Thursday, August 10, 2017

Foreign trained economists

Newly appointed chief of Niti Aayog Rajiv Kumar's article about foreign-trained economists exiting their plum posts in the Indian government one by one has sparked a controversy. Kumar wrote:
A key transformation taking place on the policy front in the current central government led by Narendra Modi, is that the colour of foreign influence, especially Anglo-American, on the Indian policy making establishment that came in the last few decades, is fading away. Raghuram Rajan has already left. Now, Arvind Panagariya has also announced his resignation from his post ahead of his term being completed. If Lutyen’s Delhi rumours are to be believed, more such resignations can come. In their place, we may see experts being posted who understand India’s ground realities in a much better manner, and who can commit to stay and work till their term ends.
I guess the point is not just about whether those parachuted into top positions from abroad understand the Indian ground reality well enough. There's also the question of whether they can work with the bureaucracy and Indian businesses to produce acceptable solutions to problems. Another issue is whether they have the commitment to complete their tenure. Panagariya has quite after two years because he doesn't want to lose his tenure at  Columbia. Did he not think of this when he accepted the assignment?

The problem is not confined to economists. Former IIM Bangalore director Sushil Vachani quit two years into his job when he found the ministry was not willing to relax the retirement age of 65 for him. Those hiring from abroad should make one thing clear to prospective hires: if you don't have it in you to complete your tenure, please do not accept the position.

The best part of the controversy is that it has spawned some excellent versification:

Bibek Debroy: “The foreign influence wanes, So read the weather vanes. Filthy lucre of a foreign land/ Has sullied many a hand/ And fogged the brains,” 

Sadanand Dhume: “All this is very well/ But it’s hard to sell/ as a native school/ as a gurukul/ How some manage, pray tell.”

Author Ravi Mantha, “Rushed back from distant shores / to join the rushing tide./ Stepped into manure for an uncertain tenure./ But luckily kept our foreign sinecure.”

Wednesday, July 05, 2017

Business Standard reviews my book on bank regulation

BS carries a review today of my book, Towards a safer world of banking: bank regulation after the sub-prime crisis

Options on the future of banking
Book review of 'Towards a Safer World of Banking'
Udit Misra July 04, 2017 Last Updated at 22:41 IST
Towards a Safer World of Banking
Bank Regulations after the Subprime Crisis
T T Ram Mohan
Business Expert Press
149 pages; Rs 2,396

Towards a Safer World of Banking by T T Ram Mohan, who is a professor of finance and economics at the Indian Institute of Management, Ahmedabad, is a nifty little book aimed at students of business management and bank executives. It makes sense to take a relook at the world of banking since it is almost a decade since some of the biggest banks in the financial world such as the Bank of America, the Royal Bank of Scotland, the Citigroup as well investments banks such as Bear Stearns and Lehman Brothers either failed or nearly did. Since then, governments and taxpayers have been bailing out the troubled banks in the hope that doing so would be, in the long run, cheaper than the cost of letting such entities sink. But this process has been arduous, with massive and unsavoury political and social repercussions. Not surprisingly, there is considerable interest in ensuring that
such a contagion does not recur. This book, then, is an appropriate read for anyone wanting to understand whether we have done enough to ensure that.

The book is divided into five chapters. In the first two, the author discusses the financial and banking crisis that started in 2007 and the causes for the subprime crisis. Now, there is no dearth of reasons advanced for the meltdown. In fact, depending on who you might have read and what you do for a living, you could choose from the long list of causes and not be entirely wrong. This is known as the “MurderontheOrientExpress” theory of the crisis. But therein lies a problem. Unless one can zero in on the exact problem you cannot even begin to provide a lasting policy solution. So the author helps the reader tussle with questions such as: Does an economic contraction cause a banking crisis or the other way round?

Similarly, the author analyses each of the 12 broad reasons given for the subprime crisis, such as the existence of  a housing bubble in the US and elsewhere, loose monetary policies, greedy consumers, excessive financialisation or the global macroeconomic imbalances, to name a few. But many of these factors existed in the past and in other places without causing a global crisis. For instance, there have been periods of low and falling interest rates or instances of housing bubbles in several other countries. In the end, though, the author settles for “regulatory failure” as the principal culprit. According to him, there were “serious failures in relation to banks” such as lowering of loan writing standards, a focus on trading income by holding securitised assets and low amount of equity capital in relation to assets and so on. The author takes into account the analysis by Atif Mian and Amir Sufi in their book, A House of Debt, which gives primacy to the excessive buildup of
private debt. But Professor Mohan Ram argues that this, too, only shows that the ambit of regulation should have been much broader.

The third chapter focusses on regulatory reforms since the crisis. Much has been done, from increased capital  requirements and far more stringent norms for liquidity to tighter norms for securitisation and macroprudential regulations. This has yielded results. As of 2015, in the US, for instance, the top five banks had a common equity Tier 1 ratio that was higher than that specified by Basel III and all but one bank surpassed higher  requirements imposed by the US Federal Reserve. There have been similar improvements in the Europe as well. And yet, chapter four argues, not enough has been done to deal with the key problem that still exists: Banks being too big to fail. There is growing concentration in the banking sector, which, in turn, makes the whole sector more vulnerable.

Chapter five is about solutions. The author is among those who thinks that radical and outofthebox
ideas are needed to disasterproof the banking system. Some of the ideas discussed include the “sharedresponsibility mortgages” proposed by Messrs Mian and Sufi. In such a mortgage, the lender offers downside protection to the borrower while the borrower agrees to give 5 per cent capital gain to the lender on the upside. Also discussed is the chairman of the Institute for New Economic Thinking Adair Turner’s even more radical suggestion to limit the amount of debt creation itself.

But perhaps the most unusual solution is the one proposed by the author: India’s experience with public sector banks (PSBs). These last 10 pages of the book are likely to elicit far more interest among the Indian readers who  are at present witnessing an embarrassing bloodletting in India’s PSBs. The author argues that the Indian experience, where PSBs account for 70 per cent of the banking system, as well as the Chinese setup, where similar entities account for 90 per cent of the system, are responsible for these countries being the world’s fastest growing economies.

But it is all too clear that Indian PSBs are holding back growth instead of delivering it. The author offers a spirited defence for the PSB functioning — but stops at 2013-14. That is exactly the point at which the problems starting showing up. The author’s argument that PSBs’ troubles in the past two or three years are the result of structural failings of a developing country (such as the lack of a well developed bond market) is not entirely convincing. The truth is that the deep rot in Indian PSBs highlights the risks associated with government ownership of banks.

Wednesday, June 21, 2017

Banking fragility remains an issue

A certain complacency seems to have set into the banking sector following the reforms put in place after the financial crisis of 2007. Bank managers especially think that banks are safe now, thanks to the combination of higher capital requirements and living wills. Jamie Dimon, chairman of J P Morgan Chase, typies this point of view.

I am among those who would beg to defer. Banks may be better placed than before but banking systems remains fragile. Regulators need to raise the capital requirements even further. The minimum leverage ratio (the ratio of equity to assets) for banks is general is 3%; for systemically important banks, it's 5-6%. The US Congress has a proposal which would give banks a choice of going with Basel 3 and the Dodd-Frank provisions or having a leverage ratio of 10%. The latter is indeed the way to go.

More in my EPW article, Are banks safer today than before the crisis.

Thursday, June 15, 2017

Watch it: the wrong joke could cost your your job

A joke deemed sexist has cost a board member of Uber his place on the board, FT reports. Board member David Bonderman, had to quit after he interrupted Ms Arian Huffington, fellow member on the board, with a remark that was considered inappropriate:
As Ms Huffington was telling staff that research showed boards with one female director were more likely to appoint a second, Mr Bonderman interjected: “Actually what it shows is that it’s much more likely to be more talking.”
Ms Huffington laughed awkwardly and said it would be his turn to talk soon. After the meeting, Mr Bonderman emailed Uber employees to apologise — and later announced he was resigning from the board. 

The problem, of course, is that the remark could not have been made at a worse time. The board of Uber is dealing with serious cultural issues, including issues of harassment, highlighted by a report commissioned by the board. The report has led to the exit of several senior executives and the founder and CEO, Travis Kalanick, has proceeded on indefinite leave, although it appears he will still be involved in strategic decisions and key leadership appointments.

The refreshing takeaway from the turmoil at Uber is that the world is no longer going to accept a firm just because it has a great valuation. Culture matters. Which means how you create value is also important. It's hard to beat a quote the FT carries on the subject:
“The spoiled brats of Silicon Valley don’t know the basics,” said Vivek Wadhwa, a fellow at the Rock Center of Corporate Governance and author. “It is a revelation for Silicon Valley: ‘duh, you have to have HR people, you can’t sleep with each other . . . you have to be respectful’.”

Sunday, June 11, 2017

Tech firms' cash pile

Infosys, TCS, Cognizant and other Indian IT firms have had to take tough questions from investors on the cash pile they have been sitting on for years. This pile produces low returns from investment in bank deposits and the rest. Investors think if the firms have no investment avenues for the pile, they should return much of it to investors. At long last, the tech firms have said yes.

Huge cash piles are not limited to Indian tech firms.Schumpeter points out that the top five tech firms of the world- Apple, Alphabet, Microsoft, Amazon and Facebook- are sitting on a net cash (cash minus debt) pile of $330 bn, twice their gross cash flow. This is set to touch $ 680 bn by 2020, three times their cash flow.

One reason for the cash pile is that much of it is stashed away abroad and not brought back to the US in order to avoid tax. But the tax bill by itself does not justify the cash hoard. Another reason is having to making large investments in R&D. The five tech firms spent $100 bn on investment last year. For them not to grow their cash pile, Schumpeter estimates that investment would have to rise to $300 bn. That is a staggering figure by any reckoning:
That is over twice what the global venture-capital industry spends each year. It is 51 times the annual cash burned up by Netflix, Uber and Tesla, three firms famous for being cash hungry. And it is 37 times the average annual amount of cash the five firms have in total spent on acquisitions to gain new technologies and products, such as Facebook’s $19bn purchase of WhatsApp, a messaging service in 2014, or Google’s $3.1bn acquisition of DoubleClick, an advertising firm, in 2007.

What could be the reason then for the cash pile? Schumpeter reckons that uncertainty about future profit could be a factor. The tech firms probably reckon that the cash pile may not grow as much as projected now, given that various threats could emerge. But if they do manage to add on to their cash they may diversity in a big way into cars, media or hardware firms. 

Friday, June 09, 2017

Harvard Business School sources of funds

Schumpeter, writing in the Economist, gives an interesting breakdown of the sources of funds for HBS: tuition fee (17%), executive education (23%), publishing (29%) and endowments (31%). The IIMs and other business schools should compare their own funding pattern with that of HBS and see how they stack up. The crucial thing to note is that tuition accounts for only a sixth of revenues.

The break-up for IIMA in 2013-14 (the last year for which the annual report is available) is: tuition fee (43%), consulting (22%), interest income (21%) and others (14%). It should be clear that tuition bears a much bigger chunk of the burden of generating funds at IIMA than at HBS.

Tuesday, June 06, 2017

Compelling case for the RBI to cut its policy rate

I argue in the Hindu today that the case for a rate cut is quite compelling. It's not just that CPI inflation is below the RBI target of 4%. The strengthening rupee and strong capital inflows address a concern RBI would have had even a few months ago: lowering the gap between Indian and dollar yields would cause an exodus of funds and destabilise the rupee. We don't have to worry that much about the Fed stance at the moment.

A rate cut will not just boost growth, it will help the bottom lines of banks and that of corporates- it would help address the "twin balance" sheet problem. The problem, as I see it, is that the RBI committed itself to a 4 per cent inflation target when the government gave it a flexible band of 4 plus or minus 2 per cent. Now, that's called being overzealous.

By the way, Surjit  Bhalla flays the MPC today for getting its inflation forecasts hopelessly wrong:

At its first demonetisation meeting on December 7, the MPC concluded that demonetisation was temporary and so, it should look through its effects on dampening inflation and growth. It expected inflation and GDP growth to hustle up in a “V-shaped” pattern. The reality — GDP growth has been flat at 7 per cent, inflation has followed just the first half of the V. The MPC’s post-demonetisation short-term three-month forward forecast for March 2017 was 5 per cent with an upside bias. Actual March 2017 CPI inflation — a low 3.5 per cent! Actual April CPI inflation — 3 per cent. I have searched far and wide but not found any central bank, or even an amateur economist, with such a large forecast error for a three-month projection. These forecast errors are liable to get worse.

He also points out that the RBI has moved deftly from targeting headline inflation to what he calls a "false" measure of inflation:
First, the MPC broadly hinted that it was going against its own mandate of targeting headline inflation and was now considering targeting core inflation. But most brazenly, it chose to emphasise false core inflation as its target, that is, core inflation including petrol. No central bank in the world targets false core; it seems the RBI felt it was appropriate to do so because oil prices were hovering round $55/barrel and domestic petrol prices were inflating at 18 per cent per annum. So false core was sticky at 5 per cent, as the MPC “rightly” concluded. However, no sooner had the MPC penned this excuse that oil prices (internationally and domestically) began to fall. And, along with it, false core inflation. The April CPI data, released just days after the MPC excuses on April 7, now showed even false core hovering around 4.4 per cent, having declined from 5 per cent a month earlier.
True core inflation — CPI minus food minus energy minus petrol — meanwhile continued its downward trend, 5.3 per cent in April 2016; April 2017, it registered 4.2 per cent.

That's a pretty strong indictment. It's necessary to require the MPC to publish its forecasting record- forecast inflation versus actual - every time it meets. There is a fundamental problem with the MPC mandate: the MPC has to explain if inflation exceeds six per cent but not if inflation falls below 4 per cent (unless it dips below 2 per cent which is a remote possibility). Put differently, the MPC is accountable for inflation but not for growth. There has to be a way to address this issue. A good starting point is to publish the MPC's forecasting record.