Microfinance bubble burst?

Many have been warning that the runaway growth in microfinance assets is not sustainable. is the bubble about to burst? Well, the AP government's ordinance is certainly ominous as it requires microfinance institutions to suspend collections until they have registered with local authorities. (see FT report). Banks cannot escape the fall-out as they as the primary funders of MFIs mainly in order to meet priority sector obligations.

A number of practices of MFIs are now coming to light: multiple lending, aggressive marketing of loans to the unwary (much like the sale of credit cards and consumer loans done by foreign and private banks), dubious HR practices (hiring 18 year olds and not issuing any appointment letters), weekly repayments, harsh recovery methods, forming liability groups out of self-help groups created by NABARD and other government agencies.

Some of the arguments for high interest rates charged by MFIs are downright absurd. Eg. The interest rate of 30% if ok as money-lenders charge over 100%. Says who? Besides, money-lenders don't market their loans. They make loans to people who come to them- and strictly against collateral.

It has taken the SKS IPO and a spurt in suicides in AP for people to wake up to what's going on. One thing is certain: microfinance will not be the same again.

Rumblings in NIT system

Directors of two NITs, Warangal and Trichy, have been suspended following various charges against them, IE reported a while ago. The ministry of HRD has sought the approval of the President for the dismissal of the chairman of the board of NIT, Kurukshetra. Apparently in a sign that it is not happy with the state of affairs of NITs, the ministry has commenced the search for various NIT directors a full year before the completion of tenures of the present ones.

I can't comment on the specific cases above. But if the system is acting at all, it is a good sign. One of the sorriest things about our elite institutions is the complete lack of accountability of directors and the boards. If people are being called to account, that is a healthy sign. I also approve of the search process commencing well in advance. Typically, the search starts so late that the incumbent hangs of for several months after his tenure.

Here's a suggestion towards ensuring accountability of directors: there should be a mid-term appraisal of all directors. The appraisal should document what has been accomplished during the director's tenure up to that point and what is proposed to be accomplished in the remaining period of his tenure. This appraisal should be placed in the public domain by being posted at the Institute's website.

US bail out cost less than 0.5% of GDP!

The US government faced fire for its $700 bn rescue of the financial sector in 2008 which was called Tarp. Surprise, surprise. The final cost is now estimated at less than $50 bn. My latest ET column explains how.

The losses in the financial sector across the world too were exaggerated by estimates made in a time of panic. Financial institutions hold mark to market securities whose prices are heavily depressed in times of panic. No point in estimating losses at these prices and the costs of a rescue. Governments will be frozen when they see the numbers. Just go out and save the large banks. Markets will bounce back and the costs will be far less than thought earlier. That's the lesson from the Tarp experience.

Khandelwal report on HR in banks

The report on HR in banks, prepared by a committee headed by A K Khandelwal, former Chairman of Bank of Baroda, came out in June. It wasn't made public. I happened to get a copy of it last week. I am concerned about the focus on variable pay in the report. As I argue in my ET column, HRD in banks is more than just pay, I have serious concerns about whether such schemes can work in the public sector.

There is much talk about the public sector losing talent because of poor pay relative to the private sector. The IAS wanted a huge job in salary to make jobs comparable to the private sector. The army, as I recall, wanted the Chief of staff, to paid Rs 1 crore. IIT faculty agitated for pay superior to what the Pay Commission wanted. The IIMs grumble about pay. And, of course, all PSUs would like pay to be benchmarked to the private sector.

In many ways, pay in academics is a lot better than it has ever been before - and there is no indication that it is drawing in superior talent. Nor are there signs of the opposite kind, that the talent coming into IAS, for example, is poorer than in the past. Senior IAS officers have told me that the composition of probationary officers is changing- more come from lower middle class and rural families and they may lack polish but they are very bright and committted. Competition for the administrative services remains fierce- as fierce as that for IITs and IIMs.

So, we should not make the mistake of seeking parity in pay across the public and private sectors. The two offer different career choices and different lifestyles. This goes for public sector banks as well. They need to improve pay but not catch up with private sector either in what they pay or how they pay (fixed pay or variable pay).

Limit IIT directors to one term

I wrote in my last post about the increase in the retirement age of IIT directors from 65 to 70. I said I did not favour the idea. Some people wrote in saying that they would like to see cogent reasoning for my position, apart from the fact that youth is to be preferred.

Well, the main reason is that in our institutions of higher education, we do not have a system of accountability for the director. So, we lack a proper basis for extending the director beyond 65 or giving him a second or third term. The decision would become subject to the whims of government or the Board.

The IIMs have long had a convention of a single term for the director and this has served them well. It was convention put in place by IIMA's legendary Ravi Matthai. I elaborate on this in my ET column, Let IIT directors retire at 65.

IITs allowed to raised retirement age to 70

The ministry of HRD has allowed the IITs to raise the retirement age for faculty to 70, according to the Hindustan Times. The retirement age of IIT directors can also be raised to 70, which would allow several directors to stay on for a second term. This is a bad idea.

Letting IIT directors stay on for until 70 is bad not just for the reason mentioned in the report, namely , that it will render IIT directors vulnerable to outside pressures. We need younger people at the top, not older ones. And, believe me, there is plenty of talent in the IIT system and outside the country that can be tapped.

Ditto with faculty. Since extensions will, in effect, be at the discretion of the director, this will render faculty totally subservient to the director. It is also not good for faculty to hang around an IIT or IIM for too long- not good for them, not good for the institution. Even as it is, faculty stay on for 30-35 years. I shudder to think of having faculty around for, say, 45 years. Faculty must be extended beyond 65, if at all, provided they have not spent more than 25 years at the institution.

I sincerely hope this does not get extended to the IIMs. The IIMs, by and large, have followed the principle of a single term for the director although, regrettably, this healthy principle was not followed in the recent past in the case of the directors of IIM Calcutta and IIM Lucknow. There is very little accountability among IIT and IIM directors and allowing them to reign for 10 years risks causing serious damage.

Basle 3 doesn't look promising

The BIS will soon unveil proposals for bank capital under Basel 3. From what has been revealed so far, these won't be tough enough on banks. The new capital requirements will be phased in over a longish period. Regulators are worried that tougher requirements will impact on the weak global recovery but this is not supported by BIS research on the impact of additional capital.

I'm afraid it doesn't look as though policy-makers are serious about preventing recurring banking crises. Maybe they just want to shrug these off as part of the ups and downs of capitalist economies?

More in my ET column, Banks, relax- until the next crisis.

Another committee on IIM autonomy

Yet another committee will go into the issue of autonomy for central universities, IITs and IIMs, TOI reports:

The HRD ministry has set up a high-power committee, under noted legal expert N R Madhava Menon, to come with a comprehensive policy on the issue of autonomy for higher educational institutions like central universities, IITs and IIMs.

The six-member committee, which also has three additional special invitees, has been asked to review the state of institutional autonomy in central universities, IITs and IIMs in academic governance and financial matters.

The panel will recommend mechanism for norm-based funding of central educational institutions for development and maintenance, with an aim to enhance their financial autonomy.

It will examine the decentralisation of autonomy within central universities, IITs,IIMs and suggest measures by which institutional autonomy can percolate to governance structure within the university and to the teacher.

An IIM review committee under R C Bhargava had submitted a report on governance of IIMs in 2008. Another committee under the same Bhargava is currently looking at governance issues and its report is awaited. What would be the rationale for another committee on autonomy and accountability and covering the IIMs again?

Paid news

In the last elections, several newspapers are said to have covered election campaigns for a price. This phenomenon of 'paid news' was exposed by P Sainath of the Hindu following which the Press council of India (PCI) constituted a sub-committee to go into the matter.

The sub-committee confirmed that news had indeed been paid for and furnished whatever information it had been able to gather in a report submitted to PCI. Following this, the PCI decided, by a narrow majority, not to make the report public. Mitali Saran has some strong words on the subject in her column in BS:

Concerned journalists on the panel called the PCI a ‘toothless tiger’. They talked about how in the 1980s and 1990s, regional newspapers didn’t pay their reporters a salary, but gave them a commission on any ads they brought in; how corporate management is increasingly sidelining editors; how journalists are given lists of subjects to cover in a target number of column inches.

The PCI sub-committee report, the burial of that report, and the media’s lack of interest in the topic points to a complicity so deep that nobody can afford to turn the lens on themselves. It takes the idea that there are always a few rotten apples in the barrel, and shows that the one you bite into every morning is ridden with maggots. There’s no better reason for you to care.

I have long maintained that two of the pillars of the fourth estate that need strengthening are the judiciary and the media. There are signs of greater accountability being brought into the judiciary. When will the media's turn come?

Land for institutions of higher education

The Punjab government has given ISB 100 acres of land in Mohali. BS is critical of institutions of higher education appropriating vast tracts of land:

Why do India’s institutions need so much land, and that too subsidised by the taxpayer? In an increasingly urbanising India, with land costs going up, the idea of large campuses, and of ones far away from city centres, should be discouraged. Some of the world’s best educational institutions function out of tall buildings in city centres. The only purpose large campuses serve is to preserve greenery and forest cover! If private institutions wish to acquire land, they should pay for it, more so if these are institutions that charge hefty fees and have well-heeled trustees, like the ISB does.

Why would they want 100 acres to build a business school that houses 500-odd students? Government-run universities and colleges, which cater to thousands of students and offer training in a number of disciplines, often operate from much less land. Is it any wonder that people whose land is acquired by the government and given out free to others feel the way they do?

There are answers to the questions raised here. Renting apartments is not as easy or inexpensive as it is in the US and elsewhere- a new batch of 500 or 1000 students will not find it easy to find rental accommodation in the vicinity of a college. Housing faculty and students on a campus makes for smooth functioning of the institutions round the year despite dislocations in the cities in which they operate. Campus accommodation is one of the few attractions of an academic position at IIT or IIM and it remains one of the very few means of attracting Indian faculty from abroad.

That said, questions may be asked as to why ISB needs so much land when it uses a visiting faculty model. We also need to push the IITs and IIMs to scale up their capacities on the land they occupy.

Licensing new private banks

The RBI has come out with a detailed discussion paper on the licensing of new private banks. The paper documents the Indian experience with new private banks and also provides information on regulations in other countries.

Prime candidates for new banks are industrial houses and NBFCs. The latter are regulated and the RBI will know whom to let in and whom not to. Industrial houses setting up banks is a dicier proposition. I discuss the issues in my ET column, Tread warily on new private banks.

My bottomline: let us make a modest start with allowing industrial houses to set up exclusively rural banks. That is where we need initiative and capital. The urban crowd and industry are well taken care of. Let us watch the performance of industrial houses for a few years and then take a view on whether they should be allowed to spread their wings.

India decoupled from the world now?

India is eyeing 9% growth when growth prospecs in the US and other advanced economies are uncertain. Fiscal and monetary policies have been tightened over the past several months in India. In the advanced economies, the stimulus vs austerity debate has not died down. Is India getting decoupled in the present situation? Maybe. We got couple in 2009 because of panic outflows of capital. In today's uncertain condition, the same sort of capital outflow appears unlikely. So we may steam ahead regardless of what happens in the advanced economies.

More on this in my last ET column, The world falters, India booms

India and China

One of the tantalising questions in economic debate is who will win the economic race in the coming years: India or China? Until recently, there was not much to debate. Everybody knew it would be China. But, in the last year or so, one notices a shift. India has a better demographic profile. China's currency is set to appreciate which will drag down export growth, so the contention goes. India will move into double digits. China will drop into a single digit.

Arvind Subramaniam wades into this debate and he favours China. He sees corruption, insurgency and poor governance in general as going against India.

Long-run growth depends on the quality of supporting public institutions. True, the India of today is less of a regulatory nightmare than before the opening-up in 1991. Some institutions – those that hold elections, preserve financial stability and regulate telecommunications, for example – have worked well. But these exceptions apart, the state is weak and fraying. Policy reforms do not deserve the spectacular acceleration in growth that the economy has delivered.

Well, then you have to explain why economic growth has improved in recent years. There is more corruption. Is there more insurgency? We may hear more about the Naxalite problem but that does not mean there we have no faced insurgency earlier- we have had enormous problems in the North- East, some of which continues. Is governance worse? There are some areas- such as tax services- where one sees an improvement. Telecom has seen a revolution. The RTI is a big change. I am not sure governance is worse than it was ten years ago.

The explanations for improved growth that Subramaniam provides- more entrepreneurship, bigger role for the private sector, competition among states- are not the whole story. The solid underpinning comes from higher savings and investment. If these continue to rise, why should governance problems hold up growth?

Incidentally, Morgan Stanley is willing to bet on India, a rather surprising forecast coming from a firm that was quite bearish about India's growth prospects some time ago.

HP boss pays for an indiscretion

HP boss Mark Hurd's ouster as CEO is a case of a board setting unusually high standards. In an earlier era, these standards may even have been regarded as puritanical.

Hurd was ousted by the board for what appears to be a minor indiscretion, according to an FT report. Hurd was accused of sexual harassment by a woman contractor. To his credit, Hurd promptly handed over the letter to the company's general counsel who took it to the board. The board's investigation found no evidence of sexual harassment but believed that Hurd had fiddled with expense statements to conceal his meetings with the contractor.

The amount involved was $20,000 over a two year period. This was considered a sufficiently serious ethical lapse to fire one of America's best-performing CEOs. Of course, it is possible that the board also believed that if it dug deeper, it might uncover worse.

Hats off to the board of HP- not many boards would have taken such a tough line. Partly, the tough line shows the extent to which boards themselves are under close scrutiny in the US.

IIT Kharagpur had quotas for faculty's children!

For over 40 years, IIT Kharagpur kept aside seats for children of faculty and staff, letting in students who had failed to secure admission through the JEE. This sensational disclosure appears in HT which procured the details under the RTI Act (for the nth time, one marvels at the wonders of this great piece of legislation):

Documents accessed by HT using the RTI Act show the country’s oldest IIT — started in 1951 — blocked 25 per cent of its seats in popular five-year integrated science courses (up to M.Sc level) for handpicked nominees, even as students from the rest of India had to clear the IIT-JEE for admission.

IIT wards merely needed 60 per cent marks in their Class XII Board examination and should have appeared in the IIT-JEE to be eligible for the quota seats, doled out at the institute director’s discretion.

Between 2003 and 2005, those who got in through this illegal quota didn’t even need to appear for the entrance exam.

The secret quota was suspended in 2005, the year the RTI Act was launched, and was abandoned in 2006 under pressure from the Joint Admission Board of all IITs, which organises entrance examination.......

The IIT admitted 88 students through the secret quota bet-ween 1998 and 2005, including 50 in 2003 and 2004, documents reveal. The quota was never disclosed in admission brochures — unlike all other reservations for backward communities that the IITs have.

Among the beneficiaries was the ward of the chairman of the IIT-JEE in 2006. One ex-director calls it a 'shameful chapter' and claims he did his best to stop it but could not convince his colleagues. Sorry, that's a lame excuse. The right thing to do would have been to take the matter to the Board and the ministry and to have gone public with the facts. The Board of IIT-Kgp must have the matter thoroughly investigated and documented and place the full record in the public domain.

Business Standard has a scathing edit on the subject. As the edit points out, these are the same characters who have opposed quotas on the ground that these dilute quality.

I may mention here that early in IIMA's history an attempt was made to introduce similar quotas. A senior professor made the request to Ravi Matthai, the legendary first full-time director of IIMA. Matthai took the proposal to the faculty where it was promptly shot down as Matthai must have known it would.

Management gurus and b-schools

I have been extremely preoccupied in recent weeks, hence this long lay off from my blog. I hope to be more regular starting next week.

What exactly is the link between b-schools and good management? Can good management be taught the way it is done at b-schools? These are questions that have vexed people for long and we don't have good answers. Of course, many successful managers have come out to b-schools but that's because b-schools simply get the brightest. And we have lots of successful entrepreneurs and managers who never touched a book on management.

Incidentally, Ravi Matthai, the first full-time director of IIMA, had no academic background in management. He was a BA (Hons) from Oxford and had been a chief executive at a firm in Calcutta before he moved into academics. He went on to become a pioneer in management education.

To return to my questions, law journals contribute to lawyers' effective practice. Doctors benefit by reading medical journals. Scholarly management journals are read only by academics so that they can produce more papers that other academics can read. HBR is, perhaps, the one management journal that executives read- and it would not help an academic make tenure in most places.

I had a chance to read Michael Stewart's The Management Myth and write an op-ed piece based on it, Begone, management gurus! Stewart skewers the OB and strategy stuff but there is more to management than that- finance and the quantitative sciences have applicable stuff that is based on sound theory. But I would go along with Stewart's proposal for a remake of the MBA programme by including a heavy dose of the classical liberal arts education.

Trends in consulting

With big cuts in government spending, consulting firms face the heat all over the world. Talk of merger between two leading firms, A T Kearney and Booz and Co, underlines the need for consolidation in the industry.

But the shake-out won't disturb the dominance of the top three, McKinsey, BCG and Bain, argues Stefan Stern in the FT. Much of consulting firm, he points out, focuses not on glamorous things like strategy but on more mundane things such as efficiency and cost reduction.

Still, with some many MBAs out there in industry, it's a bit of surprise that there is still so much need for consulting firms. One reason is that the top firms do invest in knowledge and they have sought to broaden their services by hiring doctorates, lawyers, even musicians. Another is that in the corporate world, people lack time to sit down and think, to collect and analyse data. Consultants serve as auxiliary staff- no need for a full-time strategy or planning department, just call in the consultant when required.

9% growth is within sight

It looks as though we will touch 9% growth this year itself, assuming the monsoons don't disappoint. Earlier, most forecasts suggested that growth would touch 9% only in 2011-12. If we do touch 9% this year, it will be in the face of a still incomplete global recovery. Conclusion: our growth of 9% is not entirely contingent on a global boom, as some commentators had claimed.

The challenge is to insulate 9% growth from the vagaries of the world economy. More on this in my ET column, Boom or no boom, India can grow at 9%

Tribunal for educational institutions

The foreign universities' bill has attracted much comment. But another important piece of legislation has gone unnoticed. This is a bill to set up tribunals at the National as well as state levels for educational instititions.

The Hindu reports:

The Educational Tribunals Bill, 2010, provides for the establishment of the State Educational Tribunals and the National Education Tribunal. The tribunals will exercise power and authority on service matters of any teacher or any other employee of a higher educational institution, on matters relating to affiliation of any higher educational institution (not being an University) with the affiliating University, on matters relating to unfair practices by any higher educational institution and matters that might be assigned to them by any other law for the time being in force.

This is a long overdue step. Teachers in educational institutions have little recourse against arbitary actions of management and the judicial processes are too slow to provide relief. Many of the reputed educational institutions, including the IIMs, have not thought it necessary to have an appropriate Grievance Redressal Mechanism or Appellate Authority, something one would regard as an elementary requirement of good governance.

New IITs - plenty of action

State governments have been generous in allocating land to the new IITs, reports BS. Most will have more land than the older ones. IIT Mandi in HP will have 513 acres; IIT Hyderabad 531 acres; IIT Gandhinagar 385 acres; IIT Ropar 500 acres; IIT Bhubaneswar gets 936 acres intended for 1100 faculty and 11,000 students- talk about thinking big!

Some are already operating from makeshift premises. Others plan to use research scholars for teaching until a core faculty of adequate size is in place. The build up of faculty strength so far is impressive. IIT Hyderabad already has 40 faculty.

I have never subscribed to the talk of 'faculty shortage' at the IITs and IIMs. There are ways and ways of getting faculty and I believe the newer IITs and IIMs will do a better job than the older ones because of the compulsion to deliver. Besides, there is virtue in newness- new leadership, a new campus, new ways of doing things. I believe the setting up of new IITs and IIMs is one of the best things to have happened in higher education.

Emerging market banks- home bias is best

Emerging market banks have done much better in the crisis than their counterparts in the west, especially banks in India and China. Return on assets in the crisis years, one finds, was higher than in the pre-crisis years! With loan growth poised to boom, many of the banks in emerging markets will soon catch up with western banks in terms of market cap.

They should not, however, develop global ambitions. The western banks have not succeeded, by and large, on the global stage except for three banks that have been global for a long time now (Citi, HSBC and Stanchart). Home bias is a better prescription for emerging market banks. More in my last ET column, Grow, but don't try to rule the world.

Basel III will be delayed further

Tougher capital and other rules for banks are likely to be held back for longer than thought earlier, FT reports. The UK and the US believe that delay in implementation is preferable to diluting the norms.

The Basel rules were originally expected to be phased in by the end of 2012, but sources familiar with the discussions said that the latest idea was that the new rules were likely to be put in place between 2014 and 2016.

Another G20 source said that the transition period did not matter much because once the new regulations were agreed, banks would come under enormous pressure to meet them quickly or explain why they could not, even if the formal transition was much longer.

US bank reform

A mountain of labour producing a mouse. That's my judgement on the Senate bill on US bank reform. It's meant to convey to the public that Congressmen are being tough on banks without changing anything substantial on the ground. One of the things about the bill is that the details have to be filled in by the regulators later.

I wrote about this in my ET column but didn't get a chance to provide the link.

Prescriptions for the world economy

Not many expected sovereign debt to spook the recovery to the extent it has following the Greek/EU crisis. Deleveraging of private sector and household debt has proceeded apace. Now, there is pressure to deleverage government debt as well.

Nouriel Roubini and Arnab Das propose the following:

First, the eurozone must get its act together. It must deregulate, liberalise, reform the south and stoke demand in the north to restore dynamism and growth; ease monetary policy to prevent deflation and boost competitiveness; implement sovereign debt restructuring mechanisms to limit moral hazard from bail-outs; and put expansion of the eurozone on ice.

Second, creditors need to take a hit, and debtors adjust. This is a solvency problem, demanding a grand work-out. ....

Third, it is time for radical reform of finance. The majority of proposals on the table are inadequate or irrelevant. Large financial institutions must be unbundled; they are too big, interconnected and complex to manage. Investors and customers can find all the traditional banking, investment banking, hedge fund, mutual fund and insurance services they need in specialised firms. We need to go back to Glass-Steagal on steroids.

Last, the global economy must be rebalanced....

All but the third are unexceptionable. Going back to Glass-Steagal, to my mind, is infeasible and also inappropriate. Size is the problem; not scope.

Winners' curse in India's 3G auctions

I had meant to flag this article earlier but it escaped me. There is great jubilation over the Rs 70,000 crore the government is set to rake in from 3G auctions. Some people even think this makes amends for the telecom minister not having earned enough from the award of telecom licenses earlier.

Sumit Majumdar, writing in TOI, highlights the downside. One, the firms may go broke after having paid through the nose, so we will not see enough investmen in 3G infrastructure. Two, the firms that have bid may forfeit their security deposits and walk away from 3G in which we will need a fresh round of bidding. Three, the companies may be forced to charge consumers steep prices. He sums up the implications:

The diffusion of a 21century radical infrastructure which could be both a positive and disruptive influence for propelling Indias badly-needed knowledge revolution for the masses will not happen.Since the impact of general-purpose technologies at the individual level is profound,because of changes in the organisation of activities,the diffusion of a general-purpose technology such as 3G could have raised the return to cognitive skills and education.
The ability of 3G as a generalpurpose technology to have a phenomenal capacity to transform Indian society can be on hold.India can lose a golden opportunity to transform its society via a knowledge revolution using 3G technology.Indias 3G spectrum auction is fantastic for the exchequer but a fiasco for the common man.

A first for an Indian lady academic

Gita Gopinath becomes the first Indian lady to become a full professor at Harvard's Economics department, ET reports:

Before joining Harvard in 2005, she was an Assistant Professor of Economics at the University of Chicago's Graduate School of Business.

Prior to that she completed her Ph.D. in Economics from Princeton University.

Born in Calcutta, Gopinath has studied at the University of Delhi.

Greek rescue: It's the banks, stupid

The Greek rescue is more about rescuing foreign banks with exposure to Greece than about rescuing Greece itself. Foreign banks' exposure to Greece is estimated at 76 bn Euro. A Greek default would mean a loss of upto 70% or 53 bn Euro. If other countries such as Spain and Portugal were to default, banks' losses would increase.

The 750 bn Euro rescue package is intended to shock and awe. But this is hardly the 'cost' of the rescue. The cost of the rescue, assuming the guarantees in the package are all invoked, would be the difference in the market rate of interest and the rate of interest charged on the package- approximately 4%. This amounts to 30 bn Euro, which is less than what banks would lose on Greek debt alone. That's the maximum cost that taxpayers outside Greece will pick up.

As for Greece and other troubled economies, there will be huge adjustment costs. For Greece, fiscal consolidation of 11% over a three year period. Thus, the so-called rescue places the burden of adjustment overwhemlingly on Greece and other economies. Why? So that again there can be a massive bail-out of private banks using public money. The markets don't think will work because they don't think this sort of burden will be acceptable to the people of those countries.

The more sensible course would be to restructure debt and accept losses on bank exposure to government debt. Some of these losses could be made good by the governments concerned. This course would distribute losses more evenly and make for smoother adjustment.

More on this in my ET column, Why the Greek rescue won't work

Why single out Goldman?

My earlier post on the fraud case against Goldman has drawn some strong responses. I can understand the anger against firms such as Goldman. But it cannot be that Goldman becomes a target because it has been more successful than others. The case against the integrated investment banking model, with its potential conflicts of interest, has not yet been made.

An article in FT points out the pervasiveness of the practices that form the basis for the present against Goldman.

Of the banks that dominated the market a few years ago, why would the government target the only one to survive the crisis financially intact? It is not because Goldman was unique. In Abacus 2007-AC1, Paulson & Co, a hedge fund, suggested securities for the deal and also bet against it in a swap with Goldman. That feature is not uncommon. According to a recent report from ProPublica, there were 26 deals in which Magnetar, a hedge fund, both sponsored CDOs and bet against them. (Magnetar says these deals were perfectly legal.) They were arranged by Citigroup, Credit Agricole, Deutsche Bank, JPMorgan Chase, Lehman Brothers, Merrill Lynch, UBS and others (not Goldman). There are hundreds of non-Goldman CDOs that no one has yet investigated.

.....More fundamentally, if the other big investment banks had made similar “net short” trades in 2007, there would not have been a financial crisis. Bear Stearns, Lehman Brothers and Merrill Lynch collapsed because they took massive positions in the opposite direction. Given the cost of government bail-outs, why chastise the only prudent investment bank?

I am no unabashed admirer of Goldman. But it is hard to resist the impression that Goldman is being targeted because it survived and remains profitable. That is quite ridiculous.

Goldman in the cross-hairs

I can't comment about the merits of the particular case in which SEC has brought allegations of fraud against Goldman. But the broad case about investment banks having to make disclosures of all kinds of positions- their own and their clients- is, I am afraid, rather weak.

I would go along with Blankfein that when Goldman sells a package of securities to qualified investors, it is for them to take a view on the attendant risk. What view Goldman or any other clients should not be of interest to them.

I dilate on the Goldman case in my last ET column, Gunning for Goldman.

I find my sentiments echoed in an FT piece. The author suggests Goldman is becoming a scapegoat for others' failures:

......my unease has to do with the possibility that Goldman has become a scapegoat for millions of homeowners and investors psychologically unable to admit at least partial fault for succumbing to the madness of crowds and lure of easy money. The one investment bank that hedged appropriately and enjoyed a hugely profitable rebound is an obvious target. “The idea that Wall Street came out of this thing just fine, thank you, is something that just grates on people,” said Senator Ted Kaufman. Goldman may or may not have done anything illegal, but most Americans do not give them the benefit of the doubt.

Interestingly, the author asks whether the firm's Jewishness is stoking prejudice:

In Goldman’s case, some even wonder whether the group’s perceived Jewishness has infected legitimate criticism of it with centuries-old prejudices against a group with a long history of being scapegoated. Michael Kinsley, writing in AtlanticWire, cites echoes of the infamous blood libel. New York Times columnist Maureen Dowd earned rebukes from theologians after writing that “blood-sucking banks” like “Goldmine Sachs” were “the same self-interested sorts Jesus threw out of the temple”.

Nitin Nohria, HBS Dean-designate

The process adopted for the selection of Nohria as Dean, HBS, is interesting. Harvard President Drew Faust consulted a 12-member advisory committee of faculty from HBS and three other academics from Harvard. Around 30 other members of HBS also shared their views with her. Faust also spoke to Harvard alumni and figures from the world of business. It is interesting that faculty at HBS itself had a dominant say in the selection of the Dean.

I have wondered why it is that academics, who are employees of an institution, are consulted when it comes to selecting a leader. In the corporate world, you don't select a CEO by soliciting the preferences of VPs and GMs. I guess the reason is that academics are best motivated only when they have a clear sense of ownership in the institution. They can't be given this sense through stock options. Instead, they are giving a say in decision-making in administrative as well as academic matters.

Stefan Stern, writing in the FT blog, thinks that Nohria's appointment may have to do with his focus on ethics and his questioning the traditional b-school focus on shareholder value:
<>

Together with his colleague Rakesh Khurana, Prof Nohria has challenged the orthodoxy that claimed there was little wrong with the conventional MBA syllabus or with the approach taken by the élite business schools. Both of these things played a part in contributing to the over-confident mentality which dominated business and finance, and which led to the great financial crisis. By appointing Prof Nohria, Harvard University has signalled that it is not frightened of debate, or reform - indeed, it wants to play a leading role in both these activities.

Along with Khurana, Nohria has championed the equivalent of the Hippocratic oath for MBAs, whereby they pledge to commit themselves to a code of ethics. I don't see that the Hippocratic oath has done a great deal for standards of doctors, especially those who have invested heavily in capitation fees. So, I am not sure what such an oath will do for corporate managers.

I do believe that the MBA curriculum needs big changes. But not quite in the way it is suggested above. I cannot see much purpose in loading it with ethics courses- and, certainly, I would question the presumption that faculty teaching such courses are any more 'ethical' than others. My own preference is for introducing more liberal arts courses and downgrading the repetition of 'hard' courses in accounting, finance, operations, etc

It will be interesting to see what changes Nohria rings in. As the FT blog points out, his expertise in organisational behaviour should be useful- there's a lot of 'behaviour' from colleagues he will have to take in his stride.

C K Prahalad

The business community in India was effusive in its praise for C K Prahalad. So were some commentators in the media. That Prof Prahalad, an alumnus and former faculty member of IIMA achieved fame and recognition, is something we should all be proud of. But what one missed was a serious and critical evaluation of his contribution.

Today's Business Standard editorial makes up for what was missing elsewhere. The edit makes three important points:

• Prahalad was good at articulating existing practices rather than predicting future trends. 'Core competence' had come into being at many MNCs long before Prahalad wrote about it. This stands to reason. That is what the case method that Prahalad was raised on at IIMA and HBS is all about.
  
• Co-opetition, taking the customer into account in designing products, is elementary marketing
• Bottom of the pyramid, his most famous theory, is not about making money from the poor, it is more about designing products for the lower middle class in the rural areas.
  

Let me add: BoP has little to do with poverty alleviation. Companies do little to alleviate poverty when they address the mass market, they only take care of their own shareholders. You alleviate poverty not by viewing the poor as customers but viewing them as producers and giving them purchasing power, a point that Aneel Karnani, Prahalad's colleague at Michigan, made in his devastating critique of the BoP thesis a few years ago.

The idea that we can leave it to companies to alleviate poverty can be dangerous because it provides another argument for government to vacate the space, something that neo-liberals would pounce on. Thank God, we are thinking in terms of right to education and right to food instead of embracing the BoP thesis.

The BS edit has a scathing finale:

Perhaps the best commentary on its (BoP's ) efficacy came from Praja, the BOP company Prahalad co-founded to provide a platform for common people to personalise their own experiences on the Internet. In 2002, the company was sold having made a $55 million loss and laid off one-third of its staff!

Must people abandon their critical sense in paying tributes to the departed? Whatever Prahalad's gifts of exposition, comparing him with Peter Drucker was quite a stretch.

Foreign universities' bill to bar for-profits

The foreign universities' bill to be introduced in parliament soon will bar non-profits, TOI reports.

This fine-print is the third restrictive clause the Union Human Resources Development (HRD) ministry has introduced in the Foreign Education Providers’ Bill, which aims to allow international universities to set up campuses in the country. The other two conditions include forbidding foreign universities from repatriating funds to their home country and setting up a minimum corpus of US $11 million.

I am not very sure that this is desirable. Agreed, one associates quality in education with non-profits. But, in India, we have a huge number of for-profits in various fields, notably engineering, management and medicine, which are non-profit on paper- these are the ones that charge exorbitant sums as capitation fee. Would it not be better to have a system where for-profits from abroad, with a transparent fee system, take on the covert for-profits in India?

Again, there are many institutions that generate substantial profit through hefty fees but plough them back into the institution. They are non-profits on paper since they are registered as Charitable Trusts. No point claiming the high moral ground when it comes to for-profit institutions from abroad.

Air India's woes

To many, Air India (which now encompasses the erstwhile Air India as well as Indian Airlines) sums up all that is bad about commercial enterprises run by government. It has made huge losses and people would say that is very typical of the public sector.

I argue in my ET column, Why Air India is in trouble, that this explanation does not hold nor is it true that Air India's losses are the result of the troubled merger between Air India and Indian Airlines.

The two basic reasons for Air India's mounting losses are huge investment in fleet expansion and high leverage arising from the failure to strengthen the two airlines' equity base before exposing them to greater competition. Needless to say, in government there are huge incentives for signing contracts for the purchase of aircraft.

There was talk of bringing on board some luminary from the private sector who would wave away Air India's problems. Now, the government has settled for high-profile businessmen and a foreign COO. Neither can make a big difference- N Vaghul, formerly of ICICI, was on the board of Air India for many years until it ran into its present crisis.

Tackling the Naxal problem

Congress General Secretary Divijay Singh has written the most insightful piece on the Naxal problem that I have come across so far. He is critical of home minister Chidambaram's approach and doesn't mince words saying as much.Which makes me wonder whether this is an attempt on the part of the party to rein in Chidambaram when he seems to have the overt support of the PM.

Singh's main points are:

• The Naxals cannot truly claim to espouse the cause of the tribals. They have had no difficulty making peace with businessmen and politicians- for a price. Even the mining interests, which are said to disrupt tribal life, have continued unhindered in Naxal areas
• Chidambaram is wrong in treating the Naxal problem entirely as a law and order problem- tribal issues need to be addressed
• We need to learn from the AP model of tackling Naxalism: development plus police action

Singh is spot on. Chidambaram has created a massive problem where none existed by setting an artificial deadline for solving the Naxal problem: two or three years. Setting such a deadline spells trouble because it means use of massive force with all its consequences- such as the recent killing of 76 CRPR jawans.

Why do we need to solve the Naxal problem in two or three years? There is nothing to suggest that the problem is of alarming proportions or is disruptive in any way. If that were so, it would have been reflected in national or regional economic growth. It hasn't.

In the urban areas, the mafia coexists with the forces of law and order. An equilibrium is established in which the mafia flourishes without in any way impinging on economic activity or even orderly life. The Naxals are a form of mafia in the tribal areas. We have put up with insurgency in the North-East for over 50 years. Where is the urgency to end the Naxal problem? Patience and perseverance are required, not trigger-happy solutions.

Chidambaram may be right in refusing to talk to the Naxals. But why is the government not talking to the tribals? We need to enter into a dialogue with them as to how they can participate in decisions that afffect their lives, whether it is mining or timber, and what is required by way of development assistance.

The use of massive force is misguided and it is bound to be counter-productive. Sending the CRPF or the army will only bring recruits from the tribals to the Naxals. The answer to insurgency within the country (as distinct from insurgency in border areas) is sustained police action. That is the lesson from AP. It was AP' s success that drove the Naxal leaders into Chhattisgarh and other parts of the country.

Some of these states are new and the police force may be underdeveloped. We need to enhance their capabilities. In AP, police officials were given huge war chests for developing informers. Intelligence was used to target the Naxal leaders. This method produced dramatic results. The Indian state has developed its own recipe for dealing with internal terrorism: encounter killings.

It defies imagination as to how an outside force, such as the CRPF, can tackle the Naxals. You need local contacts, you need to know the local language and you need to understand the terrain.

Chidambaram's technocratic approach is seriously flawed. Development and police action are the best answer to the Naxal problem, not overwhelming use of force. Patience is required. We must be willing to put in ten years of low key effort. This won't make for sound bytes on TV but it will produce results.

Finally, thank God, the suggestion to use the army and the air force has been shot down. Had it been accepted, that would have ended all our hopes of winning over the tribals and brought the Naxal problem into the cities.

Basel talks on bank capital

The one thing that is certain about international bank regulation is that capital requirements for banks will go up. The uncertainties are two: how much and over what time? We should have some idea by the end of this week when the Basel committee on banking superivsion meets representatives of banks to discuss possibilities.

One key item is the core capital requirement, currently pegged at 8%. In the wake of the financial crisis, one proposal was that tier I (which is half of core capital) should itself be 8%. This looks unlikely now given the resistance from banks.

Another item relates to liquidity. On this item, FT reports:

The liquidity proposals come in two parts: one, known as the Bear Stearns rule, requires banks to have enough liquid assets on hand to survive a 30-day crisis, while the other, nicknamed the Northern Rock rule, requires banks to have stable long-term funding, favouring deposits and heavily disfavouring wholesale sources. It is the latter rule that has attracted most criticism.

Good banks today operate with capital of 12-13%. We should expect this to rise to 15-16%. By what date? The earlier deadline for introduction of higher capital norms was end 2012. This may be pushed back or the introduction of new norms may be calibrated over time.

Sonia's tough line on RTI amendments

Sonia Gandhi has indicated her opposition to some of the amendments to RTI that the government is contemplating, TOI reports.

"It is important, therefore, that we adhere strictly to its original aims and refrain from accepting or introducing changes in the legislation or the way it is implemented that would dilute its purpose. In my opinion, there is no need for changes or amendments. The only exceptions permitted, such as national security, are already well taken care of in the legislation," she said.

Sonia Gandhi said the problem with the RTI Act is about "public lack of awareness of the RTI and the harassment of applicants" and "these problems need to be addressed."

Mrs Gandhi is right. One amendment that has been causing concern is giving the public information office the right not to respond to what he regards as "frivolous" applications. Another relates to keeping the higher judiciary out of the purview of the Act. The RTI Act is also in danger of being undermined by rising delays in disposal of appeals to the CIC. This needs to be addressed because information delayed is often information denied.

The RTI Act is revolutionary in its thinking and scope and will go down as one of the great achievements of UPA-I. The right to education and the right to food, now under consideration, will further bolster UPA's claim to standing up for the aam admi. In defending the RTI Act and in pushing for rights in other areas, Mrs Gandhi has displayed uncanny political instinct.

Foreign Universities: mentoring a better entry route

I said in an earlier post that I was sceptical about quality, foreign universities setting up full-fledged campuses in India. that is because the economics of higher education militates against their entry.

Quality comes from putting together the best faculty, infrastructure and students. If foreign universities are to maintain their standards in India, they will have to send some of their faculty to India. That would mean huge faculty costs. Quality infrastructure would also be expensive.

Put the two together and you have a high fee. If an MBA costs Rs 45 lakh in the US, it would cost around Rs 25-30 lakh here. If you spend Rs 45 lakh in the US, you can hope to recoup it in reasonable time because you will be earning in dollars. Recouping Rs 25-30 lakh in India is not as easy. So, a fee of this order will shut out the mass market and the best students. Schools charging such fees will be rich kids' schools. Then, you don't get a high quality of output.

It makes more sense for foreign universities to go down the mentoring route. I read that this is proposed for Yale's association with the 14 innovation universities planned. There are precedents for this- the setting up of IITs and IIMs.

IIMA benefited from a collaboration with HBS, the expenses being underwritten by the Ford Foundation. HBS faculty came in batches of about three at a time for about five years. The big gain was IIMA faculty being sent in batches of about six to the International Teachers' Programme at HBS for a nine-month stint. It got faculty who had joined from diverse backgrounds to get quickly acquainted with the course contents and pedagogy of a top b-school and it also made for a certain common approach and camaraderie amongst the early faculty. This is one reason why IIMA made a quick mark as an institution of excellence.

Faculty exchanges, help with the curriculum, governance structures and norms- these are areas where mentoring would make differenc. Foreign universities can earn fees and they have an opportunity to carry out India-related research. This makes more sense than foreign universities coming in.

More in my ET column, Foreign varsities as mentors.

Foreign bank licenses

Credit Suisse and ANZ have been given banking licenses, FT reports. The report also says that eight more banking licenses are to be awarded shortly, including to corporate groups, such as Reliance and Tatas, although a report in today's Economic Times discounts this possibility.

My own view is that both foreign banks and corporate groups can be licensed more freely for exclusively rural ventures. This mitigates regulatory problems and dovetails nicely with the overriding objective of achieving greater financial inclusion. More on this in my ET column, Let foreign banks into rural areas.

Foreign Universities' Bill

There are two issues about the Foreign Universities' Bill. Will it cause an influx of quality institutions from abroad? And should foreign universities be subject to quotas and other norms applicable to government institutions?

On the first issue, I agree with what many others have said. It is unlikely that we will have full-fledged universities with campuses set up by quality institutions. The economics militates against this possibility. Ours is a cost-sensitive market as so many foreign firms have discovered. Today, foreign car manufacturers all want to get into the small car segment. Volkswagen, Skoda, Ford all have launched small cars. Carlos Ghosn of Nissan says he would like to introduce a car that is even cheaper than Nano!

The same applies to education. To succeed, you need to be able to tap the mass market. I would say this is even more true of education than of manufacturing. Because you get the talent only if you tap the mass market. The secret of the success of IITs and IIMs is that they attract the very best- and they do so because they are affordable, despite the steep increase in fee at the IIMs in recent years. A high quality US school coming into the Indian market would be viable only at a steep cost. I would assume that an MBA fee would somewhere between the Rs 20 lakh that ISB charges and the Rs 45 lakh at a US school- say, Rs 35 lakh.

Now, somebody who can afford Rs 35 lakh will also be able to Rs 45 lakh and would prefer to go abroad and get the broader international exposure. Secondly, a price tag of that order automatically screens out the best talent in India. It will be a rich kids' school, which means its products will not be highly valued by the market.

It is striking that foreign universities have not taken off even in more affluent markets than ours- such as Singapore, China and Israel, as a very good story in today's TOI points out:

Singapore can justifiably boast about attracting some top-notch institutes — the University of Chicago, INSEAD, Tisch School of Arts, DigiPen Institute of Technology — but even today, the sector is undeveloped. .... This, despite the manner in which the country “courts the universities: the EDB played up Singapore’s cosmopolitan nature, and then used tangible material resources in the form of financial and other incentives,’’ observes Kristopher Olds, a professor at the University of Wisconsin-Madison who’s taught at the NUS for six years.

....The University of New South Wales (UNSW) also benefited from subsidies upwards of $80 million. Even so, within months of being set up, UNSW folded up citing its “unsuitable financial model’’. Three years ago, the John Hopkins Centre, which received $52 million in funding since its 1998 arrival in Singapore, also closed down as it did not meet the performance benchmark. And the UK’s Warwick University, which was to set up a full campus in the real sense of the term, backed out at the last minute.

The two universities that China can boast of are Nottingham and Liverpool - no great shakes, by world standards- and both have local partners, as required by law. Even Israel, with all its close links to the US, managed to attract only the low-grade institutions. We have to face up to the fact that no country has developed a great university sytem through imports. All great universities are home grown.

As for foreign universities being subject to quotas, well, since private universities in India are not subject to these, it's hard to see how we can impose these on foreign universities. Will the IITs and IIMs suffer as a result? Well, they haven't lost out in any way to domestic private institutions on this account, so quotas certainly won't be the reason for losing out to quality institutions from abroad- assume these come in in the first.

Shrinking CITI

Vikram Pandit told the US Congress that he expected to see Citigroup return to profit of around $20 bn by the end of 2011. He also proposes to sell 40% of Citi. In other words,Citigroup will shrink quite a bit even as it turns profitable. This is an acknowledgement that Citigroup is too big to be profitable, quite a reversal from the earlier credo that it could become more and more profitable through mergers and acquisitions.

Citigroup will be a leading case of a bank relinquishing size even without regulatory norms requiring them to do so- the proposed norms that would link bank capital to size have yet to be announced.

Separately, in an interview with FT, Pandit has spelt out what the focus of the restructured Citi would be:

The US consumer business is among Mr Pandit’s four priorities for investments once Citi stops losing money. The others are retail banks in emerging markets, the cash management unit and equities and commodities in the investment bank.

There is a bit of eastern philosophy in the interview for those interested:

"Doing the right thing for all our stakeholders – our clients, our shareholders but also other parts of society. We need to understand and embrace the responsibility that is put on banks by the general public

This belief was shaped by my Eastern upbringing, the belief that if you don’t do right now you will pay in the next life, and the importance I attach to reputation and credibility".

Pandit's remarks require a little tweaking. If he doesn't do the right thing, he and Citigroup will pay in this life, not the next.

MI 5 ex-chief criticises torture

British intelligence is exceptional in many ways- very effective, with a good international reach, especially in the Arab world, and with a good record of electronic interception. Another is that it has had women at the top- there was Stella Remington some years ago and, more recently, Dame Eliza Manningham- Buller, who headed MI 5. So, the more recent James Bond movies that have a lady as 'M' are not far-fetched. (If memory serves right, the original 'M' was Admiral Sir Miles Messervy).

Dame Eliza revealed recently that the UK government had protested to the US against the use of torture on suspects:

Asked if she had known of the use of waterboarding and other techniques of pressure while she was director-general of MI5, from October 2002 until her retirement in April 2007, she said she had done, and had disapproved. "Nothing - not even the saving of lives - justifies torturing people," she said. She added that "the Americans were very keen to conceal from us what they were doing" with suspects.

The ex-chief of MI 5 also took a swipe at the previous US administration:

"Bush, [Dick] Cheney [the former US vice-president] and [Donald] Rumsfeld [former US defence secretary] certainly watched 24 " - the Fox television drama that has run since late 2001 and features an agent, Jack Bauer, saving people and sometimes cities from terrorist destruction, often with the use of violence on suspects.

Dame Eliza's comments are refreshing indeed but one wonders what effect these would have on those in charge of security at the US. I can almost hear them saying, "We gotta cut back on intelligence-sharing with the Brits, can't trust these guys".

Stimulus withdrawal by stealth

Ahead of this budget, there was much debate on whether the fiscal stimulus given over the past two years should be withdrawn. In 2008-09, we had a stimulus of 3.5% of GDP; in 2009-10, there was a modest addition of 0.8%. This year, economists wanted the stimulus withdrawn but gradually.

The budgetary numbers make nonsense of this debate. The correct fiscal deficit, after taking into account the off-budget items, was 7.8% in 2008-09 and it declined to 6.9% in 2009-10. So the stimulus was withdrawn last year. Withdrawal by stealth, if you please. You might think that the stimulus withdrawal was greater this year because the fiscal deficit for 2010-11 is projected at 5.5%.

Not true, I argue in my ET column. The fiscal deficit measures the stimulus inaccurately. A more accurate measure would be changes in government expenditure net of centre's tax revenues. By this measure, the withdrawal of stimulus was greater in 2009-10 than projected for 2010-11.

Unknown to ecnonomists, most of the stimulus has already been withdrawn!

Budget discussion

I was on CNBC the other day. The topic was the post-budget impact on the economy.

Quote of the day

Martin Wolf in the FT:

India’s nominal GDP grew at an average rate of 14 per cent between 2004-05 and 2009-10. That makes deficits of 10 per cent of GDP quite sustainable.

Precisely the point I have been trying to make over the years. How come India's policy-makers and analysts don't get it and go on and on about fiscal consolidation?

Wolf, incidentally, goes on to suggest that the UK vacate its permanent membership at the UN in favour of India:

Exhausted by the burden of its pretensions, the UK should soon offer its seat on the security council of the United Nations to its former colony. Its condition would be that France does the same in favour of the European Union. Whether or not such enlightened statesmanship is forthcoming (presumably not), we are moving into the age of continental superpowers. Asia will be home to not one, but two, of them.

Fiscal fundamentalism

The pundits on TV made a big deal about the stock market going up on budget day- by about two hundred points. The market had gone actually declined in the run-up to the budget and, even otherwise, movements one way or another on budget day are of no great significance when the Indian market is so closely linked to global market trends.

The big item for the market was said to be fiscal consolidation. The pundits said this had compensated for 'big ticket' reform. Other than Manmohan Singh's first budget, there has been hardly any budget that measured up on this count, so you have to wonder what it is that pundits dream about. Leaving that aside, what do we make of the achievement on fiscal consolidation in Mukherjee's latest budget?

He has budgeted a fiscal deficit down of 5.5% in 2010-11, below the 7.9% and 6.9% of the two preceding years. Some of this is automatic- the pay commission arrears don't apply, farm loan waiver has got pruned. Then, there is the disinvestment effect and the sale of 3-G spectrum, some cutting of subsidies. But, the figure of 5.5% is lower than the Thirteenth Finance Commission's recommendation of 5.7%. Besides, nominal growth for 2000-10 will be higher than the budgeted 10.2% because of higher inflation, so the fiscal deficit will be lower than 6.9% and the deficit for 2010-11 will be even lower than 5.5%.

Is this appropriate when government needs to spend a lot more- on railways, roads, education, health care, irrigation, etc? We need to factor in rising government expenditure and we need to push for a higher tax/GDP ratio- we have just edged past 10%, which is lower than even the 12% we had in 2008-09. We need agriculture to grow at 4% if growth is to be truly inclusive.

Alas, there seems to be a sense that if get to growth of 9% and we meet FRBM targets, we have reached heaven. Not at all, we need 9% growth that is sustainable and inclusive- and these conditions will be met only when agricultural growth is boosted and when we spent a lot more on the social sector. Fiscal consolidation should not be confused with fiscal fundamentalism.

Purpose of business

Why does business exist? For many the answer is obvious: to make money or, let us say, profit. But this is not a definition that is operationally useful, quite apart from the fact that it's not seen as palatable. If you say profit, is it in the short-run or the long-run? And how much profit? 'Maximisation' of profit is again not operationally useful because businesses are all the time doing that may not maximise profit in any meaningful time horizon.

If we accept that in a competitive market, business cannot make super-normal profit, then business can only make profit that is equal to its cost of capital. That is why Drucker did not accept the idea of business existing to make profit. He defined the purpose of business as: to create a customer. Only this, he argued, is operationally defensible.

FT columnist, Michael Skapinker, introduces a slight wrinkle to Drucker's definition. He says businesses, no less than people, crave for respect. He says that is what banks lost in the present crisis although here he confuses respect with trust. He says businesses exist in order to make profit and serve customers by doing things they can be proud of. Here again, I sense some confusion. Pride, respect, trust are the means to profit and customers. Are they ends in themselves? Perhaps they ought to be. You can bring out your best in people when there is pride in what they are doing.

So, here is a plausible, alternative definition of business purpose: creating customers and making profit so that people who do these things have a sense of pride and well-being. In this definition, you place the employee at the centre of things, not the customer or the shareholder. But this can only be a start. How do we tackle the measurement issues?

Don't overdo fiscal consolidation

That's the title of my latest ET column. Yes, fiscal consolidation must happen but thee's no need to rush it until a full recovery has taken place.

In the long run, we need to take a fresh look at what level of consolidation of desirable.First, we need an accutate target for the fiscal deficit, one that factors in the off-budget deficit elements as well. Secondly, the target needs to be realistic- it must take into account the very real expenditure needs that will arise in the years to come, the prospect of the Indian economy moving onto a growth trajectory of 8-9% and the ups and downs of business cycles.

My sense is that the present limit of 3% for the fiscal deficit/GDP ratio, each for the centre and the states, is not realistic.

Return of the traditional bank?

FT carries a profile of Handelsbanken, an old style Swedish bank, that is expanding in the UK branch by branch. It has 62 outlets as of today. Two things make the bank stand out:

• Its belief in the traditional branch banking model, focused on the retail branch. This means key decisions are taken by branch managers, not by the central office, and customers contact the local branch, not some call centre.
• Its belief in organic growth rather than growth by acquisition.

Its CEO, Per Boman, refutes any suggestion that the branch model is uncompetitive:

Conventional wisdom suggests such a bottom-up approach should be more costly to run than the standardised, mass market operations of bigger banks. Mr Boman insists that the opposite is true and points to returns on equity and cost-to-income ratios that compare favourably with peers. “It’s not branches that cost money, it’s the headquarters,” he says

There are lessons here for Indian banks. Many public sector banks have moved away from their
their branch model and towards centralised processing- in essence, apeing ICICI Bank. But ICICI Bank was a late entrant with limited branches and it needed to do something different to quickly attain scale. For PSBs to imitate this made little sense. Anyway, ICICI, under its present CEO, has declared that it will revert to a focus on branches. So what do PSBs intend to do?

Secondly, be extremely wary of growth by acquisition- a point I have made ad nauseum in this blog. Managing and digesting acquisitions is a tall order. It requires very high managerial capabilities, which many PSBs may not have. There is also profound truth in what Boman says about bank acquisitions:

“It’s more or less impossible to find a quality bank at a discount price. And we do not think bad banks are cheap enough.”

Slow going for NATO forces in Marjah

Operation Moshtarak ("togetherness"), Nato's most ambitious military operation in Afghanistan to date, has run into rougher weather than thought. The operation is intended to clear Marjah city in Helmand province of the Taliban. Four days into the operation, the Nato forces control only a small portion of the 155 sq mile area.

The city's total population is 80,000. Nato has committed 15,000 troops, including the famed US marines. But, with all their firepower and air back up, they have not found the going easy. The invading force has been surprised by the tactical skill and training of the other side. Moreover, the Taliban has thus far not lived up to the assumption that he will melt away in the face of the onsalught. The insurgents have shown a determination to stand and fight.

FT's correspondent has an exciting eye witness account:

Marine commanders remain optimistic that their initial efforts at establishing bubbles of security around key commercial areas will have a catalyzing effect on the population and will result in residents identifying Taliban fighters, bomb locations and arms caches.

Thus far, however, most residents seem to be opting for a wait-and-see approach. Most roads used by the Marines have been devoid of people, save for a few curious gawkers. The bazaars are similarly abandoned, some so hastily that merchants left their onions and potatoes sitting atop wooden carts.

Diluting RTI

Looks as though the government is determined to dilute the provisions of RTI. Amendments to this effect are being contemplated, Outlook reports:

The DOPT proposed seven amendments, including the addition of a clause that would define some applications as “frivolous and vexatious requests”. If introduced, this will give the public information officer liberty to reject applications. This, crucially, would increase the workload of the commissions, where final appeals are heard. The other worrying proposal is to have a bench of two commissioners for every appeal. With commissioners struggling with the present workload, this will ensure further delay. Barring two information commisisoners, all rejected these amendments outright.

You can be pretty sure that information officers will use every opportunity to dub applications as "frivolous and vexatious". The applicant will have to appeal to the CIC, which involves a fair bit of work and, these days, a long wait. This would be the bureacracy's way of denying justice- delaying justice to a point where the appellant simply gives up.

Yes, we could have a provision for "frivolous and vexatious" requests provided that the CIC is empowered to impose punitive fines where the contention is rejected. The penalties for non-compliance with the RTI provisions today- Rs 250 per day subject to a maximum of Rs 25,000- are too trivial to have any bite. Even these small penalties are challenged by large organisations in courts of law- after all, the legal expenses are borne by the shareholder, not management.

The RTI is one of the great initiatives in our post-independent history and it has the potential to transform Indian democracy for the better. Here are some suggestions to make the RTI Act more effective:

• Increase the penalties to levels where they become a deterrent- there could graded penalties in the range of Rs 1000- Rs 10,000 per day
• Impose compensation where the appellant has suffered on account of non-provision of information and also get the institution to reimburse costs of travel when it loses the case
• Make it mandatory for management of organisations to report violations and rulings against it to the Board or to the appropriate higher authority.
• Where an organisation accumulates more than a certain number of rulings against it in a specified period, impose substantial penalty

Pune blast: Al Qaeda arm claims responsibility

I haven't seen this reported in our papers yet. Asia Times online reports that 313 brigade, an arm of Al-Qaeda has claimed responsibility for the recent Pune blast. Asia Times received a message that read:

“We warned the international community to play their role in getting the Kashmiris their right of self-determination and preventing India from committing brutalities in Kashmir, especially in Badipuar, raping the women and behaving inhumanly with Muslim prisoners.

“We warn the international community not to send their people to the 2010 Hockey World Cup, IPL [Indian Premier League - a cricket competition involving international players] and Commonwealth Games [to be held in Delhi later this year]. Nor should their people visit India - if they do, they will be responsible for the consequences.

"We, the mujahideen of 313 Brigade, vow to continue attacks all across India until the Indian Army leaves Kashmir and gives the Kashmiris their right of self-determination. We assure the Muslims of the subcontinent that we will never forget the massacre of the Muslims in Gujarat and the demolition of Babri Masjid [a Muslim mosque destroyed by Hindu militants in 1992]. The entire Muslim community is one body and we will take revenge for all injustices and tyranny. We again warn the Indian government to compensate for all its injustices, otherwise they will see our next action.

"From 313 Brigade"

America's Af -Pak strategy

The US vowed revenge following the daring suicide bomb attack that killed seven CIA operatives in Khost in Afghanistan. They were true to their word. Taliban commander Hakimullah Mehsud was taken out in a drone attack.

The Americans had been after Mehsud for a while. They did not have any luck. If they succeeded recently, it must have been because of high-quality intelligence. That could have come only with the cooperation of Pakistan's security apparatus. It must have been one of those situations where, as they did following 9/11, the American told the Pakistanis: deliver or else.

If this is what happened, then American resolve and the tacit Pak cooperation do suggest that, perhaps, talk of America planning an exit at all costs, following the London conference on Afghanistan is overdone. That is because the implications of a Taliban takeover of Afghanistan are far too serious for the region- and for the US itself. The recent US-led offensive on Marjah city in Helmand province, which involves 15,000 troops, suggests that the US is not inclined to follow the line of least resistance in Afghanistance. Rather, it wants to neutralise and stabilise before it exits.

Security expert K Subrahmanyam believes that there is some misreading of US intentions and is reluctant to take the view that US will just cut its losses in Afghanistan and run:

Professional analysis of the Obama strategy will focus on what will happen in the next three months as the surge gets completed and the forces take action, instead of being obsessed with the beginning of the withdrawal some 18 months later. The latest US QDR says, "The first (objective) is to prevail in today's wars" in Afghanistan and Iraq the first time this objective has been stated in a QDR. "America's ability to deal with threats for years to come will depend...on our success in the current conflicts." In other words, the US doesn't have the option of losing the war and withdrawing from the Af-Pak area.

..........CIA director Leon Panetta said one of the greatest concerns was a possible al-Qaeda attack on the US in the next 3-6 months; the threat was the prime reason the US has undertaken to dismantle terror infrastructure. A media report recently suggested that the US National Security Council has downgraded the intelligence priority of China. The speculation is that intelligence effort is concentrated on Af-Pak. In his State of the Union speech, Obama, referring to the war, said he was no quitter. He has designated five terrorist organisations as enemies to be dismantled, disrupted and defeated. He has also warned that, when actionable intelligence is available and Pakistan does not act, the US will do so.

Fighting corruption with notes

In Tamil Nadu, an expat physics professor has come up with an unusual way to fight corruption: handing out phoney R 50 notes with a photo of Gandhi, the Economist reports:

The idea was dreamt up by an expatriate Indian physics professor from the University of Maryland who, travelling back home, found himself harassed by endless extortion demands. He gave the notes to the importuning officials as a polite way of saying no. Vijay Anand, president of an NGO called 5th Pillar, thought it might work on a larger scale. He had 25,000 zero-rupee notes printed and publicised to mobilise opposition to corruption. They caught on: his charity has distributed 1m since 2007.

One official in Tamil Nadu was so stunned to receive the note that he handed back all the bribes he had solicited for providing electricity to a village. Another stood up, offered tea to the old lady from whom he was trying to extort money and approved a loan so her granddaughter could go to college.

Well, one is all for any initiative that can make a difference. But, one should be careful not to get carried away. Such strategms may work in the case of petty corruption. For bigger things, alas, only genuine notes will do. Remember, also, that the biggest forms of corruption do not involve handing over notes, they are all about transfers to Swiss banks, giving contracts to firms run by the kith and kin of corrupt officials and politicians and so on. There is not even a theoretical possibility of fighting the real thing with tokens.

In defence of business

Business has got a bad name in recent years thanks to the collapse of financial firms and, earlier, the jailing of celebrated business leaders, such as the CEO of Enron. Businessmen defend themselves with two arguments: they have concerns that go beyond business; and they have done much to advance prosperity.

Not enough, says the Schumpeter column of the Economist. The columnist advances three better arguments in defence of business:

The first is that business is a remarkable exercise in co-operation. For all the talk of competition “red in tooth and claw”, companies in fact depend on persuading large numbers of people—workers and bosses, shareholders and suppliers—to work together to a common end......

....Another rejoinder is that business is an exercise in creativity. Business people do not just invent clever products that solve nagging problems, from phones that can link fishermen in India with nearby markets to devices that can provide insulin to diabetics without painful injections. They also create organisations that manufacture these products and then distribute them about the world.

.... A third defence is that business helps maintain political pluralism. .............Companies have a difficult enough job staying alive, let alone engaging in a “silent takeover” of the state. Only 202 of the 500 biggest companies in America in 1980 were still in existence 20 years later.

These are all plausible defences. But, it would be idle to suppose that hostility towards business exists only amongst common folk, including those who are not employed by large businesses, or by the political class. Business- or, rather, businessmen or top management- today lack legitimacy within their own firms. Many are not liked or even respected by their own employees.

One reason could be that top management walks away with a disproportionate share of pay- inequality within firms has widened in recent years. Another is that so-called improvements in efficiency come at the expense of those down the line, in the form of lay-offs or reduced benefits. Thirdly, for all the talk of empowerment and enfranchisement, management and businessmen are seen as highly autocratic

Goldman Sachs bonuses

Goldman Sachs CEO lloyd Blankfein has settled for a bonus of $9 mn this year, way below the $69 mn he made in 2007 and the $100 mn that he could have claimed but for the tide of popular anger against bankers. The firm chose to keep its bonus pool at around $16 bn which works out to $500,00 per employee. The earlier betting was that bonus plus salary would hit the $1 mn mark.

The top five employees of GS will all get $9 mn but others down the line are taking home more. But I think it's the top execs pay and the total bonus pool that matters from the PR angle- and my sense is that what GS has done has calmed down tempers a bit or at least kept them from spiralling out of control.

Not that CEO Blankfein will starve- as one commentator puts it, his bonus is down to the utterly enormous from the utterly obscene. And one doesn't exactly see a flight of talent of GS or elsewhere because of the reduced bonuses.

SBI's technological razzle-dazzle

I was in Mumbai last Sunday to attend SBI's 'Technology concert'. It was intended to celebrate SBI's achievement in core banking- some 9000 branches connected, said to be the largest in the country, and accomplished with the collaboration of TCS and Cisco.

The event itself was a technological achievement. It was held at Brabourne stadium, with around 600 invitees. Even in the dark, I could spot several bigwigs of business and finance. The show was conducted against a screen that ran for several hundred feet, the largest screen ever put up in Asia, I was told. The screen as well as the rest of the area were packed with hardware. The event was heralded with spell-binding fusion music, followed by various luminaries and SBI officials coming on screen tell us what it took to get the core banking job done.

SBI chairman O PBhatt himself anchored the event. There followed a panel discussion figuring Mukesh Ambani, Sunil Mittal, Mohandas Pai, S Ramadorai, Jeffrey Sachs and the India head of Cisco. Pranab Mukerjee delivered the chief guest's address.

Next, the stage and sky alike were lit up by a laser dance. This was followed by an electrifying Kathak dance performance by Shovana Narayan and her troupe. The execution was immaculate throughout and the effects terrific- great acoustics, fantastic colours lighting up the screen and huge flames popping up all over the stadium.

It was the sort of thing one associates with Filmfare awards nite or the Oscar awards. Certainly not something one would associate with the public sector. If the intention was to demonstrate SBI's technological prowess, the message could not have been better conveyed.

Reining in large banks

The contours of Obama's plan to deal with the problems posed by large banks are slowly taking shape. Three elements have been spelt out:

• A levy of 0.15% on banks with assets of more than $50 bn
  
• Keeping banks out of proprietary trading on their own account, hedge funds and private equity
• Limits on bank size other than the present restriction of 10% of deposits

What will be the impact on bank size of all these put together? For now, US officials say it will prevent banks from growing larger. But that is just the immediate effect. When banks find they cannot grow earnings by growing bigger, that increases the incentive to sell off some of the assets and shrink. It also creates incentives against consolidation in banking.

So, yes, a modest beginning has finally made towards serious reform of banking instead of just increasing capital requirements. My own preference is to have regulatory limits on bank assets- say, 5-10% of GDP. We may get there eventually at the present rate but I would go for it without too much delay.

Secondly, I think it may not be advisable to ask banks to eliminate risky activities such as hedge funds and private equity. Instead, we may be better off setting exposure limits. More on all this in my ET column, At last, the remaking of banks?

India's unemployable engineers

India produces more engineers every year than the US but that's not necessarily a matter for rejoicing. A large number of Indian engineering graduates are unemployable, according to a report in the Economist, which quotes a study done by an Indian firm, Aspiring Minds:

According to the company, only 4.2% of India’s engineers are fit to work in a software product firm, and just 17.8% are employable by an IT services company, even with up to six months’ training. A larger share could cope in business-process outsourcing (call centres and the like). These findings are even gloomier than the 25% figure for employability that has been bandied about since 2005, when McKinsey released the results of a survey of international companies.

For this reason, Indian firms, including IT firms, find it convenient to confine their recruitment to the top 100 colleges. But this is a soft option and one that cannot help meet Indian firms' huge demand for engineers in the coming years. The challenge is to locate the small percentage in the large pool of engineers outside the top 100 colleges that is fit for employment. Apparently, Aspiring Minds has developed standardised tests that helps locate that small percentage.

If this works to the satisfaction of employers, it will be a huge gain. There is only so much extra capacity you can create in higher education. We have to make the best of the existing capacity- locate the quality in a large pool. Next, firms must invest in training. We see this happening already in banking and insurance where, again, the demand for people is going to be huge. Waiting for colleges to produce graduates who are readily employable will mean a long wait indeed.

Management consultants and the public sector

The Schumpeter column in the Economist has interesting thoughts on the role of management consultants in the public sector. Can they contribute? The evidence is damning:

They have frequently left devastation in their wake and have treated the public sector as dumping grounds for airy-fairy ideas such as “transformation” that have been rejected by the private sector. They have built overly elaborate management structures that make it harder for people to do their jobs. And they have demotivated people who like to feel that they are working for the public good. The government has wasted huge amounts of money on botched IT projects designed by consultants. The worst example, a £12.7 billion project (in the UK) to improve the health service’s systems, has now been partially abandoned; but the Ministry of Defence is still struggling with a project that is currently £180m over budget.

But Schumpeter finds some virtues in the public sector using them:

Civil services are congenitally inward-looking organisations, led by people who are plucked from elite universities and shielded from the rest of the world in government palaces; it helps to expose them to innovations from the private sector. The private sector routinely introduces reductions in costs and improvements in performance that are almost unknown in the public sector....

......the people who are ultimately responsible for the debacles are not the hired hands but their political masters. Gordon Brown and Tony Blair were suckers for flashy but insubstantial ideas about transformation. Lower-level politicians were lazy managers. In 2006 the National Audit Office provided a devastating list of ways in which the government had failed to make the best use of consultants—ranging from failing to appreciate what could be achieved with their own staff to refusing to learn from what the consultants were telling them.

I think it's important to identify where management consultants can be useful. In specialised areas, such as IT and improvements in efficiencies in particular operations, yes, they could be useful. But, giving them a broader mandate- putting in place performance measures or incentives in government, judging the necessity of particular tasks in government- would be ill-advised. That is because the ethos of the public sector is fundamentally different from that of the private sector and it is difficult for those with a private sector orientation, such as management consultants, to appreciate the difference.

On a broader note, I would be wary of relying on outsiders for solutions. There are plenty of ideas within organisations, including government, but you have to provide opportunities for these to surface. Once a set of ideas is available, it may be useful to get an outside assessment of which make more sense.