Explaining the Indian stock market's fall

Business Standard carries a report on how margin requirements contributed to the steep fall in the Indian stock market earlier this week:

According to stock brokers, the real pain in markets started with the over-zealousness on the part of stock exchanges in collecting margin money after the 700 points fall on January 18 and another 14,00 points fall on January 21.

The trading terminals of nearly 90 per cent stock brokers were shut on Tuesday when the markets hit the lower circuit of 10 per cent within a few minutes of opening bell, as the National Stock Exchange doubled the margin money overnight.

"The exchanges wanted stock brokers to pay additional margin money immediately. How can we do this when our clients' cheques take at least two days to clear?" asked a Bombay-based broker who deposited an overdue margin of about Rs 1,000 crore (Rs 10 billion) with the exchanges on Wednesday.

A payment crisis was already looming in the aftermath of the Reliance [Get Quote] Power IPO.

The call for more margin money, from stock exchanges, had a domino effect on the markets.

How far is this explanation valid? Well, increased margin requirements for brokers at a time of falling markets are always a reason for the sharpness of market declines. But, it is not as if the problem will go away if the cheque settlement system is improved.

That's because many of the investors who get into payment difficulties are those who have borrowed in order to speculate in the market. They borrow for day-trading, for IPOs and for any other investment in the stock market. They will have to sell their shares any way in order to meet margin calls. Whether the shares are sold by the brokers on whom margin demands are made or by the investors makes no difference- there will be huge sales and there will be overshooting in the market.

Theoretically, banks can provide finance to investors but they will be wary of lending when markets are in a state of free wall. As the BS report mentions elsewhere, there has to be some proportionality between margin payments made by investors and their brokers- the less stringent the margin requirement, the greater are the chances of a decline in the stock market escalating into a crash.

US crisis does not spell crisis for world economy

I have been saying this for a while now and am glad to have the formidable backing of financier George Soros, writing in the FT:

Although a recession in the developed world is now more or less inevitable, China, India and some of the oil-producing countries are in a very strong countertrend. So, the current financial crisis is less likely to cause a global recession than a radical realignment of the global economy, with a relative decline of the US and the rise of China and other countries in the developing world.

The danger is that the resulting political tensions, including US protectionism, may disrupt the global economy and plunge the world into recession or worse.

If you accept this, then it follows that what we are seeing in the Indian stock market is an over-reaction and the market should bounce back.

World Bank on brain drain

The World Bank's latest Global Economic Prospects (2008) has a section of emigration of highly skilled professionals from developing countries and its impact. Page 124 in this section has two graphs. One shows the percentage of Ph D students from various countries still living in the US after graduation. China tops with over 90%, followed by India (over 80%). Iran and Argentina also have a share of more than 50%. But a number of other countries including Brazil, Chile, Indonesia and South Korea have a share of under 50%- their doctorates prefer to return home.

Another graph alongside shows that the higher the percentage of Phds returning home, the higher is the per capita national income. But correlation, we know, does mean causality. We cannot conclude that because more Phds come back, a country will be more prosperous. It could well be that when a country become prosperous, its nationals would like to return home after studies.

I say this because the growing brain drain in recent years has gone hand in hand with an accleration in economic growth in both India and China (just as it has gone hand in hand with the decline in the quality of economists in government!). The loss of highly skilled professionals may be notional because the home country is not in a position to utilise talent of a certain order.

Moreover, once highly skilled professionals succeed abroad, they may be in a position to contribute to their parent country- remittances are an obvious way but the creation of knowledge networks and initiation of investments from MNCs abroad are other ways in which non-residents can contribute. In other words, brain drain may less of a loss than is commonly supposed.

Anil poised to overtake Mukesh Ambani

Anil Ambani is poised to overtake Mukesh Ambani as well as Lakshmi Mittal as the richest Indian, FT reports:

Anil Ambani, the controlling shareholder in Reliance Power, is set to leapfrog his brother Mukesh Ambani, as well as steel tycoon Lakshmi Mittal to become the richest Indian on the back of record investor demand for shares in his company.

.....Mr Mittal and Mukesh Ambani topped a list of richest Indians published by Forbes in November, with fortunes worth respectively $51bn and $49bn. But the value of their companies has not risen since, while Anil Ambani is creating billions of dollars of paper wealth overnight.

Reliance Power is listing just over 10 per cent of its shares at Rs450 each on the Indian stock market next month to raise $3bn. The flotation will value the company at about $30bn. Mr Ambani’s interests will be valued at about $13.5bn. He indirectly controls about 45 per cent of the company.

Interesting. When the famous spat occurred between the Ambani brothers, Anil was soon as the loser since he got a smaller portion of the assets and Mukesh walked away with the flagship, Reliance Industries. But, in the stock market, asset size is not everything. Earnings growth is what matters. Communications, finance, infrastructure- the areas that Anil inherited or is moving into are hotter areas than chemicals. They are seen as high growth areas and will attract greater interest from institutional investors, that is why Anil Ambani is forging ahead.

Bottomline for businessmen: don't be obsessed with size, think earnings growth. Go for mergers and acquisitions not if you believe it will boost earnings growth, not because you will have a larger company in your stable.

Reining in bankers's incentives

Martin Wolf weighs in on the side of those believe that incentives in banking are flawed and need to be reined in:

By paying huge bonuses on the basis of short-term performance in a system in which negative bonuses are impossible, banks create gigantic incentives to disguise risk-taking as value-creation.

We would be better off with Jupiter’s 12-year “year”, since it takes about that long to know how profitable strategies have been. The point is that a year is an astronomical, not an economic, phenomenon (as it once was, when harvests were decisive). So we must ensure that a substantial part of pay is better aligned to the realities of the business: that is, is made in restricted stock redeemable over a run of years (ideally, as many as 10).

Yet individual institutions cannot change their systems of remuneration on their own, without losing talented staff to the competition. So regulators may have to step in. The idea of such official intervention is horrible, but the alternative of endlessly repeated crises is even worse.

.....all bonuses and a portion of salary for top managers should be paid in restricted stock, redeemable in instalments over, say, 10 years or, if regulators are feeling generous, five.

Yes, locking in rewards over a long period will help as will payment in stock. If rewards are to be in made in cash, only a portion of the rewards announced for a year should be paid out; the rest should be held back over the business cycle and adjusted for losses bankers' run up. When one bank poaches people from another, the vesting period of options assumed by the hiring bank should remain unchanged.

China's economy not that export-dependent!

China is not as dependent one exports for its growth as is made out to be, according to the Economist. Investment accounts for 40% of China's growth. This won't be heavily affected by a drop in exports because over half of it is domestically driven- it has to do with infrastructure and property. It cites a research report that forecasts that a downturn in the US economy will result in China's growth slowing down from 11.5% to 10%- hardly catastrophic. The US may be more export-dependent than China- exports contribute 30% to US growth.

The high share of exports to GDP- 40%- in China may be deceptive. Exports are measured as gross revenues whereas GDP is the value added. A UBS analyst has attempted to measure China's exports in value added terms and measure these as a proportion of GDP. The ratio is much lower- 10%. This, the analyst suggests, is a measure of "true" export dependency of the Chinese economy.

I guess this reinforces my position that growth in China and India will help mitigate the effects of a US downturn on the world economy.

The price of dissent in the CIA

The Iraq war under the junior President George Bush highlighted how intelligence agencies could be pressure to produce reports that satisfied their bosses. Evidence is now emerging that much the same thing happened in respect of Pakistan's pursuit of nuclear weapons under the now disgraced scientist A Q Khan.

The Economist has a review of a recent book, The Nuclear Jihadist, that details how the US disregarded reports about Pakistan's flouting non-proliferation laws in order to secure the bomb. Worse, an intelligence agent who protested about the cover-up of the growing evidence ended up paying a heavy price:

The book's most revealing passages are about America's role in the affair. The authors argue that successive American administrations knew a lot about Mr Khan's activities, but for larger strategic foreign-policy reasons, chose to do nothing about them. Mr Khan was able to flout international rules on nuclear non-proliferation because American policymakers thought that securing Pakistan's assistance in defeating the Soviet Union in Afghanistan—and, more recently, President Pervez Musharraf's help in fighting terrorism—were more important than limiting the spread of nuclear bombs.

The story of Richard Barlow, a CIA agent who once worked in its directorate of intelligence on proliferation, sums up the American attitude. Mr Barlow had protested that intelligence was being manipulated by the Pentagon to suit the policy adopted by President Bush senior's administration of turning a blind eye to Pakistan's nuclear development. He lost his job. The authors find Mr Barlow at the end of the book denied his state pension, living with two dogs in a motor home.

World Bank optimistic on growth outlook

I have placed myself unambiguously in the optimists' camp when it comes to the economic outlook for the world in 2008- I've said that we will see a sharp slowdown in the US but not a recession and a deceleration in the world economy that will still leave emerging markets in good shape.

The World Bank takes much the same line, I'm heartened to note, in its latest Global Economic Prospects. The world economy slowed from 3.9% in 2006 to 3.6% in 2007; the Bank sees a further slowdown to 3.3% in 2008- in other words, a soft landing. Growth in developing countries will moderate only somewhat over the next couple of years- in 2008, the Bank expects growth of 7.1%. For India, the Bank projects growth of 8.4% and 8.5% in 2008 and 2009 respectively, down marginally from 9% in 2007.

The Bank does see the risk of a US recession and its impact on the rest of the world but does not appear to think this is the likely scenario. It thinks that the impact of the housing sector on the US economy will be mitigated by export growth; it also thinks that the financial markets crisis will be contained as risks are not likely to be concentrated in a few institutions.

Why neither the banking channel nor the consumption channel is likely to lead on to a recession in the US is an issue I address in my latest ET column, Liquidity, not solvency the issue.

Bankers' pay

I have written in an earlier post and in other posts about how the incentive system at banks and investment banks needs to be overhauled if recurring financial crises are to be avoided.

The problem I have been highlighting is the heads-I-win-tails- the- firms- loses syndrome. Bankers rake in bonuses when they do well. When they run up losses, it is for the firm to pick up the pieces. At the most, bankers may lose their jobs and a portion of stock options that have not vested. But they would still have the accumulated bonuses of the past to enjoy life.

I have argued that only a portion of bonuses due should be paid out in a given year; the rest should be credited to an account in which there will be entries for bonuses for profits and negative bonuses for losses. At the end of, say, five years, the balance would be paid out to managers.

I note with satisfaction that my view finds endorsement from Raghuram Rajan, former Chief Economist of the IMF. Writing in the FT, Rajan says:

Compensation structures that reward managers annually for profits, but do not claw these rewards back when losses materialise, encourage the creation of fake alpha. Significant portions of compensation should be held in escrow to be paid only long after the activities that generated that compensation occur.

Rajan also makes the point that excess returns- that is, returns in excess of that warranted by a given level of risk- are rarely achieved. What a manager claims as excess return is actually a level of return for which the appropriate risk has not been factored in. Very often, the risk shows up much later in the form of a loss, not in the year in which performance is being measured. That's why a big chunk of bonuses must be deferred.

Anti-business bias in European text books

High school text books in Germany and France take a dim view of business enterprise, says Stephen Theil, Newsweek's European economics correspondent in an article in a Foreign Policy article reproduced in FT. This, the writer says, must explains the profound mistrust towards the free enterprise economy in those countries- in France, only 36% of the people supported free enterprise in a 2005 poll and in Germany support for socialist ideals was running at a high of 47% in 2007.

Theil cites intances:

Economic growth imposes a hectic form of life, producing overwork, stress, nervous depression, cardiovascular disease and, according to some, even the development of cancer,” asserts Histoire du XXe siècle, a text memorised by French high-school students as they prepare for entrance exams to prestigious universities. Start-ups, the book tells students, are “audacious enterprises” with “ill-defined prospects”. Then it links entrepreneurs with the technology bubble, the Nasdaq crash and massive redundancies across the economy. Think “creative destruction” without the “creative”.

In another widely used text, a section on innovation does not mention any entrepreneur or company. Instead, students read a treatise on whether technological progress destroys jobs. Another briefly mentions an entrepreneur – a Frenchman who invented a new tool to open oysters – only to follow with an abstract discussion of whether the modern workplace is organised along post-Fordist or neo-Taylorist lines. In several texts, students are taught that globalisation leads to violence and armed resistance, requiring a new system of world governance. “Capitalism” is described as “brutal”, “savage” and “American”. French students do not learn economics so much as a highly biased discourse about economics.

German textbooks emphasise corporatist and collectivist traditions and the minutiae of employer-employee relations – a zero-sum world where one loses what the other gains. People who run companies are caricatured as idle, cigar-smoking plutocrats. They are linked to child labour, internet fraud, mobile phone addiction, alcoholism and redundancies. Germany’s rich entrepreneurial history is all but ignored.

I do not know how far the material in textbooks can influence and explain popular attitudes. After all, there is the mass media as well. Are the media too hostile to business enterprise in Germany and France? I doubt that would be the case because they would not be able to survive commercially if that were so. US text books, one would imagine, are not ill disposed, yet popular distrust of at least big business is widespread there.

I don't know that Indian text books have much to say either way but celebration of business is common today among the intelligentsia- so much say that many want government to vacate even education and health.

The Indian electorate has been either indifferent or negatively disposed towards a big chunk of economic reforms even though most of the media is pro-reform. People cannot be brainwashed through school text books, certainly not beyond a point. They can think for themselves. It is somewhat facile to ascribe popular attitudes in France and Germany to biases in school text books.

Priorities for the next US president

Strobe Talbott, Deputy Secretary of state in the time of Bill Clinton, spells out the priorities for the next US president in FT. It's reassuring to see that sane voices are not absent from US political discourse. But I have serious doubts as to whether the agenda that Talbott outlines has any chance of being implemented in full- the Conservative strangehold on policy-making is far too strong to permit it.

the next president should, shortly after coming into office, affirm full adherence to the Geneva and UN torture conventions, restore the right of habeas corpus for US-held detainees, and “re-sign” the treaty establishing the International Criminal Court, which the Bush administration “un-signed” in 2002..

To make up for lost time, the next administration should undertake an array of initiatives, starting with one directed to Moscow. Drastic reductions in the American and Russian nuclear stockpiles are important as an example to other countries....The US should also resume negotiations with Russia on anti-missile missiles.

....The US should work with all the current nuclear-weapon states to impose a moratorium on the production of fissile material, pending a formal, verifiable, universal and permanent ban. To attain that goal, America should join its principal allies and partners in direct, sustained negotiations with Iran and North Korea to bring them back into the NPT as fully compliant non-nuclear weapons states.

...Kyoto will expire in 2012. That means the next US president will have fewer than four years to play a decisive role in the design of an effective successor to the treaty. The US must do this through diplomacy and by example. Only if it passes legislation imposing stringent limits on itself, while offering other countries – especially developing ones – substantial incentives to be part of a global effort, will Kyoto be replaced by an accord mandating universal reductions.

Exaggerating sub-prime losses

Many expect sub-prime related losses to rise sharply. But some of the estimates appear to be on the wilder side- the figure of $400 bn, which is the upper end of present estimates, for instance.

Bloomberg columnist Jonh Barry explains why:

There are two reasons why the losses aren't likely to be so large.

First, the mortgages are backed by collateral, a house or condominium, and in a foreclosure a home typically retains significant value. When it is sold, the lender often will get 50 percent to 60 percent or more of the loan amount after foreclosure expenses.

Second, most subprime borrowers aren't going to default. Suppose even one in four does and lenders recover somewhat more than half the mortgage amount. A fourth of $1.3 trillion in subprime mortgages is $325 billion, and a 55 percent recovery would mean a loss of about $145 billion.

To reach a $300 billion loss would require foreclosures on about half of all subprime mortgages with a 55 percent recovery upon sale of the property. And a $400 billion loss would take about a 60 percent foreclosure rate with recovery of about half the value from the sale.

Credit crisis- a managerial failure?

The sub-prime crisis in the US and its impact on financial markets are seen as a failure of regulation to keep pace with innovation. Securitisation is good but we need to ensure that the risks inherent in it are properly understood and priced. Rating agencies are seen as contributing to the failure.

This is now common wisdom but it's interesting to look at the issue in managerial terms. I wrote in my previous blog about how a clever manager can emulate Mao Zedong's methods to achieve rewards not commensurate with his success. In many ways, the financial sector provides fertile ground for such managers. That's because banks are hugely leveraged. This creates huge incentives for managers to take high risks- if they succeed, there are large bonuses; if they fail, the shareholders get wiped out. Managers may lose out on stock options not cashed in but, by the time failure reflects in financial results, they will have made their pile.

John Kay has an interesting point on this in an article in FT. Managers typically go unsung and, perhaps, unrewarded when they take premptive action to avoid disaster. It is those who take calculated risks and win who get all the laurels.

Al Dunlap of Scott Paper declared his admiration for Rambo: “Here’s a guy who has zero chance of success and always wins.” But Mr Dunlap’s company was acquired by Kimberly-Clark, whose chief executive for 20 years, Darwin Smith, avoided the storm by taking the company out of the competitive coated paper businesses and into high-value-added consumer products. Mr Dunlap was a celebrity but Mr Smith is little known.

We prefer to read about Lee Iacocca and Lou Gerstner, who held the helm in the storm, or Jack Welch, ho managed the ship through turbulence largely of his own creation.

How do we deal with this syndrome? We need to encourage risk-taking, of course. But incentives for top management must be more carefully designed, as I have argued earlier, to take care of possible losses down the road than they are today. Secondly, the degree of leverage in financial firms must come down- I think this will happen in banks with the implementation of Basel II. Thirdly, the media must celebrate the triumphs of the quiet leader as often as they do those of the flamboyant variety.

Mao the management guru

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

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

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

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

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

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

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

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

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

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

Ethics or self-interest?

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

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

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


........Business is not only about accumulating wealth and glory. It is not about growth for the sake of size. It is about being a good corporate citizen. This is the model to follow for corporate India. Orient Express may come and go, but the Tatas will go on forever. So, too, will responsible Indian companies.

Das protests too much, methinks. Hostile takeovers are a means of getting rid of inefficient management and creating value for shareholders. Management will want to hang on to companies for their own reaons which may not be in the interests of shareholders. Hostile takeovers and the market for corporate control are an excellent cleansing mechanism.

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

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

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

Room for optimism about the world economy

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

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

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

The Chinese are a-coming!

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

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

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

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

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

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

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

Dangers of rupee appreciation

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

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

Central bank blitzkrieg

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

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

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

Remembering Ravi Mathai

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

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

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

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

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

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

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

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

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

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