Storm over historian article on Israel 's war against Hamas

 An Israeli professor who resides in the US has kicked off a storm by writing an article that asks Israel to stop 'weaponising the holocaust' in its conflict with Palestinians. Segal argued, as many including the UN Secretary General have, that we should not be mindful of the background to the Hamas attack on Israel, which is no way to overlook the atrocities that happened. Simply to portray Palestinians or Hamas as barbaric or as animals is not helpful:

The context of the Hamas attack on Israelis, however, is completely different from the context of the attack on Jews during the Holocaust. And without the historical context of Israeli settler colonialism since the 1948 Nakba, we cannot explain how we got here, nor imagine different futures; Biden offered us, instead, the decontextualized image of “pure, unadulterated evil.”

Segal also underlined the issue of accountability in such cases:

The history of the Holocaust also points to the importance of accountability, even as post-Holocaust accountability remained limited. In the case of Israel’s assault on Gaza, accountability needs to begin from what is very clear: incitement to genocide, which is punishable under article 3 of the UN genocide convention, even when genocide does not follow. While the debate about genocide in Israel’s current assault on Gaza will undoubtedly continue for years, perhaps also in international courts, Israeli war crimes and violations of international humanitarian law are beyond dispute.

Understandably, Israeli officials and several Jewish groups have reacted fiercely to Segal's comments.  

The important thing to note, however, is that Segal is an Israeli. There are many voices like him in Israel itself, people who do not hesitate to criticise the policies of the present government. One of the magnificent forums for the expression of dissent is the newspaper, Haaretz, that hosts the famous dissenter, Gideon Levy. It is fair to say that dissent and the tolerance of dissent in Israel is greater than in most other countries and that is an aspect of Israel that is worthy of admiration. As long as such dissent thrives, there is reason for hope. 

RBI directive to private banks on wholetime directors

The RBI has directed private banks to have at least two whole-time directors on the  board within four months. 

Establishment of such a team may also facilitate succession planning, especially in the background of the regulatory stipulations in respect of tenure and upper age limit for MD & CEO positions,” the RBI said in its notification

Of course. But we need to ask: why is it necessary for the regulator to issue such a direction in the first place? Is it not the job of banks boards to have ensure succession planning by having a couple of whole-time directors? The RBI has been nudging private banks to do so. Its directive probably reflects the failure of banks to respond suitably. It is noteworthy that public sector banks do not suffer from the malaise of having none other than the CEO on the board.

The RBI directive tells us how poor succession planning is in banks. Indeed, succession planning is poor almost anywhere in so-called professionally managed companies. No CEO wants a couple of alternatives to himself or herself around. Most succession planning is about ensuring that no successor emerges. A paper once compared the photograph of the CEO surrounded his top management team with a photo of about ten years earlier. The only constant in the two photos was the CEO! He had ensured that all others in the team had departed.

That is not unusual. Only when the CEO is about to leave or has left do boards scramble to find a successor. How pathetic!  

US regulators push for higher bank capital

 

The regulatory direction for banks is clear enough: more capital rather than less. Bankers have been pushing back for reasons that, to me at least, defy comprehension.

Bankers say higher capital will mean higher borrowing rates, lower credit growth and diminished investor interest. They are wrong. We need banks to be better capitalised in order to protect ourselves against bank failures, banking crises- loss of economic output that stretches out for several years.

It’s heartening to see that American regulators have seen the light and are pushing for higher capital norms for banks under Basel 3 regulations. 

My article in BS, Will bankers ever learn?

Will bankers ever learn?

T T Ram Mohan

Jamie Dimon, the chief executive officer of J P Morgan Chase, is that rare banker who doesn’t hesitate to take on regulators and lawmakers. He was severe in his criticism of the Dodd-Frank Act that led to stricter regulation of banks in the US after the global financial crisis (GFC).

Now, Mr Dimon has trained his guns on the Basel III “end game” rules for banks planned by American regulators. These are the final rules related to the implementation of the norms widely agreed upon after the GFC. The new rules will mean higher capital requirements for banks. While Mr Dimon may be gutsy in taking on regulators, it doesn’t   mean he’s right.

US regulators are proposing several changes in the way capital requirements are determined under Basel III. They want all banks with assets exceeding $100 billion to use standardised models, instead of internal models, for providing capital for credit risk and operational risk. For market risk, these banks will have to calculate risk-weighted assets using both standardised approach and model-based approaches and use the higher of the two. In addition, banks will have to reflect unrealised losses or gains on available-for-sale securities. These and other proposals will cause bank capital to increase, and that’s what we need.

Requiring the use of standardised models for risk assessment is a huge shift. In standardised models, risk is assessed based on the average risk experience. Under Basel II rules, which were in place until Basel III came into force, the focus was on capturing risks specific to a bank using Internal Risk-Based (IRB) models. Banks that effectively managed risk would end up having a capital requirement lower than that required under standardised models, resulting in a higher return on equity.

Only banks that could demonstrate the robustness of their risk models would qualify for use of the IRB approach. The very fact that a bank had been approved for the use of the IRB approach signalled to the markets its superior prowess in managing risk.

Regulators are now having second thoughts on the use of IRB models. During GFC, it turned out that many of the banks that used IRB models just did not have the necessary capital to cope with losses. In drawing up the Basel III norms, regulators judged that placing too much reliance on IRB models was unwise. They decided to supplement the earlier capital requirements with a simple leverage ratio, defined as Tier I capital to total assets, of 3 per cent. This translates into a debt-to-equity ratio of 33:1. If this seems an absurdly high level of leverage, remember that banks were even more leveraged earlier.

With the latest Basel III proposals, American regulators are changing tack. They would rather not rely on banks’ internal models at all. They aim to do away with internal models for credit risk and operational risk and play safe with models for market risk. The Reserve Bank of India (RBI) has been moving towards estimating credit loss based on IRB models. It may now want to revisit the proposition. 

The underlying principle driving the new US proposals is simple enough: For banks, more equity capital is better than less. Mr Dimon opposes the move based on arguments we have been hearing from bankers for years now. Two American academics, Anat Admati and Martin Hellwig, have devoted a whole book to showing up the fallacies in these arguments (TheBankers’ New Clothes).

Mr Dimon says more equity capital will translate into higher lending rates for borrowers. This is based on the premise that equity is costlier than debt, especially when we take the tax shield   for debt into account. In banking, that is true only because bank debt is hugely under-priced.

Lenders to banks know that a large bank will not be allowed to fail (“too big to fail”) and are willing to lend at a lower rate than would be dictated by the level of debt. There is thus an implicit subsidy received by banks considered “too big to fail”.  This is a cost that is borne by the taxpayer. It is only when we ignore this implicit subsidy in bank debt that it appears as cheap as it does today. To ignore this is to pave the way for more bank failures and bailouts by taxpayers.

Mr Dimon also contends that investors find bank stocks unappetising if capital requirements go up and return on equity falls. That is not true either. The share price of a bank is a multiple of the price/earnings ratio (P/E) and earnings per share (EPS). Higher equity requirements tend to cause the EPS to fall but they result in a higher (P/E) ratio as investors perceive banks with higher equity as safer and re-rate bank stocks with higher equity capital.

Which of the two effects above will dominate? Bankers seem to think it is the (P/E) effect that will dominate and result in higher valuations. What else can explain the fact that the capital adequacy ratios at the best-performing banks have raced far ahead of the regulatory minimum?

In the US, capital adequacy at an International Monetary Fund (IMF) sample of banks averages over 16 percent, while the requirement stands at around 11 per cent for most banks and slightly higher at 16-17 per cent for very few large banks. The averages in the UK, Switzerland and Sweden are 22, 20, and 23 per cent, respectively. In India, private banks operate at a capital adequacy of 19 per cent, even though the regulatory requirement is just 12 per cent. If higher capital is going to cheese off investors, how do we explain the fact that banks with higher capital than average also command the highest valuations?

Bankers must be aware of this, so why do they set up a howl every time the regulatory requirement goes up? One explanation put forward is that bankers are paid bonuses based on return on equity. The solution, then, is for boards to change the metric for performance awards from return on equity to return on risk-adjusted capital.  Allowing a high level of debt so as to show higher return on equity is certainly not the solution

The regulatory trend is in the direction of increasing capital requirements for banks. That is good for both banks and the economy. The question is: Will bankers ever gracefully accept this reality?

Central bank autonomy

This is now an old debate. But it's worth getting the perspective of Y V Reddy on the subject in India Forum. 

Reddy begins by noting that the RBI is a full service bank. It appears that bank regulation was added to RBI's mandate down the road along with various functions:

The important functions of the RBI include issue of currency, monetary management, banker to banks and the government, management of public debt, and management of foreign exchange reserves. Over a period, it has subsumed and assumed powers to regulate money, securities and foreign exchange markets, regulation of banks and non-banks and payment and settlement systems. In serving the public good, the RBI has traversed a long distance and faced many challenges. In the process, it has evolved into a full-service institution encompassing regulatory and developmental roles in the financial system, besides partnering with union and state Governments as their fiscal advisor in domestic and external sector policies.

Reddy gives the arguments for and against central bank autonomy. For autonomy:

The first is what is called time inconsistency. Essentially, it means that the time horizon of democratically elected government is short-term and hence they may favour growth over price stability. However, on matters relating to money, actions have to be taken keeping a long-term view. The central bank is expected to take a longer-term view......There is a second reason: that there are political cycles and there are business cycles, which do not coincide. For instance, elections will encourage politicians to have expansionary policies at that time... The third reason is that governments have a tendency to spend more money than appropriate and some limits have to be put on the spending. These can be put in the Constitution. This can also be enforced by independent central banks.

Against autonomy:

There is no democratic legitimacy for a technocratic body to decide on the important matter of money...Second, the independence of central bank may result in friction between fiscal and monetary authorities. Third, a central bank may 'impose' its outlook and preferences on the people, contrary to democratic preferences.

The tricky question is how to enforce accountability. Reddy gives some suggestions:

They should provide regular reports on their policy decisions and the economic outlook and be subject to external audits. Transparency helps build credibility and public trust in the central bank's actions. 

I have advocated external audits for all autonomous government institutions, including RBI. But hardly any of it happening.  It happens rarely and when it does happen, it is perfunctory.

Moreover, central bank autonomy can be largely in respect of the conduct of monetary policy. On various other matters that the RBI handles, such as bank regulation, foreign exchange and management of public debt, there has to be close consultation with the government. Autonomy cannot be sought across the entire range of a full-scope central bank's activities because ultimately the government is accountable for outcomes in a way in which the central bank is not.

  

NATO will give Ukraine arms but no membership

The NATO meeting at Vilnius in Lithuania failed to produce the outcome that Ukrainian President Zelensky was looking for. Zelensky is desperate for NATO membership because that would automatically confer on Ukraine the defence cover that NATO nations are entitled to.

The US and others are in no mood to oblige. They refused also to commit to a time-frame for Ukraine to get NATO membership. There was only a vague promise to consider NATO membership once Ukraine had met “conditions” that were left delightfully unspecified. What NATO Secretary General Jens Stoltenberg spelt out would be of no comfort to Ukraine:

We will provide support to Ukraine for as long as it takes. Because unless Ukraine wins this war, there's no membership issue to be discussed at all.

NATO clearly does not want to be drawn into a direct conflict with Russia because it knows very well that that could lead on to a nuclear exchange. What NATO is happy to do is to continue to arm Ukraine as much as it can. Ukrainians will perish in large numbers in a war that Ukraine cannot win. But Ukrainian lives will help bleed Russia militarily and economically. There is a fond hope in Western capitals that a prolonged war may create enough discontent in Russia to dislodge President Putin. That hope has been belied in the past eighteen months.

It looks as though the stalemate in the conflict will continue. The Ukrainian forces will hurl themselves at Russia in a counter-offensive that produced little thus far. The Ukrainian army has not been able to cross the buffer zone and reach the Russian defense lines. Fresh supplies of arms are unlikely to materially change the situation. More Ukrainian and Russian lives will be lost while NATO cheers from the sidelines.

The problem is that matters may not end there. There is always the risk of a serious provocation from the Ukrainian side. That will draw a severe response from Russia. We cannot be sure that the escalation will not then draw NATO into direct conflict with Russia – with perilous consequences for the world at large.  

C Rangarajan and India's economic reforms

 C Rangarajan was one of the principal figures in the making of India’s economic policies from the 1980s onwards. His memoir, Forks in the Road, should be compulsory reading for those who want a deeper understanding of the reform process.

It will interest IIMA students and alumni to know that Dr Rangarajan was a professor at the Institute for more than a decade and a half. He was at New York University School of Business (now Stern School) when Ravi Matthai, the then director, offered him a job at IIMA.

Dr Rangarajan’s course in Macroeconomics was hugely popular with students. He was entrusted with the task of launching IIMA’s doctoral program. In 1981, he was appointed Deputy Governor of RBI. Thereafter, there was no looking back.

Dr Rangarajan went on to don several hats: Member, Planning Commission; RBI Governor; Chairman, 12^th Finance Commission; Chairman, PM’s Economic Advisory Council. He was also Governor of two states and member, Rajya Sabha. A life of rich accomplishment!

My review article on the book in BS today.

It's behind a pay well, so here is the full text:

FINGER ON THE PULSE

 The ideas of economists

 Former RBI governor C Rangarajan’s memoir is a testament to the crucial role economists can play in shaping policies and people’s lives

T T Ram Mohan

Do economists matter? Can they make a big difference to public policy? Economists will find answers that are gratifying in Forks in the Road, the memoir of C Rangarajan ( ‘Ranga’ to old-timers at IIM Ahmedabad, with which he had a long association in its formative years). Yes, they do. And, yes, they can make a big difference to public policy, provided they can get political masters to align with their thinking. 

Dr Rangarajan’s memoir is about the economic events and decisions in which he was an active participant for nearly three decades, starting in the early 1980s. He wore several hats: Deputy governor and governor of the Reserve Bank of India (RBI); member of the Planning Commission; chairman of the Twelfth Finance Commission; and chairman of the Prime Minister’s Economic Advisory Council (with Cabinet rank). Somewhere in between were stints as governor of two states and member of the Rajya Sabha.

Unlike most memoirs, Dr Rangarajan’s is less about himself and more about issues. It is replete with tables and statistics. But it doesn’t just tell us what transpired. It examines the alternatives that were open to policymakers and explains why a particular course was chosen and what outcomes followed. The result is a fascinating piece of economic history. 

Dr Rangarajan joined the RBI in 1981. As deputy governor and governor (with a break in between), he dealt with two of India’s biggest balance of payments (BoP) crises,  the overhaul of monetary policy and banking reform. 

The first BoP crisis, in 1981, was handled largely within the then economic paradigm. Yet, operating  within the paradigm, Dr Rangarajan and his colleagues at the RBI managed a steady depreciation of the rupee in both nominal and real terms. They were very clear that it would be difficult to manage the current account deficit without boosting exports and curtailing imports.  The economists at RBI seem to have had a free hand in managing the exchange rate even before the reforms of 1991. 

Another significant reform in the 1980s arose from the Sukhamoy Chakravarty report of 1985. Following the report, monetary targeting or setting a money supply target consistent with output growth and prices came into vogue. This was the first attempt to tackle “fiscal dominance” over monetary policy. Here again, the political authority went along with the recommendations of the economists. 

The BoP crisis of 1991 required far more drastic measures. An immediate step was the raising of a foreign currency loan by pledging some of our gold reserves. The Chandra Shekhar government gave the go-ahead, and the Narasimha government that followed raised no objection. Again, a steep depreciation in the exchange rate of the rupee was required. This was done in two stages with the approval of the government. Yet another win for economists.

The achievement of the time, as is well known, was the radical break with the past that finance minister Manmohan Singh pushed through. Dr Rangarajan highlights the three significant breaks that are now part of economic lore: The dismantling of licenses, the reduction in public ownership of business enterprises, and the move away from the inward-looking trade policy of the past. All of this was possible only because of the backing of the political authority. Dr Rangarajan notes wryly that Narasimha Rao was able to rally his party behind him by talking of “continuation” in economic policy when there was really a break. At the time, Dr Rangarajan was at the Planning Commission.

Returning to the RBI in the early 1990s, Dr Rangarajan set in motion reforms in monetary policy and banking at a breath-taking pace. The phasing out of ad hoc Treasury bills; market-determined rates for government borrowing; the dismantling of the administered structure of interest rates in banking; the reduction in  the Statutory liquidity ratio and cash reserve ratio; licensing of new private banks; and a great deal more was done. The chapter is titled “The beginnings of autonomy” but  but the freedom given to the professional economists at RBI was not inconsiderable.

In the management of the external sector, the RBI worked closely with the finance ministry. Far-reaching reforms happened: Foreign institutional investors were allowed into the Indian stock market; foreign direct investment (FDI) norms were liberalised; and the exchange rate became largely market-determined. The framework for management of external capital flows was put in place. There was clarity that long-term equity flows should be preferred to short-term debt flows. These and other measures taken at the time have since become pillars of Indian economic policy. 

On all these, the political authority had no difficulty in heeding solid professional advice. There must have been occasions when the economists couldn’t quite have their way. Perhaps those occasions were not so consequential. At any rate, there is little indication in the memoir of any serious confrontation between economists and the government. On the major issues of policy, once the politicians had decided on a fundamental change of course, they didn’t interfere with the work of economists. On lesser, more technical matters, they always left it to the professionals to do what was required.

The big area of failure for economists has been the fiscal deficit or the savings-investment balance. Dr Rangarajan highlights the point in his concluding chapter, “Ruminations”, where he ponders the long-term outlook for the economy. Over the past three decades, it is an issue that has not proved amenable to the persuasions of economists, no matter what the complexion of government. We have since arrived at times when the global consensus on keeping public debt relatively low has been undermined. Economists themselves seem resigned to greater levels of public debt than they have been comfortable with in the past.

Not pushing through “big-bang” reforms— such as aggressive privatisation, including bank privatisation, land acquisition, and the freedom to hire and fire labour — is seen as a big political failure. Dr Rangarajan doesn’t seem to think so.  He makes little mention of these. “The reform regime,” he writes, “will be incremental in character. It has to be”. That is also the political consensus on reforms.  

Working quietly within the system, Dr Rangarajan was able to make a difference. His place as one of the principal architects of economic policy from the 1980s onwards is secure. For his compelling chronicle of the economic history of the period as much for his many contributions, he deserves a bouquet of the choicest roses.

Rethinking fiscal rules

Public debt ratios have risen since the Covid shock as governments sought to cushion the impact of the shock. Global debt to gdp averaged 96 per cent in 2021. The average for advanced economies was 120 per cent. In 2008, after the Global Financial Crisis, the numbers were 64 per cent and 79 per cent.

The general view, articulated by the IMF, is that the rise in public debt was inevitable and desirable. But… it needs to be brought down quickly. That is, of course, the received wisdom taught in all Macroeconomics courses, namely, the lower the public debt, the better.

It is refreshing to hear a different view from Andy Haldane, former Chief Economist of the Bank of England. Haldane makes two interesting points. One, over centuries, global debt to gdp has tended to rise as governments respond to the need to create more and more public goods. Two- and this is very interesting- even as public debt has risen, the interest costs have fallen. Not quite what you the Macro course would tell you.

How do you explain these? Well, public debt is used often to create assets. These assets generate streams of income over time that can service the debt. So lenders to government look, not just at the debt, but at the assets that the debt creates. What matters thus is not public debt per se but net worth of government, that is, assets minus debt.

Recognising those assets would give us a measure of the true net worth of the government. Just as a company or household would look at their net worth when making investment choices, so too should government. Countries with high net assets have been found to have lower borrowing costs. Bond market vigilantes target poor ancestors, not borrowers.

Moral of the story? The need to create important public goods remains, perhaps, including those relate to climate change. No need to panic over rising debt levels- focus on debt sustainability. As long as debt creates productive assets, physical or human, chances are debt will be sustainable.

 

India's growth prospects in FY 2023-24

 

Growth projections for India for FY 24 show wide divergence.

•  The RBI Governor recently threw his weight behind the RBI forecast of 6.5 per cent
• The Chief Economic Advisor estimates growth at 6-6.8 per cent with downside risks being greater, meaning growth will be closer to 6 than to 6.8 per cent
•  The IMF has scaled down its growth forecast for India to 5.9 per cent
• Dr C Rangarajan, former Chairman, PM’s Economic Advisory Council, thinks we will end up with 6 per cent
• Many private sector forecasters see growth below 6 per cent, some peg it close to 5 per cent  

What do we make of these forecasts? I guess much depends on whether or not the downside risks materialise. A big one is an escalation in the conflict in Ukraine. Another is further bouts of banking instability in the US and elsewhere. The IMF mentions several other downside risks: higher than expected real interests at a time when debt levels are high; stickier inflation; sovereign debt distress in emerging and developing economies (already seen in Sri Lanka and Pakistan); faltering growth in China; greater retreat from global integration.

The IMF estimates that the probability of global growth going below 2 per cent in 2023 is 25 per cent- this has happened only five times since 1970. (The IMF’s baseline forecast is for 2.8 per cent). That will happen if many of the downside risks materialise. 

My guess is that we will be lucky if India’s growth rate exceeds 6 per cent in FY 24.  

Interpreting Karnataka poll results

 

 

We are seeing all commentaries about the decisive victory score by the Congress in the Karnataka Assembly polls. We need to be careful in interpreting the results. Going by the seats secured by parties in elections, we know, can be deceptive. Small swings in votes can result in disproportionate changes in seats won.

A better gauge of a party’s popularity is vote share. The BJP vote share in Karnataka remains what it was in 2018- 37 per cent-, going by this article. It appears that the BJP lost marginally in some areas, gained massively in Bengaluru and held on to its vote share in the coastal regions. The marginal losses in some places sufficed to change the outcome in terms of seats. What brought about the small change in votes in areas where the BJP lost needs to be analysed.

It does seem that the theories for the outcome that are being put forward- polarisation gone wrong, developmental story winning, leftist orientation of Congress going down well, etc- are premature. We need a rigorous analysis of the outcomes in various regions to tell a convincing narrative.

 

FRB review of the failure of Silicon Valley Bank

The US Federal Reserve Board has published a review of the failure at SVB. The lessons are pretty straightforward. Regulation and supervision have to get tighter. Boards have to do a better job. Managerial incentives need to be aligned to risk-adjusted returns, not nominal returns. With respect to boards, I would add: we need an overhaul of the mechanism of independent directors- we can’t leave it to promoters and CEOs to decide who the ‘independent’ directors should be.

The RBI may want to commission a similar review of the failures at IL&FS and Yes Bank. Regulators unilaterally subjecting themselves to public scrutiny is good for good for the regulator’s credibility and standing- and good for bank stability in the long run.

My article in BS, Anatomy of a bank failure

Anatomy of a bank failure

A radical change is necessary in the appointment of independent directors in India in light of the extensive failures in oversight and management of banks in the US

 

T T RAM MOHAN

 

Silicon Valley Bank (SVB) and its holding company, Silicon Valley Bank Financial Group (SVBFG), failed last March. This resulted in the immediate failure of Signature Bank and, with a lag, of First Republic Bank. More mid-sized banks may follow.

 

The US Federal Reserve Board (FRB) has been quick to commission and publish a review of the failure of SVB. Even more creditable, the review pulls no punches in apportioning blame. The bank’s management failed. The board of directors failed. The supervisor failed. Regulations turned out to be inadequate. Everything that could go wrong went wrong.

 

The Fed review should be compulsory reading for bankers, bank boards, regulators and supervisors. The report will help drive home an important point: It is futile to expect “market discipline” by itself to take care of banking stability.

 

Let us begin with management and board failures. SVBFG’s assets tripled in size between 2019 and 2021. Deposits flowed in. The technology sector was booming, so lending expanded rapidly. Any growth in loans that is way above average loan growth in the sector is a recipe for trouble, a point often lost on managements as well as boards. Management does not have the bandwidth to assess risk properly. Internal controls and systems cannot keep pace with runaway growth.  Reliance on volatile wholesale deposits tends to increase. 

 

Managerial incentives are often linked to profits without adjusting for risk. For CEOs, the temptation to quickly grow the loan book is irresistible. The onus is on the board of directors to apply the brakes.  Rarely does this happen. Boards tend to be mesmerised by CEOs who show dazzling performance for a few years. They find it hard to tell a performing CEO, “Sorry, this is not on.”  

 

At SVBFG, the board was not even responsive to supervisory warnings. The FRB report remarks acidly, “Moreover, the board put short-run profits above effective risk management and often treated resolution of supervisory issues as a compliance exercise rather than a critical risk-management issue.” That could be said of many boards. 

 

Starting in July 2022, SVBFG failed its liquidity stress tests repeatedly. Management moved to increase funding capacity but the necessary actions were not executed until March 2023 when it was too late. Management chose to mask liquidity risks by changing the stress test assumptions. 

 

Interest rate risk too was poorly managed. The bank had breached its interest rate risk limits on and off since 2017. Instead of reducing dependence on short-term deposits, management fiddled with assumptions about the duration of deposits. Hedges on interest rate risk were removed in the interest of boosting short-term profits. Management was massaging earnings by hiding the underlying risks. The Risk Management Committee of the board should have picked up these lapses. It failed to do so, again not a huge surprise. 

 

The supervisors did not cover themselves with glory either. For governance, SVBFG got a “Satisfactory” rating, despite repeated supervisory observations about inadequate oversight.  The bank had large, uninsured deposits that were volatile, yet managed a “Strong” rating on liquidity. Despite breaching interest rate risk limits repeatedly, it got a ‘Satisfactory’ rating on the item.  Clearly, supervisors in the FRB set-up were hard to displease. Banks in India must pine for such a supervisor; they find the Reserve Bank of India (RBI) almost impossible to please. 

 

What accounts for these supervisory failures? The report says joint oversight by the FRB and the 12 Federal Reserve Banks is a factor. The Board delegates authority to the Reserve Banks, but Bank supervisors look to the FRB for approval before making a rating change. Getting a consensus is time-consuming. 

 

But that was not the only reason. In 2018, heightened supervisory standards were made applicable only to banks with assets of more than $100 billion. Moreover, supervisors were under pressure to reduce the burden on banks and to exercise greater care before reaching conclusions or taking action

 

Finally, there were the failures of regulation. The Dodd-Frank Act, passed after the Global Financial Crisis (GFC), provided for stiffer prudential standards for banks above a threshold of $50 billion. In 2018, the Act was amended to raise the threshold to $250 billion. For banks in the range of $100-$250 billion in assets, the Fed was given the discretion as to what standards to apply. When SVBFG reached the threshold of $100 billion, it was subjected to less stringent regulations than would have applied before 2019. Had the dilution in regulations not happened, SVBFG would have been compelled to enhance liquidity and capital before it was too late. 

 

The problem is fundamental. The philosophy of “light touch” regulation and supervision hasn’t quite lost its hold on the US system. Multiple regulators and supervisors are another problem. There is also the “revolving door” syndrome -- regulators join private banks, then jump back to the regulator in a senior capacity. The relationship between regulator and banks is too cosy for comfort, which may explain the kindness shown to SVB. 

 

The RBI, as your columnist argued last month, is well ahead of the regulatory and supervisory curve in the West. Its intrusive approach is a better safeguard for banking stability than the light touch elsewhere. However, supervision can only be a third layer of defence against bank instability. Regulations are the primary layer, followed by the board. The RBI must find ways to get bank boards to do a far better job.   

 

A radical change would be to alter the way independent directors are appointed at banks. At present, the promoter or CEO has the dominant say in the appointment of independent directors (at both private and public sector banks). The RBI may want to insist that, for instance, one independent director be chosen by institutional investors and another by retail shareholders (from a list of names proposed by the Financial Services Institutions Bureau). Until we have independent directors who are distanced from the promoter and management, it’s unrealistic to expect board oversight to improve. 

 

The RBI is hosting a conference for bank directors later this month. Here are two suggestions.  One, in the interests of transparency and accountability, the RBI may want to commission a review of the failures at IL&FS and Yes Bank. Two, it may prescribe the FRB’s review of SVB’s failure as one of the “readings” for the conference. It may also include the report of the UK's Financial Services Authority on the failure of Royal Bank of Scotland during the GFC. At least, bank directors can’t say they weren’t warned.

 

 

 

 

Whom does the current bout of inflation the West hurt?

The rise in inflation in Western economies has caused a massive transfer of wealth from savers to investors, contends Adam Tooze in an article in the FT. 

Higher inflation means the nominal debt to nominal gdp ratio goes down as the denominator rises on account of inflation. The denominator has risen also because of the rebound in real output post Covid.

Borrowers, namely government and corporates gain, but savers lose. The poor face higher inflation and a loss of jobs. Tooze thinks this can lead to explosive discontent. 

I am not so sure. The only net debt in an economy is government debt (corporate and household borrowings are from other household savers, so the net borrowing on these two counts is zero). So whoever has invested in government debt is a loser. The rich are losers and also the middle class. But the poor are not investors in government debt. They are net borrowers, hence stand to gain from the real value of their debt getting eroded. If inflation can be quickly reined in, they could emerge as beneficiaries from the current bout of inflation. 

The notion that inflation hurts the poor is common. Higher prices mean a higher cost of living. True. But this effect could be overwhelmed by the erosion the value of debt that the poor carry. 

 

Crisis? What crisis?

 Last November, there was talk of a serious external accounts crisis staring in India in the face. Maybe, not as bad as the one in 2013 but still pretty bad.

The current account deficit, analysts said, could exceed 3.5 per cent of gdp for FY 23. The rupee would be above Rs 85 to the dollar, could even touch Rs 90. It was futile for the RBI to expend dollars to support the rupee- better to simply let the rupee fall and exports do the trick.

Well, less than six months on, little of that has come true. The current account deficit has narrowed and may end up at under 2.5 per cent of gdp, a comfortable position for us. The rupee is trading in the range of Rs 82-82.7. Foreign exchange reserves are at an eight month high of $579 bn.

Lower commodity prices are a factor. Another is that world economic growth has turned out to be better than forecast, with the US escaping a recession in 2023, again contrary to many forecasts. India's gdp growth for FY 2023 is projected to be slightly below 7 per cent

No sign of any crisis, eh?

Recent bank failures

 The question pops up again: what was the board of directors doing at the spectacular bank failures we have seen recently?

An article in FT is informative. Only one of SVB's directors had banking expertise and he didn't sit it on the Risk Management Committee (RMC). The bank's RMC included a director with considerable experience in the premium wine industry. SVB did not have a Chief Risk Officer (CRO) for months and when the CEO appointed one, it was considered a big enough achievement to be a factor in his outsized bonus. At Silvergate Bank, the CRO happened to be the son-in-law of the CEO.

Questions need to be asked also about governance at Credit Suisse as it hurtled from one scandal to another over several years. Even if they are, we are unlikely to get lasting answers. It does seem that the board of directors of a company is amongst the most unreformable institutions in the world.

Consulting as the Big 'Con'

 

Mariana Mazzucato made a huge splash with her book, The Entrepreneurial State. She argued that there are high-risk, breakthrough ideas such as the Internet that could never have happened with massive funding of the initial creative work. In an interview with FT, she takes on consulting firms, the McKinseys, BCGs and the rest.

Her point is not the usual one about consulting firms not adding much value: as the old chestnut goes, a consultant is somebody who looks at your watch and tells you the time. No, her point is more nuanced. She says that governments are becoming too dependent on consulting firms for ideas. As a result, governments are taking enough responsibility and doing worthwhile work. In the process, the civil services are not attracting the brightest.  

I don’t think that’s true of the IAS. The beauty of India’s competitive exams is that the talent pool is so incredibly large that when you are looking to fill, say, 150 slots out of half a million applicants, you are bound to get incredibly good talent. The IAS, in my view, still gets some of the best talent in the country. But that could also be because our government hasn’t developed the UK sort of dependence on consulting firms! Or, there is so much of work to be done in government that if even if you farmed out work to consultants, there would be a great deal left for government to do.

Four trends that will impact the Indian economy

 

I identify four broad economic trends from which there is no escape for the Indian economy:

1. Government capital expenditure will drive the economy in the medium-term.

2. 2. High fiscal deficits are here to stay.

3. 3. Inflation will be higher than before

4. 4.  Self-reliance and import-substitution are a reality

The macroeconomic outcomes that we can realise will be constrained by these four trends.

More in my BS article, Four economic trends that will impact India.

Four economic trends that will impact India

There are four broad trends that will impact the Indian economy in the years to come. The Budget for 2023-24 affirms these trends.

1. Government capital expenditure will drive the economy in the medium-term: The latest Economic Survey underlines the fact that government capital expenditure has risen from a long-term average of 1.7 per cent of gross domestic product (GDP)in the period FY09 to FY20 to an estimated 2.9 per cent of GDP in FY23. The latest central Budget expects capex to rise to 3.3 per cent of GDP in FY24.

 

This points to an inconvenient fact: Private investment has remained sluggish and the government has had to compensate. The behaviour of private investment is not unique to India. It is part of a trend that is seen in emerging and developing economies (EMDEs). As the World Bank’s Global Economic Prospects (2023) points out, investment growth in EMDEs in 2022 remained about 5 percentage point below the 2000-21 average, and nearly 0.5 percentage point below in EMDEs excluding China. 

 

The World Bank does not see private investment returning to the level suggested by the pre-pandemic trend through 2024. It lists several factors responsible for the slowdown in investment growth in EMDEs: Slower output growth in 2010-19; lower commodity prices; lower and more volatile capital inflows to EMDEs; higher economic and geopolitical uncertainty; and a substantial build-up of public and private debt. Many of these factors apply to India.  

 

The government sees a sharp rise in capex in FY24 as boosting output growth. This overlooks the fact that the fiscal deficit is projected to decline by 0.5 per cent of GDP in FY24. We have a withdrawal of stimulus, something that is contractionary in nature. 

 

True, the composition of expenditure has shifted even more towards capex, and this is expansionary. But this effect can overwhelm the contractionary effect of a fiscal deficit decline only if the rise in capex is greater than the decline in the fiscal deficit.  In  the budgetary projections, the rise in capex is 40 basis points whereas the decline in the fiscal deficit is 50 basis points. The net effect will, therefore, be contractionary

 

2. High fiscal deficits are here to stay: Analysts cheered the finance minister for sticking to the fiscal deficit of 6.4 per cent for 2022-23, and projecting a fiscal deficit of 5.9 per cent for 2023-24. The figure for 2023-24 is a budget estimate. If the Ukraine conflict escalates and the global situation worsens, government subsidies (which have been pruned in FY 2023-24) will rise and we could be back to square one. We must also expect sops to be rolled out in the run-up to elections in 2024.  

 

The fiscal situation can be turned around in a fundamental way only if the tax-to-GDP ratio goes up significantly (say, above 12 per cent of GDP) or if capital receipts from disinvestment rise significantly or both. On either count, the outlook is not promising. The tax-to-GDP ratio   is estimated at 11.1 per cent for 2023-24.  The peak in the past decade has been 11.4 per cent.  

 

As for the proceeds from disinvestment, the Economic Survey notes that total proceeds from sale of equity in public sector units (PSUs) amounted to ~4 trillion in the eight-year period from 2015 to January 2023, or an average of ~50,000 crore in a year. Strategic sales have yielded a mere ~69,412 crore in the entire period. It does look as though the Fiscal Responsibility and Budget Management target of 3 per cent will remain a distant dream. 

 

After the global financial crisis and then the pandemic, we are seeing a rise in government deficits and public debt everywhere. India is no exception. If anything, the rise in debt to GDP ratio from 81 to 85 per cent between 2005 and 2021 looks modest in comparison with the increases elsewhere-- 66 to 128 per cent in the US; 39 to 95 per cent in the UK; 26 to 72 per cent in China; and 69 t 93 per cent in Brazil. India’s public debt position looks even better when we take into account the fact that 95 per cent of the liabilities are domestic, and we have the growth-interest differential working in our favour.

 

3.Inflation will be higher than before: High fiscal deficits can be expected to translate into high inflation. That apart, de-globalisation will happen in a greater or lesser degree. The movement may be gradual, but the direction is clear enough. 

Globalisation was about procuring goods and services at the lowest cost from almost anywhere in the world. Princeton historian Harold James noted recently that there is a historical pattern of globalisation driving disinflation. Alas, it appears the trend towards globalisation is now being disrupted.

Post-Covid and post-Ukraine, every country is reassessing its extent of dependence on outside suppliers from a range of goods and services. The US and its allies are determined to reduce dependence on China to the maximum extent possible as the containment of China has become the West’s strategic priority. 

There has been serious academic discussion in the US about revising upwards the inflation target of 2 per cent so that monetary policy has more room for manoeuvre in the downward direction. In India, the inflation target of 4 per cent threatens to become largely notional. We would be thankful now if inflation falls below 6 per cent.  

4. Self-reliance and import-substitution are a reality: For the reasons cited in (3) above, “make at home” will gain in importance. This will be especially important for leading economic and military powers. As India moves towards becoming the third largest economy in the world with matching military clout, a lurch towards greater self-reliance is inevitable. We need not be unduly apologetic about this trend: We are only falling in line with a worldwide trend. The adjustments in tariffs in the recent Budget, analysts have noted, are aimed at helping domestic industry.

It’s no use bemoaning the trend towards protectionism in various economies, including India. It makes no more sense instead to make a success of schemes such as Production-Linked Incentives. We must find ways to limit abuse of discretion in industrial policy. We need to monitor the effectiveness of the PLI scheme using appropriate metrics. Industrial policy will be integral to economic policy in the years to come.

 Macroeconomic outcomes in the coming years will be governed by the four trends outlined above.