Small banks, manageable banks

I wrote earlier that we needed banks that idiots could manage and this meant that banks should not become too large or complex. The Economist carries a profile of a successful East European bank wherein the banker talks about the virtues of being small. The bank is Erste Bank,Austria's second biggest. Its CEO says banks should stay small because they can't attract the best talent, only mediocre people.

People who want to make a lot of money fast go to work in investment banks, but people who work in commercial banks are pretty average people," says Mr Treichl in an office so understated that it almost seems calculatedly so...."We should not think we can invent something brilliant. If we could we would be working somewhere else,"he says of the exotic credit derivatives that spread risk, like a contagion, through the financial system.

The banker also points to the difficulties in managing large banks, sprawled across several countries.

If you run something like Citi how the hell do you know what's going on in Poland if you only go there every three years?" he asks. "This is very much a people business. I need to touch and smell and feel what's going on."

Very true. But I would question the presumption that because investment banks attract brighter people, they can afford greater risks. If this were true, then Lehman, Bear and others would not have gone under. The problem is two fold. First, firms that are beyond the capability of even the brightest to manage because of their sheer size. Then, the problems of excess leverage, which create incentives to take excess risk that even the brightest are not immune to. Greed is not something that bright people are free from.

Should IITs and IIMs become universities?

Yes, says the recent Yash Pal committee on higher education. I say: no. The IITs and IIMs have serious work to do in their respective fields, engineering and management, and cannot afford to fritter away energies in diversifying into unrelated fields. More on this in my ET column, IITs and IIMs:Yash Pal is wrong.

The Yash Pal committee also takes too benign a view of governance at IITs and IIMs. On the hierarchy of governance, the committee places universities, IITs and IIMs in an ascending hierarchy. Now, it's true that IITs and IIMs have done a better job than universities. But that doesn't mean they have no governance issues. The IITs and IIMs have become high quality teaching institutions, thanks, in large measure, to generous financial support from government and the benefits of exclusivity in a highly uncompetitive Indian market for higher education.

I argue in my column that, to progress further, they need substantial improvements in governance and accountability. The composition and performance of their boards is one area that cries out for reform. The Bhargava committee noted that the IIM boards tended to reduce their roles to one of providing routine administrative approvals.

The most important function of a board is to lay down performance objectives for top management and to measure performance against objectives. How many IIT and IIM boards can claim to have done this? Somewhere along the line, many have forgotten that boards don't exist in order to approve canteen contracts.

I would add: there are limits to the effectiveness of board monitoring. We have seen this in the corporate world and must not expect anything different from academic board. The difference is that companies are subject to the discipline of the market place in a way in which academic institutions are not- certainly not, institutions of higher education in India.

America has a reasonably competitive market for higher education.Yet, it has state universities of high quality. In India, the government cannot afford to withdraw from public institutions until a more competitive market has evolved. For the same reason, board monitoring at the IITs and IIMs will not suffice. There must be periodic, external audits commissioned by an Appointments Committee for Higher Education that I propose.

The Bhargava committee provided an overview of the functioning of the IIMs. The government must now ask for detailed, institute-specific audits for the older IIMs and IITs. These audits must be based on extensive interactions with all stakeholders, not written documents provided by the institutions. There are private schools in the west that have subjected themselves to such an audit on their own. One b-school I know has benefited enormously from external audit is Toronto's Rotman School of Business which has moved up in the international rankings quite a bit over the years.

Do we need mega banks?

I had a post earlier on the problems posed by large banks and I proposed then that we may need to impose a regulatory cap on bank size.

I find that this proposal is being mooted by some very illustrious names and indeed is gaining some momentum- although I doubt that large banks, with their political clout, will allow the proposal to fructify. In an article in ET, Joseph Stiglitz writes:

We need to break up the too-big-to-fail banks; there is no evidence that these behemoths deliver societal benefits that are commensurate with the costs they have imposed on others. And, if we don’t break them up, then we have to severely limit what they do. They can’t be allowed to do what they did in the past — gamble at others’ expenses.

Much the same is echoed by Henry Kaufmann, a much respected figure on Wall Street. In his book reviewed in the latest Economist, Kaufmann is quoted as warning against the dangers of consolidation forced on the financial sector in the wake of the crisis and the problems posed by large banks:

Driving the weak into the arms of the strong may have been expedient, but it swelled the oligopoly of financial conglomerates deemed too big to fail.

Mr Kaufman draws a convincing link between this consolidation and greater market vulnerability. He sees two possible roads to reformation: dismantling the monsters or curbing their riskier activities to the point that they become public utilities, too safe, rather than too big, to fail.

So, if you can't limit the size of banks through regulatory fiat, then you have to limit the nature of their activities. My own view is that the former is,perhaps, the lesser evil. But, a former deputy governor of the Bank of England, John Gieve, quoted in FT, thinks the latter is preferable:

Sir John (Gieve) doubts that policymakers can set an optimum size for financial services, but suggests the industry could be subject to the sort of economic regulation applied to other utilities, such as telecommunications.

Green shoots, what green shoots?

Hopes of a quick recovery in the world economy are overblown. Emerging markets may bounce back but the advanced economies are mired in problems, especially the US. Nouriel Roubini thinks the chances of a double-dip recession are rising. He gives several reasons for this, including the damage to the US financial system and the failure to revive it. He also thinks the rise in oil prices, driven by excess liquidity, may well stymie a quick recovery.

The Obama administration has ducked the banking challenge, I argue in EPW. Not only is there no quick solution to the present crisis, I am increasingly sceptical about long-term proposals for reform after seeing the US treasury proposals. We have a serious problem of government capture by the financial system in the US. The proposals do not tackle the too big to fail problem, they do are not tough enough on bank compensation and it is unlikely that rules for bank capital will be stringent enough, as and when they emerge in the US. We probably need another serious crisis for banking reform to take place.

Meanwhile, China has circulated draft proposals for increasing bank capital to 12%. We in India should do likewise. We have a golden opportunity to create an even stronger, more competitive banking system in the near five years as the international banks struggle to get out of the present mess.

Let's put a cap on the size of banks

Large, complex financial institutions are lethal to the financial system. They can fail and when they do, they wreak havoc on the economy.That's why they have to be rescued- as we have seen in the present crisis. We also saw what happens when they are not rescued, as in the case of Lehman Brothers when confidence in the system evaporated.

I do not believe that the present two-pronged approach, which consists of a regime for winding down such institutions in the event of failure and higher capital requirements, will suffice. You have to tackle the root cause of the problem, the bigness of the bank itself. I cannot see how any CEO can manage risks in institutions with over a trillion dollars or so in assets. Ask any bank CEO with, say, $10 bn in assets and he will tell you he is fully stretched.

I elaborate on this in my ET column, Banks that can be run by idiots. I propose a ceiling a bank size- say, 5-10% of GDP. For a large economy, we should be closer to the lower end of the range; a smaller economy could be at the higher end. In addition, regulators should keep in mind some absolute size limit beyond which financial institutions become impossible to manage. In the process, we will also have less concentration and more competition.

In defence of economists

Morale in the economics profession is rather low, given the panning that economists have received in the wake of the sub-prime crisis. People have asked: how come economists did not provide warnings or don't seem to have solutions? (although some did warn and many have proposed solutions). The Economist ran a cover story in July about all that went wrong with the economics profession.

Robert Lucas responds to the criticism about why models failed to predict the depth of the downturn:

The Economist’s briefing also cited as an example of macroeconomic failure the “reassuring” simulations that Frederic Mishkin, then a governor of the Federal Reserve, presented in the summer of 2007. The charge is that the Fed’s FRB/US forecasting model failed to predict the events of September 2008. Yet the simulations were not presented as assurance that no crisis would occur, but as a forecast of what could be expected conditional on a crisis not occurring.

Until the Lehman failure the recession was pretty typical of the modest downturns of the post-war period. There was a recession under way, led by the decline in housing construction. Mr Mishkin’s forecast was a reasonable estimate of what would have followed if the housing decline had continued to be the only or the main factor involved in the economic downturn. After the Lehman bankruptcy, too, models very like the one Mr Mishkin had used, combined with new information, gave what turned out to be very accurate estimates of the private-spending reductions that ensued over the next two quarters. When Ben Bernanke, the chairman of the Fed, warned Hank Paulson, the then treasury secretary, of the economic danger facing America immediately after Lehman’s failure, he knew what he was talking about.

Lucas is right, of course. Models do incorporate policy responses. Few economists would have thought that the US government would let a big bank fail. Such a failure would not have been part of the model. The decision to let Lehman was an inexplicable blunder- and it is doubtful that the crisis would have been as severe if that had not been allowed to happen.

Lucas also points out that the policy response to the crisis, based on whatever economics has taught us about crises in the past, has been pretty effective at least ensuring that there is no repeat of the Great Depression:

The recession is now under control and no responsible forecasters see anything remotely like the 1929-33 contraction in America on the horizon. This outcome did not have to happen, but it did.

Crisis won't upset US dominance

That's the title of my last ET column. Several commentators have predicted the eclipse and decline of the US consequent to the crisis just as gloomier commentators have forecast the demise of capitalism. They are both wrong. Capitalism will reinvent itself, with fresh rules for the financial sector, and the US will retain its pre-eminent position.

One reason, as historian Niall Ferguson points out, is that when the US has a serious recession, its principal economic rivals suffer sharper setbacks to growth, so the US ends up the winner. Another is that the dollar does not have a serious competitor- does anyone seriously believe that the world's central banks will hoard their reserves in remnimbi?

America's economic dominance is to some extent derived from and supported by its military and political dominance. The US can, if it is really pushed, exert pressure on its oil producing allies to rein in oil prices. It can get economies with surpluses to park these in US treasuries. It has a major say in the creation of rules for the world economy through institutions such as the IMF, World Bank and WTO.

There are two areas in which the US is far ahead of the rest of the world: military power and higher education. Its lead in these areas will serve to ensure its pre-eminence in the world economy for as far as we can see now.

Status of IIMA

An important judgement related to IIMA is due on August 25- and it seems to have escaped the notice of much of the media. The only detailed report I have seen appeared in DNA.

The Gujarat High Court, the paper reports, will rule on "Whether the legal status of IIM-A (Indian Institute of Management, Ahmedabad) is of an autonomous institution, a State or an instrumentality of State..". If IIMA is a state institution, then article 226 of the constitution would become applicable whereby a high court can entertain a writ petition against the state or any state institution.

The issue has arisen in the context of a case filed by a dismissed IT manager of IIMA. The employee stated that "despite having performed her duties satisfactorily, she was illegally dismissed by the present director in complete violation of the principle of natural justice.".

Claims and counter-claims regarding the status of IIMA were made by the concerned counsels:

The IIM-A counsel, Nandish Chudgar, countered the argument by stating that the petition was not maintainable as the institute was an autonomous institution - it did not fall under the status of 'State' and 'an instrumentality of State' under Article 12 of the constitution, as held by a division bench of the Gujarat high court in 2002 in a case against IIM-A.

In his counter reply, Sinha argued that the decision of the division bench of the Gujarat high court, which is relied upon by the IIM-A's advocate, was mainly based upon the decision of the Supreme Court in the case of Chander Mohan Khanna vs. National Council of Educational Research and Training in 1991. However, by a subsequent judgment of a division bench of the supreme court, in the case of Pradeep Kumar Biswas vs. Indian Institute of Chemical Biology in 2002, has specifically held that the decision in Chander Mohan Khanna does not lay down the correct law.

IIMA has thus far scrupulously adhered to norms applicable to public institutions in matters such as SC/ST quotas, OBC quotas, the Pay Commission awards and the RTI Act. It is also subject to CAG audit.

Goldman Sachs under fire

Goldman Sachs has been, at some point at least, a much admired firm. But it has come under heavy fire in recent months, as reputations in banking and investment banking have tumbled following the sub-prime crisis. The firm's stellar second quarter performance has done nothing to diminish the criticism. If anything, talk of record bonuses has infuriated people even more- the talk is that average pay at Goldman this year could touch a million dollars.

I wrote about this phenomenon in my ET column, Goldmine Sachs is an illusion. On the face of it, Goldman's performance looks impressive. It has increased return on equity while reducing its leverage by half and reducing its dependence on proprietary trading. But, then, Goldman today is a bank fully backed by the Fed. Its borrowing costs are surely lower than what they would be if it did not have an implicit central bank guarantee.

In return for the guarantee, the central bank is entitled to lay down capital requirements and other regulations for Goldman. Goldman's tier I ratio of around 13% is way above the Fed's requirement of 6%. But that is only because the regulatory requirements are far too low and are yet to be revised upwards. Capital requirements for banks will rise, even more so for banks with trading operations and for systemically important banks such as Goldman. The key question is what sort of return on equity Goldman can show after higher regulatory requirements kick in.

I argue that abnormal returns on equity such as the one Goldman showed this quarter (23%) arise not just from inadequate capital requirements but also from other market imperfections. There are others who argue that Goldman was close to imploding like Lehman and was saved only by its alumni ensconced in the corridors of power in the US. They cite the bail-out of AIG and the form it took- cash payments to counter-parties of AIG- as proof.

There's been a huge outpouring of venom towards Goldman. The most recent one is in New York magazine. The earlier celebrated diatribe appeared in Rolling Stone magazine.

Meanwhile, FT reports that Goldman's reputation has been tarnished by recent events.

In a survey of 17,000 Americans, Brand Asset Consulting found that Goldman’s stature – as measured by several gauges of brand strength – had suffered in 2008 and 2009.

“Goldman Sachs still has that Gordon Gekko look to it among the general public,” said Anne Rivers, who oversaw the survey, referring to the villain of the 1987 film Wall Street.

ICICI plan for credit card defaulters

ICICI Bank is never far from controversy, is it? A couple of weeks ago, it made waves when it sent a legal notice to the HR head of rival HDFC Bank for allegedly saying in an interview that she didn't want the ICICI culture to seep into her bank.

Now, ET carries a story about ICICI Bank's plans to recover dues from credit card defaulters by getting employers to deduct specified sums from employees' salaries and remit these to the bank. Apparently, ICICI Bank is inserting a clause into its agreements with credit holders permitting such deductions.

As you can see from the ET website, the move has provoked a storm of outrage and even some downright abusive comments. As one reader has pointed out, such a clause may not be legally enforceable and would certainly require a tripartite agreement involving the employer. Moroever, it's doubtful that the regulator and government will permit such a clause. The move has the potential to create embarassment similar to that caused by ICICI Bank's strong arm tactics to recover housing loans.

For bankers, caution in lending has to be the watchword. Toughness in recovery won't work in this country- it will only create hostility all round. Sympathies are always tilted towards the borrower as they are towards the tenant.

Capital requirements for banks

How much additional capital do banks need? The Economist reports on the results of some stress tests:

Based on the estimates used in the American government’s stress tests, the 19 firms involved collectively need to hold minimum core capital of $313 billion. Between the start of the crisis in mid-2007 and the end of 2010, these firms are expected to eat up about $317 billion of capital (with gross losses of almost a trillion dollars offset by core earnings). On this basis, they would need to have entered the crisis with $630 billion to have avoided breaching the floor. That is equivalent to 8.1% of their current risk-weighted assets. The American and European systems actually had a core-capital ratio of nearer 6% at the end of 2007, according to the Bank of England. The Basel rules allowed core-capital ratios to go as low as 2%.

If anything this calculation is generous. Using Bloomberg’s higher estimates of the losses recorded so far, a peak core-capital ratio of nearer 10% would have been needed for the big American banks. And of course losses are not evenly distributed across the system. Citigroup would have needed a starting core-capital ratio in the mid-teens. Using a similar methodology, Switzerland’s UBS would have needed a pre-crisis ratio of about 12% to have avoided hitting the floor of 4% .

If we accept 8% as the core capital requirement and posit an equivalent requirement of tier II capital,we end up a minimum capital requirement of 16%. There will be further additions based on the size of the trading book and for large banks. One thing appears reasonably clear: in about two years from now, we can expect banks to be operating at a capital level of 15-20%. The current capital adequacy in the Indian banking system is 12-13%. Topping up capital to meet the new requirements will be quite a challenge considering that the government is committed to retaining 51% equity ownership.

Quotas and quality

Everytime, the subject of quotas for disadvantaged in education comes up, the refrain is that this will undermine 'quality' or 'excellence' in education. We will end up with engineers who can't design bridges properly and doctors who are no better than quacks. This argument was heard during the OBC quota debate.

I argued at the time that the cut-offs for OBCs- of, say, 98 percentile at the IIMs- would still mean that OBC students who got admission were in the top 2% of an applicant pool of over 200,000. This was very high quality considering that your chances of getting into a top B-school in the US are high if you are in the top 10-15% in an applicant pool of 10,000!

Well, we have the benefit now of having had a chance to see how OBC candidates have done. Outlook reports that they have done pretty well in several places:

Outlook accessed records from a few premier institutes—IIT Kanpur, IIM Ahmedabad and two Delhi-based colleges, Hindu and Lady Shri Ram—to gauge the performance of students. admitted through the OBC quota. And the good news is that all these students have fared rather well—a fact confirmed by teachers in
these institutions.

As with other institutes, IIT Kanpur too had implemented the nine per cent quota in the first phase in 2008. Of the total of 564 students admitted through the joint entrance examination, 63 were from the OBC reserved category. And if the average marks (on a grade point average) for first-year students in the general category in a coveted course like B Tech (Computer Sciences) was 7.92/10, the OBC students were not far behind at 7.2/10.......Things are equally encouraging at IIM Ahmedabad, which admitted 17 OBC students in the reserved category out of a total of 297 candidates . All have moved to the second year, and with mostly ‘A’s and ‘B’s.

So much for the concern about undermining quality through quotas. Let me add: if anything undermines quality, it is the capitation fee racket. And what is the neo-liberal answer to that? Let us have market-determined fees so that what happens underhand is legitimised. The argument is eerily similar to that made for legalising drugs. And the consequences of such legitimisation could be as malign.

One problem with legalising drugs is that it renders drug use respectable and that could stimulate demand further. With market-determined fees, your render the politics of exclusion legitimate. There is no pretence of being apologetic about cutting out a large chunk of the population from higher education.

Governance issues at Delhi Metro

Delhi Metro has had more than one big failure. Since its CEO, E Sreedharan, is something of a folk hero, the general response has been to shrug it off as a failure on the part of people down the hierarchy. I had a post on this subject the last time. Again, putting on my B-school prof hat, I would argue that management failures that occur repeatedly or are significant point to governance failures. Sunil Jain elaborates on this point very well in his column in BS in which he also asks for Sreedharan to step down:

... it (the CAG audit of Delhi Metro) points to the novel 50:50 management structure to mean that neither of the governments is in charge, so the company is pretty much run by the management, namely Sreedharan. The company’s board doesn’t even have the token independent director. There appears no standard proocedure for evaluating contracts and several changes have taken place in contracts after they have been won. The CAG talks of testing standards being watered down to meet deadline, of tests being conducted in non-accredited laboratories, of these being done without DMRC staffers being present, and so on. To top it all, DMRC hasn’t kept any records of test reports since it ‘would involve additional expenditure’!

This is a danger we need to be alive to all the time, namely, that an individual can become bigger than the system - and no individual is infallible. It is the system that must loom larger and the individual must always be subordinated to the system. That, after all, is the principle of democracy. Unfortunately, despite enormous evidence to the contrary, there continues to be a strong preference for the dictatorship model in a corporate setting on the ground that it delivers results. It is forgotten that the results are always in the short-term and they arise from storing up huge problems for the future.

CAG Audit of Delhi Metro

Delhi Metro's iconic CEO, E Sreedharan, tendered and withdrew his resignation in quick time following the recent collapse of a Delhi metro bridge. The CAG Audit of the Metro, tabled a year after it was submitted, is damning in its contents. Although the Audit was of Phase I and not the ongoing Phase II, the report suggests that some of the problems that have arisen at the Metro are the result of flaws in procedures.

A comptroller and Auditor General (CAG) audit report has found that the Delhi Metro Rail Corporation scaled down testing requirements in four contracts as these were falling behind schedule. ...

The report also says DMRC has not been put under direct control of any administrative ministry. “This model,” the report points out, “presents ambiguity relating to coordination and control by the executive government and the proper forum for legislative accountability.”

The bidding process was also found to have flaws: out of 13 “design and construct” contracts reviewed in seven cases, the estimates were revised or approved after the opening of financial bids, the CAG report says.

So, what does the Delhi government propose to do now? I am in no position to comment on the way the Metro is proceeding. But, as a B-school prof, I will say one thing: there is something terribly wrong with a situation where a 77-year old engineer is considered indispensable.

Privatising education

Two phrases to beware of in discussions on HRD policy are 'skill development' and 'public-private partnership'.

To understand why, just take a look at Latha Jishnu's article in BS. 'Skill development' can easily become a substitute for a proper education, going all the way up to a university degree and, worse, it can mean creation of skills with limited earning potential. As for 'public private partnership' or even 'private initiative' in education, it could well mean that the government abdicates its role in education in favour of profit-seeking ventures in education that will, by definition, be non-inclusive in character.

On 'skill development', Jishnu chronicles a recent Delhi initiative:

To ensure that such a lacuna should not reflect on its image as the capital of an economic superpower in the making, it launched the programme for skill development of domestic workers, a programme to turn out trained housemaids for the rich and the burgeoning middle class. And in this endeavour, it had impressive sponsors: the International Labour Organisation (ILO) no less, the Union Ministry of Labour and Employment and the Delhi government, all under the umbrella of the high-sounding National Skill Development Programme.

For the most part, domestic workers are poorly schooled or illiterate and their skill development consists of nothing more than a basic course in how to stay clean and speak well and learn to operate household gadgets. Part of the package is learning how to prepare an ‘urban meal’, serving food in a formal environment and handling domestic pets. All this would help in their ‘career progression’, we are told.

According to figures given by the government the demand for domestic servants is scheduled to grow six-fold to 600,000 in the next five years. That clearly is an underestimation. Even today, the average middle class home in the capital employs an average of 2.5 maids, apart from drivers and gardeners, according to another calculation. In coming years, the socialist republic of India would need, perhaps, two or three times that number of domestic helpers to serve its burgeoning middle class.

The focus on 'skill development' coincides perfectly with the state truncating its obligation to provide quality school education.

There clearly is a vested interest in keeping the system thus. The debate on reforming the system, too, is skewed and dishonest. Those who advocate market-based solutions to the lack of schooling in India refuse to acknowledge that the common school system prevalent in the US, UK and other developed Western countries was vital in nation-building and building egalitarian societies.

All the solutions that are being suggested now, such as education vouchers that would allow the poor to send their children to a private school of their choice — one wonders at the choice that exists between non-functional government schools and profit-making private institutions that are just a notch above them — and the 25 per cent reservation in private schools for the poor are nothing but a deflection from the need to overhaul the grossly divisive and unequal system.

...In the intervening 45 years the gulf has only deepened. But if all of India went to the same kind of schools how would one get the endless flow of domestic helpers

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How do we reform Indian banking?

Pranab Mukherjee's budget disappointed reformists and it would have been particularly crushing for advocates of banking sector reform. Not even a token reference to the Raghuram Rajan committee report; on the contrary, Mukherjee jangled the nerves of commentators by hailing Indira Gandhi's nationalisation of banks.

Here again, reformers were being foolish if they expected 'big bang' moves- greater entry for foreign banks or dilution of government shareholding in public sector banks (PSBs) below 50%. No policy maker would like to stick his neck out on foreign banks in the wake of the financial crisis in which the biggest banks have been badly hit. And after Sonia Gandhi's stout defence of bank nationalisation a few months ago, no FM could even think of diluting social control of PSBs.

But, it's not as if banking sector reform only means things like the above. We need to find creative ways of encourage more domestic players without undermining domestic stability. Letting industrial houses into banking may not be advisable but we could tinker with private bank ownership norms so that lesser entrepreneurs can get in.

But, also, as I argue in my ET column, In banking, do what is doable, we have focus on improving governance and management at PSBs. Makes sense because the global economic reality and the domestic political reality together imply that PSBs will continue to dominate the Indian banking landscape in the foreseeable future.

Pranab Mukherjee's budget

The market tanked yesterday. I wasn't surprised at all and had forecast a correction in my ET column a fortnight ago, Market rally may prove deceptive.

I based my assessment on two things. One, the $ 5 bn plus FII inflows in the present financial year represented something of a correction to the huge outflow of $11 bn last year. We could not expect this sort of inflow to continue. Secondly, I, for one, have never bought the notion that the Congress or the present UPA is hugely reformist is orientation and that all that it needed to get into reform mode was shake off the Left. Sonia Gandhi retains the leftward leanings of the family and this is duly reflected in the Congress today.

So, I had a few quiet laughs when I saw the commentators and businessmen on TV shake their heads in sadness at the many missing items- fiscal consolidation or even a medium term plan for one, disinvestment, petroleum deregulation, impetus to FDI, labour market reforms, financial sector reform (the Raghuram Rajan report was not even mentioned in passing).

I must mention one distinguished exception to the nay-sayers: Surjit Bhalla, whom one would regard as ultra-reformist. I did a double take reading his piece in BS today. He hails this as the second most reformist budget ever presented after Yashwant Sinha's 1999 budget. I read his piece again thinking this was being said tongue- in- cheek. No, Bhalla is serious. Well, leaving aside the critics on TV, I doubt that that is a claim that even the FM or the Congress would make!

What do I make of the budget? Well, I am yet to put the numbers on a spread sheet and pore over them (which is what I do once the media frenzy dies down). I have just a couple of thoughts for now. One, the budget is true to the Congress manifesto and the broad indications given in the President's speech.

Two, the focus is on providing the maximum fiscal stimulus. This probably reflects the government's view that the 'green shoots' hypothesis is premature, that the global economy will take its own time recovering and that, therefore, the Indian economy's growth momentum is best sustained through as big a stimulus as possible. People fear that this will push up interest rates and crowd out private investment. But private demand for credit is weak, which is why there is huge liquidity out there in the markets, so this fear may prove misplaced.

Three, my guess is that the FM has left the possibility for greater disinvestment proceeds than budgeted and spectrum auction for later in the year. To do this now would detract from the stimulus. So, give the maximum stimulus now and once there are signs that growth is of the order of 7%, push ahead with disinvestment. If this hypothesis turns out to be right, the FM may well surprise us with the fiscal deficit number in his next budget- it could prove lower than 6.8%.

Now, this is not how economists and market analysts view matters. They would have liked some fiscal consolidation here and now and they probably reckon that economic recovery is happening anyway. Unlike most of the intelligentsia (which is not necessarily very intelligent), I have great respect for the instincts of politicians, so I would go along with the FM. If the FM's calculations prove right, it would be quite an achievement.

Ram Guha in Nehru Memorial controversy

Historian Ramachandra Guha finds himself in the midst of a controversy at the Nehru Memorial Museum and Library. I haven't seen this reported anywhere and got to know about it only through a debate in ET last week. In the debate, Ram Guha and scholars on his side and Madhu Kishwar and several others on the opposite side aired their views.

I reproduce portions of the two versions below. The question I have is: in matters such as this, is it possible at all establish the truth? How does one do it? You can't have a judicial probe into every single matter- and even then the findings will be questioned. I don't pretend to have solution. If anybody does, please let me know.

Kishwar and company write:

The Petitions Committee of the Lok Sabha had found serious irregularities in the fellowship selections process conducted in NMML in 2004-05 (one year before Prof Mukherjee joined). Mr Ramachandra Guha was a member of the fellowship selection committee and of the sub-committee which did the shortlisting.

Their role has been questioned by the Petitions Committee and by the fact-finding inquiry set up by Dr Karan Singh, the NMML Executive Council chairman. The standing committee of Parliament for the ministry of culture and the Central Vigilance Commission have also asked NMML to take action in the matter. It is following this that Dr Karan Singh suspended the deputy director, N Balakrishnan, pending an enquiry, on 1 May 2009.

It appears that Ramachandra Guha and some others involved as selectors or beneficiaries want to remove Prof Mukherjee to subvert the process of a fair inquiry because they are afraid of being implicated by it. To this end they even launched a campaign in early May 2009 to get Balakrishnan’s suspension revoked.

Guha and others write:

The ET report vilified a senior scholar while disregarding the wider issues raised by 57 signatories to the memorandum to the prime minister, who include such widely respected intellectuals as Rajmohan Gandhi, Sunil Khilnani, Sanjay Subrahmanyam, Sumit Sarkar, Nandini Sundar, Krishna Kumar, and Mushirul Hasan.

These scholars list four objective indicators of the decline of the NMML: (1) The once excellent publication programme has been discontinued; (2) The acquisition of rare manuscripts and oral histories is virtually at a standstill; (3) The once dedicated staff is totally demoralised; (4) The NMML has abandoned its principled non-partisanship by opening its doors to political use and misuse.

The fourth charge is perhaps the most grave. In past times, the NMML was open to all ideological currents. Its vast collections include the papers of Jawaharlal Nehru and Indira Gandhi, but also of such longstanding opponents of the Congress as Dr S P Mookerjee and E M S Namboodiripad.

Will more capital harm banks?

Regulators are determined to impose higher capital requirements for banks in the wake of the present crisis. The rationale to is to make sure that banks are less vulnerable in future than they have proved this time.

Takafumi Sato, commissioner of Japan's Financial Services Agency, questions this approach in an article in the FT:

Suppose stronger regulations make banks issue more equity. Then the capital market will expect greater profits in return, and bank management may be tempted to meet such profit pressure by taking more risks. Was this, however, not the cause of the catastrophe?

Also, bigger capital requirements may induce complex risk-taking. If bankers add simple risks, regulators will notice and request more capital. In order to satisfy both regulators’ demand for a high capital-to-risk ratio and investors’ demand for return on equity, bankers may want to take risks in a sophisticated manner, inventing exotic products and creating a darker shadow banking system.

So, Sato thinks there is moral hazard attaching to more bank capital rather than less. Sato's argument is flawed on several counts:

• With lower bank capital, equity holders today have less incentive to monitor managers.With higher capital, they will need to be more alert.
  
• Also, managers have greater incentive to take risks- payoffs to risky gambles are higher with lower capital and more debt.
• It's not as if investors' return expectations from banks are cast in stone and they will demand the same returns from banks as they have in the past even when bank capital goes up. Investors in banks will have reconcile themselves to lower returns, treating bank stock on the same par as, say, utilities. As they say, banking will become a more boring sector but a safer one.
  

Sato is on firmer ground when he writes:

Capital adequacy regulations are a cornerstone in our efforts towards financial stability. They, however, should be complemented by reliable valuation, good risk measurement and proper incentives.

On this, I agree. Higher capital should be accompanied by closer supervision and regulation. Isn't that what all the talk of regulatory reform is all about?

Of awards and encomiums

Trying to work out which banks are the world's best is a bit like awarding the prize for the prettiest war-torn village. It is a title that carries little kudos. It is also likey to prompt further shelling. Winners of industry awards in the past three years include Ken Lewis, the chief executive of Bank of America for banker of the year (2008); Societe Generale for its risk management; and Angelo Mozilo of Countrywide, a failed mortage lender, for a "life-time of achievement"

- The Economist (May 23)

I am reminded of a terrific quote from Martin Wolf, FT''s economic pundit, "Those whom the gods wish to destroy, they first put on the covers of business magazines".

But why blame business chambers and the media alone for idolising the wrong guys? Remember the best-selling book by McKinsey gurus, Peters and Waterman, In search of Excellence, that identified companies that had got it all right? Within a few years of the book's coming out, many of the famous names in the book that had been held up as role models were in trouble.

Alan Greenspan was hailed as the ultimate central banker and was the subject of more than one gushing biography. Today, he's among those held primarily responsible for the global crisis.

Moral: Be careful whom you lavish praise on, be it a company or an individual.

Slavery- fresh links

Rothschild, the British investment bank, and Freshfields, a top law firm in the UK, are the latest prominent names to be linked to slavery through archival research, FT reports.

Determining Britain's links to slavery is important because it's not entirely true that innovation and the industrial revolution drove British and western growth and caused them to surge ahead of the rest of the world, including China and India. Slavery, with all its underlying brutality, was a factor although how much of a factor it was is contentious.

FT quotes a Britsh academic as saying, "“We need to fill the gaps between those who deny slavery’s role and those who believe Britain was built entirely on the blood of slaves. "

A book based on updated research is required methinks.

Conflicts of interest in academia

I wrote earlier about b-schools and their alleged role in the crisis. One complaint about b-schools is that they don't inculcate the right values in their wards- I have made it clear this is not something I take seriously. Another is that the ideas that came out b-schools are flawed- the glamourisation of financial innovation, the myth of market efficiency and so on. But these ideas didn't emanate from b-schools alone, you might fault the economics profession at large, including the famous Chicago school.

Devesh Kapur, writing in FT, has a more interesting view. He says that academics have developed a vested interest in pushing certain ideas- and suppressing others- because they stand to gain financially in the process. In other words, academic research is susceptible to considerations of pecuniary gain, just as doctors' prescriptions in the US and elsewhere are driven by gifts of various kinds, including stock options in pharma companies.

Many academics, particularly those from institutions that enjoy high prestige and reputation, now have serious business interests and an array of financial ties to the very institutions that their studies address. These interests range from lucrative speaking fees, advisory roles at financial institutions, managerial roles and stakes in private equity and hedge funds to corporate non-executive directorships.

.....There would be little chance of being invited to give a lucrative talk at Citicorp if one were in favour of sovereign debt forgiveness in the 1980s, against capital account liberalisation in the 1990s or against stock options in the 2000s..

...In recent years, the biological sciences have moved considerably to ensure greater transparency where there are potential conflicts of interest between research and financial remuneration, providing mechanisms for whistle-blowers to report conflicts of interest. Regrettably, these requirements are extremely weak in the social sciences and business schools.

There is something to what Kapur is saying. I am not sure, though, that industry and other links influence academic research in economics and business but they certainly seem to influence academics' positions on various issues of public policy, especially in so far as they impact on business.

For instance, there has been much comment about the huge fees earned from financial institutions by Larry Summers, an influential figure in the present Obama administration, and whether these are impacting on the administration's approach to solving the crisis. Academics who take positions that threaten the interests of corporates certainly stand to lose out on consulting and other sources of income and may even be denied visibility in TV and other media.

There is a more serious problem with academics sitting on boards and this has to do with governance more than research. As we saw in the Satyam episode, academics are not above using their board positions to earn consulting fees. There are other instances where academics sitting on boards have wheedled training programs out of the companies. This introduces serious conflicts of interest. Sebi must impose a ban on independent board members earning any kind of consulting income from companies with which they are associated.

Addressing the too big to fail problem

In my last post, I highlighted that central banks and regulators have begun to focus on this issue with renewed interest.

In its Financial Stability Report, the Swiss National Bank suggests three ways in which this problem can be addressed:

There are three basic strategies for resolving, or at least alleviating, the ‘too big to fail’ problem. First, one can impose very strict capital and liquidity regulations on systemically important financial institutions. This can reduce both the likelihood of government assistance being required and the cost of such an intervention. Moreover, strict capital requirements reduce moral hazard, by forcing banks to themselves bear more of the risk of losses, and also reduce the banks’ incentive to inflate their balance sheets. ...

Second, one can adapt the legal framework and the financial market infrastructure to simplify, or make possible,an orderly wind-down of large financial institutions during periods of severe crisis.
......
Third, one can directly tackle the cause of the ‘toobig to fail’ problem by limiting the size of financial institutions. One could consider direct size restrictions, forinstance by imposing a maximum market share or balancesheet-to-GDP ratio, or indirect incentives – as mentioned
above – such as increasingly strict capital requirements for big banks.

Banks- too big to manage?

Governments the world over have rescued banks that are too big to fail- Citibank and Bank of America in the US, RBS and Lloyd's in UK. One fall out is that regulators and central banks are actively contemplating measures to prevent banks from growing beyond a certain size, FT reports.

This is what the incoming head of the Swiss National Bank has to say:

“A size restriction would of course be a major intervention in an institution’s corporate strategy,” Hildebrand, the central bank’s current vice-chairman, observed with masterful understatement. “Naturally the SNB is aware that there are advantages to size. [But] in the case of the large international banks, the empirical evidence would seem to suggest that these institutions have long exceeded the size needed to make full use of these advantages.”

But what would be that size? How do you operrationalise this concept? I haven't seen any concrete ideas on this. I guess one parameter could be the recapitalisation cost as a percentage of GDP in the event the bank fails. But this only leads on to another question: what percentage of GDP? There cannot be an absolute limit across all countries. Much would depend on an economy's fiscal situation. An economy where the fiscal situation is good could afford a failure that costs, say, 15% of GDP. Another- like India's- may not be able to afford even 5% of GDP.

But this creates a piquant situation. Larger economies can afford bigger banks. So can well managed economies. In other words, the size of the economy and the fiscal situation become determinants of competitive advantage based on size.

Should we worry? I don't think so. Because beyond a point, size ceases to confer any big advantage and, in fact, becomes a problem. In India, I would say that any bank with a balance sheet of around Rs 150-200,000 crore has the requisite size to take on competition. For the regulator, the problem is: too big to fail. For bank managers, the focus should be: too big to manage.

That's why I am not enthused by talk of SBI merging with all its associate banks. Is SBI getting the most out of its current size? Does it have the necessary depth and breadth of management at its current size? If not, HRD and systems should be focus, not simply getting bigger.

B schools and the global crisis

This may seem a bit surprising but B-schools have emerged, in popular perception, as among the culprits in the present economic crisis. People think managers are to blame. Some of the high-profile managers in the crisis- Hank Paulson, former US Treasury Secretary, Christopher Cox, former Chairman of the SEC, John Thain and Stan O'Neal- are all HBS products. The conclusion drawn is that B-schools bear some responsibility for the crisis. Whether this is true and what needs to be done is the subject of my ET column, Crisis:are B-schools to blame?

Surprisingly, this view finds acceptance among b-school academics themselves. FT is running a debate on the subject and so is the Harvard Business Review. I must confess I find much of the discussion lacking in substance.

Let us grant that irresponsible managers have had a role to play in the crisis. Partly, this was a matter of bad judgement; partly, it was greed or lack of regard for the stakeholders in a business. Where do B-schools come in? You could say B-school research failed to pick up the warning signs of the crisis. But so did economic research outside B-schools. As for the greed factor, it is not confined to managers but is rampant in every walk of life- law, medicine, accounting, etc. Amongst greedy or corrupt managers, managers with MBAs are a tiny subset.

So, what can B-schools do in terms of revising their curricula? Well, there is a huge debate going on about the relative roles of state and market and, no doubt, B-school research will focus on this and weave findings from this research into revamped curricula. This is fine. The thing that disturbs me is the suggestion that B-schools also have a role in inculcating superior attitudes or ethical values in their students. HBS's contribution is to get their graduating MBAs to take a pledge or oath of ethics!

B-schools have responded to talk of their role in the present economic crisis with courses on ethics and leadership. No problem with that. But, one has to be sceptical about what to expect. To those who wish to create the New Man, I wish luck. I doubt that B-schools can contribute much. There are primary and secondary schools that were set up by saintly figures and began with similar, lofty goals but whose products are indistinguishable from those produced by ordinary schools.

Don't get me wrong.There is a hell of lot that B-schools need to do by way of updating their curricula and make it more relevant. But improving the ethics of their wards is not something that falls within B-schools' core competence. At the risk of offending people, I would suggest that there is a certain presumptousness involved in setting such goals. I mean, who's going to impart ethics to B-school faculty?

TN medical college expose

A TV channel catches the Deputy Registrar of a medical college in Tamil Nadu asking for capitation fee on camera. The HRD ministry, duly outraged, sets up an enquiry. The UGC also jumps in with its own probe. The minister, who is said to be chairman of the board of trustees of the college, dissociates himself from the medical college.

I don't know how one is supposed to react. It's good to have this sort of thing exposed but is it news to anybody? Two facts have been public knowledge for quite some time- and thousands of families who have paid through their nose can testify to these.

i. Hundreds of private engineering and medical colleges in TN, Karnataka, Maharashtra and other places offer admission on the basis of large capitation fees.
ii. Many of these institutions have been promoted by politicians.

I recall a secretary at our Institute telling me how her husband had to fly down to Chennai with around Rs 3 lakh in a suitcase in order to secure admission for her child in an engineering college there. I wondered how the suitcase had passed scrutiny at the airport- didn't the security people ask about such a large amount of currency being transported around?

Capitation fee flourishes despite the Supreme Court ban on it. The government and the quasi-regulatory bodies in education have been mute spectators thus far. (It was interesting to read in the papers that a court actually described the Medical Council of India as "den of thieves". Former minister Anbumani Ramadoss confessed that he had failed to clean up the MCI inspite of trying).
The new UPA government has education reforms high on its agenda. Tackling the menace of capitation fee and donations in various forms must be a priority in education. They render education inaccessible, of course, but they also breed corruption, with doctors and engineers coming out of these places focused on getting the quickest return on the huge investment they have made.

Downgrade in Indo US relations

President Obama's unequivocal endorsement of the two-state solution of the Palestinian problem and his criticism of continued Israeli settlements in the occupied region were undoubtedly high points of his speech and they have rightly attracted attention. For us in India, another point is equally compelling: his suggestion that Israel must be drawn into the NPT before long. If the US is unwilling to make an exception in the case of its staunchest ally, we must wonder where that leaves the Indo-US nuclear deal and the special dispensation it creates for India.

Expect Obama to focus on the NPT as well as the fissile material cut-off treaty. The signs are clear enough: the Obama administration does not attach quite the same importance to India as a 'strategic partner' as President Bush did. Chances are we will be pushed back into sub-continental status with a possible re-hyphenation with Pakistan. Earlier, Hilary Clinton's visit to China signalled that the US sees China as its principal partner in the conduct of international affairs, a view that appears to be getting reinforced with Treasury secretary Tim Geithner's recent visit to China.

The signals coming out from US moves in Pakistan reinforce this view. Relative silence on the release of Saeez Hafeez; a massive aid package for Pakistan in order to reinforce its war against the Taliban; Pakistan upping the ante on Kashmir. The unkindest cut of all: the US state department advisory to American nationals against travelling to India.

In his election speeches, Obama had made references to Kashmir that were not exactly music to our ears. It does appear that he sees the resolution of the Kashmir issue as an important item in his agenda, next only to the Palestinian problem, although he chose to omit any reference to Kashmir in his Cairo speech. The signs are that the US is willing to allow Pakistan to bring Kashmir to the top of the table in return on Pakistani cooperation on Afghanistan and the Taliban.

This must inevitably mean more firing across the LOC and greater infiltration into Kashmir and into India generally in the coming months. This may sound terribly grim but the US advisory does seem to point to an increase in terrorist activity in India in the months ahead. We have been patting ourselves on the back on the improved domestic outlook with the installation of the a stable government at the centre. Not to spoil the party, but it appears the domestic pluses may come to be outweighed by the minuses on the external front.

Anniversary of Tiananmen

The twentieth anniversary of the Tiananmen massacre- and massacre it was, of that there is little doubt- has been marked by ritual on both the western and Chinese sides. Western commentators want Beijing to allow more democracy and they also want the communist regime to come clean on what happened. China has responded with a clampdown- on BBC yesterday, I saw their Beijing correspondent being politely but firmly being shooed away from the Square by Chinese cops.

What has been the outcome of Tiananmen? China is incomparably stronger and more powerful today than it was 20 years ago. But has the communist party maintained its brutal ways and refused to learn? Not really, suggests the newly started Banyan column in the Economist (which is devoted to matters Asian). It responded to the movement in appropriate ways:

It is a commonplace that the party’s legitimacy is built on economic growth. Yet China’s leaders have long considered that to be merely the (simplistic) half of it. After the massacre, the Communist Party set about transforming itself. It launched a vast historical investigation into how political parties fall, and how they stay in power. Everyone was scrutinised, from Saddam Hussein to Scandinavian social democrats. The conclusion: adapt or die.

The outcome is a wholesale reinvention of the party, a process accelerated after Mr Hu stepped up as paramount leader in 2004. Shortcomings that were identified included corruption (a chief complaint of the Tiananmen students), lack of accountability in decision-making, no convincing ideology, and an ossified structure.

..Bright technocrats and entrepreneurs have been recruited. Retirement rules have been revamped (the Soviet Union’s gerontocracy was noted). Party members have gone back to school: three weeks a year and three months for every three years of mid-career training. More appointments are open to peer scrutiny before they are filled. The Communist Party is vastly more able to govern

......This is little comfort to Westerners projecting their hopes for democratic change on to China. Nor is there any sign that Chinese intellectuals identify with the myriad grievances of their poor countrymen, as they did during the Tiananmen protests. And the growing middle class appears more fearful of the great unwashed than of the depredations of a party that once was at war with the bourgeoisie.

FT's China expert, James Kynge provides a slightly different perspective. He questions the very characterisation of the Tiananmen protests as being "pro-democracy". The reality, as always, was more nuanced, more complicated, he suggests:

Almost everything fell within its (the movement's) scope: campaigns against corruption, nepotism, inflation, police brutality, bureaucracy, official privilege, media censorship, human rights abuses, cramped student dormitories and the smothering of democratic urges. But to say the demonstrations were to “demand democracy” is an oversimplification.

The truth is that the students in the square had only the haziest understanding of western-style democracy. To the extent that the protests were directed at abuses of an existing system by an emerging elite, they were motivated more by outrage at the betrayal of socialist ideals than by aspirations for a new system.

In other words, the protesters were asking for reform, better governance, an improvement in the quality of their lives. They were not necessarily asking for more democracy. It appears from the Economist's interpretation that the communist party got the message and responded appropriately.

When the western world pushes for democracy, what it means is the right to vote in a multi-party system. But, if a monolithic party can make itself responsive to people's needs, it can contain disaffection. It appears the communist party has managed this. The world's understanding of Tiananmen and what followed, its continued focus on "human rights" in China and prognostications about the inevitable collapse of communism there, may thus be badly flawed

Agony of Afghanistan

Khaled Hosseini's novel, A thousand splendid suns, richly deserves the accolades it has received. Hosseini is an Afghan, now settled in the US. He gives us a glimpse of the grim struggle for existence that is the stuff of daily life in Afghanistan - or was at the time when the mujahideen were trying to drive out the Russians, when the mujahideen fought amonst themselves for control and, later, when the country came under the control of the Taliban.

The novel' s special contribution is its focus on the plight of women. It deals with the lives of two women, Miriam and Laila, thrown together by reason of having got married to an ageing (in Miriam's case) and aged (in Laila's case) tailor, Rasheed. Miriam is the illegitimate child of a wealthy businessman in the city of Herat. Her father keeps her mother, a cook, and Miriam at a distance. When Miriam's mother dies, her stepmothers get her married off to Rasheed who is from Kabul. Miriam is in her teens and Rasheed in his forties.

Laila's misfortune is even worse. Her family is killed in the shelling of Kabul and she's badly wounded herself. She's nursed back to health by Rasheed and Miriam until Miriam understands the motivation behind Rasheed's concern- he wants to acquire Laila as a second wife. Rasheed is in his sixties then and Laila in her teens.

The novel deals with the humdrum existence of the trio and the two children they have (one is Laila's through her teenaged lover before her life fell apart). It's a grim struggle for existence, unrelieved by anything joyful (except the two children). There is nothing the two women can expect by way of caring from Rasheed. The only reason they have to stay with him- and endure his taunts and his endless beatings- is that there is no way they can survive otherwise. What awaits them outside Rasheed's humble house is even worse. It is a tribute to Hosseini's craftsmanship that he's able to sustain the reader's interest in this colourless existence.

As you read through the novel, you begin to wonder whether there is anything left but despair and wretchedness, whether there is any salvation at all for these two helpless, yet cheerful women, whether such a life is worth living at all. Finally, salvation arrives in the only way it possibly could......the reader is left at once happy and saddened at the outcomes.

Hosseini gives us an idea of what life under the Taliban is like- no music, no TV, no education or jobs for women, women can't even go out unescorted, nothing to life other than what purports to be the pure Islamic way of life. Taliban rule is a return to some barbaric past, except that even in that past, one would like to believe, things were not as bad.

You may have your reservations about America's posture towards Islam in general, its attitude towards Palestinians and Iran, about the so-called clash of civilisations. But, when it comes to the Taliban, there is no room for doubt as to the rationale for the US and its allies waging war against them. A Taliban take over of Pakistan is the ultimate nightmare for that unfortunate country, for India and for the rest of the world.

Indian bashing in Australia

Is the Indian media overdoing the incidence of racial attacks in Australia? There is something about the sheer power of repetition on TV, the same visuals being played by different channels throughout the day and for days together. I tell you, the effect can be inflammatory.

I have no means of knowing what the situation on the ground is. Most cities, including New York and London, have their share of lumpen elements who will bash up or rob anybody who looks vulnerable. Indians must appear as soft targets because of their build but that doesn't quite explain why the Chinese are not similar targets. Colour must be a factor.

The question is how big is the racial issue in Australia. I was there in 2007, visiting Sydney and Canberra. I came back and declared that if there was one white country that was not hostile to brownies, it was Australia. It was friendliness all the way. Of course, these fleeting impressions can be deceptive and it's only when you live somewhere that you get a feel for the place.

But, I have found that the acid test is the immigration counter. There you can sense the hostility or the lack of it. For the first time in my visit to a white country, I encountered a very warm welcome. Very different from what you would experience in, say, New York where, at immigration, every South Asian is presumed to be a terrorist unless proved otherwise.

Another test is the country's airlines. Both on Quantas and the domestic airlines, I experienced a total lack of hostility. Again, these could be misleading. Or it may be well be that the changed economic environment has caused a certain souring of moods.

Budget and reforms

Another budget will be upon us in a month or so. One of my secret fantasies is to flee town and head for some place that lacks TV around budget day. Then, I will be spared the cacophony that erupts at budget time.

Budget time is big money for the media. They create the hoopla around the budget and profit immensely from it. Live budgetary analysis is not terribly educative. You can't react to any of the numbers put out by the FM until you have had a chance to put them on a spread sheet and compare like with like in the previous year. But before people have had a chance to do that, instant wisdom will have been delivered on TV. So heavy is the overkill that informed analysis that comes a few days later in newspapers or journals is lost on the public.

Well, anyway, now that another budget is on its way, the clamour for "reforms" has begun. The argument is that the government could not push ahead with "reforms" the last time thanks to the benighted Left but now there are "no more excuses". Sorry to play spoilsport, but it appears those who clamour thus haven't read the Congress manifesto. It is reformist to my mind but the reforms it talks about are not the ones that pro-market enthusiasts have in mind- cuts in subsidies, labour market reforms, privatisation, financial sector reforms, FDI etc.

The Congress appears to have learnt from the defeat of the BJP and the lesson will have been reinforced by its own performance this time- "reforms" that the media and the business community clamour for are not vote-catching propositions. My guess is that those who are talking up the stock markets in anticipation of "big bang" reforms are in for a disappointment.

More on this in my last column, Redefining the reform agenda.

Winds of change in US board rooms

Whatever else governance reform may mean, I have always been clear about one thing it should mean: independent directors cannot be selected by management; to begin with, at least some independent directors on the board must be chosen by institutional shareholders.

I am not aware of any country where this happens. It certainly does not happen in the cradle of the governance movement, the US. In the US, the majority of companies have provisions that allow shareholders only to vote for directors proposed by management or withhold their vote. This has created a situation where directors get elected even when they do not command a majority of shareholder votes.

As the head of governance Calpers, the California pension fund, notes in a recent FT article, this is set to change. Legislation has just been introduced in the US Congress that allows shareholders to say 'no' to a director proposed by management and to propose their own directors subject to certain clauses intended to keep out frivolous proposals. The legislation also seeks to separate the chairman and CEO rules, another reform I have myself long urged. The SEC, under its new head, is introducing proposals of its own that are consistent with such legislation.

Governance reform is on the agenda of Sebi as well. This is the time for Sebi as well as the government to take the lead to usher in governance reform along these lines in India as well. After the Satyam and Nimesh Kampani affairs, there is concern about the need to protect independent directors from legal actions in matters for which they can hardly been held responsible. Two independent directors are said to have quit every day since Satyam erupted- resignations to date total over 400.

A certain measure of protection for independent directors is fine. But this must go hand in hand with measures to strengthen the mechanism of independent directors. Independent directors who collect huge fees in return for nodding their heads to whatever management wants done is clearly not on.

UK's financial sector

UK has long prided itself on its competitive financial sector and its comparative advantage in that sector. How did this advantage come about? Because of light regulation. In other words, the UK benefited from regulatory arbitrage. To put it more accurately in light of the ongoing crisis, UK bankers benefited from such arbitrage. So, what's to be done about it?

Martin Wolf reviews an astonishing report prepared by a committee that included UK's chancellor of the exchequer, Alistair Darling. The report recommends “ the financial sector be allowed to recalibrate its activities according to the sentiments and demands of the market”. They must be nuts to recommend this after seeing how the market has worked.

Wolf makes a set of eminently sensible suggestions:

First, the UK needs to make global regulation work. It should discourage regulatory arbitrage even if it expects to gain in the short run.

Second, it must, in particular, help ensure that owners and managers of financial institutions internalise most of the costs of their actions.

Third, it must reject egregious special pleading from the industry. The sector argues that moving derivatives trading on to exchangesmight damage innovation. So what? Maximising innovation is a crazy objective. As in pharmaceuticals, a trade-off exists between innovation and safety. If institutions threaten to take trading activities offshore, banking licences should be revoked.

Fourth, while trying to create a stable and favourable environment for business activities, the UK should try to diversify the economy away from finance, not reinforce its overly strong comparative advantage within it.

Fifth, UK authorities need to ensure that the risks run by institutions they guarantee fall within the financial and regulatory capacity of the British state. They should not let the country be exposed to the risks created by inadequately supported and under-regulated foreign institutions. At the very least, they should not undermine other governments’ efforts to regulate their own institutions.

Since "reforms" are the flavour of the day in India today, let me add that some of the above principles should guide banking sector policy in India as well.

A cohesive and stable government?

Those amongst the chatteratti who were euphoric about the mandate for the UPA government must be having to think again, seeing the birth pangs of the new government. The DMK leadership has retreated to Chennai and into a big sulk. Even if compromise is reached on the number of berths, it appears unlikely that the Congress can dictate who the DMK's ministers should or should not be: I doubt that any self-respecting party can concede the point that two of their earlier nominees were inefficient and corrupt.

As for the markets' relief over a patchwork of parties from the Third or Fourth Fronts forming the government and the Left being kept out, it's worth remembering that, in Mamata Banerjee, the Congress has to contend with somebody who was to the left of the ruling coalition in West Bengal. Banking reforms, labour reforms, SEZs- it won't be easy to breeze past Mamata on these issues.

Lastly, I do hope good sense prevails in the Congress and the finance portfolio stays with a politician and doesn't go to a technochrat. It wasn't the pro-reform brigade that helped the Congress do well in the 2009 elections, it was the solid political instincts of the Gandhi family, much of which goes against the spirit of "reforms".

Understanding the results of the 2009 elections

I don't know in which case instant wisdom is worse: the Union budget or the elections. In both instances, it is the idiot box that plays havoc with sober judgement. Even as the news is happening, pundits are ready to shoot their mouths. Whereas in both cases, a careful dissection of data is required in order to arrive at an informed judgement.

Let us consider some of the conclusions that abound in post-election punditry:

1. Regional parties have been shown their place, national parties have regained their dominance: We need always to distinguish between number of seats won and share of the vote. It is possible for a ruling party to become unpopular and see its share of the vote fall. Still, it may win more seats because the opposition vote happened to be more splintered.

In the present election, Yogesh Yadav estimates that the combined vote share of the Congress and the BJP climbed from 48.7% in 2004 to 48.9% in 2009- hardly any change. This translated into a disproportionate increase in total seats of the two parties from 283 to 321, with the Congress gaining 61 seats and the BJP losing 23 seats.

So, the regional parties have retained their importance. It is just that the relative shares of the Congress and the BJP in the national party pie changed so as to place one party in a stronger position than before.

2. The results are a vote for stability and good governance: This implies that regional parties are an unstable factor and the national parties alone can provide stability and good governance. The figure for the vote share of regional parties has hardly changed. Besides, the BJP, which has provided stability and good governance in Gujarat, is a big loser. The Congress benefited from the electoral arithmetic in many ways: for instance, it made big gains in AP because the Chiranjivi factor ate into the votes of the TDP and in Maharasthra, the MNS ate into the votes of the Sena-BJP. A slight change in the electoral arithmetic could once again create instability at the centre.

3. The results are a vote for "reforms" and the Congress-led UPA should, therefore, fast forward "reforms": The Congress benefited from a rise in rural incomes and prosperity driven by growth in agriculture, an area that is least touched by reforms. It also benefited from measures that "reformers" relentlessly fought: NREGA, the farm debt waiver, the Sixth Pay Commission award, an increase in subsidies and OBC quotas.

The one formation that lost heavily from its attempt to push through "reforms" was the Left in West Bengal which tried to usurp farm land in order to push ahead with industrialisation. (SEZs are an important item on the "reforms" agenda). It is fair to say that the UPA benefited from measures associated with the Left while the Left lost because of measures associated with the "reformers'!

4. The nation has rejected the "communalist" BJP: It is said that it was the BJP's attempts to project Narendra Modi as a future national leader and the vitriolic outbursts of Varun Gandhi that cost the BJP dearly. Really? Then, how come Varun himself won handsomely in Pilibhit and the BJP did well in Karnataka which is considered progressive and was out of the BJP orbit until recently?

I'm afraid none of the explanations put forward, such as the ones above, are free from infirmity. There are only three things one can say we can with a degree of certitude. One, regional parties remain a force. Two, the electoral arithmetic can cause the outcome in terms of seats won to diverge significantly from the outcome in terms of vote shares. Three, the only way to combat the anti-incumbency factor is to focus on measures that have a pro-poor and rural orientation.

The rise and rise of regional parties

The great game of searching for alliance partners is on and regional parties are being wooed arduously by the Congress and BJP alike. I hear much tut-tutting over the rise of regional parties. Somehow, there is a perception that regional parties' support or dominance leads to instability and weak governance and only the two national parties, Congress and BJP, can provide stability and good governance. So, take your pick- the secular guy or the commual guy.

Alas, life is much too complex and messy to conform to the preconceptions of the Indian elite. There is no stopping the rise of regional parties, as I note in my ET column, Fear not the regional parties, and, more importantly, there is no reason to get jittery over this phenomenon.

Regional parties have shown themselves more responsive to caste and regional aspirations and this has inevitably eaten into the vote share of the national parties. This will continue until a more homogenised and prosperous nation emerges with the middle-class being truly middle, meaning accounting for, say, more than 5% of the population, as is the case today (depending on what income level you want to take as a cut-off).

As political scientist, CP Bhambhri, writes in a companion piece in ET, regional parties have found it necessary to capture power at the centre in order to better cater even to regional aspirations because, in the Indian federation, the centre still calls the shots. In the process, regional parties are compelled to develop a national perspective. That is the beauty of democracy: it causes political actors to modify their behaviour in ways that generate wider support and hence leads to more acceptable behaviour.

There is much condescension when it comes to regional leaders- they are not as savvy or well dressed as their national counterparts and so the inference drawn is that they may not have the skills to run the nation. Nonsense. If you have run UP or Tamil Nadu and done so more than once, believe me, you have what it takes to run the nation. I quote a distinguished bureaucrat in my column as saying nice things about Deve Gowda. TSR Subramaniam, former cabinet secretary, expresses the same sentiments about Gowda. Outlook editor Vinod Mehta wrote recently that the most impressive performer from the Indian delegation at a Davos conference he attended was Gowda, not one of our high-profile businessmen.

So, let us not deride regional parties and regional leaders. Instead, let us welcome gracefully the changes being ushered in by our marvellous democracy.

Gujarat a star in agriculture

Gujarat has always been a star in industrial performance. It was news to me that Gujarat is a star i in agriculture. Gulati and Shreedhar analyse the phenomenon in an ET article. Agriculture has grown in Gujarat at an astonishing 9.6% in 2000-01, more than the thrice the all-India figure.

One key driver has been the Sardar Sarovar project and the increased availability of water in a state in which irrigation cover is only 36%. One can understand why the project arouses strong emotions in the state. Another driver is technology, especially new varieties of cotton with the private sector taking the lead. Then, good roads, better regulation of electricity for agricultural use and a thrust on extension services have helped.

The authors conclude, "Strong political commitment to promote rural development, a long term vision, and the capacity to implement this are perhaps the key ingredients of Gujarat’s success story".

That must explain Modi's success- there's a lot more to development in Gujarat than the Nano project.

Indian firms in world's 'most reputed' list

Rediff has a story on a list of the world's most reputed firms listed by the Reputation Institute of the US. (I must confess I have no clue who they are). The following are some of the Indian firms that figure (world rank in brackets):

1. Tata group (11)
2.SBI (29)
3. Infosys (39)
4.L&T (47)
5. Maruti (49)
6.HLL (69)
7. ITC (95)
8. Canara Bank (102)
9. Hindustan Petroleum (111)
10. Indian Oil (112)

Interesting omissions are the Ambanis and the Birlas. It's also interesting that Infosys, which has invested so much in building an international brand and HLL, which is a well known brand, rank below Tata and SBI. The top 10 includes four public sector firms.

Shantaram

I finally finished reading Shantaram. I say 'finally' because I am a slow reader and the novel runs into over 900 pages.

Shantaram, which came out in 2004, is penned by Gregory David Roberts, an Australian who was serving a jail sentence for armed robbery in his country. He escaped from jail, landed in Mumbai, spent several years there as part of the local underworld, was recaptured in Germany and, after serving the remaining sentence, got his novel published. He needed to write it thrice because his captors destroyed the first two versions when they found out. Roberts has since made Mumbai his home.

The novel is an epic, along the lines of,say, Gone With the Wind. And it's more than a novel, it's a soul-stirring experience. To think that a man could go through all that, retain his humanity and find the reserves to write a splendid novel! Roberts' mother taught him to appreciate literature and he spent his time in the Australian jail devouring first-rate fiction. It shows in his own writing.

It's impossible to capture the splendours of the novel in one short post. Roberts has said in interviews that the events are real, only the narrative is fictional. There is a charming account of Roberts' six month stay in a village in Maharashtra's interior where he is given his Indian name, Shantaram; a moving description of life in the slum near Cuffe Parade where the locals adopted him as one of their own; great encounters with Abdel Kader Khan, the underworld don, who combines a fine command of the English language with a fondness for philosophical speculation (every week, he and his comarades meet for lofty discussions); Roberts' embroilment in the war in Afghanistan when he accompanies Khan and others on a journey through Pakistan to arm the Taliban in their war against the Russians; and Roberts' falling in love with Karla Saaranen, a mysterious, beautiful and thoughtful American lady of European extraction... (you have to read the novel to know what the mystery is about).

Some of the scenes in the novel will stay with me for a lifetime. On one occasion, Roberts and a small boy (Khan's nephew entrusted to Roberts in order to experience slum life) find themselves attacked by a whole horde of dogs in the slum at night time. They try to fend off the pack with bamboo sticks but it's a losing battle. Then, Kader Khan's bodyguard materialises out nowhere, iron rod in hand. He's a trained martial arts specialist. He leaps into the air in true martial art fashion, swirls and strikes. Two dogs have their brains shattered. The entire pack, stunned at somebody taking the attack to them where Roberts was merely defending, flees.... Roberts is saved.

Then, there is the Colaba police station where Roberts is held for a few weeks. The lucky ones are those behind bars. The others are herded into a small corner leading to a toilet where shit is overflowing.... the weakest have to stand for days in a heap of shit until they drop dead....

One day, the detainees are led out and taken to Arthur Road jail (home to Sanjay Dutt for a while). Roberts is motioned to a corridor. There, the convict warders are waiting with lathis.... Roberts has to run the gauntlet but choses to walk in a gesture of defiance as the blows rain on him. He lands in his cell bloodied. The jail itself is hell with the warders showering blows on inmates at will. It makes your blood boil to think this is what the Indian system has been reduced to. One gets a sense of the daily brutality visited on the weak and the defenceless by the Indian law enforcement system.

What, one wonders, is the IPS brass doing? The only thing you could say in extenuation is that things are not much better in jails elsewhere. In his jail in Melbourne, Roberts was subject to the same kinds of senseless beating and cruelty. Recently, during the G-20 meet, the cops in UK, considered to be more civilised than the rest, were flailing their batons at harmless protesters. I guess it goes with the uniform, the sense of power it gives you. The power to ill-treat and also the power to extort huge sums of money.

The Afghan expedition is a story in itself. It takes weeks of trekking through the mountains to get there, with a maniac as escort. This man has only one mission in life and that is to catch hold of Russian soldiers and torture the life out of them. The return journey is a horror, with Roberts and a few survivors holed up in a snowy cave with no food or water for several days. Roberts makes it to a hospital in Pakistan and then finds his way back to Mumbai. With his heroic role in the Afghan expedition, he becomes a privileged member of the gang, specialising in counterfeit passports. He makes good money out of it.....

I won't narrate more. I will leave you to find out for yourself. Shantaram is being made into a film by Mara Nair. I can't wait to see it (I understand work on the film has stalled because of some problems in Hollywood). Let me just say that the book leaves you shaken and stirrred, to use a famous James Bond line.

I had a post some time back on another book on Mumbai, Suketu Mehta's Maximum City. That is also about the seamy side of Mumbai. But the philosophical approaches of the two books are very different. Mehta is appalled and outraged at the violence and corruption that lie beneath the surface in Mumbai.

Roberts writes with empathy and affection for those on the seamy side. There is understanding and love, an underlying humanity that comes from having experienced the worst of it. Roberts is now off smoking, drinks and drugs and leads the life of a celebrity in Mumbai. I doff my hat in humble salute to the man.

Unconvincing "stress" tests

The much awaited results of the "stress" tests on top US banks is out- the idea is to see how much extra capital these banks would need under fairly realistic economic scenarios over the next couple of years. The estimate: $75 bn in order to be well capitalised by the end of 2010. The biggest requirement is at BofA: $34 bn.Total losses at the banks are estimated at $600 bn. Of this, $363 bn would be recouped through earnings.

What do we make of these figures? Two points. One, these losses come after the accounting standards were tweaked on mark-to-market losses of toxic assets. Two, the IMF had estimated US bank losses at $1.6 trillion over the next couple of years and estimated the extra requirement of capital at around $500 bn. The market is, therefore, likely to perceived the US Treasury as under-estimating capital requirements in order to hide the gravity of the problems at banks. That, in turn, means the chances of raising additional capital from the market would be zero.

Even otherwise, chances of banks raising additional capital are bleak. FT estimates total capital requirements at $55 bn, assuming some banks want to repay capital given by the US government and also some asset sales. This amount is three times total US equity raisings in the last six months. There you are.

Since banks can't raise capital from the market and the US government is unwilling or unable to pump in more, Richardson and Roubini, writing in the FT, say that insolvent banks should be closed down, with creditors taking some of the hit (depositors alone should be fully protected). What about the Lehman effect? The authors argue that market discipline would force banks to change their behaviour in ways that would instil confidence in the market, so credit would become available.

Well, well. For this process to work out would probably take years. So implementing this solution would require some nerve. Academics have the license to prescribe theoretically neat solutions but the global crisis requires a solution here and now because there is real suffering all round. I doubt that there will be any takers for the Richardon-Roubini solution where large banks are concerned.

How real is the Taliban threat in Pakistan ?

I have been following with interest the scare stories about the Taliban being 60 kms from Islamabad and the dire prophesies about Pakistan's nuclear weapons falling into the hands of terrorists. Are things really as bad as that? I came across an article in Asia Times, which made a lot of sense to me:

Pakistan is not an ungovernable Somalia. The numbers tell the story. At least 55% of Pakistan's 170 million-strong population are Punjabis. There's no evidence they are about to embrace Talibanistan; they are essentially Shi'ites, Sufis or a mix of both. Around 50 million are Sindhis - faithful followers of the late Benazir Bhutto and her husband, now President Asif Ali Zardari's centrist and overwhelmingly secular Pakistan People's Party. Talibanistan fanatics in these two provinces - amounting to 85% of Pakistan's population, with a heavy concentration of the urban middle class - are an infinitesimal minority.

The Pakistan-based Taliban - subdivided in roughly three major groups, amounting to less than 10,000 fighters with no air force, no Predator drones, no tanks and no heavily weaponized vehicles - are concentrated in the Pashtun tribal areas, in some districts of North-West Frontier Province (NWFP), and some very localized, small parts of Punjab.

To believe this rag-tag band could rout the well-equipped, very professional 550,000-strong Pakistani army, the sixth-largest military in the world, which has already met the Indian colossus in battle, is a ludicrous proposition.

So, what's behind the hysteria being drummed up in Washington?

To start with, what Washington - now under Obama's "Af-Pak" strategy - simply cannot stomach is real democracy and a true civilian government in Islamabad; these would be much more than a threat to "US interests" than the Taliban, whom the Bill Clinton administration was happily wining and dining in the late 1990s. What Washington may certainly relish is yet another military coup - and sources tell Asia Times Online that former dictator General Pervez Musharraf (Busharraf as he was derisively referred to) is active behind the hysteria scene.

.........Moreover, there are canyons of the Pakistani military/security bureaucracy who would love nothing better than to extract even more US dollars from Washington to fight the Pashtun neo-Taliban that they are simultaneously arming to fight the Americans and NATO. It works. Washington is now under a counter-insurgency craze, with the Pentagon eager to teach such tactics to every Pakistani officer in sight.

There are wheels within twisted wheels. The only thing unexplained above is in what ways concretely the US stands to gain from a military regime in Pakistan. What are the larger designs of the US to which a civilian regime would be an obstacle? And, more importantly, where does India figure in the US plan for Af-Pak?