance to flawed incentives, incompetent risk management to foolish strategies, the failures of the financial system have been so widespread as to ren­der a coherent regulatory riposte impossible. The likely outcome is that tight capital requirements will be forced to serve as a catch-all res­ponse to risk. If so, the banking system will look more like that of the 1960s – a low-risk, low-return utility business. The ambitious and the avaricious will no doubt seek more exciting hunting grounds with hedge funds and private equity groups.

FT's criticism is misplaced. Many of the problems the quote above mentions- flawed incentives, poor governance, bad risk management- have their roots in high leverage. In the face of high leverage, managers will take all kinds of bad decisions- they will take excessive risks, for instance, knowing that the payoffs will be large if they succeed and costs to themselves pretty low if they don't.

So, while a great deal needs to be tackled by way of regulation, higher capital is an important starting point.

'The worst crisis in the last century'

The quote is from Alan Greenspan. And there is no dearth of other doomsayers. But how bad is the economic situation following the collapse of Lehman and the sale of Merrill? Just a couple of quick points.

First, failures in investment banking and also banking are inevitable (although it is mainly the smaller banks that will be allowed to fail). In key products such as sub prime mortgages and securitisation, demand has shrunk and we will never see anything like the old volumes again.
That means that capacity must also shrink. This happens through bankruptcy or consolidation.

Two, I take heart from the US authorities' decision to let Lehman fail. (It's said that the US treasury secretary was adamant on this issue but I imagine the Fed chairman backed him). The decision reflects confidence in the managers of the US financial system as to the ability of the economy to withstand the fallout.

Let's face it: the US economy is in better shape today than most people had expected at the beginning of the year. (Greenspan was amongst those saying the probability of a recession was higher than 50%; now he's quoted as saying the chances are under 50%). A big chunk of banking losses has already been made good through fresh infusions. Major participants have had enough time to unwind risky positions.

Putting these two points together, the financial markets should stabilise in the near future and the survivors will emerge strengthened by the fall of rivals. So, it's not quite the end of the world.....

Lehman in dire straits

Lehman Brothers, the 158 year old investment bank, is battling for life. Perhaps its future will be known by the time the weekend is over.

Lehman must find a buyer quickly or declare bankruptcy. Finding a buyer is complicated by the fact that the US government is said to be unwilling to provide support to a rescue- as it did with JP Morgan's acquisition of Bear Stearns. Moreover, the authorities are less intimidated by the prospect of bankruptcy than they were in the case of Bear Stearns- they reckon that the fallout can be borne by counterparties because these have had enough time to prepare.

Well, we shall see.... it looks as through the government's reluctance to support a rescue will eventually push Lehman towards a sale at a very low price- bad news for its shareholders including executives holding stocks and stock options in the firm.

And to think that only a few months ago, analysts and media commentators were singing the praise of Lehman and waxing eloquent about how well its CEO had handled its problems, including the challenge of 'communicating' with the markets. When the chips are well and truly down, communication isn't of much help, I guess.

Looking ahead, the big question markets will be asking is: who next? Lehman is not such a big player itself but the message now is that no one is really safe. It's not Lehman's disappearance so much as the possibility of bigger players going under that will give the markets jitters in the weeks to come.

US opts for nationalisation!

Nationalisation and government ownership may be dirty words in the US but this is not time to fuss about ideology- the crisis in the financial markets required drastic action. So the two secondary mortgage institutions - Fannie Mae and Freddie Mac- will go under "conservatorship" which, for all practical purposes, means government owernship.

The government will infuse equity as required and it will also provide debt finance by subscribing to the mortgage backed securities floated by the two institutions. Banks and financial institutions are holding paper issued by the two, so a collapse would have had serious consequences for the already troubled financial sector. The housing market would have seen another fall. Hence the government is stepping in.

FT estimates the cost of the rescue at around $200 bn - or nearly 1.5% of GDP. S& P places the cost at 2.5% of GDP. That's smaller than the $300 bn (in today's terms) that it cost to save savings and loans institutions in the US in the eighties. Still, the amount is not exactly small change. In India, the government has spent a total of $7.5 bn to recapitalise the banking system- or under 2% of GDP. But this was roundly condemned at the time. The same editorial writers (in India) are lauding the US government for its rescue act today- what's good for the US is evidently not good enough for us Indians.

The rescue should calm frayed nerves in the US banking system and elsewhere. It should also help put a floor on housing prices for the US. So it's good news for the world economy. The US economy has grown against all odds in the first two quarters and it increasingly appears that it's the UK economy that stands to suffer most in the present crisis, not the US.

Nuclear deal- is it such a coup?

The media seems convinced we are on to a terrric deal- I refer to the NSG waiver given to India. This is one of those issues where it's really hard to make an accurate judgement. The key is the right to test in future. Now, it's not that we have abjured the right to test. But, the terms of the Indo- US accord are such that the economic costs could turn out to be prohibitive.

I read that the US and other suppliers may ask for all equipment and materials to be returned. If so, the cost would be sufficiently high to deter Indian policy makers from going in for a test. The tricky part is whether in the evolving world scenario, the US and others will want to enforce those terms, given that India will have grown in stature and is also perceived as a reasonable player that will not test without reason. So, I guess this is one of those things that time alone will tell.

A second issue is that we don't seem to be getting full cooperation in the nuclear energy field. Brahma Chellaney has some caustic remarks to make in Rediff.com:

Today, there is not even the pretence that the deal offers 'full civil nuclear energy cooperation' or that India is to 'acquire the same benefits and advantages' as the US. But why blame the US? In his desperation to secure the deal, Prime Minister Manmohan Singh [Images] has repeatedly moved the goalpost.

For example, he has breached his assurance to Parliament on August 17, 2006 on 'the removal of restrictions on all aspects of cooperation and technology transfers pertaining to civil nuclear energy'. He had added: 'We will not agree to any dilution that would prevent us from securing the benefits of full civil nuclear cooperation as amplified above'.

Dr Singh also has reneged on his July 29, 2005, promise in the Lok Sabha: 'We shall undertake the same responsibilities and obligations' and 'we expect the same rights and benefits' as the US. As is apparent, the NSG waiver is neither clean nor unconditional. If anything, it is messy. Yet Dr Singh was quick to hail it as 'a forward-looking and momentous decision', even claiming that 'It marks the end of India's decades-long isolation from the nuclear mainstream and of the technology-denial regime'.

He again pegged his newfound interest in commercial nuclear power to 'environmentally sustainable economic growth' and to meeting 'the challenge of climate change', although one of the first things to be knocked out of the US-drafted waiver text at the earlier August 21-22 NSG meeting was Section 1(e), which read: 'recognize the world's need for clean and reliable sources of energy for sustained growth and prosperity'.

Not many NSG members buy the spiel that nuclear energy can help reduce global CO emissions or be a cost-effective answer to the growing electricity demands. The path to energy and climate security lies through carbon-free renewable energy, which by harnessing nature frees a nation from reliance on external sources of fuel supply. Yet such is the nuclear power hype that few Indians know that their country today generates much more wind power than nuclear energy.

Olympic medals

Reams have been written about the stellar performance of countries such as China and the US at the Beijing Olympics and the lacklustre performance of others, including India. Economist Gary Becker highlights the determinants of Olympic success in his blog, based on a journal paper:

The article "A Tale of Two Seasons: Participation and Medal Counts at the Summer and Winter Olympic Games", published in 2004 in the Social Science Quarterly by Professor Daniel Johnson of Colorado College and a co-author, examines the determinants of how many medals were won by different countries in the summer and winter Olympics since the end of World War II. Their regression analysis shows that two very important variables are the total population and per capita incomes of different countries. Also important are whether a country has an authoritarian government-such as communism- a country's climate, and whether a country is the host country for a particular Olympics. These five variables taken together predict closely the total number of medals won by different countries in the winter as well as summer Games.

Rising interest rates? Not to worry!

Most forecasters have lowered their forecasts for Indian economic growth for 2008-09. The RBI thinks growth will end up slightly under 8%. The PM's Economic Advisory Council projects growth of 7.7%. Many investment banks think growth will be even lower.

These forecasts rest on two things: the adverse global economic environment and lower global growth; and rising interest rates in response to inflationary trends.

Yes, weaker global growth will moderate India's growth but higher interest rates, I think, are not such a big worry. This is the subject of my ET column, Interest rate rise not a big worry.

Why do I say this? Briefly:

• Lending rates have risen but remain below levels in the nineties.
• Corporate leverage is much lower than in the nineties, so higher interest rates do not threaten corporate profit to the same extent
• Consumer borrowing has been impacted but housing demand should revive once property prices correct
• Banks' capacity to make loans remains unimpaired despite four years of rising interest rates. Even NPA levels in the aggregate are not a problem because five years of high growth are causing past corporate NPAs to revive, far from adding to fresh NPAs in a big way.
  

Novel on Zia ul Haq's death in air crash

I've just finished reading A case of exploding mangoes, Mohammed Hanif's novel based on the mysterious air crash that killed Pakistani rules Gen Zia ul Haq. Also killed in the crash were a Lt Gen in the army and the US ambassador to Pakistan. Hanif is a former air force office now residing in the UK.

It's a terrific read, a thriller of sorts. Hanif is South Asia's answer to John Le Carre, I daresay. The story cuts between the interrogation of a suspect in the assisination plot and Zia's own life in the months leading up to the crash. The protagonist, an air force officer, wants to assasinate Zia in reprisal for the murder of his father, a former Colonel in the Pak army.

Col Shigri was a key figure in the funneling of arms and money to the Afghan militia in their war against the then Soviet Union. The sums involved were large and a good deal went into the pockets of Pak army men. Shigri inteferes- and is found hanging in his own house. For the record, his death is described as a suicide.

The novel shows that the CIA wanted Zia out of the way and ambitious army officers were eager to carry out its bidding. It shows that the US diplomat's death in the crash was the result of a mishap but probably the sort of price that people in Washington are willing to pay when they want a job done. A Major Kiyani figures prominently in the story- I wonder if that is the present Chief of the Pak army.

Zia's paranoia makes for hilarious reading. The novel is tightly written, with a wry humour that never fails to find its mark. The murky goings-on in the Pak army are well chronicled. I said to myself after reading the novel: if a former Pak air force officer can write with such ironic detachment and so well about his country and the armed forces, there must be something very right with that country. Pakistan a failed state? No way, if this novel and its author are anything to go by.

Raghuram Rajan Committee

The Raghuram Rajan committee on financial sector reforms, constituted by the Planning Commission, submitted its draft report sometime ago. I have a critique of the banking sector reforms proposals contained in the report in EPW (Aug 9-15, 2008).

A few things I would like to highlight:

• The report does not recommend privatisation on all public sector banks. It is rather more cautious than, say, the Percy Mistry report. It urges experimenting with sale of a few under-performing PSBs to foreign banks.
• On opening up to foreign banks, the committee does not favour a level playing field with domestic banks right away. It wants abolition of branch licenses for domestic banks, followed by extension of the same to foreign banks with a lag of a couple of years or so.
• It prefers reform of PSBs through overhaul of governance. But some of its proposals, such as the government not appointing top management and leaving this to an independent board, are unlikely to fly. With good reason. 'Leave it to an independent board' sounds very lofty but it risks creating a dangerous governance vacuum where we can least afford it- the banking sector. And now is the not the time to be singing the praise of independent boards in the financial sector-see what has happened to some of the best known names worldwide in the sub-prime crisis.
  

Changing face of the Indian bureaucracy

I must thank Abi of Nanopolitan blog for pointing me to this article by S Narayan, former finance secretary, on how better representation for the backward castes is turning out to be a force for good in the Indian bureaucracy. I get a chance to meet several bureaucrats and I keep asking them: is there any truth to the contention that the bureaucracy is going to the dogs, thanks to reservations?

Generally, what I hear is that there is nothing wrong with the candidates selected- they may not speak immaculate English and you may fault their accents but they have competence and motivation, alright. The problem is that political interference has increased. This will happen regardless of who gets into the services.

I have every hope that reservations at IITs and IIMs will achieve the same thing that Narayan suggests it has acheived in the bureaucracy: making the corporate world more representative of and responsive to the large mass of Indian people, instead of being elitist in character. The price that critics say we pay- dilution of standards - is, even if it is true (I have never bought this), small compared to the benefits in terms of social harmony and equity.

Here is an excerpt from Narayan's article:

The character of the All India Services has changed in my lifetime, and in my view, the new entrants are far more representative of the aspirations of the “inclusive growth” view. Bright and hard-working, yet from families that know the meaning of hardship, these are the youngsters most likely to be able to administer from the heart, not just from the book. I have also seen a complete social transformation in the composition of the services, a transformation, though painful, which has brought up people much more representative of the diversities in our society. In the South, especially in Tamil Nadu, it has taken almost 70 years to get here, and I do believe that the rest of India must follow, and it may perhaps take far less time. Though one had to compete all the harder to succeed, I am a strong votary of affirmative action to provide preferential opportunities, especially education, to those who don’t have them.

I can hear sceptical readers wondering: Will the new dispensation be ethical and fair? I cannot say. When I teach these students, I see the core of goodness and fairness—what the real world of politics and bureaucracy will do to their hopes and aspirations is yet to be seen. I like the fact that the collector’s office is not a mysterious, forbidding place for citizens — that they can see their own kind sitting there. Will he be fair? As in economics, the laws of supply and demand will operate. Let’s hope the citizenry wants fair deals — I am sure that the new class will deliver.

Zardari's mental health

FT carries a story about the man who aspires to become president of Pakistan:

Asif Ali Zardari, the leading contender for the presidency of nuclear-armed Pakistan, was suffering from severe psychiatric problems as recently as last year, according to court documents filed by his doctors.

The widower of former prime minister Benazir Bhutto was diagnosed with a range of serious illnesses including dementia, major depressive disorder and post-traumatic stress disorder in a series of medical reports spanning more than two years.

......In court documents seen by the Financial Times, Philip Saltiel, a New York City-based psychiatrist, said in a March 2007 diagnosis that Mr Zardari’s imprisonment had left him suffering from “emotional instability” and memory and concentration problems. “I do not foresee any improvement in these issues for at least a year,” Mr Saltiel wrote.

.....Mr Hasan, a long-standing political ally and friend of the Zardari/Bhutto family, told the Financial Times on Monday that Mr Zardari had subsequent medical examinations and his doctors had “declared him medically fit to run for political office and free of any symptoms”.

“You have got to understand that while he was in prison on charges that were never proven, there were attempts to kill him,” Mr Hasan said. “At that time, he was surrounded by fear all the time. Any human being living in such a condition will of course suffer from the effects of continuous fear. But that is all history.

'Azaadi' for Kashmir

Arundhathi Roy has created a stir by supporting Azaadi for Kashmir. Some columnists have done likewise. This seems a cute, liberal thing to do. Without pretending to be an expert on Kashmir, let me highlight a few issues:

• Would a move to allow Kashmir to secede be without implications for the rest of India? What would it mean for the principle of secularism and for the fate of Muslims spread over India?Partition was followed by a holocaust. Will this not be seen as a partition-like move?
• Can an independent Kashmir maintain its independence for long given the interest of every single power in the area? Pakistan would fish in troubled wars; so would Iran, Afghanistan, China, Russia. India and the US would not be able to hold aloof. Kashmiris, who detest India's presence, will find themselves sitting on a veritable tinder-box.
  
• What would be the basis for the economic viability of a an independent, landlocked Kashmir?
  
<>I doubt that western opinion favours the creation of another Muslim state in a highly combustible zone of the world. Because of its location,because of the interest of every power in the area in the state, western opinion would view Kashmir as having the potentialf for becoming another Iraq or Afghanistan- perpetually on the boil thanks to warring factions serving as proxies for various competing powers.

Autonomy and self-rule must seem preferable options once you consider the implications of 'azaadi'.

No caste please, we're Indians

Outlook magazine carries a story on how an attempt to carry out a caste census is being stonewalled by private sector companies.

When the OBC quota controversy flared up, people questioned the basis for the 27% quota, saying there was no data to back it up. At the time, it was pointed out that there has been a marked refusal on the part of successive governments to collect the data in the first place. Ok, what is past is past, but surely there is merit in trying to see whether quota policy rests on a sound basis of data? This is what the Outlook story says:

<> The Karnataka State Commission for Backward Classes (KSCBC) is embarking on a massive caste census for the first time since Independence. Besides covering 1.18 crore households across the state, it will also look at the private sector—which is where it runs into resistance. The commission has written to 176 companies, including IT majors like Infosys, Wipro, Dell, Yahoo, MindTree, Sun Microsystems, IBM and HP, asking them to furnish "religion and caste-wise information" of employees But the response has so far been cold. KSCBC wrote to the companies in March this year and set a May 15 deadline for submission of data. But, as a KSCBC official pointed out, "Only 11 companies have provided information, 18 letters were returned undelivered, and three companies have written back that they are unable to furnish the data." Last fortnight, the commission sent out reminders to as many as 154 companies

The report points out that opposition to the survey is not confined to the private sector- many in government would rather not have the facts coming out. Because then we will know who has benefited so far and who hasn't.

Russia sends a warning to the west

The west has rushed to condemn what it regards as Russian bullying of Georgia. I refer to the recent hostilities between Russia and Georgia over Georgia's province of Ossetia which harbours a large Russian population. Russia will not accept Georgia trying to ride roughshed over the province and thinks it has every right to protect the interests of Russians there.

The west is outraged. But, as Kishore Mahbubani points out in the FT, not the rest of the world, including India and China. Mahbubani is dean of the Lee Kuan Yew School of Public Policy in Singapore, a former minister in the Singapore government and a well regarded commentator on international affairs.

Indeed, most of the world is bemused by western moralising on Georgia. America would not tolerate Russia intruding into its geopolitical sphere in Latin America. Hence Latin Americans see American double standards clearly. So do all the Muslim commentaries that note that the US invaded Iraq illegally, too. Neither India nor China is moved to protest against Russia. It shows how isolated is the western view on Georgia: that the world should support the underdog, Georgia, against Russia. In reality, most support Russia against the bullying west. The gap between the western narrative and the rest of the world could not be greater.

The lesson from the Russian intervention, Mahbubani says, is that the world is not going to watch while the west tries to lord it over. Moreover, the west must make up its mind where the primarily challenge to the west lies- is it Islamic militancy or China?

Western thinkers must decide where the real long-term challenge is. If it is the Islamic world, the US should stop intruding into Russia’s geopolitical space and work out a long-term engagement with China. If it is China, the US must win over Russia and the Islamic world and resolve the Israel-Palestine issue. This will enable Islamic governments to work more closely with the west in the battle against al-Qaeda.

RBI proposes, Finance ministry disposes?

The RBI wants to bring down growth in banks' commercial credit in a bid to slow down growth in money supply. Money supply has been growing at over 20% against the RBI's target of 16.5-17%. The RBI has raised interest rates but commercial credit has been growing at 24-25%, against the RBI's target growth of 20%.

Many think this is because public sector banks have not been aggressive enough in raising their lending rates, thanks to interference from the finance ministry. The ministry, they say, wants to sustain growth and it wants to keep home loan borrowers happy as elections loom, so it gets PSBs to refrain from raising rates as much as they should.

I am not so sure. I examine this whole issue in my ET column, Is finmin foiling RBI? and find that there isn't a strong enough case for this view.

There are just a couple of points I would like to add. One, the finance minister asking banks not to hike rates on home loans of upto Rs 30 lakh is not such a bad thing. A rise in home loan rates, as I mention in my column, may push many borrowers into default. Also, a sharp drop in home loan demand will affect a whole range of industrial sectors to which banks are exposed. So, in trying to extract better returns on home loans, banks may end up shooting themselves in the foot where corporate borrowers are concerned.

It is in the collective interest of banks not to raise home loans. But no bank on its own has the incentive to maintain home loan rates on its own- some other bank will then try to produce better returns by raising interest rates. In other words, we have what is called a "coordination failure". For the ministry to step in and provide coordination is appropriate.

The second point is that commercial credit growth is one element in high growth of money supply. A more difficult problem is the rise in forex reserves. There isn't much the RBI is able to do about this, so we can't expect a deceleration in commercial credit alone to bring down the inflation rate.

Creating world class universities in India

Dinesh Mohan, Professor at IIT Delhi, has an excellent piece in Business Standard on where India stands in the business of creating world class universities. The Shanghai Jiao Tong University's latest academic ranking of world universities confirms what we already know: we have been left far behind in the race.

In the top 500 universities in the world, India has only two: IIT Kharagpur and IISc, both ranked in the lowly range of 303-401. China itself has 18 universities in the list. Predictably, the US tops the list with 159, all of Europe has 210. The US has 9 of the top 10 (the tenth is Oxford) and 17 of the top 20. In academics, as in defence, it is a superpower.

The methodology, Prof Mohan points out, is sufficiently sound to command respect. The motivation behind the exercise was to figure out where China stands and what it needs to catch up. Prof Mohan highlights a number of interesting findings:

• A vast majority .... are large public universities enjoying liberal funding. Even in the USA, where many private universities exist, over 70 per cent of the universities making the list for engineering sciences are state funded. Even in the private universities, a significant proportion of research funding comes from the public sector. In the middle and low income countries, only state-funded universities are able to do any scientific research of any consequence.
  
• The age of specialised institutions like IITs, IIMs and IIITs seems to be over. A great deal of modern research involves interdisciplinary work and that is why such institutions are the exceptions.
• The kind of people who take up research and teaching jobs in any country come from middle and lower middle class family backgrounds. They are the ones who look for security in a job and work hard. Those who have spent money on education or taken loans are unlikely to take teaching jobs. We will have to reverse the trend of rising costs of education and give liberal scholarships even for living expenses.
• Our public sector institutions like the railways, NTPC, ONGC, DRDO, municipalities, BIS, building and road departments, etc. must put in place policies to hire such people (people with Master's and Ph D degrees) and give them meaningful jobs to do.
  

The bottomline? Forget the notion, currently popular, that in order to create world-class universities, we need government to get out of education. Forget also the notion that private institutions, motivated by profit and charging appropriate (that is, sky-high) fees will do the trick. Think again about the notion that you need fabulous pay packages in universities in order to attract talent- no, the types who are attracted look for job security, decent pay and a supportive environment.

We need to strengthen the IIT-IIM model and give it wider application. At least where the IITs are concerned, fees remain reasonably low and affordable and they must remain so. Improved governance at generously funded state institutions and inclusive, affordable education are the key to creating world class universities. In short, the drift towards privatisation, higher fee and higher pay packets for faculty as the answer must be checked before it is too late.

American prisoners in the Soviet Union

I had heard of a US invasion of the former Soviet Union in a bid to abort the communist revolution- the invasion was ineffectual. But it's news to me that the Soviet gulag harboured last numbers of Americans.

I got to know this from a review of a book on the subject in the Economist. The Americans were workers who landed in the Soviet Union during the Great Depression, desperate for jobs. At first, they were welcomed with open arms. But later the mood of the Soviet authorities changed:

Initially lauded as welcome refugees from the miseries of capitalism (and as useful specialists who might help replicate the bits of it that worked, such as factories) from 1935 onwards they became enemies of the people, infiltrators and spies. A tiny handful, such as Paul Robeson, a singer, were tolerated as propaganda trophies. The rest sank into a living Hades of torture, rape, slave labour, starvation, frostbite and death, shared with millions of others.

American diplomats in the Soviet Union and also American journalists turned a blind eye to the fate of these unfortunate workers. 'Serves them right' for having forsaken the US for the Soviet Union seems to have been the attitude:

Even before their arrest, most of the Americans were, in effect, prisoners: with their passports confiscated they were involuntary Soviet citizens. But the only people who might have helped saw no reason to do so. Diplomats in America’s newly established embassy in Moscow regarded all the migrants as communist sympathisers who had thrown in their lot with the system.

... If the diplomats look bad, so too do the Moscow-based foreign journalists, who shunned the story as liable to risk their official accreditation; the debaucheries on offer nightly at the Hotel Metropol, courtesy of the NKVD secret police, may have led them to choose their own livelihoods over the lives of others.

There was a shabby postcript to all this: American prisoners of war, freed by Soviet troops in Germany, were also packed off to the Gulag. And even this did not evoke outrage in the US!

Oil bubble burst

Excuse my giving myself a pat on the back but, as readers of this blog would know, I did say that oil prices would head towards $100. I said this at a time when oil was ruling at $140 and people thought it was headed towards $200. I based my forecast on two facts: the run-up in oil prices had been too steep; and the supply-demand imbalance was too small to warrant an increase of the order we had seen.

I did not say so at the time but we must also recognise that the world's sole superpower will not accept a situation where oil prices threaten to destabilise the US economy as well as the world economy. And it has some ability to influence oil prices. President Bush's visit to Saudi Arabia and some tough talk on his part elicited an assurance from the Saudis about an increase in output. Demand has been moderated by the passing on of some of the increase in oil prices to users. The SEC has toughened norms for speculators in oil. All this has combined to force down oil prices.

I read an excellent analysis in ET today of the issues related to the oil bubble. The author, a Chief economist with a US think-tank, addresses each one of the arguments made as to why the oil price rise was related to fundamentals and not speculation. He shows the arguments are dead wrong ( quotes from the article in italics:

• Oil prices rose because of a weak dollar: The price of oil has risen far more than the dollar has fallen. That means that oil prices have increased in other countries, which should have reduced, not increased, demand.
• Oil producers have held back production in anticiption of higher oil prices down the road: Nor have there been any report of unusual production cutbacks — the linchpin of the second argument. Indeed, the spike in oil prices actually gives independent producers an incentive to boost production.
• There can't be speculation in oil because inventories have not risen: the storage argument fails to recognise different types of inventory. Thus, record-high speculative prices have likely caused bunker traders to release inventory, but those releases may have been purchased by speculators who are now active lessees of commercial storage capacity. The implication is that speculators can drive up prices and increase their inventory holdings even as total commercial inventories remain little changed.
  

<>The author also underlines the fundamental change in the character of oil trading in recent years: speculative trades account for 70% of all trades compared to 37% seven years ago.
<>

<>

HBS's two failings

The Economist reviews a book, Ahead of the curve: two years at Harvard Business School, by a recent graduate, Philips Delves Broughton. It quotes Delves as citing two main failings of HBS:

First, it pushed the idea that its alumni would be equipped as leaders capable of solving all the world’s problems, rather than merely doing a decent job of running a company. “Business needs to relearn its limits, and if the Harvard Business School let some air out of its own balloon, business would listen,” he grumbles.

His second worry was that so many of his classmates seemed destined for careers that would leave them no space for a happy personal life. He opted for more time with his family, rather than follow in the footsteps of the “Goldman Sachs executive who came to talk about leadership and values…I just remember this look of total defeat on his face when he said how he had four ex-wives.”

Policy towards foreign banks in India

As per the RBI's roadmap for foreign banks, there is to be a review of policy towards foreign banks' entry into and expansion in the Indian market in 2009. My own assessment is that the RBI will continue to be cautious unless a government with a very different attitude comes to power next year. I don't see major sales of public sector banks to foreign banks, for instance.

Branch licensing policy may become more liberal but a level playing field between foreign banks and Indian banks is unlikely. Even the Raghuram Rajan committee on financial sector reform, which wants abolition of branch licensing, does not favour extending such a policy to foreign banks until a couple of years after it has been extended to Indian banks.

I wrote an article about the theoretical pros and cons of foreign bank entry into India for EPW recently.

More on "lessons from sub-prime crisis"

Philip Purcell, former chairman of Morgan Stanley, lists five lessons, all of which are familiar enough by now but are worth repeating:

First, profits matter more than revenues.....

Second, compensation should be based on profits, margins and return on equity over time, not current year revenues....

Third, leverage works not just on the upside but on the downside as well...

Fourth, diversified and recurring revenue streams not based on trading or principal investing have immense value in a down cycle....

Finally, risk management should become a board-level responsibility, with appropriate committees meeting regularly with management....

Perhaps, it's worth asking: how many of these were practised in Mr Purcell's own firm?

Shiller on the sub-prime crisis

Robert Shiller of Yale has come out with a book on the sub-prime crisis, The Sub-Prime Solution (Princeton). I had a chance to review it in my ET column, Can we prevent a sub-prime crisis?

Shiller's focus is on sub-prime loans. I thought the focus was somewhat misplaced. The problem may have originated in the sub-prime market but it got magnified into a financial crisis because of financial institutions' leverage exposure to sub-prime loans. It is financial regulation that needs to be revisited after the sub-prime crisis, not so much the sub-prime market and the protection of home loan borrowers.

Nuclear deal and the Hyde Act: Burns clarifies

One of the more asinine assertions in the nuclear debate has been that India is not bound by the Hyde Act because it only a "domestic legislation" in the US. This assertion has been made despite categorical statements to the contrary from US Secretary of State Condoleeza Rice.

Nicholas Burns, who was the chief negotiator on the US side, emphasises this point in a story reported in Rediff.com.:

Burns said, "When this agreement was negotiated, it was fully consistent with the provisions of the Hyde Act. So we have the right to terminate it if India tests." But he said it was highly unlikely that India would conduct a nuclear test.

He also added, "No aspect of this deal recognises India as a nuclear weapons state."

I also do not buy the argument that this only a deal about nuclear energy. I am inclined to believe the deal is more about a strategic partnership with the US. It will give us access to dual-use technologies and it makes us an ally of the US at a time when China is on the rise and there are serious threats to Indian security arising from the Pakistan- Afghanistan neighbourhood as well as unfolding developments in Nepal, Burma and Sri Lanka.

No alternative to tighter financial regulation

I wrote in my post yesterday that Greenspan's arguments in favour of competitive markets was misplaced in the context of financial institutions especially those that have a regulatory safety net.

Henry Kaufman, an erstwhile Oracle of Wall Street, echoes this viewpoint in an article in FT today that rebuts some basic premises of Greenspan:

First, we should recognise the deregulation illusion. When faced with the choice between regulated and deregulated financial markets, most nations try to sidestep. Market participants laud the virtues of unhindered competition over regulation for disciplining market behaviour. That works, by and large, for small and medium-sized companies, but not for the integrated financial giants that dominate many aspects of financial markets. These behemoths are “too big to fail”. Whenever one of these favoured institutions gets into serious trouble, some kind of formal or informal safety net is deployed.

A second and related precept is that comprehensive financial deregulation is impractical as well as politically and socially intolerable. This precept rests on the necessity that financial authorities safeguard the payments mechanism. Indeed, most large depositors are also fiduciaries (investment advisers, corporate treasurers and the like) that are compelled to shift funds out of institutions that seem to be in peril. Given these realities, the only way to abandon the “too big to fail” doctrine is to ensure that leading institutions are too strong to fail. That, in turn, requires close, ongoing official scrutiny.

The more free-market oriented our economy, the greater its need for official financial supervision. A truly ­market-oriented economy poses high risks of business failure and, correspondingly, high risks to institutions that lend to and invest in the private sector. Moreover we need to acknow­ledge that, while financial competition fosters innovation, it also contributes to instability

Greenspan on the sub-prime crisis

How to deal with asset bubbles? At the policy level, Alan Greenspan's view is: not much. If central banks act to fend off bubbles, they risk derailing growth. The best they can do is manage the problems that arise when a bubble bursts.

In an article in FT, Greenspan seems to suggest that firms do not have much of a choice but to ride the bubble. Not to do is to lose market share.

A financial crisis is heralded, in fact defined, by sharp discontinuities of asset prices. The crisis must thus be unanticipated. The fact that risk was heavily underpriced for much of this decade was broadly recognised in the financial community, but the timing of the sharp price correction was nonetheless a surprise.

Recent history is replete with such underpricing persisting for years. Those market players who withdraw from “long” commitments at the first sign of an excess of exuberance, risk losing market share. They thus continue “to dance” as Chuck Prince, the former Citigroup chairman put it, but always assume they will have time to exit the markets. The vast majority invariably fail. When the current crisis emerged, it was assumed that the weak links would be unregulated hedge and private funds. The losses, however, have been predominately in the most heavily regulated institutions – banks.

We see this happening all the time . No fund manager wants to exit the stock market in a hurry; banks are reluctant to switch off the lending tap; investment banks' proprietary trading desks are reluctant to forgo long positions. This is fine as long as the institutions concerned do not pose systemic risk when they fail. That is not the case in the sub-prime crisis. As Greenspan points out, banks are the biggest losers and this is what is creating problems for the world economy. It's hard to see how we can regulate banks with a lighter hand after the recent experience.

Sting operation on cash-for-votes

Most broadcast organisations have rushed to the defence of CNN-IBN and have criticised the BJP for its handling of the sting operation in the cash-for-votes affair. Readers would know that CNN-IBN has withheld broadcast of the tape. The BJP has said it will not entertain the channel until it airs the tape.

Today's Business Standard has an edit that argues in favour of airing the tape and it also suggests that balance of evidence is tilting against Amar Singh and company:

With the BJP on Monday releasing more information on the link between a certain Sanjeev Saxena, who gave its MPs money to support the government, and Samajwadi Party leader Amar Singh — the party alleged that Mr Saxena’s son’s college admission form has Amar Singh’s residence address on it — the circumstantial evidence in the cash-for-votes scandal appears to point in only one direction.

Earlier, on Sunday, the BJP had alleged that mobile phone records showed calls were made from Mr Saxena’s mobile to Amar Singh’s residence when Mr Saxena was at the house of one of the BJP MPs, handing over the cash (how the party got the phone records could well be the next controversy!). The party also said the car that Mr Saxena used was registered at an address that belonged to Amar Singh.

To establish that the two were closely linked, the party showed old SMSs sent by Mr Saxena to journalists, inviting them to Mr Singh’s press conferences. If all that the BJP says is true with regard to telephone records, car identity and college admission forms, there is strong justification for the television channel CNN-IBN to air the sting operation and let the public make up its mind.

Perils of PPP

I return to this blog after a bit of a layoff thanks to various preoccupations.

As somebody who has been somewhat sceptical about public-private partnerships (PPPs), I have watched with some interest the sly bailouts of Freddie Mac and Fannie Mac, two, private, secondary market institutions for home loans in the US. These guys operated for years on public sector and raked in enormous returns for shareholders and executives. Now, when they are in trouble, the taxpayer has to step in.

The obvious thing to do- as even the die-hard exponent of the free market economy, The Economist, has urged- is to nationalise the two institutions. One option later would be to privatise the commercial components, leaving behind a rump that can be remain in the public sector in order to meet social obligations. But, nationalisation is anathema to the neo-cons in power, so what we have is covert public ownership.

More on this and the implications for Indian banking sector in my last ET column, Private profits, public losses.

Reforms? What reforms?

Now that the UPA government has survived, there is the usual babble about "pushing ahead with reforms". What reforms are people talking about? Can you imagine any government cutting subsidies or changing labour laws in the run-up to elections?

Many reforms require legislative approval and are time consuming. Unless the market rally continues, disinvestment may not be attractive. Not least, the government cannot move an inch if any measure offends one of the numerous small groups whose support it garnered in order to survive.

Even the survival of the government for long cannot be taken for granted. So, talk of a burst of reforms that will lift the stock markets is just hot air. What will lift the markets is the decline in oil prices (which I had predicted) and a return of net FII flows later in the year.

More on the prospect for reforms in ET's debate last Tuesday.

Mayawati gains in stature

One unintended consequence of the PM's insistence on seeing through the nuclear deal is the emergence of Mayawati as the head of a Third Front and contender for the PM's job sooner than most people had thought.

It's fair to say that opposition to the deal came mainly from the Left and Mayawati. The BJP and many of its allies would gladly opt for the deal with some minor changes- or that's the impression they have created. The BJP's lack of determination to topple the UPA also registered- witness Advani's statement in the course of his speech in parliament that the NDA wanted to defeat the government, not destabilise it.

Mayawati made two important points about the nuclear deal: one, it increased the chances of a US attack on Iran with all its implications for India; two, an attack on Iran would see oil prices shooting up further and worsening the suffering of the poor. It does appear that she is carving out a distinctive position for herself. The constituency she is targeting- dalits, upper castes,muslims, the economically backward- is the one that kept the Congress in power for decades after independence. Both the UPA and the NDA have cause for worry.

Why did UPA want a "Confidence" vote?

Tomorrow is D-day. We will know whether the UPA government stays or goes.

I am little puzzled, though, as to the rationale for a "confidence" vote in parliament. As far as my understanding goes, a party or a coalition is required to prove its majority only when it stakes its claim to government and there are doubts that it has the necessary numbers. Then, the president may ask the leader of the coalition to demonstrate its majority on the floor of parliament.

At any other time, it is for the opposition to move a "no confidence" motion. In the present instance, after the Left parties withdrew support, the onus was on them or the other Opposition parties to move a no-confidence motion. At least in constitutional terms, it is not obvious that Congress and the UPA needed to seek a vote of "confidence".

The PM assured parliament that he would seek its approval for the nuclear deal. The right course for the UPA would have been to table a motion on the nuclear deal and seek parliament's approval. The UPA should have done this before approaching the IAEA with the safeguards agreement. Even if the motion had been defeated, the government could have carried on- only a defeat on a no-confidence motion requires the government to quit. The Left would not have had a problem with the UPA government even if the motion was defeated- after all, its opposition to UPA centres on the nuclear deal.

So, why did the PM and the UPA not do the obvious thing? Why seeek a vote of confidence? Was it because they feared that a motion on the nuclear deal itself may not have a great chance of going through? If so, the only way to ensure the success of the deal would have been to stake the survival of the government itself. Then, all members of the UPA and others as well would have had to choose - between the survival of the government and, perhaps, the present parliament and fresh elections. Confronted with such a stark choice, there was a better chance they would back the government- and the nuclear deal.

If the UPA government survives and goes ahead with the nuclear deal, all this may seem clever politics. But it carries with it a heavy price: a fall in standards in politics to new lows and a badly divided nation. The nation would have been better served had the government done what it had promised- come to parliament solely for its approval of the nuclear deal.

What were bank boards doing?

What were bank boards doing as the sub-prime crisis built up? What penalties do they face in banks that has suffered huge losses. Many CEOs have lost their jobs; not many directors have. One fact that took away my breath was mentioned in an FT report: nearly two thirds of bank boards were bereft of banking expertise.

So, who typically sat on these boards? Well, the mighty and the respectable, ex-CEOs of manufacturing firms, faces and names that have wide recognition. Is that good enough? I don't think so. I think it makes sense to have a minimum of finance and banking expertise on board boards. Here, India's Banking Regulation Act gets it absolutely right: at least 51% of board members must have expertise in specified areas: banking, economics, agricultural, small enterprises, etc.

The RBI also has norms for bank governance over and above the norms applicable to listed companies under clause 49. This is entirely appropriate: in many other countries too, governance for banks tend to be stiffer than for other firms or there are separate norms for governance for banks and for other companies.

Is having expertise on boards an insurance against failure? Not at all. Boards are limited by the information that management presents to them and the form in which these are presented. So, the best-intentioned boards may proved ineffective. But there is a more fundamental reason why boards are not as ineffective as one might like.

Most boards are clubby affairs. Those invited to serve as "independent" directors are pals of the CEO, they brush shoulders in the same watering holes and they are often retired people who value the handsome fees that many companies pay these days.

The atmosphere in boards is that of a mutual admiration society. CEOs pay ritualistic obeisance to the "sage guidance and wisdom" of boards in their annual statements- one retired CEO, whom I respect, told me there was not an iota of truth in this. Boards compliment management on their stewardship. Over sumptuous lunches and equally sumptuous snackes, top management and directors share jokes and anecdotes, there is a general air of conviviality. I mention this because, in this atmosphere, it is not done for an independent director to probe or to question. Bad form, old chap.

So, having expertise on bank boards is not enough. We need to ensure that there are enough directors who are independent of management, that is, they are not beholden to the management for their positions. This can happen only if financial institutions with equity stakes in the company and minority shareholders can directly elect a certain number of directors. The present concept of "independent" director, whereby management invites outsiders on to boards, is something of a farce. Alas, I don't see such a revolution happening in the near future.

More on this in my ET column, Banking's governance disaster.

Rating agencies - only a light rap?

Moody's confession of a botched $1 bn securities rating, thanks to a computer bug, is only latest in a series of woes for the ratings industry. Let's face it- rating agencies are not the most popular species in the financial sector today. They had eggs on their face after the East Asian crisis; they seem to have gone and blown it again in the sub-prime crisis.

But it appears the agencies will get away with a mild rap or two. The Economist reported last month that despite half a dozen agencies looking into their role in the recent crisis, the outcomes will be inconsequential: a commitment not permit 'ratings shopping' among clients; more transparency; more disclosure of the collateral; and the like. No fines, no crippling prohibitions.

I guess part of the reason is that it's hard to find an alternative- an independent rating agency promoted by government and funded by investors through the exchanges is a non-starter because governments getting into financial markets is the last thing people want.

The role of rating agencies is poised to get bigger with the implementation of Basel II because, for starters, most banks will rely on the ratings approach- this requires capital to set aside based on ratings assigned to borrowers by rating agencies. Basel II itself is under discussion now. I think there is a case for allowing the better banks to go with their own internal ratings instead of requiring them to go by rating agencies' ratings.

In India, I can't see that the better banks' rating of borrowers is likely to be of lower quality than that of the agencies- most banks, in any case, use the rating models supplied by the agencies and superimpose their own judgement. This probably makes more sense than banks relying entirely on the rating agencies.

Contrarian views on the nuclear deal

The debate on the Indo-US nuclear deal has been reduced to a test of patriotism. Those who who favour the deal want India to be a great economic power with the help of the US and are patriots. Those opposed to it have hang-ups about the US and are not averse to India falling behind China; their patriotism is questionable.

I have found this characterisation utterly puerile given the many nuances to this issue. Remember three top nuclear scientists in the country have come out with a statement expressing their reservations even now.

How refereshing, then, to come across two contrarian views on the deal on the same day. In an interview to Rediff, former diplomat M K Bhadrakumar makes a number of points:

• The UPA government is guilty of breach of trust in pursuing the matter of IAEA safeguards without the concurrence of the Left. When the Left gave the go-ahead to the UPA government to negotiate safeguards with the IAEA last November, it was on the understanding that the agreement itself would later be discussed and approved by the joint UPA-Left committee on the subject. The Congress has gone back on this assurance.
• There is lack of transparency on the safeguards agreed with IAEA- the government has not disclosed what these are.
• The IAEA agreement, once signed, will be 'in perpetuity'; once this agreement is signed, the further course of the nuclear deal is out of India's hands. Even if the form of the NSG waiver is unpalatable to India, it is out of our hands.

In another article, Brahma Chellaney questions the current line that the deal is about reducing dependence on oil and opening up prospects for nuclear power. He points out that India's dependence on oil for electricity purposes is negligible- just 4% of all our needs. Oil is primarily required for transportation purposes whereas nuclear power plants are all about generating electricity! He goes on to blast the case for nuclear energy as a substitute for oil:

If global oil demand is threatening to outstrip supply, so is the case with uranium. Current concerns associated with oil’s price volatility, supply security and geopolitical risks are no different than uranium’s. And if global oil reserves are finite, so are uranium resources, with proven uranium reserves likely to last barely 85 years, according to the Red Book published jointly by the OECD and IAEA.

In fact, in the past five years, the international spot price of uranium has risen faster than that of crude oil, with uranium today trading six times above its $10 a pound historical average. Oil and uranium prices are likely to stay volatile, but the long-term trend for both is surely up. Just as cheap oil now seems fanciful, cheap nuclear power for long has been a mirage.

Chellaney is right. This deal is about a strategic alliance with the US to counter the rise of China, it is merely being presented as an energy proposition for political and diplomatic reasons. The real worth of the strategic alliance lies in the transfer of a whole range of advanced dual-use technologies- these technologies cannot be transferred unless India's status as a nuclear power changes.

The key question is: do we want the strategic alliance at the cost of surrendering some of our freedom of action in foreign policy and in the nuclear field? I do think there is a case for an open national debate and that there is no compulsion to be bound by some artificial time-table.

Governance issue at Ranbaxy?

In today's TOI, Gurcharan Das has this to say about the sale of the promoters' equity in Ranbaxy to Daiichi of Japan:

For some years now I have been on the board of Ranbaxy and have watched with admiration as the company transformed itself into India's first real multinational. I have seen it inspire a dozen other companies and helped create a world-class generic drugs industry that is feared by western giants for aggressively challenging their patents and admired for lowering the cost of medicines around the world. How, then, was I to respond to the announcement by Ranbaxy's CEO, Malvinder Singh, that he wanted to sell his family's stake for Rs 10,000 crore to a Japanese company, Daiichi Sankyo? The family was equally shocked. A CEO's ability to keep months of negotiations secret in a country afflicted by verbal diarrhoea speaks of the company's character.

Das' comments suggest that, as a board member, he had little inkling of the deal until it was announced in public. Are we to conclude, then, that the deal was not approved by the board? If yes, is this appropriate?

This is not a case of any investor selling off his stake. The dominant investor is also top management. The decision of the promoter to sell his stake thus implies a decision by top management to let another company acquire Ranbaxy. Can such a decision be taken without the concurrence of the board? It does look as though there is something here for Ranbaxy's shareholders as well as Sebi to ponder.

Media hype is a threat to growth outlook

Seeing the coverage of the rise in inflation and the reactions to it, you might think the Indian economy is in the midst of a crisis or headed towards one. Relax. Take a few deep breaths, pinch yourself nicely and chant thrice: this economy is growing at 8%. Done? Now, read my latest ET column, Inflation threat is exaggerated. Let me elaborate on why I am fairly optimistic.

A top CEO told me a couple of days ago that most firms are "investing like there is no tomorrow". Existing projects will be not be delayed or cancelled. Any hesitation will relate to future projects and fresh fund raising. This means investment will continue to drive growth this year. That is one reason for optimism.

Another is corporate profitability- PAT growth of 40-50%! In most economies, this would be regarded as a fantasy. That gives enough scope for absorption of price increases. The consumer will not face much higher prices, so consumer demand, while being moderated, will not be undermined.

Thirdly, extremely low leverage, thanks to strong profit growth in the recent past. With such low leverage, interest rate increases can be shrugged off by corporates.

Fourthly, the runaway increases in salaries- these make it possible for the real spenders to keep spending. The distributive implications of inflation are another matter. Inflation will not affect growth but will demolish the UPA's chances especially if it relates to food inflation.

Most analysts take the view that cost-push inflation is a threat and the RBI needs to clamp down even if it means putting the brakes on growth. I disagree. The impact of supply shocks on the price level is not clear enough, although we can say with some assurance that large supply shocks tend to raise the inflation rate.

I go with the view that inflation is primarily a demand-side problem. This is true of our present situation as well. Aggregate demand is much too strong for comfort. If the Indian economy accelerates in the second half of the year as global problems recede, we may find growth in the region of 9% plus, which I would regard as the 'overheating zone'. So, in my view, it is the prospect of too rapid a growth rate for the sixth year running that provides the rationale for a rise in interest rates, not cost-push factors.

It is not interest rate increases that pose a threat to growth. The biggest threat to growth is posed by media hype on inflation, the global outlook, etc- the continuous blast from news channels may come to be taken seriously at some point by investors and consumers, which is when the problems will begin.

Soaring cost of living- yuppies feel the pinch!

The Indian Express on Sunday had a story about this IT professional, Srijesh Nair, who's struggling to make both ends meet because of the home loan burden he is carrying.

Nair's annual income is Rs 14 lakh. His home loan monthly payment is Rs 17,000. The increase in interest rates in recent months meant an additional Rs 2000. Nair says that he found it difficult to maintain his standard of living in consequence. Nair disposed of stock options and other assets to shrink the home loan outstanding.

I read the story in some amazement. Nair's annual pay translates into a monthly income of around Rs 1 lakh (assuming that Rs 14 lakh includes company contribution to PF). Take away income tax of Rs 34,000. That would leave Nair with Rs 66,000. The home loan at the increased rate of interest would mean a deduction of Rs 19,000. So, Nair would have had Rs 47,000 to cover his monthly expenses. Evidently, this was just adequate, giving Nair's standards of living, so Nair has no savings to dip into.

I do not for a moment wish to question any of this- I accept that Nair's predicament is for real. The question that troubles me is: if this is the situation with somebody making over a lakh of rupees a month, what about millions of others, including salaried employees, who make a lot less? The Arjun Sengupta committee on the unorganised sector showed that the majority of workers were making barely Rs 20 a day or Rs 600 a month.

The question is particularly troubling at a time when the inflation rate is rising. For millions, even a small rise in prices, especially of food, is the difference between subsistence and starvation. When you read stories like Nair's, you begin to understand why a rising inflation rate spells doom for the government of the day.

Business media boom

This is boom time for the business media and business journalists. A business journalist recently filled me in on what is going on:

Mint, the HT publication, is said to have crossed the 2 lakh mark in circulation. Financial Chronicle of the Deccan Chronicle group is also said to be doing well.

The buzz now is about the entry of Financial Times into the Indian market. This should be cause for worry for its present partner, Business Standard, which has positioned itself in the quality segment. Another foreign entrant that can be expected to pose a threat to Indian journals is Forbes magazine of the US.

TV channels for business news are also proliferating. UTV has launched UTVi, its business channel. The Economic Times is said to be readying to launch a TV channel. The Sahara group has plans for a business paper in Hindi.

All this is great news for business journalists. Salaries have spiralled. Journalism in general and business journalism is no longer an underpaid profession- it has become highly lucrative.

CMIE growth forecast is 9.5% !

As readers of this blog and my column, I remain upbeat about growth prospects in the current year (2008-09) despite the combination of financial market shocks and oil shocks. But the CMIE forecast for this year takes the cake- they see growth at 9.5%! This is driven by a huge investment boom.

I agree that investment will be a big driver but my own assessment was that growth would be moderated by interest rate rises and would settle at 8-8.5%. If the CMIE's forecast is borne out, Indian growth would be an astonishing achievement. It would demolish once and for all the thesis that the recent growth boom was a cylical phenomenon, driven by foreign inflows, cheap credit and global demand. It would confirm the view that many of us hold that growth is structural in character.

Secondly, if underlying growth is as strong as CMIE believes, that gives the RBI so much more elbow room to tackle inflation. The inference that would follow is that there are strong demand pressures in the economy and monetary policy needs further tightening.

Bank consolidation not a priority in India

Some people get a terrible complex when they look at the size of Indian banks. Too small, they say, compared to even banks in China. We have to do something about this. Indian banks must consolidate.

I have long been sceptical about this proposition and have written about it at length. My scepticism was reinforced when I had a chance recently to compare the market caps of Indian banks with those of the world's top banks. The comparison is quite revealing.

India's top two, SBI and ICICI Bank, are not very far from the world's top banks in market cap. Both are valued at over $20 bn today. This is not bad compared with $110 bn of Citigroup or about $53 bn each of Barclays Bank and Deutsche Bank. Only HSBC with a market cap of $200 bn looks distant.

Two factors are responsible for Indian banks drawing closer to the world's top banks in market cap. The proximate factor is the sharp decline in share prices of international banks consequent to the sub-prime crisis. Indian banks too have seen sharp declines in prices. But the effect has been to narrow the absolute difference in market cap. Citigroup is down from over $250 bn to $110 bn. SBI is down from nearly $50 bn- which was one fifth of Citigroup's market a year or so ago- to $23 bn, which is close to a quarter of Citigroup's market cap today.

The longer term factor is the wide difference in earnings growth. Indian banks are growing earnings at 20-25%; the world's top banks consider themselves lucky if they touch 10%. This is bound to draw the top Indian banks closer to the world's majors.

Can Indian banks then hope to make international acquisitions? Unlikely, I am afraid. Financial muscle is not the only thing that counts, you need solid managerial capabilities. Most banks lack this. ICICI Bank may just bring it off but not public sector banks.

More on this in my ET column, Banks' asset size is not the issue.

Six new IITs- will 'merit' be a casualty?

Today TOI carries an article by Swagato Ganguly on the proposal to set up 6 new IITs. Ganguly finds fault with the idea of starting IITs without campuses. Later in the piece, he indicates they may not have the requisite faculty either given the huge shortage of faculty.

What is the government to do? Should it wait until full-fledged campuses are set up and the country starts generating enough faculty? IIMA started off in a small building and with a small complement of faculty. So have the newer IIMs such as IIM (Indore). Over time, these problems came to be addressed. The point is: you get started, you muddle through for a while and then things start happening. I am optimistic about the new IITs and the contribution they can make.

Let me add: you can have spanking infrastructure, you can pay faculty very well and yet you may not have a good institution. In many private business schools, neither of these is a problem but the institutions don't count for much in academic terms.

The concerns about faculty and infrastructure may be valid but from there Ganguly wanders off into reservations and their potentially malign impact on IITs. He seems to suggest that the new IITs are all about pandering to caste politics:

The human resources minister, in particular, has turned the IITs and IIMs
into a tool of his political ambitions. A 27 per cent OBC quota is being rammed
down their throats, yet the number of open, non-quota seats has to be preserved.
It was decreed, after doing the math, that the total number of IIT seats
have to be expanded by 54 per cent, with next year's Lok Sabha elections setting
the general deadline. Therefore, the phenomenon of building- and facility-less
IITs, in one case even a homeless IIT which doesn't know where it will be
eventually plonked down.

Sorry, I don't get the connection. You can have OBC quotas by expanding seats at existing IITs by 54%- the government was under no obligation to set up new IITs. Having new IITs expands the availability of seats for the general category as well, so I can't see what the complaint is.

Ganguly warns: "If IITs are made to jettison merit they, too, will be forced to their knees."
As an ex-IITian, he should know that IITs have long had SC/ST reservation. Over 50 years of such reservation, the IITs have built up a formidable brand. I rest my case.

Oil prices in India

Two notions about oil prices in India need to be debunked.

One, the notion that the consumer is being subsidised. True, the consumer is being charged a price less than what the price would be tax is added to oil companies' selling price. But this is only because the duties are stiff. The consumer today does not bear all of the duty but he is still paying a price above the oil companies' selling price. This means he is being taxed, not subsidised.

Two, the notion that oil in India is still very cheap. The Economist compares petrol prices at the retail level in several countries. India ranks seven in a list of 15 countries- China, the US, Malaysia, Indonesia all have lower prices than we do.

Secession of the Indian elite

Gated housing enclaves, private guards, exclusive clubs, private aircraft.... the Indian elite has known how to insulate itself from the masses. But when industrial barons decide to hope from their helipads to private airports they propose to build for themselves, they have taken a truly gigantic leap.

Ronald deSousa, director of the Indian Institute of Advanced Studies, Shimla, has interesting thoughts on the subject in an article in ET:

Three basic arguments have been forwarded for private airports. The first concerns simple pragmatics. It will reduce congestion at a time when our airports are getting overcrowded and since private planes take longer to land, by moving them out we will save landing time of the other aircraft. The second relates to safety. The aviation authorities will ensure that these airports will maintain the highest safety standards and so, for the flying public, there is no cause for anxiety. The third is a version of ‘he who pays the piper calls the tune’. As long as they pay for it they can have it.

......When seen from a host of other perspectives the policy seems perverse. Take the secessionist argument which holds that the policy encourages the super-elite to live life in a bubble. From the helipad at the top of the corporate headquarters, to another helipad in the factory complex, to perhaps a private airport for a journey to Delhi, the captains of industry can journey across the country without having to meet, or rub shoulders with, or even see the ordinary Indian, let alone experience the minimal existential reflections on the lives of those who live in the slums they have to drive through on their way to the airport

Those people, in many cases, might be their own workers. They will thus never know the possible causes that have reduced to a life of indignity those who beg at red-light crossings, or the conditions of the villagers who have to walk for miles for water, or the anxieties of our rural youth as they search for a space between the rural and urban

There is more to private airports than elitism or snobbery. At a time of soaring oil prices, we would like to encourage public transport as a substitute for private cars. Private aircraft as a substitute for public ones seems the ultimate obscenity. Finally, as always, there is always the issue of land, as deSousa points out:

There is another important concern. Private airports will require a lot of land. The country has just witnessed political movements on the SEZ policy requiring the government to take corrective measures and in some cases reverse its decisions. Again the poor farmer will have to give up prime land with the Land Acquisition Act being used to get (let me get it right) private land for a public purpose for a private airport.

Managing versus teaching management

"Those can, do; those who can't, teach." There is profound truth in the old crack. But we need not be ashamed of it. Teaching management and managing require very different skills and temperament- and rarely shall the twain meet.

Accepting this fact would save us all unncessary vexation. The question is frequently asked: if management professors know so much about management, why can't they do a good job of managing- starting with their own institutions? For instance, B-schools have renowned professors of strategy who go out and advise corporations on how to win. Why can't they apply more of their expertise indoors?

The story is told of a finance professor who was asked by a senior executive in a training programme, "If you are smart, why aren't you rich?" To which the prof retorted," If you are rich, how come you are dumb?"

I argued in my last ET column, Can management gurus manage?, that this is a pointless debate. Knowing something in the sense of being able to conceptualise something is very different from translating it into practice- the translation requires implementation skills, people skills, high energy levels, commercial acumen, etc all of which management gurus are liable to lack.

By the same token, we cannot expect managers to come into the classroom and excel. They may have done a great job of managing but putting things in a conceptual framework is a discipline in which professional teachers excel, not managers. My own experience with inviting senior executives to offer sessions has been less than exhilarating. Many can't do better than recount anecdotes. ("I was having lunch the other day with the prime minister of Singapore...). The ultra-bright types at the B-schools can recognise bullshitting when they hear it and quickly switch off.

How can managers contribute to improving the quality of teaching at B-schools? My column offers a couple of suggestions.

World Bank wisdom- or lack of it?- on growth

This is the hottest new thing on how to achieve growth and it has been driven by the World Bank, among others.

A high-powered 21- member Commission on Growth and Development headed by Nobel Laureate Michael Spence has published a report, “Growth Report: Strategies for Sustained Growth and Inclusive Development.” (India is represented by Montek Ahluwalia, Dy Chairman, Planning Commission).The Commission is an independent body supported by Australia, Sweden, the Netherlands, United Kingdom, William and Flora Hewlett Foundation and the World Bank Group.

I haven't had a chance to read the report but I did read the overview at the World Bank website. The report identifies 13 economies that sustained growth of ovr 7% for 25 years. It says they had the following in common. Each economy:

• Fully exploited the world economy
• Maintained macroeconomic stability
• Mustered high rates of saving and investment
• Let markets allocate resources
• Had committed, credible and capable governments

Since China is among the economies mentioned, one has difficulty accepting all the five "common" elements. Nobody can seriously argue that China, which has undervalued its currency and has a state-dominated banking system that funnels resources to state enterprises lets "markets allocate resources".

The report will fuel much comment, not necessarily favourable. William Easterly, himself formerly of the World Bank, has a scathing piece in the FT- he calls the report a "debacle":

After two years of work by the commission of 21 world leaders and experts, an 11- member working group, 300 academic experts, 12 workshops, 13 consultations, and a budget of $4m, the experts’ answer to the question of how to attain high growth was roughly: we do not know, but trust experts to figure it out.

... Why should we care about the debacle of a World Bank report? Because this report represents the final collapse of the “development expert” paradigm that has governed the west’s approach to poor countries since the second world war. All this time, we have hoped a small group of elite thinkers can figure out how to raise the growth rate of a whole economy. If there was something for “development experts” to say about attaining high growth, this talented group would have said it.

What went wrong? Experts help as long as there are useful general principles, such as could be established by comparing low-growth and high-growth countries. The Growth Commission correctly pointed out that such an attempt to find secrets to growth has failed. The Growth Commission concluded that “answers” had to be country specific and even period specific. But if each moment in each country is unique, then experts cannot learn from any other experience – so on what basis do they become an “expert”?

China's turn to lecture the West !

A fallout of the sub-prime crisis is that financial regulation in the US and other industrial economies has been shown in poor light. In contrast, regulators in China and India are patting themselves on their backs for their measured approach to financial sector liberalisation, which, they say, has helped insulate their systems from the financial market crisis.

The acting of the China Banking Regulatory Commission did not mince words in an interview to FT:

“I feel the western consensus on the relation between the market and the government should be reviewed,” said Liao Min, director-general and acting head of the general office of the China Banking Regulatory Commission.

“In practice, they tend to overestimate the power of the market and overlook the regulatory role of the government and this warped conception is at the root of the subprime crisis.”

When asked what other countries could learn from China’s regulatory system, he pointed out that Chinese financial institutions needed CBRC approval to launch individual product types, making it nearly impossible for exotic financial instruments, such as the ones blamed for the subprime crisis, to exist in China.

The majority of China’s financial sector is still owned by the state, and the government retains tight control over many aspects of the industry, including senior personnel decisions at the country’s largest banks, insurers and brokerages.

Thanks to China’s lack of integration with global financial markets as well as the cautious regulatory approach of the CBRC, Chinese banks have emerged relatively unscathed from the global credit crisis, which so far has caused nearly $380bn of losses at western financial institutions.

Not everybody buys the argument that the diminished frequency of crises is an argument for hastening slowly with financial liberalisation. Alan Greenspan argued recently that occasional financial turmoil may be the price to be paid for rapid innovation and growth. The answer, Greenspan urges, is to ensure that banks have enough capital to withstand shocks:

“If we want rapid growth in productivity, innovation, standards of living, we may have to accept that there will be periods of turmoil,” the former chairman of the US Federal Reserve told the Financial Times.

Rather than try to suppress bubbles, he said, policymakers should ensure that financial institutions were well enough capitalised to withstand the hit from bursting bubbles as well as other shocks.

Mr Greenspan backed efforts to develop counter-cyclical capital rules that would force banks to hold more capital in good times than bad.

Such rules might make it less likely that asset price and credit booms would feed each other, as they did during the housing upturn.

But he said this would be difficult to implement in practice because “we are never certain where we are in the cycle”.

New spin to dynastic politics

PA Sangma was among those who walked out of the Congress along with Sharad Pawar to form the Nationalist Congress Party. At the time, they said they could not stomach the Congress' brand of dynastic politics any more.

Now, Pawar has now qualms about being part of a Congress-led coalition. As for Sangma, he is busy inducting his kids into politics, whether at the state or national level. His justification: he is not grooming any kid in particular, there will be equal opportunities for all, so he can't be said to be guilty of practising dynastic politics.

Sangma even distinguishes his brand of dynastic politics from Sonia's: Sonia has clearly identified one successor, Rahul! Even by the standards of Indian politics, this qualifies as a new low.

ET has some acerbic comments:

His (Sangma's) daughter Agatha has just been elected India’s youngest MP. His elder son Conrad is Meghalaya’s Cabinet minister for finance and power.

His younger son James is the parliamentary secretary for home. The position of Meghalaya Planning Board chairman is itself defined as equivalent to that of the CM who is expected to step down after two-and-a-half years so that Sangma can take over for the next 30 months.

And yet Sangma maintains he is not trying to encourage any dynasty. His children, he says, are foreign-educated and it is their duty to pay the state back. Earlier this year, when he resigned as MP from Tura to contest the assembly elections and his daughter was chosen as the NCP candidate for the Lok Sabha by-election, he was quoted as saying that the “people of Garo Hills did not have any other choice as Agatha K Sangma is the only available right choice”.

....Maybe it is just as well Sangma left the Congress exactly nine years ago. In the latest Karnataka polls, the Congress insisted that the kith and kin of party office-bearers should not be allowed to contest. All of which upset some senior leaders who wondered why the same principle did not apply to the Nehru-Gandhi family

UBS

UBS has had the second biggest write-downs in the sub-prime crisis after Citigroup. This once highly regarded bank is now the butt of jokes. The Economist has a crack in its recent survey of international banking about what the acronom stands: Used to be Smart.

Soaring oil prices- are analysts to blame?

Are high-profile analysts responsible for oil price soaring past $130? One analyst who's frequently mentioned is an Indian, Arjun Murti, who works for Goldman Sachs. Murti is credited with having forecast the rise past $100 long back- now he's looking at $200 in the near future. FT has a report on this:

Ali Naimi has been the most powerful man in the oil market since he was named Saudi Arabia’s oil minister in 1995. Even the smallest hint from him about future supplies or prices could send energy prices spiralling up or down.

But Mr Naimi’s influence is today being threatened by a gang of Wall Street and the City of London analysts whose price forecasts and trade recommendations are not only moving spot prices but also shaping long-term trends.

Among those with the strongest claim to take over Mr Naimi’s mantle are Jeffrey Currie and Arjun N. Murti of Goldman Sachs.

Three weeks ago, Mr Murti suggested that crude oil prices could hit $200 in the next two years.

“The current energy crisis may be coming to a head,” he said on May 5. This immediately sent spot prices to a new record, but also triggered an unprecedented rally in long-term prices such as contracts for delivery in 2016. The bullish trend was reinforced last Friday when Mr Currie told investors to buy long-term crude oil futures, warning that “long-term oil prices will need to continue to rise to bring trend oil demand growth in line with trend supply growth”.

I have said before: speculation is an element in the rise in oil prices but the root cause is a imbalance in supply and demand. The imbalance is small but in commodities small imbalances suffice to create huge swings in prices. I would also mention geopolitical factors: nervousness over the Middle East and especially Iran.

How high will oil prices go? As far as the US can stomach, to put it bluntly. George Bush's visit to Saudi Arabia elicited a commitment from the Saudis to step up output. That and weakening demand from China in the coming months should rectify the supply-demand gap in the near future. The medium-term outlook is hard to call.

Techies didn't vote in Bangalore

Bangalore's techies were vocal on TV during the Karnataka elections. The Congress directed much of its campaign towards them. But they couldn't be troubled to go to the voting booth, it appears.

Swapan Dasgupta had some scathing comments in Sunday's TOI:

In London, the voter turnout on May 1 was 45% — very high by the standards of British local elections; it was 44% or so in Bangalore — pathetic by Indian standards. The turnout of registered IT professionals was estimated at just 20% — a far cry from the 78% turnout in Bangalore Rural.

The poor turnout of those who see themselves as the face of a new India is intriguing. First, the English media gave disproportionate coverage to the views of the IT sector during the campaign. To a non-Bangalorean it appeared that there is nothing apart from IT in the city. The Congress Party's advertisement campaign seems to have been directed totally at this special interest group.

Secondly, the ambassadors of the Brave New World were vocal in articulating their dissatisfaction with the state of Bangalore. They gave umpteen sound-bites sneering at politicians, almost implying that it would have been better if politics was run by corporates. Finally, while "old industry" engaged with politicians to promote and safeguard their own interests, the IT sector spurned them — that is, all except S M Krishna with whom it has a very special relationship. The techie honchos conveyed the impression that they were in Karnataka on sufferance; they could just as well have been in Shanghai.