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REFLECTIONS ON FREE MARKET

ECONOMY, CAPITAL MARKETS, BANKING, FOREX MARKETS AND GOVERNANCE

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REFLECTIONS

ON

FREE MARKET

ECONOMY, CAPITAL MARKETS, BANKING, FOREX MARKETS AND GOVERNANCE

GRK Murty

ICFAI BOOKS

THE ICFAI UNIVERSITY PRESS

REFLECTIONS ON FREE MARKET ECONOMY, CAPITAL MARKETS, BANKING, FOREX MARKETS AND GOVERNANCE
Author: GRK Murty 2006 The ICFAI University Press. All rights reserved. Although every care has been taken to avoid errors and omissions, this publication is being sold on the condition and understanding that the information given in this book is merely for reference and must not be taken as having authority of or binding in any way on the authors, editor, publishers or sellers. Neither this book nor any part of it may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, microfilming and recording or by any information storage or retrieval system, without prior permission in writing from the copyright holders. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. Only the publishers can export this book from India. Infringement of this condition of sale will lead to civil and criminal prosecution. First Edition: 2006 Printed in India Published by

The ICFAI University Press 52, Nagarjuna Hills, Punjagutta Hyderabad, India500 082 Phone: (+91) (040) 23430 368, 369, 370, 372, 373, 374 Fax: (+91) (040) 23352521, 23435386 E-mail: info@icfaibooks.com, icfaibooks@icfai.org, ssd@icfai.org www.icfaipress.org/books ICFAI Editorial Team: Editorial Co-ordinator Editors Visualizer Designers : : : : K Krishna Chaitanya R V Harnoor and C V Ramaswamy S Ganesh S Hari Krishna Reddy and B Yugandhar

ISBN: 81-314-0387-4

ABOUT THE AUTHOR


GRK Murty, a postgraduate in Agricultural Sciences is currently working for The ICFAI University Press, as Managing Editor. Earlier, he worked at AP Agricultural University, Hyderabad for six years and later with Bank of India for 27 years. He has published 45 papers in Science, Banking, Management and Insurance journals. He has also presented papers on Banking and Insurance at National and International seminars. He has authored two books Soft Skills for Success and Currency Market Derivatives. He has to his credit three edited books: Forex Markets: Exchange Rate Dynamics; Derivatives Markets Vol. 1; and Infrastructure Projects Current Financing Trends. He is the Consulting Editor for The ICFAI Journal of Bank Management. He can be reached at grkmurty@hotmail.com, grkmurty@icfai.org

In reverence for my brother Dr. G Venkatramaiah, MS (Ortho) my arch-educator.

CONTENTS

Foreword Preface SECTION I

I V

ECONOMY
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. Growth: The other side Reservations: Where are we heading? Prof. Galbraith, the visionary Budget 2006-07 Japan: Back to Normal? Higher education: Why not private participation? End of green (span) years for economy? Must learn fast, and act faster A true zentrepreneur! 3 7 13 17 21 25 30 35 39

Commodity price uncertainties: Role of derivatives 44 100% FDI in real estate: Is it enough? Can India stitch its textile industry in time? Indian agriculture at crossroads Flapping wings of a butterfly in China make the world sneeze? 49 53 58 63

15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30.

Sri Lankan economy: It has a lesson to teach us We get petrol from the benevolence of oil companies? No stifling of growth, please! FDI in insurance: Thats what the economy needs, baby! Is India shining amidst dark clouds of fiscal profligacy? FTA or no FTA, industrial competitiveness alone matters ECBs or FIIs: Which is more good? Cancun or globalization: Whose somersault is it? Why poor LIC, why not post office? Why & how macroeconomic policies work and work on us? Isnt it ironic? Walk the talk Oh! me? no way To disinvest or not to. Interest rates under deregulated regime and market dichotomy Why is gold still good as gold? CRR reduction-package: Is it really all that?

67 71 75 79 83 87 91 95 99 103 107 112 116 120 125 129

SECTION II

CAPITAL MARKETS
31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. Sense and sensex Its all politics of economics! Thundering in the Indian skies? Samvat 2062 Transaction tax: No more deals, please! IPOs rating: What for? Imperfect information! Imperfect competition! Imperfect markets! No contrarian fund: Only contrarian investors, please! Nothing will come of nothing Indian hermeneutics of suspicion Investment sans trading nirarthakam? Clarity-driven regulatory intervention alone makes sense Who is hedging who? Socially responsible investing no more a fad Stock market behaviour: A method in madness 135 139 143 146 151 155 160 164 168 172 176 180 183 188 193

SECTION III

BANKING
46. 47. 48. 49. 50. 51. 52. 53. 54. Recent rise in undesirable consumerism: Credit to credit cards? Central banks trilemma Here again PSBs are in the news, of course for a good cause! GTB fiasco: A new lesson for the market economy? Is RBI a big brother or a helping hand? Shining NPAs: A reflection of national character? Queering flat pitch/curve Out, lazy banking & in, resilience Reserve banks duvidha? 201 206 211 216 221 226 231 236 240

SECTION IV

FOREX MARKETS
55. 56. 57. 58. Capital account convertibility: Is India ready for it? Who is great: God or the economist? Forex reserves and infrastructure investment: Strange bedfellows? Forex reserves for domestic investment: A bold move 247 252 257 262

59. 60. 61. 62. 63. 64. 65. 66.

Wrestling to manage the swamp of plenty? Blossoms sadder than tears on griefs eyelids Hail thee, Jalan and thy rustic wisdom! What does an appreciating rupee mean? Is rupee strong enough to go in for Euro-loans? Do forex reserves serve those who only stand and wait? Mere expression of exuberance and abundance? Can removal of regulations build a market for swaps?

266 271 276 279 282 286 291 295

SECTION V

GOVERNANCE
67. 68. 69. 70. 71. 72. 73. 74. Indo-US nuclear agreement: The road ahead We all have to act on it! Indo-US nuclear deal Religion vs. ghastly acts of the angry apes Clause 49: A step towards good governance India Pharma Inc.: What is in store? PV: The prime minister who empowered his colleagues to dissent Our quarrels are ours, their ends none of our own 301 306 311 316 321 325 330 335

75. 76. 77. 78. 79. 80.

Thank you, Anil Ambani! Solving negotiation problems Self-regulation, the obvious panacea Silence of lambs Individual interests vs. public good Anandame jeevita makarandam Index

339 344 347 351 355 359 365

PREFACE
It is about four years ago that the Consulting Editor of Portfolio Organizer mooted the idea of my writing a regular column for his magazine. I just wondered at the suggestion and forgot, but not the editor. He kept on reminding me and ultimately, being coerced into it, I was to ponder over it, of course with a lot of trepidation. Ultimately, I stumbled on a template: to pick an event from the market and analyze its dynamics the antecedents, its impact, likely future scenario, and its theoretical underpinnings in about 1200 to 1300 words. The exercise was repeated month after month in the two publications of the ICFAI University Press Portfolio Organizer and Treasury Management. In short, that is the genesis of this book. Selection of columns for inclusion in the book is based on the philosophy that they can endure, though dated. The selected articles are arranged under five heads: Economy, Capital Markets, Banking, Forex Markets and Governance. None of them is edited afresh, with the intention of retaining the originality of reaction to the events considered. And to keep the readers interest alive, they are sequenced in a descending fashion in terms of month and year.

VI

In analyzing these events I have very liberally drawn on the wisdom of many intellectuals of the world as available from books, magazines, periodicals, research papers, newspapers, etc. And it is very difficult to thank them all individually, except to say that but for their wisdom the book would have not been what it is. Many of my colleagues have helped me in bringing out this book. Notable among them are Prof. G Kumara Swamy Naidu, the then Consulting Editor of Portfolio Organizer and Prof. K Seethapathi, Consulting Editor, Treasury Management who have gently nudged me into this writing and I thank them for their encouragement. I am grateful to my professor Dr. S S Prabhakar Rao who has obliged me by going through some of the manuscripts. My sincere thanks are due to Sri R V Harnoor, for kindly going through the manuscript and offering his excellent inputs. I also thank Sri Koshy Verghese, Director, ICFAI Books and his team, particularly Sri K Krishna Chaitanya and Sri C V Ramaswamy for their excellent co-operation in publishing this book. I sincerely thank my colleague Sri S Hari Krishna Reddy for his tireless patience in typing these articles. I am highly thankful to Prof. B Ramesh Babu, Adjunct Professor, The ICFAI School of Public Policy, Formerly, Sir Pherozeshah Mehta Professor of Civics and Politics, University of Bombay, who has graciously acceded to my request to write a foreword, by patiently going through the manuscript and then penning those beautiful words. I remain grateful to him. Lastly, my sincere thanks are due to Sri N J Yasaswy, Founder Member and Member of Board of Governors, ICFAI, who has provided me space and encouragement to express myself, but for which this book would not have seen the light of the day. GRK Murty

SECTION I

ECONOMY

ONE

Growth: The other side


An economic growth rate of 8% is fine. Equitable distribution of its fruits through well-targeted aid and good governance is still finer!

cursory glance at what the Indian corporates had accomplished in the fiscal 2004-05 reveals certain intriguing features, besides reaffirming that India Incorporate had the tenacity, though its competitiveness was earlier constrained by governmental actions, to face global competition with lan and put up a bright show. During fiscal 2004-05, the top 500 companies of India Inc notched up an impressive combined net sales figure of Rs.12,78,159 crore an increase of 19% over the previous year testifying to the booming economy. Not surprisingly, it was the old economy companies (interestingly, many of them are the Public Sector) that occupied the higher echelons of the best 500 list. Oil Companies have contributed as high as 31.43 per cent to the total net sales of the top 500 companies, followed by sectors such as banking, IT, pharma, and automobile industries. Though the performance in fiscal 2004-05 is quite in line with the average annual growth rate of 6 per cent that we have been witnessing over the last 15 years, we cannot afford to be oblivious of the emerging other side of the growth.

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Our growth is essentially of a bi-polar nature. Even today we have around 31% of population living on less than US $1 per day. Around 81% of the population is living below US $2 per day as against 45% in China, 22% in Brazil and 0% in Japan and the US. On the other hand, according to a 2006 survey carried out by Barclays Capital, the wealth management firms will be holding or managing an estimated $256 billion for Indian clients, which incidentally is almost half the GDP of the country. The report also reveals that for the affluent class, China will be the largest market in Asia with an estimated $93 billion, followed by Korea and India with $50 billion each. The latest world wealth report makes similar revelations: India has 70,000 high networth individuals, with financial assets of over $1 million. Interestingly, the number of the super-rich is growing in India at the rate of 14.6% which is twice the world average of 7.3%. The spread of wealth across the country can be gauged from the fact that almost two million new two wheelers and one million four wheelers are sold every year. All this only indicates how skewed our wealth distribution is. Amidst plenty, we have half of our population living in poverty. We are no doubt a super-competitive country at least in sectors such as IT, where our software companies are known to provide solutions to the best of multinationals. At the same time, we also have a great chunk of population reeling under illiteracy, poor healthcare, and undernourishment. Accretion of wealth is thus highly uneven. No wonder if all this makes India a country of contrasts. The lousy infrastructure that we are living with is another example of contrasts. On the one hand, our software companies transmit complex data of trillions of bytes via undersea cables at the click of the mouse while on the other, it takes hours for a rider of a Maruti, Indica or Benz to inch forward on the choked roads of Mumbai, Bangalore or Hyderabad. We have a national highway network of 1,24,000 miles

Growth: The other side

as against 8,70,000 miles in China and most of it is of two lane, with poor or no maintenance. According to one estimate of Morgan Stanley, India hardly spends around $2.5 billion a year on building roads while China spends more than $25 billion a year. Owing to the poor port infrastructure and bureaucratic interventions such as customs, it is estimated that it takes 6 to 12 weeks for the Indian goods to reach the US, while it is hardly 2 to 3 weeks from China. Similarly, the cost of power is much higher in India vis--vis China. All these constraints mean that businesses in India pay more than what their competitors in China pay for producing goods, and that makes Indian goods that much less competitive in the global market. The World Bank index of cost-ofdoing-business places India at the 116th position in a list of 155 countries. Indeed, one section of the world market still considers us as a country of licence raj. With the advent of globalization, we have been experiencing a boom in the service industry, mainly arbitraging on our human capital. More and more countries are realizing the hard-working nature of Indians as a means to cut their costs while being sure of productivity enhancement. Thus India became the hub for Business Process Outsourcing (BPO) and Knowledge Process Outsourcing (KPO). Incidentally, the outsourcing industry has become the major employer of the market. The availability of jobs in BPO and KPO segments resulted in higher consumption leading to increased demand for retail credit which in turn fuelled further consumption. This whole virtuous circle of jobs creating demand and demand creating jobs made an interesting revelation: our source of competitive advantage in both BPO and KPO is simply the availability of quality manpower in the required quantities. Now, the threat is that this advantage may not last long unless we maintain a minimum standard of education. The curriculum needs to be upgraded in line with the industry

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requirements with professional training as mandatory under every course. The focus of education must be moved away from theoretical discourse to implanting problem-solving analytical skills, team learning skills, team working skills, team decision-making skills, etc. Unless the country produces quality manpower we would not be able to move up in the value chain. Indeed, we may not be able to face even the emerging competition from countries like China which are investing heavily in upgrading human skills. And all this calls for huge investments in the educational sector. If we have to sustain whatever growth our corporate world has registered, and at the same time keep the negative fallouts of the free market economy under check, we, taking a cue from the developed countries like the US and Germany which are known to spend considerable share of their GDP on public expenditure, must make political choices quickly. We must use the wealth created to provide healthcare, education and social security to the teeming population. We must create basic infrastructure that fuels growth further. As the Prime Minister stated at some conference, we have to make an investment of $150 billion in the infrastructure development in the next seven to eight years. We must re-engineer our educational system to churn out employable graduates in the fast-changing technological world of tomorrow. Corporates too canand need tochip in in this whole exercise of creating a more inclusive brand of capitalism by incorporating previously excluded voices and simultaneously delivering economic, social and environmental benefits, all in one go.

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Reservations: Where are we heading?

TWO

Reservations: Where are we heading?


The current move to increase reservations from 22.5% to 49.5% in IITs, IIMs etc., if viewed in the backdrop of globalization, is sure to undermine national interests.

verything in this world has an expiry date: aspirin of Bayer, VS Naipaul of literature, Ramanna of BARC, Dilip Kumar of Bollywood, Lata Mangeshkar of the world of music, even communism in Russia, but not the reservations of India. The recent announcement of the ministry of HRD proposing to create reservations for Other Backward Classes (OBCs) to the extent of 27%, in Central educational institutions including the Indian Institutes of Technology (IITs), Indian Institutes of Management (IIMs), Central Universities, etc., and the consequent reactions of the society would corroborate the statement. It is averred that the present proposal is an outcome of the 93rd Constitutional Amendment Act, though it has only an enabling clause to offer such reservations; it is not mandatory. The impact of the proposal could be gauged from the fact that 4500 odd seats that are on offer in the seven IITs under the merit category, would now stand reduced by a whopping 1200 seats.
May 2006.

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It is further feared that the government may extend quotas to private educational institutes, foreign universities operating from India and even private businesses for employment. This has raked up a fresh debate nationwide. Reacting to the proposals, Mr. Ratan Tata, Chairman of Tata Sons, as quoted in The Hindu, said: Though I do not want to comment on it, it (reservation) is bad In some way it will tend to divide the country into different groups. That aside, the current move, unlike yesteryears propositions, merits critical examination from the perspective of the ongoing globalization process, which is an altogether different ball game of economic pursuits that the country is engaged in. As Edward S Herman observed, globalization, as an ideology, connotes freedom and internationalism. It helps realize the benefits of free trade, and thus comparative advantage and division of labour. It is supposed to enhance efficiency and productivity. It is therefore both an opportunity and a risk. It is an opportunity when one can master the craft of doing business at increased levels of efficiency. On the other hand, if the economy is plagued with inefficiencies, there is no greater risk than globalization. It has ushered in the era of changing paradigms: a move away from financial capital to intellectual capital; horizontal/ vertical to virtual and time-tested procedures to innovation. In a globalized economy, businesses, while competing for a share in the highly competitive markets, essentially look for qualified knowledge workers for improving their product differentiation. This automatically calls for excellence in the educational system. The function of the education system then becomes more of generating employable graduates, which means admission of students on merit rather than on any other consideration. Klein Lawrence, while analyzing the economic growth in China and India, identified the intervention of bureaucracy as the obstacle to Indias continuing economic expansion. He opined that in the highly competitive global

Reservations: Where are we heading?

economy, slow reaction movement will hold back many potential players, and India should reconsider the place of class-society in future development. According to the Nasscom McKinsey Study 2005, India faces a potential shortage of skilled workers for IT and BPO industries in the next decade. According to it, at present only about 25% of technical graduates and 1015% of general college graduates are suitable for employment in the off-shore IT and BPO industries respectively. That being the quality of students our educational system is turning out today, what the plight will be after the proposed regulations is anybodys guess. The seriousness of the problem can be gauged from what Nasscom has recommended: one, to set up focused-education zones to improve the quality of higher education and to deregulate higher education in stages over the next 5 to 7 years and shift to a largely demand-based funding system for colleges and universities, and two, for industry to pilot skill development programmes in over 2000 colleges by 2010. That being the reality, it is needless to say that the present move to increase the reservations to 49% is sure to jeopardize national interests in the long run. There is a gnawing fear that reverse discrimination resulting from reservation policies, which has all along been simmering under the lid, is likely to become open and vocal, in a knowledge economy. This would only get further aggravated by the present move to increase the quotas. Secondly, the denial of entry into an institute of excellence owing to the increased quotas despite the applicants credentials, that too, for an individual who is not responsible for what the lower castes have been subjected to in the past, is being perceived as unfair by the deprived lot and is sure to cause intense resentment and this is sure to impact economic pursuits of the society adversely. IT is Indias unique competency in the global market. If we have to retain this lead and leverage on it for future growth, the industry can

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hardly afford anything other than excellence in skills-profile of its work force. Reservation policies which enable a less skilled person to walk over a competent person to grab a job, is bound to shrink the competency levels across the organizations making businesses less competitive. This phenomenon, whether we like it or not and desirable or undesirable, is quite certain to challenge the current reservation policies as we march further into globalization. Indeed, this fact is well reflected in what Mr. Azim Premji, Chairman of Wipro, said at his companys annual meeting: We appreciate the compulsions of the government. But we are an organization which needs to select people on merit. We compete with global companies and are primarily in the services business, which is highly people-dependent. Under the threat of being punished for inefficiencies in a globalized economy, the businesses will go all out to attract talent from any corner of the globe, and may even recruit non-Indians for leveraging on diversity while functioning at multi-locations. Such overseas recruitments are sure to go up as a consequence of the current move on reservations. This emerging reality has another dimension placing together highly endowed and poorly skilled employees in a team that is assigned the task of, say, development of a software package, simply derails it, for the highly talented individuals resent the presence of the poorly skilled, considering them as a drag on the teams performance. Such poor hygiene at work places pulls down the overall efficiency of the businesses. Fearing this, businesses are resenting reservations as is reflected in the comments of Mr. Ratan Tata, Chairman of Tata Sons, and Mr. Rahul Bajaj, Chairman of Bajaj Auto Ltd. There is of course a flip side to globalization: It widens the gap between the highly endowed sections and those who are socially disadvantaged. Over it, if businesses, which have of late become the prime employers, stay focused on talent/merit, the plight of weaker

Reservations: Where are we heading?

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sections is bound to worsen further. This may generate social unrest and may even threaten the very social fabric. And this cannot be arrested through mere reservations, for it caters to a minuscule of population. So, the state should activate use of its power and responsibility towards the ends of protecting citizens against economic adversities and ensuring a certain standard of prosperity to all. It should work towards eliminating discrimination and reverse discrimination from the society. Such unison of energies is only possible when the government provides the means to acquire the essentials of life to the less endowed, which alone encourages them to re-brand with newer skills for seeking employment. The state should create trampolines that offer the cushion for all those who get laid off by the businesses or fail to get employment for want of new skills. As a part of the proposed trampoline architecture, it must also create community vocational training centres, that can retrain those who lost their jobs and make them re-employable. Psychologists have something different to say: cognitive skill development is influenced to a great extent by the quality of care that a child receives during its early phase of growth. Therefore, well designed intervention in terms of balanced nutrition, facilitating mental hygiene, etc., launched in the early phase of child growth matters more than quotas, later. The government should simultaneously strengthen elementary education on priority. Today it is said that the government spends around Rs.3000 per child per year, by way of running a poor quality primary school system. Instead, why should it not encourage private initiatives to establish quality schools and run them on a template that ensures infusion of analytical skills? The government can even experiment issuing a voucher of Rs.3,000 in favour of parents to encourage them to choose a school of their choice, and thus make them accountable for their childrens quality education. It is time we implemented the 1986 National Educational Policy without further loss of time.

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Our schools and colleges must be made to allocate time and grades to students in order to encourage them to undertake social work to better the lives of the less endowed, so that such interactions would build a right mindset at the right age among the youth for cultivating the concept of social inclusiveness, besides eliminating acrimony between the haves and the have-nots. Similarly, companies must volunteer to let their employees go out and work for the welfare of the less endowed for a specified period and the same must be taken cognizance of while appraising their performance. It is time companies walked beyond resenting reservations and exhibited a sense of social responsibility by undertaking various skill development activities for people in areas around their workplaces and made them employable. Thus, it is not reservations that the government should aim at, but develop human capital in partnership with corporates.

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Prof. Galbraith, the visionary

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THREE

Prof. Galbraith, the visionary


The most loved American of Indians and in his death India lost a good friend.

rof. John Kenneth Galbraith, an iconoclastic economist, a teacher, a diplomat, above all a visionary who empathized with mankind, died on April 29, at the ripe age of 97. He was a Keynesian and a protagonist of political liberalism and progressive politics of 20th century America. His faith in governments ability to build a welfare state reflects in many of his speeches, in which he forcefully hailed the role of government planning as opposed to economic freedom. It is his articulations such as, The market cannot reach forward to take great strides when these are called for To trust to the market is to take an unacceptable risk that nothing, or too little, will happen that surprisingly made the lanky and angular at 6 feet and 8 inches, yet imposing personality of an AmericanJK Galbraith a darling of many young and old Indians of 60s. Its a different matter that today many may accuse India of having not taken that risk of relying on market, and ending up as a permit-licensequota-Raj; but no one can deny the need for governments to create safety-nets, more so in todays globalized economy.
May 2006.

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Prof. Galbraith spent almost seven decades of public life as a bureaucrat, a diplomat, or as an adviser to many presidents or fearlessly firing cannons at Washington from Harvard as its Professor. His passion for and understanding of political liberalism can well be gauged from what he said about Franklin D. Roosevelt: A singular feature of Franklin D. Roosevelt was his pragmatic accommodation to whatever needed to be done. If you ever hear a politician say, Im going to adhere strictly to principle, then you should take shelter because you know that you are going to suffer. His longing to be free from dogmatic ideologies and doctrinaire politics while researching for answers to political and economical questions is well reflected in his statement: Under capitalism, man exploits man. Under Communism it is just the opposite. Prof. Galbraith, true to his iconoclastic nature averred that classical economic theory was true to the eras of poverty but not to the present, when the economy has moved into an age of affluence warranting a completely new economic theory. He argued: if the individuals wants are to be urgent they must be original with himself. They cannot be urgent if they must be contrived for him. And above all, they must not be contrived by the process of production by which they are satisfied one cannot defend production as satisfying wants if that production creates the wants. Being disturbed by the widening gap between the richest and the poorest and fearing that it can one day threaten the very economic stability of a country, Prof. Galbraith desired that the state should invest in parks, transportation, education, and such other public amenities. He lamented the back seat taken by education, literature or the arts in measuring the human advance vis--vis production of automobiles including Sports Utility Vehicles. Prof. Galbraith abhorred war, for in his opinion it represents the decisive human failure. He argued against the Vietnam and Iraq wars. He said: wars are a major threat to civilized existence and a

Prof. Galbraith, the visionary

15

corporate commitment to weapons procurement and use nurtures this threat. His concern and empathy for mankind and his international vision are rightly reflected in what he wrote in the guardian two years before his death: civilized life, as it is called is a great white tower celebrating human achievements, but at the top there is permanently a large black cloud. Human progress dominated by cruelty and death. It is, perhaps, to drive away that black cloud farther and farther, he wrote more than 48 books spanning across politics, economics, memoirs and novels. His writings, to quote the New York Times, are known for: his customary clarity, eloquence, and humor that cuts to the heart of what economic stability means (and doesnt mean) in todays world and lays bare the hazards of complacency about economic inequality. Here it would be educative for us to hear from him as to what writing means to him: one extraordinary part of good writing is to avoid excess, next is to be aware of the music, the symphony of words, and to make written expression acceptable to the ear. Never to assume that your first draft is right And it is only in the second and third and fourth drafts that you really escape the original pain and have the opportunity to get it right. I do not put that note of spontaneity that my critics like into anything but the fifth draft. That prodigious labor made him one of the most gifted writers tumbling the tribal gods of both left and right. Prof. Galbraith is considered a great epigraphist a sample of which can run as: money is a singular thing. It ranks with love as mans greatest source of joy. And with death as his greatest source of anxiety. Over all history it has oppressed nearly all people in one of two ways: Either it has been abundant and very unreliable, or reliable and very scarce. This epitomizes his belief that there are no propositions in economics that cant be stated in clear, plain language. There just arent.

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His unusual world vision can be safely traced to his student days at University of California at Berkeley a hotbed of radicalism that awarded him Ph.D in Agricultural Economics, which, to quote him, shaped a certain tendency to question the official wisdom that he later termed conventional wisdom. Driven by a faith that social science should be tested by its usefulness, Prof. Galbraith pursued that stream of economic thought which Thorstein Veblen from Stanford labeled as exoteric knowledge knowledge related to practical application instead of the esoteric knowledge which is more concerned with mathematical expressions, econometric niceties, etc., that have a tendency to leave the real world alone. His immense faith in the power of the conscientious individual to act against the tyranny of the corporate power made him less of an economist and more of a mixture of sociologist, political scientist and a far-sighted writer. This side of Galbraith has no doubt attracted criticism from the likes of Prof. Milton Friedman: Galbraith believes in the superiority of aristocracy and in its paternalistic authority, he proposes that consumers wants be decided by those with higher minds. Friedman asserts that many reformers are averse to a free market. The great trilogy of widely read and highly influential books American Capitalism that pointed out the loss of perfectly competitive model; The Affluent Society which contrasts the affluence of the private sector with the squalor of public sector; and The New Industrial State which accuses The mature corporation that enjoyed the means for controlling the prices at which it sells as well as those at which it buys penned by him, brilliantly profiling the America of their time, are sure to keep the legacy of Prof. Galbraith alive for generations to come.

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Budget 2006-07

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FOUR

Budget 2006-07
It has, for good, become a non-event though it has certain interesting provisions.

he way Indians, Indian businesses, Indias media, and its politicians reacted to the budget 2006-07 stands out as unique. It simply made the budget a non-event. Is it a reflection of the maturity that Indians and Indian democratic institutions have accomplished in the last 50 odd years of independence? If so, nothing like it, for it reflects the confidence Indians have in themselves and their faith in their democratic institutions. It only reaffirms that India has come of age Indians are today silently but resolutely telling themselves: we can manage our affairs; we no longer look at others including the Government, to micro-manage our lives and its affairs. It is now up to the leadership to not only take this new-found confidence forward but also use it as a platform to build a new India whose atmospherics permit every citizen to explore his full potential. Now, coming to the budget per se, though the media acclaimed it as a budget that didnt tinker with the ongoing economic growth process by doing any wrong, we must admit that Shri Chidambaram
March 2006.

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did work for creating the right atmospherics, at least on two fronts: one, he made an attempt to exhibit a sense of commitment to fiscal discipline, and two, kept his budget compassionate despite severe fiscal constraints. As for his commitment to fiscal discipline, he projected a fiscal deficit of 3.8% as against 4.1% of GDP for the current year. This perhaps augurs well for the nation to ultimately catch up with the targeted fiscal deficit of 3% by 2008-09. However, the projected revenue deficit of 2.1% as against the current 2.6% is not all that encouraging, though it must be admitted that it is on the right track. Looking at the research findings of Smt. Indira Rajaraman, RBI Chair Professor at NIPFP, which reveal that the increment in fiscal and revenue deficits in pre-election years over the last 30 years was found to lie between 0.7- 0.9% of GDP, one cannot refrain from saying that the proposed reduction under revenue deficit sounds insufficient as in the remaining two years the Government has to achieve a reduction of more than 1% if the Government were to catch up with the FRBM Act by 2008-09 which incidentally happens to be the pre-election year. But, for the time being, it sounds encouraging, particularly when we take note of the elections that are in the offing in a couple of important states. The other significant element of the budget is the allocation of resources to certain key programmes such as rural employment guarantee, rural health mission, rural roads, Sarva Shiksha Abhiyan, that signifies a major effort towards bettering the life of the common man. Although the experiences with public expenditure under such programmes has so far been quite bitter, allowances must be granted, for the present administration is aiming at increasing the accountability and efficiency of the delivery channels by focusing more on program approach than on project approach.

Budget 2006-07

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There is yet another interesting provision in the budget. After all, we cannot afford to forget that there are almost 700 million Indians living in 6,00,000 villages, for whom agriculture continues to be the mainstay of life. Despite all the technological advancement that todays India can gloat about, Indian agriculture is still dependent on the vagaries of monsoon. Besides irrigation, the other major constraint for Indian agriculture is timely availability of credit, which even today continues to be a daunting task for every farmer. No civilized Indian could afford to ignore the fact of erratic behaviour of the monsoon coupled with the burden of credit causing insurmountable woes to the farming community as reflected in the suicides by farmers from time to time. Against these ground realities, the budget proposal to make short-term credit available to the farmers at 7% per annum is a welcome feature. The significance of this otherwise none-too-important provision in the budget gets manifested when one juxtaposes the prevailing interest rates of 10% and above on crop loans given to a farmerwho is known to trade on todays grains by sowing them in open fields for tomorrows more outputalong with the interest rates of around 7.5%-8.5% prevailing on car loans and other consumer loans given to the urban elite. The Finance Ministers idea of giving subvention to ensure its effective implementation is again laudable. Well! The orthodox purists may on this score accuse the government of intervening in the interest rate administration mechanism. But the truth is, neither the present prescribed interest rate of 7% under short-term crop loans, nor the intention of supporting its implementation through budgetary provision is not out of the market context. The prevailing interest rate on deposits up to two years in banks is hardly 4.5%. As against this cost of funds, a rate of 7% on crop loans is sure to take care of banks operating cost. So, whatever subvention the government has

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proposed is perhaps meant for only bolstering banks profits. As against this, it is a well-known fact that banks have been heavily subsidizing corporate loans during the last 3-4 years by fixing interest rates on deposits at negatively returning rates. There is yet another positive side to this provision: it goes well with the proposition of the Finance Ministers reliance on growth for eradicating poverty. Ever since reforms were initiated, India did realize commendable economic growth, but it was more of a bipolar nature which is likely to cause more resentment among those sections that are left out of the growth. There is, thus, a great need for an all inclusive model of budgeting to ensure least resistance to market-driven economy and that precisely is what this provision has accomplished. The cut in duties on small cars is another positive attempt which may generate more demand and, in the process, make India a hub for small car manufacturing, which if realized, is certain to create more secondary employment opportunities that in turn can give a gentle push to consumption. It is altogether a different matter that a simultaneous rise in the duties on cars other than small could have not only further strengthened this argument but also paved the way for easing the congestion on the roads. Nevertheless, all this does not matter so long as the citizens are confident of managing themselves and the Government refrains from micro-managing peoples affairs as it has done in this budget.

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Japan: Back to Normal?

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FIVE

Japan: Back to Normal?


A move of Bank of Japan from Liquidity targeting to Interest rate targeting may unwittingly challenge the asset prices elsewhere in the global markets.

he Sun is at last rising, albeit slowly, or so it appears. The Japanese economy is slowly emerging out of its more-than-a-decade old deflation a deflation that was once considered a remote possibility in a fiat-economy since there is a plethora of policy instruments available for Central Banks to support aggregate spending in a fashion that best suits its given context. Even Ben S Bernanke, the present Fed Chairman, in one of his presentations before the National Economists Club, Washington, DC, on November 21, 2002 said: Under a fiat money system, a government should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero and hence positive inflation. That was the theoretical assumption. The reality proved otherwise. It all started way back in the 80s when an appreciating yen made Japanese exports less price-competitive. It was to bail out the exporters that the Bank of Japan (BoJ) initiated in 1986 an easy monetary policy by cutting the discount rate. Unwittingly, this resulted in real estate and share price bubble. To cool the markets, the BoJ was to reverse its easy monetary policy by raising the discount rate thirteen
March 2006.

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times between May 1989 and August 1990 to 6%. But this resulted in the fall in the Nikkei by around 39% in 1990. This caused further problems: the moneys said to have been lent recklessly by banks during the bubble period turned out to be bad loans, and this led banks not to undertake fresh lending. All this cumulatively resulted in stagnation. The subsequent lack of demand triggered deflation a general decline in prices. By 1999, it became clear that the economy could not be kicked out of stagnation unless drastic monetary policies were adopted which culminated into bringing down the overnight call rate to zero by the BoJ. But to everybodys surprise, nothing could halt the fall in prices. In the year 2001 the BoJ initiated an unprecedented and untested policy of quantitative easing. Under this policy the BoJ simply flooded the system with more money liquidity went up to 35000 bn which was almost six times the amount that was actually needed to push the overnight interest rates to zero. However, nothing positive happened: no discernible economic activity in terms of spending/investing could be traced. One reason cited for such dismal performance was the failure of banks which were by then heavily loaded with nonperformance loans, to pass it on as credit to the broader economy. On hindsight, it appears that the failure of even quantitative easing policy in pushing Japan out of deflation was perhaps more due to the massive financial problems that the Japanese banking and corporate sectors faced coupled with a large overhang of Government debt. Anxious to come out of this syndrome, the BoJ subsequently increased its purchase of Government bonds massively from 400 bn a month to 1200 bn. This was followed by another drastic step: in 2002, to prop up the falling stock market, the BoJ purchased shares in unnamed companies worth around 2000 bn, which of course helped the stock market revive. All these measures at last helped the economy recover: the GDP grew 2.8% in 2005 and 4.2%, year-on-year in the 4th quarter. There

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were indications of inflation returning. The stock market started looking up with corporates brimming with good order books posting good profits. Every economic indicator has at last started pointing towards the exit of deflation. Prompted by these developments, the BoJ announced on 9th March 2006 its scrapping of the existing quantitative easing policy and its desire to pursue a more normal monetary policy henceforth. This move, however, should not alter the Japanese economic scenario overnight. The BoJ has promised to maintain overnight interest rates at zero percent during the transition. So long as the BoJs tightening remains behind the yield curve, the economy is sure to flourish leading to rising equity prices. On the other hand, if the tightening is too harsh, it may hit the economy very hard, that too, when people take time for their psychological shift from deflation to inflation which means poor spending during the transition. This in turn can hit corporate profits badly. The expectation of higher yields on Japanese bonds is already causing the yen to become strong against the dollar. A stronger yen would only mean less export-receivables in terms of domestic currency which could eat into corporate profits. In any case, the full effect of BoJs decision to move into orthodox monetary policy will only be known in the country a few years hence. Coming to the international scenario, one may be tempted to believe that Japan emerging out of deflation must sound pretty melodious. Yes, everyone is delighted to hear that Japan is out of deflation but not BoJs announcement of ending its quantitative easing policy. Particularly, it is those who are engaged in carry trade that are terribly disturbed indeed, must be shivering in their pantsby its intended return to normal monetary practices. Even many Central Bankers must be wondering at the likely fallout of BoJ abandoning its quantitative easing policies on the world economy. The easy money policy hitherto practised has indeed contributed a good deal to higher bond prices and the accompanying low long-term

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interest rates in major global markets all because of too much money chasing too few assets. Against this backdrop, one likely scenario to emerge is: a grinding halt to carry trade, which means no longer borrowing Yen at no cost and buying assets elsewhere in the global economy; Japanese investors would be encouraged to invest more in the domestic assets for better returns than invest abroad; the resultant rise in yen value vis--vis foreign currencies, and fall in the price of foreign assets due to drop in demand. The other worst scenario, which is of course a far-fetched one, could be: fall in carry trade resulting in lesser investment in American assets that in turn can lead to higher yields on the US Treasury bonds, which means expensive mortgage loans and falling house-pricesall leading to the much-feared pricking of the US housing bubble. Whether or not such scenarios are a mere figment of a fertile brain, one thing is certain: it is potential enough to rattle the global economy. This jolt along with that of the mounting US trade and fiscal deficits and the Asian surpluses can collectively inflict severe pain on world economyat least for some time to come. The only blessing in disguise is that the world has been expecting these changes for quite some time and is thus not taken by surprise, which means the market players must be well preparing for all the eventualities. Secondly, Japan coming out of its decade-old deflation is in itself a good cause for the world economy to cheer about, for it can fuel the world economic growth, should the US or Europe falter. In all probability, everything may come out all right since the process is supposed to be gradual, which incidentally allows for monetary loosening elsewhere. The only nagging fear, however, is: how BoJ will achieve the targeted 0-2% inflation for it is the fulcrum of global economy.

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Higher education: Why not private participation?

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SIX

Higher education: Why not private participation?


The quest for knowledge workers in a globalized economy compels India to hone its infrastructure for higher education.

oday, there is hardly any discussion under economics that is globalization-free. Its all pervasiveness is mostly attributed to multilateral trade liberalization; success of the economic reforms in developing countries, particularly China and India; technological advancement and convergence in communication and computation technologies, and the resulting blurred demarcation between what can and cannot be traded in the international trade. The net result of these developments is the emergence of new macroeconomic interdependencies that transcend sovereign boundaries. With the advent of globalization we have been witnessing many seismic changes in the world. One of them is the intense international competition that many businesses are today facing. This has led to companies outsourcing and offshoring of manufacturing activities and services to countries that are endowed with low-cost labor. McKinsey Global Institute predicts that by 2008, 160 million jobs in services are likely to be performed away from the customer.
March 2006.

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India has emerged as one of the prime beneficiaries of these global developments. During 2000-04, the offshore IT and BPO industries contributed 90% of the absolute growth in foreign exchange inflows under service industries, said CMIE. According to Nasscom McKinsey Study 2005, if we maintain the current global leadership level in IT and BPO industries, our off shoring industries could, by 2010, well become one of the worlds great export industries. But to maintain the growth momentum, the report says that India will need a 2.3 million strong IT and BPO workforce by 2010. The report, on the downside, warns that India will encounter a potential shortage of skilled workers in the next decade or so. According to the report, it is only 25% of technical graduates and 10 to 15% of general college graduates who were suitable for employment in the offshore IT and BPO industries respectively. To stay in the lead, the report states that India needs to improve the quality and skills of its workforce. It recommends the establishment of focused educationzones to improve the quality of higher education; deregulation of higher education and a shift to a largely demand-based funding system for colleges and universities. Higher education system in the country has, of course, come a long way: the number of university level institutions has increased from 18 in 1947 to 307 by the end of 2004. The student enrolment has also grown impressively from 2,28,804 in 1947 to 94,63,821 in 2002-03. Despite such an impressive growth that is rated to be the second largest after the US, it hardly covers 7 percent of the population which is lower than even that of developing countries such as Indonesia (11 percent), Brazil (12 percent), and Thailand (19 percent). Physical infrastructure aside, there is nothing much to gloat over quality. According to Ramamurti committee report (1990): Academic activities (of universities) are at a low ebb and the academic calendar

Higher education: Why not private participation?

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itself gets seriously disrupted almost every year. The system of higher education continues to encourage memorization of facts and regurgitation rather than creativityWe cannot ignore the fact that we do not have many colleges today which can pride themselves of imparting under graduate education of the higher quality, comparable to some of the well known institutions in the world. The findings of the report, though old, are as valid today as they were when reported. As though its not enough, the government, in its anxiety to curtail fiscal deficit had drastically reduced financial outlay per student from Rs.7676/- at 93-94 price levels to Rs.5873/- in 2001-02 (budget estimates). That aside, we are continuing with the system of affiliation that was started in 1857. Indeed, today it has become more complex because of affiliating an infinite number of colleges to a single university. As a result, the already depleted financial resources are expended on administration rather than on creating academic resources. According to Andre Beteille, Our universities are simply functioning as degree giving institutions concentrating on conducting examinations rather than becoming a system that transmits, generates and interprets knowledge. Against this backdrop, a need has arisen for encouraging private participation in higher education for reasons galore. One, creation of better infrastructure for quality higher education is a must for sustaining our current levels of economic growth. Two, World Bank in its report of 1994 observed that institutes of higher learning equip individuals with advanced knowledge and skills to discharge responsibility in government, business and professions; produces new knowledge through research and serve as conduit for the transfer, adaptation and dissemination of knowledge generated elsewhere. But, the Government is no longer in the mood of investing in higher education, for the ministry of finance opines that higher education benefits individuals more than the society. This is further corroborated

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by the Birla Ambani report submitted to the Prime Minister suggesting that government subsidies to higher education should be minimal and the funds thus saved should be invested in expanding facilities at the primary and secondary stages of education. Three, according to the census of 2001, the overall literacy rate in the country has gone up by 10 percent during the last 10 years. It is therefore possible that around 8 to 10 percent of this freshly educated lot would seek admission at college level in the next 8 to 10 years. As against the current capacity of 8 million college seats created in the last 150 years, we would be required to create an additional capacity of 8 to 10 million college seats in the coming 8 to 10 years. Obviously, this is a gigantic task that cannot be addressed by the government alone, nor can it ignore the surging demand for it. Globalization is changing the structure of higher education radically by moving the services across the boundaries, instead of the people moving across the borders as witnessed earlier. Such migration of education to new locations in search of clients is necessitating institutions of higher education in India to reorganize themselves to withstand the competition. In the light of these facts, investments from private bodies must be encouraged to freely flow into higher education. Certain sections of academia however, harbor an apprehension that private universities may give a go by to quality. This argument sounds hollow since no institute can survive for long on poor quality product and education is no exception to this universal truth. For that matter, no one can afford to ignore the contribution of private institutes such as NIIT, APTECH, and various other private computer training institutes that have made India what it is today in the field of IT. It is only by serving their intended cause through quality programmes that institutes like Manipal Academy, ICFAI, Symbiosis etc. could survive thus far.

Higher education: Why not private participation?

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Even otherwise, the state can and should always ensure that the private universities once established, comply with the basic quality standards prescribed. All that is required to ensure the quality across the board is to have a national level overseeing body that is teethed with powers to grant permission to establish a university and also to derecognize an already established university if it fails to maintain the prescribed standards. That aside, as the private universities, which are to survive purely on fee income have to necessarily re-equip themselves with newer programs from time to time, real academic autonomy becomes an essential prerequisite. For that matter irrespective of ownership, universities must not be strangled by excessive bureaucracy, if education is to be bettered. Private universities are to recover their cost by charging fee from students proportionate to their expenses. Hence, such fee structure may not always be within the reach of the common man. A need thus arises to fund such candidates. It is to be noted here that if Harvard or Stanford or MIT is being fed by a continuous stream of students and if these institutions are able to maintain such reputation for excellence in education, it is only because there is an institutionalized support available to the students to borrow money, pursue studies and pay it back from their future earnings with no hassles attached. Although, the Indian banking system grants loans for higher education, it is not as formalized, institutionalized and simplified as in the US. There is a need to urgently streamline and make loaning system student-friendly. Aside of these conflicting demands, one thing is certain: all possible thrust must be given to higher education for maintaining the current growth-momentum.

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SEVEN

End of green (span) years for economy?


Mr. Alan Greenspan the most intently watched central banker has become the missing variable of economic predictions.

ts not a year or two, five or ten; it is eighteen and a half long years, after which Alan Greenspan is going to retire from the Federal Reserve as its Chairman. He has been showered with accolades from across the globe. He has been acclaimed as the the greatest central banker who ever lived. There are of course enough reasons for everyone to praise his performance at Fed, for its impact is often found influencing the rest of the global economy too. Secondly, his handling of Fed policies has not only provided impetus to sustain growth in the US economy but also helped emerging economies such as those of China, Russia, and India that were integrating themselves into global economies either by design or by default. Ever since he took over the reins of Fed from Paul Volcker, he has pursued the singular objective of price stability and he did succeed in accomplishing it except for a blip or two in his long and eventful journey. He could also succeed in steering the American economy
February 2006.

End of green (span) years for economy?

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through two major crises: the 1987 stock market crash that occurred immediately after his taking over the reins of Fed and the bursting of the dotcom bubble in 2000-01. He provided a massive monetary stimulus for the strong growth of American economy for 10 years on the trot. Fed maintained real interest rates negative for several years and even now real rates are notoriously low. Inflation averaged at around 2.4% per year during Greenspans era as against 3.7% per year from the end of World War II to Volckers tenure. This greater price stability can be described as his greatest contribution to the economy, for it enabled enterprises to use their resources more efficiently and steadily. This performance has obviously made Milton Friedman, the Nobel Laureate in Economics, say: There is no other period of comparable length in which the Federal Reserve System has performed so well. In accomplishing all this success Greenspan has not only demonstrated that it is possible for central banks to maintain stable prices but also set a standard for the other central banks around the world. Every central banker is essentially judged for his performance by how well he managed the value of the national currency and on that score, Mr. Greenspan did a better job than all his predecessors. The fact that he did so by liberally supplying dollars to the world despite strong criticism from a section of economists and the underlying threat of raising bubble in the stock market or real estate, is all the more remarkable. There is courage of conviction rather than a method in madness of his pursuit of such monetary policies. Similarly, his handling of financial markets deserves all praise. His tenure witnessed fewer bank failures despite two bouts of recession. His handling of LTCM debacle in 1998, which was considered potential enough to seize markets, inflict substantial damage on many market participants including those not directly involved with the firm, impair the

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economies of many nations, including that of the US, is in itself a testimony to the understanding Mr. Greenspan had about the financial markets and his ability to manage financial crises with finesse. Greenspan has shown to the world that central banks need to distrust any ism or rule. His innate ability not to get bogged down with any particular economic idea or model but to quickly change the gears whenever any performing model is found no longer working, has proved to be the bedrock of his success. For instance, in 2003, watching Japan sliding into deflation and stagnation, Greenspan maintained US interest rates at 1% for almost a year until the economy picked up momentum keeping the threat of deflation at bay. Mr. Greenspan, as aptly proclaimed by himself in many of his speeches, is a Bayesian a person willing to make decisions based not on the most probable outcome but on a range of likely outcomes. In other words, he preferred to manage the bigger risk, while letting the minor risks be taken care of by themselves. This trait alone enabled him to do everything in his power to avoid a recession. In the process he might have inflated one asset price bubble (equities, housing, bonds) after another. But he had clarity of his own about whatever he did, as reflected in one of his statements, of course, made in a different context: We do not have the choice of accepting the benefits of the current system without costs. Greenspan left behind another amazing intellectual tool for the future central bankers to use: a method of enquiring for the missing variable the driving force behind the current market behaviour that was not captured into the already known economic models. Whenever the behaviour of economy defied the existing understanding, he relentlessly searched for that unidentified factor to unearth the root cause so that he could effectively manage it. In the late 90s he undertook one such search for a reason that can

End of green (span) years for economy?

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explain how both unemployment and inflation were together falling as against the known norm of falling unemployment resulting in a raise in wages leading to higher inflation. His passion for searching for new understanding and ability to think unconventionally across the boundaries can be traced to what he said in one of his late 90s presentations: A missing variable is not an observable phenomenon, but neither was the planet Pluto before 1930. He went on to say scientists figured out that there had to be something there, given the extent to which Uranus and Saturn were deviating from their forecast orbits. Having said that, he launched a massive research effort and finally his staff could come up with an explanation that it was the information technology that had triggered a once-in-ageneration acceleration in productivity. His understanding of the market mechanics is amazingly displayed in his statement: It is noted that robust competition including from foreign producers (which is) helping to contain cost and prime pressures. This statement, though sounds bland at first sight, is pregnant with deep insights. The passionate enquiry that he undertook in 2003 to understand how high US trade deficits, which are to be necessarily financed by external borrowings, could keep going without asserting any upward pressure on US interest rates and downward pressure on the dollar, enabled him to conclude that it is the indifference of the investors towards sovereign boundaries while deciding where to invest their money that has kept American deficits getting bridged with least turmoil. He could thus spot that it is the globalization which has kept inflation and wage growth under check despite the rising employment rate and growth rate. All these accomplishments lead to the question: Are Mr. Greenspan and the assorted strategies that he has used in managing the US monetary affairs unquestionable? The answer is perhaps a certain no, for he left behind a record trade deficit, vanishing household

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savings, raising real estate bubble, etc. His reputation in posterity, however, squarely rests on how these imbalances would be resolved. There is also a strong criticism of his indifference to arrest the emergence of bubbles in the economy be it in the bond market, stock market or real estate. In his singular pursuit of arresting deflation and keep the economy on growth path, Mr. Greenspan perhaps became indifferent to the bubbles, maybe overdriven by his belief that markets will unwind these imbalances on their own but with a big if of there being no policy blunder. True, the central banks of many Asian countries have so far exhibited enthusiasm in financing American deficits maybe in their own interest of holding their currencies from appreciating. But there is a limit to such accumulation of dollars by these countries: China has expressed its desire to spread its reserves across currencies to optimize risk and return. Once they decide to diversify their reserves, the dollar is sure to fall. Should this happen, bond yields will automatically rise as investors would demand higher compensation against the risk. Along with it if the real estate bubble bursts, consumer spending in the US will dry up. This automatically results in the economic slowdown. The obvious next question is: Will the American economys hard landing slow down the rest of the world economy? There is of course good news: the economies of Japan and Germany are showing signs of pick-up which may avert the crisis. Nevertheless, time alone will reveal the impact of what Greenspan left behind on world economy. In any case, as Greg Mankiw, the economist from Harvard University, said luck plays a large role in how history judges central bankers.

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Must learn fast, and act faster

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EIGHT

Must learn fast, and act faster


IT has made the globe look not only flat but also ideas to freely slide from one end to the other and it is only the agile that can reach destiny without falling.

homas Friedman, ace columnist of The New York Times, in his recent bestseller, The World is Flat: A Great History of the 21st Century, concluded that the global web-enabled platform for multiple forms of sharing knowledge and work, irrespective of time, distance, and geography has simply made the world flat. More than this, he made a startling revelation in his address to the 12th annual conference of The Indus Entrepreneurs: American moms better tell their children to do their homework; else, there are millions of Indian and Chinese kids waiting in the wings to take their jobs. Of course, to smoothen the ruffled feathers of the anxious listeners, he also said that kids need to learn how to learn and learn fast! Apart from American moms, the Indian fiscal managers also need to pay heed to Friedmans advice: Learn to learn fiscal management fast and pool up gumption to act upon it. We all know that when the total expenditure of the government exceeds its total revenues, a country ends up in fiscal deficit. In such situations, the government has to compulsorily borrow from the market to bridge the gap between
June 2005.

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expenditure and revenues. Such borrowings from domestic markets result in internal debt and, on the other hand, if borrowed from external sources, increases external debt. Economists use the debtto-the-GDP ratio as the key indicator of a sovereigns solvency. It is often the governments fear that if the debt-to-the-GDP ratio is very high, lenders may doubt the governments ability to service debt and thereby shy away from investing in the government paper. Now the question is, what is the debt-to-the-GDP ratio that can be considered high and hence to be corrected with no further loss of time. The debt-to-the-GDP ratio, being only one of the indicators of the governments ability to repay loans, there is no single number that can be quoted as an anchor. It is how one uses the other macroeconomic fundamentals and the inferences drawn therefrom that define the likely crisis resulting from rising fiscal deficit. To have a better appreciation of this significant issue, let us first look at internal debt and external debt separately. If fiscal deficit is financed by external debt and if the country has no capital account convertibility, it is the export performance, management of real exchange rate, quantum of forex reserves and the maturity pattern of the debt that defines an impending crisis. As is currently being witnessed, as long as our export base is growing, we are more likely to have enough foreign exchange to service debt. Similarly, as long as the Reserve Bank does not allow the Rupee to overvalue in real terms, there is no danger of Indian exports becoming less competitive in the global arena, and thus, there would be no threat to widening the export base; and as long as exports grow significantly, the country can be assured of foreign exchange earnings that can be used for servicing foreign debt. Secondly, when a country holds substantial foreign exchange reserves vis--vis its short-term debts, there is no fear of credit risk of the lenders. Lastly, when the debt is essentially of a long-term nature, the overall risk for the flight of capital is minimal. Today, we are enjoying a firm ground on all these parameters and thus

Must learn fast, and act faster

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need not get scared by the theoretical threat under the high debt-tothe-GDP ratio as the risk of external payment crisis is pretty low. On the other hand, if the fiscal deficit is to be financed internally, the government sells securities to the investing public with a promise to pay a certain fixed interest on them. Most of such securities are usually bought in our country by banks and financial institutions. Banks are known to mop up small deposits from various savers across the country and use them for investing partly in government securities and partly for lending to investors to earn interest in excess of what they pay to their depositors and stay liquid. However, as the debt-tothe-GDP ratio rises, investors in government securities may doubt the governments ability to pay the promised interest and retire the debt through ever increasing fiscal deficits. Once banks and financial institutes anticipate such a scope for default, they may withhold further investments in government paper. At such a turn of events, the only alternative for the government would be to mandate the banks to invest their funds in government securities. However, that is fraught with risk: The common depositors of the banks, fearing that banks are holding worthless securities, may withdraw their deposits, forcing a banking crisis. In the event of such a crisis, the sovereign ratings will be downgraded, leading to the exit of foreign investors. And as these people rush to the market to offload their investments and flee the country, the rupee may depreciate, precipitating the real crisis. However, here the question is: Are we in such a predicament? We must realize that today we are in a very strong position: Our foreign exchange reserves stand at US$142 bn; our interest rates are comparable to the rest of the world; the banking system is comfortable with liquidity, and the economy is enjoying a stable growth rate of above 6% for the last couple of years. It is time we learnt to free ourselves from the phobia of fiscal deficit and built up courage to make use of debt financing both

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external and internal, to build essential infrastructure that takes care of generating additional resources to service future debt payment obligations. As a first step in this direction, we may encourage FII participation in the debt market by relaxing the existing restrictions. Such FII participation improves the depth and width, particularly of the bond market. Such a vibrant debt market enables midcap companies and those companies that are sub-investment grade to mobilize capital for expansion, diversification or upgradation. The Indian debt market certainly needs a diversified investor base to improve its maturity level. Today, FIIs are mere fringe players in the debt market. Even otherwise, the average trading volume in the debt market hovers around Rs.3,000 cr, and thus it is not a big deal for the market players to absorb the FII outflows. In most of the developed markets, debt markets are quite larger than equity markets, whereas our debt markets are still smaller than the equity markets. We should therefore allow foreign institutional investors to invest both in sovereign and corporate bonds, of course, with a caveat that they could invest only in securities having a residual maturity of more than three years. Such participation will certainly make markets more liquid, resulting in dependable price discovery while reducing borrowing costs in the medium term. If we, under the fear of rising fiscal deficit, do not learn the technique of using debt funds for creating world-class assets, the global capital may bypass us, as there are many other countries who are willing to welcome them to augment their own production base. Time is now ripe for us to borrow from the global financial markets, of course, with built-in prudential protections, and use it for creating new assets. Thomas Friedman is right. The world is getting flat, and unless we wake up to this momentous development and learn to muster courage to explore every available means to raise capital and build the necessary competency to thrive in the global competition, we will simply miss out on the tremendous upcoming opportunities.

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A true zentrepreneur!

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NINE

A true zentrepreneur!
Evolution is a means to overcome limitations, and entrepreneurs have to evolve to break the barriers to better the society.

he recent ruling of the Insurance Regulatory and Development Authority on the acquisition of Max India shares by Parkville Holding and Ensley, two Mauritius-based entities, reminds us of what Charles Darwin said in The Origin of Species: If under changing conditions of life, organic beings present individual differences in almost every part of their structure causing an infinite diversity in structure, constitution and habits to be advantageous to them . If variations useful to any organic being ever do occur, assuredly individuals thus characterized will have the best chance of being preserved in the struggle for life. This principle of preservation, or the survival of the fittest, I have called Natural Selection. His theory of Natural Selection perhaps rests on the living beings power of better adaptation in however slight a degree to the surrounding physical conditions. Organizations being in no way different from man, the philosophy of survival of the most adaptable holds good for the survival of companies too. Indeed, that is what reflects in the ruling of IRDA:
May 2005.

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Foreign equity held by entities other than foreign partners in an insurance joint venture will not be counted while calculating the foreign investment cap of 26%. Theoretically, this could mean that the cumulative foreign holding in an insurance joint venture can now cross even 50%, while of course the management control remains in Indian hands. This ruling has far-reaching consequences. It helps private insurance companies infuse additional capital into their companies; it eases the pressure on Indian promoters for capital infusion from their own sources and allows Non-Resident Indians, overseas commercial banks, etc., to invest in Indian insurance companies. To better understand the spirit of adaptability exhibited by IRDA to the emerging needs of the insurance industry, we need to take a peep into what the economic theory says about insurance and its growth. Economists of different hues say that insurance plays a complementary role in the production of goods and services by eliminating uncertainties that are otherwise associated with every business activity. It plays a stabilizing role in trade and commerce by transferring the risk from one person to a group and by sharing of losses on some equitable basis by all members of the group. Insurance, thus, makes many contribute to the losses of the unfortunate few in an organized fashion and in the process, everyone in the group is provided with freedom from the burden of uncertainty embedded in businesses. The insurance industry helps in the economic growth of a country in many ways. It promotes financial stability and reduces anxiety; it acts as a lubricant for trade and commerce; it enables entrepreneurs to undertake such businesses as would not have been taken up for the risks associated with them but for the availability of insurance; it mobilizes national household savings in a big way; it enhances financial intermediation and due to the long-term nature of liabilities, life insurance companies and pension funds could be natural investors in medium and long-term infrastructure projects.

A true zentrepreneur!

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Prudent investment by insurers fosters a most efficient allocation of countries capital. The significance of the insurance industry as a stimulant of our economic growth can be gauged from the fact that for the financial year 2002-03 its investments in industry and infrastructure stood at Rs.2,91,418.36 cr, which is 11.89% of the GDP. A sound and vibrant insurance industry is thus a must for the economic growth of a country in terms of employment generation, improvement in the standards of living and growth in investment in industry and infrastructure. Against this backdrop, insurance penetration in India is still at an abysmal low when compared with even some of the developing countries. Insurance premium as a percentage of our GDP in 2001 stood at 2.71 as against 5.18, 17.97, 4.23 of Malaysia, South Africa and Chile respectively. As against this, the Indian economy has been among the fastest growing economies of the world for well over a decade. Backed by such growth prospects, life premium in India is expected to grow at an annual rate of about 18 to 20% and the pensions at a rate of about 20 to 30% up to the year 2009-10. Similarly, the growth prospect in the non-life sector is reported to be quite rosy: estimated to grow from Rs.83.78 bn as of 1998-99 to Rs.386.3 bn by 2004-10. There is, thus, a huge untapped potential in the Indian insurance market which needs to be harvested for the growth in the economy. Driven by these growth prospects, we opened our insurance market to foreign participation in the late 1990s under the overall supervision of the Insurance Regulatory and Development Authority, as the market regulator. As a result, many new private companies have entered the market, mostly as joint ventures with foreign collaboration. But, industry reports indicate that no new entrant into insurance business has so far succeeded in creating new insurance business except for eating into the existing market share of LIC or other public sector undertakings. There is, thus, a need for penetration of insurance

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business into newer markets, which calls for more players and additional investments even from the existing players. The need for additional capital arises on two counts: One, to comply with the regulatory requirements under maintenance of solvency margins and two, it takes a minimum of five years for new insurance companies to stabilize and break even and hence require their own capital to service claims in between. But, the Indian partners in joint ventures have been unable to bring in additional capital. Domestic investors may not be attracted to commit their funds to insurance business, for it takes a long time to pay dividends. This predicament was well captured by the Finance Minister in his last proposition for increasing FDI from the present 26 to 49%. FDI has the potential to add a competitive edge and there is an urgent need for infusing huge amounts of capital into insurance business. The move is of course opposed by some sections on two counts. One, it is believed that strategic sectors should not be in the control of foreigners, and two, the possible insensitivity of MNCs to local needs as they will be purely driven by profits. But, in todays globalized economy, it is not profitable for states to determine who can do what and to whom, instead, they should stay focused on monitoring the businesses and ensure that they are carried out as per the template prescribed. Having already opened the insurance sector to foreign participation, we stand exposed to no new sovereign risks merely by increasing the cap from the present 26 to 49%. Secondly, market reports indicate that in many of the new insurance companies that have come up in the recent past with foreign collaboration, the management is already in the hands of the foreign partnering company since many of the domestic partners lack the domain knowledge to manage such companies profitably. In view of this reality, no new threat is likely to arise out of the proposed hike in the cap on FDI.

A true zentrepreneur!

43

Insurance business is after all a known capital guzzler. Domestic savings are proved to be insufficient to finance the capital requirements of the growing sectors of the economy. Indeed, it is already being felt by the insurance industry that the present levels of capital investments are quite insufficient to underwrite new businesses. If there is no infusion of fresh capital into the already existing insurance companies, many may not be in a position to undertake new business. Yet, the proposal for increasing FDI participation remains an impasse. Well, maybe, the government is in a stalemate. But the IRDA, having immense faith in the positive force of a pliant attitude, which allows one to adapt to circumstances and to attend to those things that can be controlled, paved the way for otherwise capital-starved Indian insurers to mobilize capital from overseas investors by giving a positive ruling of the Max India case. A true Zentrepreneur!

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TEN

Commodity price uncertainties: Role of derivatives


Market liberalization process has only weakened traditional commodity price stabilization measures that governments hitherto practiced exposing farmers to a greater price-risk.

raditionally, developing countries are known to rely heavily on export of commodities for income generation. One study estimates that primary commodities account for 68% of exports of low-income developing countries while it is 44% in the case of highincome developing countries. Such dependency on a few commodities obviously exposes the traders and producers to commodity price uncertainties. For instance, a trader who purchased tobacco or coffee from local farmers with an intention to export faces enormous risk if the international prices collapse before he sells his stock of tobacco/coffee. In the absence of any protection from the risk of fall in price, the traders work for large margins to keep themselves secure. In other words, the price-risk is ultimately transferred to the original producer i.e. tobacco/coffee farmer. Uncertainty in commodity prices also affects the debt servicing capacity of the traders as well as producer-farmers. This indirectly
May 2005.

Commodity price uncertainties: Role of derivatives

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makes the cost of their debt prohibitively high. Even the availability of credit may at times become difficult, particularly for farmers. Theoretical analysis suggests that commodity prices will fall relative to others because of the relatively inelastic demand. Thus, the real income of the commodity producers falls because inelastic demand prevents them from offsetting price movements with volume changes. The prime reason for extra volatility in commodity prices is the presence of natural shocks that are not predictable and mostly relate to the previous years production or consumption-decisions. A shockproducing reduction in supply will lead to a sharp increase in price followed by a slow or rapid reduction, depending on the nature of the commodity. Commodity price cycles are mostly of flat bottoms with occasional sharp peaks. There are four types of price problems: short-term fluctuations common among the agriculture products, either within a year due to seasonal variations or from year to year because of normal weather variations; medium-term changes as seen often in oil or other mineral markets, responding to multi-year business cycles in the world economy; permanent changes affecting one or a few countries owing to technological changes or discovery of new technology which alters competitiveness; and long-term declining commodity prices. Normally, the behavior of commodity prices will be shorter periods of rises than falls and this asymmetric behavior tends to impose costs on any scheme meant for balancing price fluctuations. All this cumulatively exposes producers to the dual problem of lower returns and higher risks. Although commodity-price-risk problems are common to both developed and developing countries, they are more serious in developing countries, since the extent of their dependence on commodity exports is critically high. Secondly, their specialization may remain restricted to one or a few commodities

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and thus commodity price variations affect a much higher proportion of the developing countries economies. Thirdly, the share of developing countries in the world commodity markets often being small, they stand additionally exposed to the risk of decisions of other countries. Thus, commodity price risk is likely to raise the real capital intensity of commodity production above the direct production cost. This adds extra burden to the already poor, particularly those engaged in production of agricultural commodities, where the producers are poor even relative to the individual countrys average income. The increased openness of countries, creation of global commodity markets, improved communications facilitating immediate knowledge of competing prices across the globe and the resulting increased market efficiency have only added further agony to the people exposed to commodity price uncertainties. The impact of commodity price changes is thus greater in countries that are more than averagely dependent on commodity exports. Similarly, imports such as food, oil and gas of developing countries are known to be adversely impacted by global commodity price movement. Developing countries are hitherto known to manage commodity price risks essentially in three ways. One, governments implement domestic and international price stabilization schemes; two, reserve management; and three, contingent finance. Domestic price stabilization scheme involves purchase of commodities and creation of buffer stock when commodity prices fall below a certain pre-determined price and selling it when the prices recover. Some countries like India are known to prescribe minimum support prices for various commodities produced by farmers to protect them from the falling prices and thereby enable them to recover at least their cost of production. It is, of course, a different matter that such practices have only increased the need for a huge budget provision. Some other countries

Commodity price uncertainties: Role of derivatives

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maintain a stabilization fund with an objective to compensate producers when prices fall and accumulate reserves when prices increase. However, large commodity stabilization schemes are known to demand large capital outlay. Secondly, they are often found to be ineffective, during the periods of crisis. Thirdly, most of such schemes are found to be used more for achieving social objectives than for price-stabilization. The net result is huge corruption and mismanagement of the scarce capital. In view of these facts, and as a sequel to the ongoing liberalization process, the governments are slowly withdrawing from commodity markets. The slow withdrawal of government from market stabilization activities resulted in a search for new alternatives and thus entered derivatives into commodity markets. Commodity derivative instruments aim at making commodity prices and/or revenues more predictable rather than stabilizing prices or revenues. They simply remove price uncertainty for commercial transactions and thereby reduce uncertainty in revenues. They reduce the uncertainty regarding future revenues by enabling producers to lock in a price. Trading in derivative instruments exposes traders to market prices and to market expectations of future prices. Dependence on market prices automatically allocates the resources to those sectors where market prices are likely to be more favorable. Trading in commodity derivatives can also result in transfer of risk from domestic markets to global markets. Trading in commodity derivatives increases the creditworthiness of a borrower by insuring his revenues from future price fluctuations. India, being no exception to these global changes, initiated steps in 2003 to create a market for commodity derivatives trading by withdrawing all the existing restrictions on forward trading in commodities. Today, there are four national level commodity exchanges offering online futures trading facilities in agricultural commodities. They have also established terminals across the

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country to create a national market for commodity derivatives. Despite the hype, trading volumes have not yet picked up and whatever trading currently going on is mostly confined to traders. To realize the full benefits of the market for price stabilization there is a need to encourage farmers to avail these facilities. Farmers, at least, large farmers having commercial farms, can use derivatives such as forwards and futures to eliminate price uncertainty by lock-in into a price for a future date delivery of agricultural produce, well before even sowing the crop. Such secured prices enable them to make appropriate decisions about allocation of resources i.e. which crop to sow, how much to sow, etc. Similarly, exporters and importers also can use derivative instruments for removing price uncertainty associated with their export/import transactions. Compared with government-sponsored price stabilization programs, management of price risk through commodity derivatives market is considered to be less expensive to manage and operate; is consistent with WTO directions; can provide producers with benefits comparable to traditional program, and is market neutral, since premiums are determined by markets. But the million dollar question is how to make derivatives trading accessible to Indian farmers. And a still bigger question is: How to educate farmers to use commodity derivatives? Perhaps, that is on what government has to work through its extension wings, besides making derivatives trading more user-friendly by legalizing warehouse receipts as negotiable instruments, duly accompanied by construction of adequate warehousing capacity in the countryside.

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100% FDI in real estate: Is it enough?

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ELEVEN

100% FDI in real estate: Is it enough?


Real estate is no longer made but can only be used sensibly for bettering the lives.

ommon sense shows that the construction sector has a positive correlation with employment creation and income generation. One estimate says that a 10% rise in construction project expenditure is likely to increase GDP by 3%. Such an increase in GDP has enough potential to create around 1.5 million jobs. Perhaps, driven by this philosophy, the cabinet committee on economic affairs has recently cleared 100% FDI in all forms of housing, commercial premises, hotels, resorts, hospitals, educational institutions, recreational facilities, etc. It has also set pretty liberal norms for such participation: Minimum area to be developed under each project is 25 acres; a minimum built-up area is 50,000 sq. metres; minimum capital investment for wholly-owned subsidiaries is $10 mn; capital investment for joint ventures is a minimum of $5 mn, and the lock-in period of original investment is 3 years. To avoid speculative trading, the committee has of course barred sale of undeveloped land. The current move is expected to have a multiplier effect not only on employment creation, but also on building techniques and technology. It will also
April 2005.

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have tremendous ripple effects on ancillary industries of construction. The net result: Market hype. However, Niranjan Hiranandani, Managing Director of Hiranandani Constructions Ltd., a noted real estate tycoon from Mumbai, has something different to say, 100% FDI without scrapping the Urban Land Ceiling and Regulation Act is like giving a half-blind man a pair of glasses without the frame. True! If the current move has to yield the desired result, the clearance must be supplemented by quite a few reforms in stamp duties, land records, land acquisition procedures, etc. More than anything else, the construction business must first be freed from the mafia. Simultaneously, the local urban developmental authorities have to reorient themselves in offering basic municipal facilities to builders so that foreign investors do not end up constructing state-of-the-art buildings with no takers. Constraints aside, the current move will surely pave the way for integration of our real estate business with that of the global market where property commoditization is proceeding rapidly. This is likely to bring in a new breed of players into our markets: Real estate syndicates; real estate investment trusts, etc., who are said to be very active in western markets. Real estate syndication has become the means to channel private savings into real estate investment in the western corporate world, particularly for financing purchase and sale of properties of high-end value. Syndication is nothing but a coming together of investors who pool capital for investment in real estate. A typical syndication involves three phases: i) Originationthat consists of planning for and acquiring property, getting it properly registered, etc.; ii) Operationmanaging the syndicate as well as the property acquired; and iii) Liquidationresale of the property. Syndication, besides offering professional management which is crucial for success, allows small-scale investors to own and operate a property that is far beyond the reach of any single investor.

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Real Estate Investment Trusts act as conduit for investing shareholder funds in real estate. The trusts make up a large amount by pooling funds from investors to invest in buying or constructing buildings, developing real estate projects, etc., and then collect rents for distribution among shareholders. REITs are of three types: Real Estate Equity Trust, Real Estate Mortgage Trust and a combination of these two. Equity trusts essentially own properties of a residential, commercial or an industrial nature and their main source of income is rent. They are prohibited by law from holding any property primarily for sale to customers and are entitled to claim depreciation. The equity trust ultimately distributes a great chunk of its revenue on the property to shareholders. Mortgage trusts essentially invest in short-term and long-term mortgages on real estates. They earn income by way of interest on mortgages and the same is distributed among shareholders. The current move may even prompt domestic mutual funds to float real-estate related schemes for pooling capital from domestic investors and participate actively in the real estate business as a measure to fight inflation. Whether our mutual funds float real estate-linked schemes or not, one thing is certain: the present move is bound to make the market more sophisticated, with diverse market players and increased transactions. As the domestic real estate market integrates with global markets, the spectrum of risk associated with the construction business will simply widen, calling for critical analysis, constant measuring, monitoring and management. As risks multiply, real estate valuers must assume the role of spectrum analyzers. They must build up necessary acumen to analyze property rights, legal and regulatory frameworks, and value the property transparently, taking into account the value cycles of the market. They must build transnational networks to educate themselves about the market behaviour, both during booms and busts, and use the information to minimize similar future market shocks. It is also to be borne in mind that the fundamental starting-point for real estate risk analysis is the

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independence of valuers. As real estate is becoming more and more a commodity, like gold futures or corporate bonds, the importance of independent, ethical and well-educated real estate valuers is increasing. True, it is difficult to estimate the present value of a real estate project as it essentially rests on projected rents, discount rates, anticipated inflation, loss in value due to depreciation and vacancies due to the development of competing projects, etc. Moreover, data on building permits, new construction contracts, rents, market prices and vacancy rates is often not readily available, and if available, is difficult to verify. This results in banks underestimating the risk of their heavy exposure to the real estate sector. This risk gets accentuated by the fact that Basel II proposed a higher capital adequacy ratio for high volatility commercial real estate loans, which Indian banks that are currently active in home loans market must keep in mind. Once the primary market is well established, the secondary market in housing loans, which is currently dormant in India, is likely to take off. There are of course certain essentials such as right legal, tax and regulatory framework; robust primary market; a capital market that has the appetite for mortgage-backed security bonds, and economic incentive to securitize home loans that must be in place for the secondary market to take off. As securitization picks up, the need for evaluating single transactions loses significance, while it becomes essential for evaluating a pool of loans. In other words, real estate valuers must move away from being information gatherers to becoming information arbiters. This obviously calls for a new set of skills, and this in turn calls for new market rating systems. To cater to these emerging needs, we must nurture a team of professionals that includes accountants, brokers, engineers, lawyers and government regulators. In short, the valuation profession must become an army of full spectrum analyzers of real estate-related risk, else the current move may remain as one more attempt aimed merely at giving a boost to the construction sector.

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Can India stitch its textile industry in time?

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TWELVE

Can India stitch its textile industry in time?


Economics is all-pervasive, and yet someone somewhere has to make a beginning to give it a desired direction.

oo Hoo Hoo Amma! Cover me at least with your pallu! said the half-naked boy shivering in biting cold.

Beta! Its pretty worn out! Can it provide warmth to you? said the mother in a poverty-laden tone. Amma, isnt it my Baba who weaves bedsheets and sarees? How come we dont have any of them for our use? Beta, we weave them for wages! We should have money to buy them. Wont we get money if Baba weaves clothes? Why doesnt he weave them? For want of buyers, bales and bales of cloth remain unsold. What is the gain in weaving more?

March 2005.

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Amma, are people so overstuffed with clothes that they have stopped buying? And we dont have anything? Its not because of overstuffing but because there is no money that people are not buying clothes. Without work nobody gets money, right? Yes With no money, no one can buy clothes, right? Yes When nobody buys, they remain stocked, right? Yes So long as they remain unsold, no new jobs, right? Yes No work means no money; no money means no buying of clothes; no buying of clothes means no work. No work means? Time to be wise Amma! Hoo Hoo it is pretty cold down here That is a touching Telugu story of Bollimuntha Sivaramakrishna written some four decades back, which still haunts every reader. More haunting is the current state of our textile industry. The world textile trade was estimated at US $395 bn at the end of 2003, of which textiles had a share of $169 bn as against $226 bn worth of clothing business. The same is estimated to increase to $856 bn by the year 2010. With the WTO-mandated lifting of quota restrictions

Can India stitch its textile industry in time?

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on textile exports of developing countries, more and bigger opportunities are likely to be thrown open. How prepared are we to take advantage of these global opportunities that are certain to emerge post-MFA scenario of global textile trade, is the big question that sends a chill down the spine. To get a fair answer, let us begin at the beginning. Our textile industry is estimated to be worth $37 bn, of which exports are worth about $13 bn. During the period 1990 to 2004, we could hardly increase our share in the textile and clothing export market from 2% to 4% and 1.66% to 8% respectively, as against 7% to 16% and 4% to 23% respectively that China could accomplish. It is true that we have been working on improving our industry but certainly not with the requisite amount of speed. It is surprising how the textiles industry that was the key constituent of postindependent Indias industrial revolution could fall into such a technological rut and remain indifferent to the scale of economies for this long. Today, it is believed that we could be outsmarted by rivals such as China and Bangladesh since we havent made the requisite investments to catch up with the likely growth of 3% to 15% in our share of global export market by 2010. It is reported that an investment of hardly $3 bn has been made in the textile industry despite various relaxations from the government: Incentives through TUF (Technology Upgradation Fund); cut in customs duties for imported machinery; rationalization of domestic duties; dereservation of woven garments; permitting 100% FDI (Foreign Direct Investment) through the automatic route, etc. This poor investment, when looked against the current trend of global buyers who want fewer clients and bigger suppliers, that too, from fewer locations, is certain to prove disastrous tomorrow. We have simply failed to invest in creating scales.

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The mistake may sound more fatal if we realize that our competitors have been relentlessly expanding their capacities during the last 10 years. China is reported to have invested around $30 bn during 2000-04 in its textile industry. It is also reported to have established around 150 professional colleges and 120 research institutions exclusively for the apparel industry to make its textile workers more efficient so that they could encash the market opportunities likely to be thrown open post-MFA scenario. Even countries like Pakistan are reported to have invested substantial sums in building and stepping up capacities in the textile industry. As against these global trends, we, even today, have labourintensive small companies that account for 90% of our fabric weaving segment. Even in the garment sector, we have fewer than 20 companies with sales of more than $50 mn with little or no scope for improving their productivity owing to inflexible labour laws. But the benefits of barrier-free trading can be grabbed only by those who have invested in creating larger capacities with matching technical and managerial skills that are essential to attract big orders from global clients. The message is: scale is the decider of long-term relations with clients like Wal-Mart and other US retail outlets. So, the Indian producers must get their act together. We have every physical advantage to encash on these opportunities: Availability of inputs like cotton, yarn and low-cost, skilled labour. All that we need to cultivate today is agility and zeal to compete in product development, quality, service, and most important, to be proactive and innovative. The already well-established companies with a brand reputation of their own in the global markets such as Aravind, Raymonds, Madura Garments have to substantially invest to expand their manufacturing capacities, if required, even by inviting FDI. It also makes great sense to invite FDI even in the form of technology or import of capital goods to manufacture quality apparel. It is equally essential to sensitize

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the local designers with trends in global fashions so that our exports remain constantly in tune with the global tastes. The export-oriented units must even explore the scope to build diversity in their human resources, particularly in their R&D wings, by hiring designers from those countries whose markets they want to capture, so that continuous innovations in tune with the client country tastes can be captured in their products. It is time that the government and the industry joined hands in creating global level scale of operations in the textile industry to capitalize on the newer opportunities. During the transition, the state should aim at creating trampolines across the country which can offer the cushion for all those who get laid off by the businesses or not getting employed. The state must also establish community vocational training centers if not research institutes that China created, which can retrain those who lost their jobs and make them re-employable. These centers must design the curriculum and impart training in such a way that the citizens are helped to constantly reequip themselves with new skills much before they become redundant in the job market. Are there any takers for the government is not that hapless as the mother of that half-naked shivering boy?

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THIRTEEN

Indian agriculture at crossroads


Post-WTO, Indian agriculture is likely to face grave challenges and the State cannot afford to ignore it under the illusion of an otherwise shining India.

oor people face a variety of risks: labor market risk, health risk, earnings risk, etc. To enhance security for such poor people who constitute around 36% of our population, we should reduce their vulnerability to ill health and economic shocks. But their only significant asset is their labor. So any attempt to improve their welfare must first attempt to increase their employment opportunities and the productivity of their labor. For a majority of population under this category, even today agriculture is the main economic activity. As against this hard reality, the contribution of agriculture to GDP is declining from year to year, which currently stood at 26% of GDP while population growth is adding more numbers to the unemployed category in the country side. It is a commonsensical knowledge that growth in employment is directly proportional to the economic growth. Today, globalization is being advocated as the ultimate panacea for generating and sustaining increased economic growth. Though existing literature suggests that economic integration across borders enables every
February 2005.

Indian agriculture at crossroads

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country to grow better than what it used to be earlier, it is doubtful if it equally benefits all workers and businesses of a developing economy since they can lose out their markets to more efficient manufacturers of foreign origin competing with the local manufacturers, particularly during transition to modern technology. Such loss of markets for the domestic businesses can result in further loss in employment and thereby hit the vulnerable sections of society more severely, resulting in major dislocations and loss of status. The worst sufferers will be urban poor and agricultural laborers, and marginal farmers, and within these two groups it is the latter who suffer most. Over and above this, the four major elements of the World Trade Agreement namely market access, domestic support, export subsidies, and trade related intellectual property rights under agriculture pose further threats of stiffer competition, greater uncertainties under the new world order, and price fluctuations to Indian agriculture. This is likely to jolt the Indian farming community out of their reverie challenging them to adjust their operations to external stipulations and adopt the new technological practices which enable them to manage external threats and opportunities with minimal damage. The Government Procurement Agreement (GPA) which claims to offer twin benefits one, the benefit of transparency-driven competition resulting in better value for money spent on government purchases including agricultural commodities for public distribution and two, the scope for widening export markets for Indian agricultural products as a result of purchases by governments of other member countries is indeed likely to adversely impact the demand for agricultural products within our market as developed countries are more likely to out-bid the domestic traders/agriculturists in the price war owing to their technological superiority in agricultural production. The net result could be falling employment opportunities and economic distress to all those who are dependent on agriculture, directly or indirectly.

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These challenges demand that we rapidly modernize our agricultural production and its marketing. And that is where the State enters the scene to undertake technological upgradation of agricultural practices, buildup institutional support for making capital available in time at an affordable price, building rural infrastructure for free movement of technical inputs and storage and marketing of output and create private-public partnerships in improving the overall rural productivity. In short, the State has a greater role to play in securing the livelihood for rural labor. But ironically, nothing substantial is happening today under this head. As a first step in this direction, the State should activate research under agriculture. There is, of course, a well-established network of research laboratories across the country that are engaged in inventing newer ways of farming for better results and, indeed, it is these very laboratories that have once ushered in green revolution in the country. But, they appear to have lost their steam. What is therefore, urgently needed is to make these institutes resilient once again, besides investing heavily in creating well equipped laboratories in the new fields of science biotechnology, water management etc. The other important input that the State must make available to farmers is capital. The banking system is today more engaged in catering to the needs of urban consumers than meeting the demand under farm loans. It is paradoxical that an urban consumer can today easily avail a loan for buying a car at an interest rate of 7 to 8%, while a crop loan costs anywhere above 10% for a farmer. The need of the hour is low cost farm loans and insurance coverage for the agricultural produce. That aside, it is everybodys experience in India that many new initiatives under agriculture launched by the government for improving the economic lot of rural populace have often failed miserably for obvious reasons. It is in this context that Contract Farming popsup as the best alternative. It is essentially an agreement

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between unequal parties: companies, government bodies or individual entrepreneurs on the one hand and economically weaker farmers on the other. But it can contribute to both increased income for farmers and higher profitability for sponsors. When efficiently organized and managed, contract farming is known to reduce the risk and the uncertainty for both the parties, as compared to buying and selling of crops in the open market. It offers many advantages to farmers: sponsors often provide inputs and production services of high quality; access to timely credit through or from sponsors; sponsors often tend to introduce appropriate technology and also impart new skills to farmers; farmers price risk is minimized as sponsors specify prices at the time of entering into agreement; and access to reliable markets, which are, otherwise, out of reach of small farmers. There is, of course, a flip side to contract farming. If the management is not fair, it could lead to: increased risk, particularly, when growing new crops, owing to both market failure and production problems; unsuitable technology and crop incompatibility; manipulation of quotas and quality specifications by the sponsor in such a way that all the contracted for production is not purchased; domination of sponsors owing to their monopolistic nature that can lead to exploitation, unreliability, and corruption; and indebtedness and over-reliance of farmers on advances because of production problems. Contract farming, being a win-win proposition, offers certain advantages to the sponsors too. Although companies can have a number of options to obtain raw materials for their processing and marketing activities such as purchase from spot market or large-scale estates, it is always advantageous to mobilize it from small and marginal farmers, as it affords them greater political acceptability. Working with small farmers under contract farming enables them to overcome land constraints and ensure production reliability and, to a great extent, shared risk as production risks are totally faced by farmers.

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At the same time, contract farming affords quality consistency as farmers undertake cultivation of crops with the inputs provided by the sponsors and that, too, under their technical guidance. It also enables the sponsors to market their own farm inputs. Of course, there are also certain potential problems that sponsors face: land availability constraints owing to legal lacunas resulting in lack of security of tenure and thus jeopardizing sustainable longterm operations; social and cultural constraints that come in the way of farmers ability to produce in keeping with the expectations of the sponsors; farmers discontent resulting from the behavior of the sponsors employees in guiding them through the new technologies and ensuring better returns from the investment; and farmers entertaining extra-contractual marketing for realizing better spot market prices or their diverting the inputs supplied by the sponsors from the intended purposes can as well jeopardize their production/ processing plans. Ultimately, as in any other promotional activity, what matters under contract farming too is integration of all the involved parties interests fairly well. This can be achieved only when all the parties are aware of their interests and thats what government agencies must facilitate, besides monitoring it. It is time the government wake up to these challenges and drafted strategies to secure the lives of the less-endowed agricultural labourers and marginal farmers.

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Flapping wings of a butterfly in China make the world sneeze?

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FOURTEEN

Flapping wings of a butterfly in China make the world sneeze?


The globe has become small and truly round where every incident is impacting every other happening elsewhere.

fter about nine years, Chinas central bank has at last raised interest rates on one-year lending from 5.31% to 5.58%. It has also hiked the interest rates on deposits by an amount equal to 27 bps. Simultaneously, it has removed a host of lending restrictions imposed earlierparticularly, the ceiling imposed on the interest rates that banks can charge on their loans. Intriguingly, this paltry raise of 27 bps in interest rate has not only become global news, exciting the whole clan of financial analysts the world over to churn out reams of comments on this grand move of China, but has also brought about a sea-change in the very dynamics of global financial markets. At least, that is how the analysts are looking at Chinas current move towards market-determined interest rates. The worlds reaction to this move is quite instantaneous. A spectacular reaction was, however, noticed in oil prices which have dropped by almost $5 per barrel. The reason is simple: the present set of rate-hikes announced by the Chinese authorities is an indicator of
December 2004.

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their desire to cool the economy in an orderly fashion which in turn means a fall in demand for oil. The International Energy Agency forecast the demand for oil from China to grow by 8,40,000 barrels per day during the current year, which incidentally amounts to around 35% of estimated growth in the global demand. At the same time, as Alan Greenspan stated, American economy entered a soft patch, which means a fall in demand for oil. With two of the world economy growth engines thus heading to a soft patch and Japans economy still not coming out of its hibernation, the Organization of Petroleum Exporting Countries and other oil-exporting countries are obviously a worried lot. In the wake of these developments, any further rise in the oil prices is certainly going to adversely affect the demand for oil. Perhaps these are good enough reasons for the market to greet the Chinese central banks rate-hike announcement with a slide in the global oil prices. This surprise move also ignited strong trading volumes in bonds and interest rate futures. Initially, the bond prices were reported to have gone up by 15 bps. It is, of course, a different matter that the hike subsequently evened out. This paradoxical development of Asian central banks supporting the rising US interest rates can be explained by the fact that it is the insatiable desire of these banks to hold back their currencies from further appreciation that compelled them to support the US paper. Next to Japan, the Chinese central bank is reported to be the biggest holder of American treasury bonds. But the current rate hike by China is all set to have a tremendous impact on American treasury bonds. Coming to the impact of the Chinese central banks rate hike on the international trade, it must be admitted that the demand for commodities such as steel, aluminum, copper, will witness a steep fall which would mean a reduction in exports to China from other Asian countriesincluding India, both in terms of volumes and price

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realization. Dampening of the Chinese economy which, along with the US, has become a global growth engine in the recent past, will pull down global oil prices. No doubt, the fall in oil and commodities prices will be welcomed by Indian manufacturers as it improves their margins. It is also a welcome development from the consumer point of view. But countries having export relations with China will be hit hard. It is not yet clear if China follows the next logical step of revaluing its currency that has been pegged to the US dollar at 8.28 yuan since 1995 despite a worldwide protest led by the US at the yuan being pretty undervalued. In any case, a higher interest rate differential between the dollar and the yuan that is to emerge from the current rate hike is likely to appreciate the yuan. If yuan appreciates, Indian exports to other countries, where we are in direct competition with China, are likely to improve further. Amidst these calculations, the US Federal Reserve had gently nudged its interest rates by a quarter percentage. The press release of the Federal Open Market Committee said: Output appears to be growing at a moderate pace despite the rise in energy prices, and labor market conditions have improved. With the current move, the credit cost goes up from the present level of 1.75% to 2.0%. Now, the question is whether this increase in the cost of capital will have any effect on the overall demand for industrial output. One school of economists argue that mounting American deficit may lead to international financial instability. As America continues to borrow more and more from others for bridging the deficit, the real interest rates may rise. This is potential enough to erode the worlds confidence in the US fiscal policy which can in turn weaken the dollar. If it happens, Europe and Asia will face a real crisis in their export performance. This vicious circle may finally retard the growth of world economy. Against these global developments, our interest rates, as usual, remained unresponsive. We have witnessed for almost one year interest

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rates moving only southward. Now that interest rates, having reached the nadir, are they set to go up? But even when the inflation rate has gone up to a record high in August, no bank felt it necessary to raise its interest rates. It is a different matter that the poor depositors were to be content with negative rate of return. The Reserve Bank of India was perhaps obsessed with its twin goals of price stability and providing adequate credit to industry at competitive interest rates. The soft interest rate regime has only helped government and industry to borrow capital at cheaper rates. It has also made retail loans available at hitherto unheard of interest rate, encouraging undesirable consumerism in the country. In the process, everyone appears to have been overtaken by a feeling that the good times are here forever. While we are under the sway of good times, inflation has been raising its ugly head all over the globe. It is difficult for Indian authorities to be indifferent to these developments: Policy initiatives, though unpalatable, must be taken for staying agile. RBI has ultimately sent a signal about the likely direction of interest rates by raising the Repo rate by 25 bps. Today, all the banks are considering raising their interest ratesboth on deposits and loans. Now, the question is how far can the banks go in resetting their interest rates on deposits and loans? There is certainly a limit to raising interest rates on loans, for corporates of repute are enjoying varied sources for raising capital today and that too, at a very competitive price. At the same time, they cannot be ignorant of their profit margins. So, the victim would perhaps again be the depositor. It will be interesting to watch how banks are going to balance these multiple demands. But one thing that is certain in a globalized economy is that we need to be doubly right in picking up the sounds of flapping wings and be instantaneous in our policy responses to those global sounds (changes); else we may risk being left far behind in the race.

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Sri Lankan economy: It has a lesson to teach us

67

FIFTEEN

Sri Lankan economy: It has a lesson to teach us


Though Sri Lanka adopted economic planning, it, unlike India, didnt stay stuck with any one model and that has put its economy on growth curve despite civic strife.

ri Lankas economy, like the island itself, is a small economy. Like India, it is a multi-ethnic, multi-cultural, and multi-religious country. At the time of independence during 1948, Sri Lankan economy was wholly dependent on agriculture and was considered vulnerable to external conditions. Against this backdrop, like any other newly independent country in Asia and Latin America of those days, Sri Lanka too was attracted towards the then emerging economic philosophy of maximization of growth through capital accumulation and industrialization based on import substitution. The belief that the vicious circle of low savings and low growth prevailing in developing countries can be turned into a virtuous circle of high savings and high growth by government intervention, has become the Pole Star of its policy initiatives. Driven by this impetus, immediately after independence, Sri Lanka resorted to the exercise of national planning for achieving rapid economic growth.
December 2004.

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Intriguingly, planning in Sri Lanka passed through many perplexities that emanated from shifting definitions of economic growth models and types of planning. The first document of Ceylon National Congress (CNC) A policy and program for the CNC gave high priority to health and education, import substitution in agriculture, and establishment of local governing bodies with the active participation of local communities that would assume responsibility for health, education, sanitation, agriculture and irrigation, etc. Though the Congress manifesto of 1947 omitted explicit reference to planning, the leadership expressed its implicit commitment to some degree of planning for the future. At the time of its independence the situation prevailing in Sri Lanka did not reveal its strong commitment to planning as much as the unequivocal commitment of its neighbour, India, to the planning and a mixed economy and its socialist bias. Perhaps that was one reason why Sri Lanka could not infuse the required amount of clarity into the planning exercise as much as the other developing economies such as India did. One good thing that happened to Sri Lankan planning exercise was the constant changing of models and its application to development problems and the commitment of political rulers to the planning exercise in tune with the changing governments. A new era had, however, begun with the taking over of the government by the left-oriented coalition parties led by the SLFP in the general elections of 1956. It expressed its firm commitment to the formulation of a national plan by establishing the National Planning Council by an Act of Parliament with the Prime Minister as Chairman, the Minister of Finance as Deputy Chairman and eminent professionals drawn from different fields as members. The NPC, treating planning primarily as an intellectual and technical task, came up with a well-drafted 10-year plan fulfilling all the technical and professional requirements of a sound economic development plan. The plan articulated the need for turning the

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countrys existing export sector into the equivalent of a capital goods sector by the domestic production of consumer import substitutes, so that external payments crisis would not impede industrial and agricultural growth. The plan was acclaimed worldwide for its high professional content. Its implementation, however, suffered a setback with the assassination of S.W.R.D. Bandaranaike, the prime minister. Nevertheless, the early seeds sown for active collaboration between public and private investment giving a thrust to manufactured-goods-led-exports indeed paved the way for its inviting foreign investment in to the country much earlier to its neighbours. Here, it is worth recalling the statement of Sir John Kotelawala that clearly establishes the glaring difference between the Indian and Sri Lankan planning process: The government and the private-sector are therefore like oarsmen in a boat. While they must row together, they must ensure that they row in rhythm, for it is only in a spirit of cooperative endeavour that they can reach the promised land of contentment and prosperity that will give us confidence in ourselves as a nation. It is, however, a different matter that this well-intended planning exercise turned topsy-turvy during the 60s and became worse by the 70s due to the oil crisis which ultimately made the two decades of the progressive policy stance that aimed at making the economy less vulnerable to external conditions, simply a failure. Driven by the philosophy that nothing about development is predestined, and economic growth depends on initial conditions, product differentiation amongst exporting economies and the speed and quality of reforms, this time, the government was able to weather the crisis by adopting orthodox fiscal policy measures which, unlike in the past, were duly supported by appropriate monetary policies. The exchange rate policy was also used as a specific tool to reduce current account deficit. There was also widespread support for the removal of domestic marketing restrictions, besides a favourable response from

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the political circles to the opening up of the economy. The privatization program helped to increase private sector participation, and improved efficiencies, particularly in tea estates and telecommunications. All this cumulatively enabled the country to achieve an average annual growth rate of 5% for the next quarter century. Export of manufacture goods went up from 0.9 percent of all exports during 1965 to 76 percent of exports by 2001, while primary exports declined from 99 percent to 16.5 percent during the same period. Manufactured exports from Sri Lanka are heavily tilted towards textiles, clothing accounting for 52 percent of manufactured exports. With these changes, Sri Lanka has emerged as one of the only four countries outside East Asia that have achieved a clear policy shift from import substitution to export-oriented industrialization. Sri Lanka indeed gained the reputation as the most aggressive pursuer of privatization among the South Asian countries. Whether or not Sri Lanka succeeded in accomplishing planned economic growth through its various shifts from one model to the other during the last four decades is beside the point. What is important to learn here is the ease with which Sri Lanka could shift from one model of economic development to the other with utmost ease and despite civil disturbances, how it could metamorphose from an inward-looking economic entity to an export-driven economy. Its most noteworthy feature is that it has not mortgaged its economic growth to public sector. It could thus become the first country in South Asia to open its economy to foreign investment as early as 1978. It enjoys the highest per capita income of $837 in South Asia and has a literacy rate of 90 percent. But for the civil strife for almost two decades, it could have achieved a growth rate far higher than what it is enjoying today. Are there any takers in India?

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We get petrol from the benevolence of oil companies?

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SIXTEEN

We get petrol from the benevolence of oil companies?


In economics there are no free lunches! To be economical, every exchange must take place on mutually satisfying monetary terms.

ore than 200 years ago, Adam Smith said: It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our necessities but of their advantages. We, as a nation, have, however, been, trying to prove that Adam Smith and his economic principles are wrong. This relentless pursuit of ours continues no matter economic reforms or no reforms. One can cite umpteen examples in support of this point. Take, for instance, our oil companies. They, unlike Smiths butcher, the brewer, or the baker, are highly benevolent. They have every concern for us, the consumers. They are so benevolent that they are unmindful of their own costs. They are more concerned about our affordability than their rising input costs and waning profit margins. It is everybodys knowledge that world oil prices are on flare. Crude oil prices have touched $55 per barrel. The input costs of oil
November 2004.

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companies are thus rising day by day. The intensity of heat can be gauged from what the Chairman and Managing Director of ONGC said: The governments refusal to allow domestic oil companies to hike retail prices of petroleum products was pushing them into bankruptcy. Perhaps, it is for the first time that any executive from public sector undertakings could muster courage, even to utter a fact. He said: Whether you have an oil pool account or some other mechanism to subsidize the prices, at the end of the day, someone has to pay. Even the Chairman and Managing Director of Indian Oil Corporation aired his anguish at the losses sustained by the firm due to the current hike in the crude prices. Yet the governmentthe owner of the majority of oil companies in the countryis not allowing them to pass on the increased input costs to consumers. If it is not benevolence, what is it? Arent we defying the basic economic principles of production? That apart, what now causes more anxiety is the reported move of the Oil Ministry directing the upstream companies; such as the Oil and Natural Gas Commission, Oil India Limited, and Gail; to share the subsidy burden since they have made windfall profits owing to the surge in international prices of crude oil. The current subsidy burden under kerosene and LPG is estimated at Rs.4,200 cr, and of this, if the reports are true, these three upstream companies have to shell out about one-third of Rs.4,200 cr while the rest comes from the government. The investing public who have put in their savings in the recently launched Initial Public Offer of ONGC are the worst hit by this move. Incidentally, this could be one of the concerns due to which the ONGC Chairman could have lamented his woes in public. The irony of this will not stop at ONGC doorstep or at the IOC, HPCL, or BPCL. Tomorrow, if the government comes out with a fresh bout of disinvestment of public sector enterprises, investors would think twice about committing their savings since they cannot be sure of the said company functioning on bare economic principles.

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If such awareness dawns on the investor community, the government will have it. Of course, we cannot presume that the government is unaware of these basics, but then, why this? One reason could be that the government expects that the current hike in the oil prices would be a temporary phenomenon. If that be the case, let us examine what is happening on the world crude oil front. It is reported that all the major oil-producing countries are already operating at full capacity. No one is sure when things in Iraq will get cleared. Uncertainties attributed to Iran, if true, are yet another cause for the world oil market to worry. On the other hand, winter acquisitions of western countries are in full spree. Any threat to the current supply levelsbe it in terms of escalations of clashes in Iraq, or political action such as the Russian government taking over oil giants, will only make markets murkier. Over and above all this, prices of any traded commodity are prone to jump up with the spread of bad news. One such bad news currently doing the rounds in the global oil market is the threat of rebels fighting for sovereignty against oil facilities in Nigeria. All this cumulatively leads to the belief that the current uptrend in the crude prices is not likely to witness southbound journey, at least in the foreseeable future. Besides supply, the other element that gives a push to any commoditys price is the rising demand for it. Even on this front, there is no respite. On the one hand, consumption in China during 2004 is reported to have gone up by about 9,00,000 barrels per day. Similarly, the consumption level in the other Asian countries too has gone up. The rising world consumption patterns and falling production levels including the spare capacities available with OPEC countries, has obviously resulted in a big gap between supply and demand. In such a scenario, the possibility of a fall in crude prices is quite remote. Of course, it is possibile, if the US Fed Reserve withdraws its support to the growth momentum witnessed in the economy in the recent past. But, the current mood of the Fed Reserve does not

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hint at this possibility. China is another country which can impact the oil prices. But if it has to happen, China should either revalue its currency or hike domestic interest rates so that demand for oil slides. But this is more unlikely to happen. The net result is that there would be no respite from the rising prices, at least in the immediate future. As against these world developments, our crude oil imports are rising. It is reported that we have imported 51 million tonnes during the current fiscal 2005 and it is likely to grow about 11% over the previous year. What is important to note here is that demand for oil has gone up despite the rise in international prices. One of the reasons for this peculiar phenomenon could be the tariff cuts imposed by the government to soften the impact of global price rise on retail domestic consumers. It means price rise or no price rise, the consumption pattern is certainly poised for constant growth. The current level of car production in the country is in itself a pointer towards the emerging reality. Secondly, it is also evident that the rising consumerism, particularly in the high-end segment of the society, is more out of the increased earnings that they are enjoying by virtue of economic reforms and the opening up of the economy. This raises the obvious question: How long does the government want to subsidize the consumers and for what reasons? One may argue here that raising the oil prices will have a cascading effect on the prices of all manufactured goods whose production consumes oil. True, but when the cost of inputs goes up, the consumer has to bear the additional cost or reduce his consumption proportionately. Unfortunately, neither of these is happening as the Sovereign is unwittingly encouraging citizens to consume more by (1) reducing the tariffs and (2) not allowing the manufacturers to pass on their full costs to the consumer. So, the result is benevolence. And let us enjoy as long as it lasts.

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No stifling of growth, please!

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SEVENTEEN

No stifling of growth, please!


Inflation whether it is cost-push or demand-pull is inflation and needs to be handled with dexterity but transparently.

he dragon is raising its head again: Inflation has surged to a three-and-a-half-year high of 7.61% for the week ended July 31. The rising global oil prices and the increase in the prices of domestic commodities such as steel, iron ore, edible oil, and other manufacture goods, vegetables, fruits, since June this year are portrayed as the real culprits that have led to the current rise in inflation in the country. Another school of thought states that the present inflation is more because of money supply growing at a higher rate than desired, which resulted from the accumulating foreign exchange reserves. Reasons apart, the inflation has done what it is known to do: It has spooked the market. The yield on ten-year benchmark government security has gone up from 5.06% in the first week of April to a high of 6.28% by the second week of August 2004. The sharp reaction of the market is understandable since inflation, actual or expected, in a deregulated market is technically bound to impact the bond rates. The hardening bond yields are indeed causing anxiety to banks since they need to make a huge provision against their portfolio of government securities that is fast depreciating.
September 2004.

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The Finance Minister has of course ruled out knee-jerk reaction but assured that the government would take action in a measured way on the fiscal side and the RBI on the monetary side, to tackle inflation. He also warned the manufacturers against hiking commodity prices. Understandably, the equity markets have reacted negatively to the evolving scenario and the governments reaction to the rising inflation by shedding 77 points in the 30-share BSE Sensex. The call market too is looking up though for a different reason. RBIs intervention in the foreign exchange market is reported to have sucked out liquidity from the market. The only encouraging phenomenon amidst the current turmoil is the reported rise in credit off-take from the banking system. What does all this mean? It simply means a general and progressive increase in prices. Under the pressure of inflation, everything gets more valuable except money. In other words, what Rs.100 fetched prior to the rise in inflation can no longer be acquired with the same sum; instead, one needs to spend more than Rs.100 to acquire the same commodities. One school of economists strongly feels that the present rise in inflation is more of a cost-push nature, which means the rise in price levels is the result of rising input costs. Theoretically, cost-push inflation is generated by three factors: One, rising wages; two, increase in corporate taxes, and three, imported inflation, which means that the imported raw material or partly-finished goods become more expensive, often as a result of currency depreciation, etc. However, the current inflation that is rightly referred to as an imported inflation, is due to sky-rocketing oil prices in the global markets. And everybody is aware how rising oil prices adversely impact a large proportion of the countrys production activities. It is still fresh in memory how, even during the controlled price mechanism regime that was expected to cushion consumers from the impact of rising prices, higher crude oil prices invariably pushed the general price level in the country higher, adversely affecting the common man.

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Indeed, it is a well-recorded phenomenon all over the globe that the price rises resulting out of oil shocks, remained active for almost two subsequent years. What then needs to be done? The answer is simple: We must first learn to accept reality, for it is suicidal to deny the prevailing inflationary trends in the economy as it is after all a disease that is potential enough to destroy a society. And how can we say that the current rise in prices is not that threatening on the plea that it is only a base-period effect which merely made them look menacing on a year-on-year basis; i.e., the rise in current wholesale price index is not truly that threatening as it is made out to be by virtue of their comparison with last years low inflation rate. It is nothing short of an illusion. At one point of time, government agencies aired a feeling that the worst was over and the prices were likely to come down, more so with the onset of the monsoon, although it was anybodys guess that the global oil prices were not likely to cool down immediately. The crude prices had in fact touched a high of $47 per barrel. Why this fooling? This brings to mind Milton Freidman, the Nobel laureates words: The cure for inflation is simple to state but hard to implement. The problem is to have the political will to take the measures necessary. It is time we showed gumption to accept the reality and made citizens understand the governments willingness to manage inflation most judiciously. If in the process people are required to put up with transitional adversities, the government should prepare them to face it with a promise that these hurdles are temporary and the citizens are certainly wise enough to bear it, provided the government comes out clean and transparent. To be fair to the current crop of political leadership we must, of course, admit that this trend has indeed been exhibited by the government and hope that it becomes a norm for the future. Theory associated with cost-push inflation says that the standard methods of fighting inflation using either monetary policy or fiscal policy to induce a recession are extremely expensive, since it can

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raise unemployment to frightening levels, besides pulling down the existing gross domestic product to far lower levels. As it is evident that the current inflation is an imported one, the normal monetary responses such as reducing monetary growth, rising interest rates, may not yield tangible results. On the other hand, such a move is more prone to cripple the growth in the economy. Any positive indicators that have emerged in the recent past about increased credit off-take from the banking system towards fresh investments by the corporates should not be choked by monetary policy initiatives, in our anxiety to arrest inflation. As the surging crude oil prices is a world-wide phenomenon, the government must watch out for the reaction of the larger players in the market carefully and shape its policies accordingly. Either way the current inflation calls for more of fiscal policy initiatives than monetary policy measures. Against these theoretical underpinnings, the proposed move of the government to cut customs duty and excise duties on major petroleum products across the board sounds appropriate to offset the inflationary impact resulting from the rise in crude oil prices. Of course, there is a flip side to it: The government revenue may come down. This may be true in the short run but in the long run, the reduction in the duties is sure to encourage growth which is otherwise choked by any monetary policy initiative and thereby offset the revenue losses owing to reduction in rates by increasing the very collection-base. What therefore matters most now is a quick and transparent proclamation by the government about its intended action for two reasons: One, it eliminates uncertainty from the market, which is quite essential for orderliness in the market and two, it enables the market players draft their own readjustment measures so as to tide over the crisis with least side-effects. Let us hope the current dispensation in the North Block sets in motion a new but effective trend in the governance of the economy.

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FDI in insurance: Thats what the economy needs, baby!

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EIGHTEEN

FDI in insurance: Thats what the economy needs, baby!


Prospects of insurance business a known guzzler of capital cannot be insured without adequate capital.

ach epoch, after all, will have its own passions and foibles. The Government sometime back threw open the insurance market, much like pulling down the Berlin wall, for private investment. And as a natural sequel to this, the Finance Minister has now made a budgetary proposal to increase the Foreign Direct Investment cap in insurance from the present 26% to 49% since FDI has the potential to add a competitive edge and there is an urgent need for infusing huge amounts of capital into insurance. This proposal, as anyone could anticipate, has sparked opposition from several political parties. Without getting into the political compulsion of those who are opposing the current move, we shall make an attempt to objectively analyze the dire need for infusion of huge capital into the insurance sector and how its infusion or no-infusion via FDI matters to the insurance sector and to the economy at large. Insurance is an important device designed to deal with risks through sharing. It has two fundamental characteristics: One,
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transferring the risk from one person to a group, and two, sharing of losses on some equitable basis by all members of the group. To render this service, an insurance company basically undertakes three functions viz. risk-taking creates the counterpart of risk, which is security; asset management undertakes sound investment of the premium collections to maximize returns; and servicing the customer by selling policies and honouring claims. Economists of different hues agree that as an economy develops, the contribution of the primary sector declines and that of the service sector increases. Within the service sector, it is the insurance sector that plays an important role in the economic growth of a country. Insurance plays a complementary role in production of goods and services by eliminating uncertainties that are otherwise associated with every business activity. It plays a stabilizing role in trade and commerce. There is yet another important function that insurance performs: it stimulates economic growth as could be gauged from the fact that for the financial year 2002-03, its investments in industry and infrastructure stood at Rs.291418.36 crore, which is 11.89 percent of our GDP. A sound and vibrant insurance industry is thus a must for the economic growth of a country. As against this, there is a huge untapped potential in the Indian insurance market which needs to be harvested for the growth in the economy. Insurance is basically a business of accepting future risks for an upfront fee today. Ironically, at the time of accepting such risks, the insurer has the least knowledge about the cost of the goods sold. But he only believes that the future value of the premium income will compensate for the adverse risk selection or early occurrence of risk or any adverse investment climate at the time the claim under the product sold needs to be paid. Insurance business is thus saddled with underwriting risk, timing risk and investment risk. As a part of

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proactive management, these risks call for maintenance of adequate capital at all times. Thus, adequacy of capital to underwrite insurance has simply become critical for its very survival. In order to protect the interests of the policy-holders the Insurance Regulatory and Development Authority (IRDA) prescribed various solvency margins and monitors their compliance by the insurance companies. The IRDA (Assets, Liabilities and Solvency Margin of Insurers) Regulations, 2000, requires all insurers to maintain an excess of value of assets over liabilities, to the extent of not less than Rs.50 crore, or a sum equivalent based on the prescribed formula given in IRDA (Actuarial Report and Abstracts) Regulations, 2000. Similarly, in respect of general insurers, a minimum solvency margin of Rs.50 crore is required to be maintained or a sum equivalent based on formula given in IRDA (Assets, Liabilities, and Solvency Margin of Insurers) Regulations, 2000. In addition, the registration requirements stipulate that all insurers are to maintain a solvency ratio of 1.5 times the normal requirement. Besides, the newly established insurance companies will take a minimum of five years to stabilize and till then they need to fund their underwriting losses by infusing their own funds. The need for such infusion of additional funds from time to time for undertaking fresh business could as well be gauged from the report that ICICI Prudential increased its capital nine times since its inception in December 2000 from the minimum prescribed capital of Rs.100 crore to Rs.625 crore, Max New York to Rs.346 crore, HDFC Standard Life to Rs.218 crore, Birla Sun Life to Rs.230 crore, SBI Life to Rs.175 crore, etc. Insurance business is a known capital guzzler: it needs a constant infusion of fresh capital which Indian partners are reported to be unable to bring in. Now the moot question is what is the alternative?

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Press reports indicate that in view of this predicament, even IRDA supported the industrys demand for increasing the cap under FDI. Such a move alone can help these capital-starving new insurance companies raise additional capital through their foreign partners who are ready with deep pockets. But, there is opposition to increase the FDI on two counts: One, strategic concerns because of which a sector should not be in the control of foreigners, and two, the insensitivity of MNCs to local needs as they are driven purely by profit goal. But, in todays globalized economy, it is not profitable for states to determine who can do what and to whom, instead they should stay focused on monitoring the businesses and ensure that they are carried out as per the template prescribed. Incidentally, the existing guidelines from IRDA direct every insurer without prejudice to Section 27 or Section 27A of the Act to invest and at all times keep invested his controlled fund in the manner prescribed by it. The IRDA also obtains compliance certificate from the insurer as per the prescribed format along with the investment returns on a quarterly basis. On any score there is thus little to be worried about FDI and its side-effects. Instead, we must learn to use FDI like China for our economic development.

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Is India shining amidst dark clouds of fiscal profligacy?

83

NINETEEN

Is India shining amidst dark clouds of fiscal profligacy?


Long-run fiscal deficits are sure to kill the economy though temporary relief can be enjoyed under the guise of technicalities.

aswant Singh has shown a great sense of timing in announcing his giveaways at a time when growth in the economy is buoyant, interest rates are low, foreign exchange reserves are at an all-time high and the industry is better composed to face global competition. He exhibited gumption in reducing the peak customs tariff rate from 25% to 20%, abolishing special auxiliary duty of 4%, and lowering duties on items like computers, VCDs, DVDs, and coal. These reductions, which were termed by some as pre-poll measures, are estimated to reduce revenue yield by Rs.8000 to 10,000 crore. The present set of mini-reforms without any reference to the expenditure side led some to label them as an opportunistic behaviour but the industry as a whole has welcomed it for, in its opinion, the economic benefits stemming from these reductions far outweigh the revenue losses. True, many in the past demanded a reduction in peak level tariff rates to Chinese levels so that India too could achieve a GDP growth rate of 8%. They have all along been arguing that if the duties are
February 2004.

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reduced, corruption would decrease, output increase and, as a result, revenue collections too would increase. Indeed, the tax cuts offered now in areas such as telecommunications, computerization, infrastructure development are more prone to generate a mood of overall confidence in the economy which in turn can encourage consumers to consume and investors to invest. And that is what is required now to build the much-needed economic tempo in the country. Secondly, they also set the tone for the post-election reforms to be launched by the new government. That they might also serve the political ambitions of the party in power is perhaps irrelevant. Well, maybe, but economists have something else to lament: apocalyptic vision of fiscal crisis. Certainly, some economists are quite worried about the impact of these concessions on the already burgeoning fiscal deficit. True, one of our major problems is large budget deficit and the resulting high level of national debt. The budget deficit of the Central Government alone stands at around 6% of the GDP. It rises to about 10% of the GDP if the deficits of State governments are included. It is a different matter that we are not alone in having a high fiscal deficit. France and Germany are no exception to this. Even the United States suffered a budget deficit of around 3.7% in 2003 which is projected to further rise to 4.3% by next year. Japans fiscal deficit stands at 8% of the GDP. The average ratio of budget deficit to the GDP among the emerging market economies is about 4%. This globally pervading phenomenon obviously posits a few questions: How does peacetime deficit matter for the economy? Could any of the cuts proposed by the Finance Minister be countered under the plea of fiscal deficit? Why worry about a debt that is primarily supported by domestic borrowings? To better appreciate these questions, let us first take a look at what fiscal deficit is and the theoretical underpinnings of its impact on the economy. The budget deficit is traditionally defined as the difference between total government outlays, including the interest on the

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national debt, and the governments revenue receipts. Fiscal deficit is a consequence of a too self-indulgent conduct of the government, i.e., the government spends more than it collects in taxes. A budget deficit therefore means increased borrowing by the government. Of course, here one may argue that as the GDP is also rising, the ratio of the national debt to the GDP will not increase. But this depends on whether the growth rate of national debt is more than the growth rate of the GDP. A continuously increasing ratio of debt to the GDP, as in India, runs the risk of its non-sustainability in the long run. To better appreciate the drivers behind the growing ratio of debt to the GDP, let us peep into what and how standard deficit and primary deficit influence the fiscal crisis. The primary deficit is the standard deficit minus the interest on the government debt. In other words, primary deficit is nothing but the governments non-interest outlays minus total revenues. Obviously, the existence of primary deficit and a positive difference between the interest rate on the national debt and the growth rate of the GDP result in increased ratio of debt to the GDP. The very positive difference between the interest rate and the growth rate of the GDP means that the interest payments alone cause the debt to rise faster than the GDP. Therefore, to reduce the ratio of debt to the GDP, a country must either enjoy a primary surplus or its economy must grow faster than the rate of interest or both. Experience around the world indicates that a rising ratio of debt to the GDP leads to higher interest rates and this in turn results in increased growth in debt. It is in this context that economists argue that a sound fiscal policy must ensure that the government revenue exceeds governments non-interest outlays and the excess of revenue over non-interest outlays must be sufficient to finance enough of the interest payments on the public debt. If not, they warn that the large fiscal deficits can hold back economic growth, lower real incomes, reduce national savings and capital formation and increase the risk

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of financial and economic crises of the type countries of Asia and Latin America suffered in the recent past. Secondly, they also warn that fiscal deficit can lead to higher inflation, despite the Reserve Banks tight monetary policies. Experience the world over indicates that a country which runs fiscal deficit over a long period, exposes itself to poor capital accumulation, lower economic growth, lower levels of real income and the real standard of living. Suffice to say that by any logic no one, including governments, can live on borrowed funds forever. This takes us back to square one: How can Singhs mini-reforms that are known to increase fiscal deficit be termed as pro-growth? A plausible argument in favour of Singhs mini-budget could be that the reduced tax rates would give a fillip to growth in the GDP and thus the overall debt to the GDP ratio will not rise, if not come down immediately. Secondly, the impact of growing debt to the GDP ratio may not be felt immediately since the world today is passing through an astoundingly low interest rates phase. Even otherwise, the adverse effects of budget deficits are rarely immediate and thus every political system, prefers, though unfortunately, to ignore budget deficits, and Singh is perhaps no exception to this temptation. That apart, the very nature of economic decisions, the results of which always reveal themselves only in the future, affords the ministry the comfort of predicting a most favourable outcome for its decision. So, wait for time to reveal whether India is shining or living on fiscal profligacy.

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FTA or no FTA, industrial competitiveness alone matters

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TWENTY

FTA or no FTA, industrial competitiveness alone matters


More than free trade agreements, it is the qualityand price-competitiveness of the industrial output that generates international trade.

ndian foreign exchange reserves are inching towards the hundred billion mark. The hoopla generated by the first ever appreciation of the rupee in the recent past by almost 6% in a matter of a few months and the resulting surge in foreign exchange reserves have almost muted even such milestone events as the Free Trade Agreement that India signed with Thailand and a few such other economic cooperation agreements that are in the offing. Incidentally, its not only the FTAs that were drowned under the surging foreign exchange reserves but also the warning aired by the noted economist Jagdish Bhagwati, who said: the world trading system comes to look like a spaghetti bowl of ever-more complicated trade barriers, each depending on the supposed nationality of products. This warning raises many questions: Are Preferential Trade Agreements (PTAs) so dubious? What really are PTAs? How do they affect trade between countries? Are they good or bad?
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Let us now take a look at what these preferential trade agreements mean and how they matter in the international trade, which understanding alone can enable us to dispassionately evaluate the good or bad of the recently signed trade agreements by India. Preferential trade agreements are of two types: Free trade agreements and customs unions. Free trade agreements are defined by the World Trade Organization as agreements among two or more parties in which reciprocal preferences are exchanged to cover a large spectrum of parties trade in goods. Customs unions, on the other hand, are the PTAs with a common external tariff in addition to the exchange of trade preferences. Such agreements can be either bilateral or plurilateral. It is reported that as at the end of the year 2000, there were about 240 preferential trade agreements, of which 170 are already in force, while the rest are in various stages of negotiation. A major chunk of these PTAs are in the form of FTAs. The Euro-Mediterranean region is known to have a high concentration of PTAs. However, in the recent past, a lot of PTA activity was witnessed in America and Asia. Indeed, it was after the failure of Cancun talks that both the European Union and the US threatened the rest of the world to pursue bilateralism in world trade, perhaps giving a sweet burial to the rule-based multilateral trading system granted under the WTO. To better appreciate the consequences of such a burial, it is desirable to look at what the WTO does. The WTO administers the trade agreements negotiated by its members in the past, settles trade disputes and also acts as a forum for negotiations for further trade agreements all of which cumulatively guarantee the smooth flow of trade within a rule-based trading system. Under the WTO, anti-dumping rules and subsidiary restrictions can be enforced and thus it can, to some extent, control the unilateral actions of the major trading nations. Its dispute settlement mechanism

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has also become very powerful vis--vis the mechanism to resolve disputes under the bilateral agreements. There is of course an argument in favour of bilateral negotiations under the plea that they can be brought to a conclusion quickly because of limited participating members than in talks under the WTO a multilateral framework. The bilateral agreements are often found to result in a substantial improvement in political relationships between the partner countries. Without going deeper into the merits and demerits of bilateral and multilateral framework of trade agreements, let us take a quick look at what economists have got to say about the FTAs. Historically, it is presumed that Free Trade Agreements expand markets and economic efficiency for they are necessarily meant for trade liberalization. However, this traditional view was later challenged by economists like Jacob, Viner and James Meade. According to them PTAs exert two effects: Trade creation and trade diversion. Trade creation under PTA occurs when a countrys domestic production is replaced by lower cost imports from the partner country while trade diversion occurs when the low-cost imports from countries other than the PTA partner are replaced by higher cost imports from partner countries, of course, owing to tariff preferences. Obviously, PTAs could enhance welfare only when their trade creation effects outweigh their trade diversion effects. They argue that emergence of such a benefit rests on several factors and maybe that is the reason why many trade economists are often found to be suspicious of the alleged benefits of PTAs. Over and above that, free trade agreements or customs unions are not only antithetical but also engender a lot of problems in terms of defining and policing rules of origin of goods. Such rules are quite essential since tariff preferences are accorded only to goods actually produced in the partner country but not to the goods from the rest of the world that make an entry via the partner country with the lowest

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external tariff. For instance, Singapore, being a trade-dependent economy, maintains zero tariffs on almost all products. It also has free trade agreements with countries like South Korea and Japan. In view of this, goods of Korea or Japan can enter India through Singapore and thus warrant policing to arrest Indias losses that could either be in the form of a fall in customs revenue or eating into the market share of domestic firm. Despite these disadvantages, FTAs are mushrooming all around, that too, more out of non-economic considerations. It would not be surprising if this trend gains further momentum owing to the failure of Cancun talks. Against this backdrop, let us analyze what India has in store from the FTAs. The CII claims FTAs will provide Indian companies the right platform to position themselves as global players. It sends the right signal to the global business fraternity that India is not a protectionist economy. But it is also equally true that the envisaged benefits squarely rest on the details of the product lists, phasing, rules of origin etc. For instance, penetrating into the Thais already well-established auto components market would call for a consistent effort from Indian manufacturers in improving and sustaining quality of their output that, too, over a number of years. Similarly, till our tax structure, labour laws, energy costs, capital costs, infrastructure quality etc., match with those of Thailand, the FTA may in effect be counterproductive, though unintended, owing to which our products are more prone to price-uncompetitive. In any case, FTA with Thailand cannot generate trade creation gains as much as an FTA with the USA or the European Union can. The moral of the story is that, to reap full gains from any such trade liberalization agreements, we need to build at once industrial competitiveness and in that context, the government and the industry should work together.

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ECBs or FIIs: Which is more good?

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TWENTY ONE

ECBs or FIIs: Which is more good?


Cutting off the leg is not a cure for pain but administration of a cure certainly is.

conomics textbooks say that participants in the market transactions must bear the full consequences of their decisions, be it losses or gains. Obviously, market players go to considerable lengths to pocket the profits from the success of their businesses, while passing on the costs to others. But this simple logic is often lost sight of by the market regulators in their anxiety to put off any emerging instability in the market and the recent act of the government in revising the policy guidelines under the External Commercial Borrowings (ECBs) is an example of this phenomenon. The Finance Ministry has recently tightened the norms for ECBs. According to the latest guidelines, companies can borrow foreign currency denominated loans of US $50 million and above from international financial markets only to finance infrastructure projects which involve foreign exchange needs, such as for importing capital equipment and technology. The revised guidelines also prescribe a cap on the interest rate: the maximum spread over the six-month
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Libor cannot exceed 150 basis points. It is also made mandatory for the corporates to park their ECB proceeds abroad until they are utilized for the intended purposes. The immediate fallout of the current move is quite obvious all corporates cannot borrow from global financial markets and reap the benefit of the historically lowest interest rates prevailing in the global financial markets. Now the question is why this sudden change in the guidelines under the ECB programme? One immediate motive that strikes to mind is the pressure caused by the mounting foreign exchange reserves and its management to the Reserve Bank of India. Secondly, the government might have thought that such restrictions on ECBs would automatically drive many of the corporates to Indian banks for their capital needs, so that banks can be helped to come out of their liquidity-overhang. True, the management of forex reserves that have crossed $93 billion is certainly a matter of concern and any further inflows would only make matters worse. This prompts us to take a look at the underlying reasons for the current upsurge in forex reserves. The major culprit for the increased inflow of forex is the FIIs who are reported to have so far invested in the stock market around $6 billion. It is of course pretty encouraging to note that our capital markets could attract the attention of global investors by offering good valuations, which reaffirms that India Inc. is doing well. But there is also a bad news embedded in it: What if tomorrow the FIIs find that another market is offering a better return than ours? The answer is simple: Driven by the basic principle of economics, they would simply unlock their positions in India and move on to the markets that offer better profit. In other words, their investments in the Indian market are purely profit-driven and are therefore unstable. An extension of this argument makes it clear that surging forex reserves too are vulnerable to frequent changes.

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Well! Thats not the end of the story since vulnerability of forex reserves to frequent changes means volatility in the market both the stock and forex markets. Even otherwise, what purpose do these FII funds serve? These funds at best can only power the stock market rally. They dont add to any fresh investments in the country. One may at best argue that they would unlock the domestic funds from the existing investments and make them available for fresh investments besides generating a feel-good factor about India Inc. But that is not what is happening today and in any case the FII inflows cannot be treated as investments for they are simply trades. Now, as against this, the ECBs are long-term borrowings and thus assume the status of investment meant for generating fresh wealth. They facilitate availability of cheap funds to corporates either for investment in new projects or to manage the existing businesses by making dirt-cheap working capital available. Secondly, funds being available today at historically low prices of around 1.25% in the global financial markets as against the prevailing PLR of about 10% in the domestic market, the ECBs would simply bring down the cost of output of businesses. Reduced cost of production automatically makes Indian exports price competitive in the international market. Secondly, with the opening up of markets and drastic reduction in tariffs in the recent past, Indian consumers are flooded with imported goods at affordable prices, as a result of which even companies operating within the domestic market are required to offer competitive prices vis--vis imported goods, which could be accomplished to a great extent by availing loans under the ECB scheme at low interest rates. Against these realities, imposition of restrictions on companies from availing loans from global markets all with the objective of easing the burden of managing the surging foreign exchange reserves by the RBI and giving a fillip, though misplaced, to credit off-take from Indian banks, does not sound logical.

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There is of course another argument in favour of current guidelines under ECB: many of the corporates who have earlier borrowed under the ECB program are found not managing their forex risk properly either due to lack of awareness or absence of proper risk management practices, which authorities regard as not a healthy practice for the system as a whole and hence the current restrictions. If this is true, it is nothing short of the government taking over upon itself the corporates responsibility to manage their forex risk exposure. This imposed macro measure for managing the micro risk would only wipe out the scope for Pareto efficiencies, if any. Instead, it would have made greater impact had the government tinkered with guidelines for FIIs participation in capital markets as a measure to minimize further inflows of foreign exchange. But, logically speaking even that would have sent a wrong signal to the market players that, too, when we are making an attempt to integrate with the global economy. So, the obvious answer to all these problems is honing of our skills to manage the forex reserves more optimally and for the government to stay focused on the macro-economic management leaving micromanagement to the respective agencies for it is they who as entrepreneurs required to pocket gains and suffer losses as well.

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Cancun or globalization: Whose somersault is it?

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TWENTY TWO

Cancun or globalization: Whose somersault is it?


The wealthier nations must realize that justice is the main pillar that upholds the whole edifice of global trade.

erestroika and glasnost are not just two words in the Russian language but they are of tremendous historical significance. They helped Germans pull down the Berlin Wall. They caused the collapse of communist regime in East European countries. They have been instrumental for these countries in shedding off their faith in central planning and the command and control system of economic decision-making. It led to their embracing the market-driven economy. Unashamedly, they have even sought Foreign Direct Investment for giving a boost to their flagging economies. Ultimately, these words have achieved immortality by eclipsing the cold-war syndrome and launching the world on an altogether new trajectory. The third world countries from Asia and Africa, too, have fallen in line. They have come out of their cocoons that had been woven under the guise of self-reliance and have started liberalizing themselves slowly but steadily. Its, of course, such countries as Taiwan, Hong Kong, South Korea and Singapore who were the first amongst
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the developing world to liberalize and join the international trading regime. Subsequently, China joined the liberalization process, followed by India. Cumulatively, globalization has become the buzzword. Globalization is understood as a process under which capital, people, goods, information, and culture move freely across the sovereign boundaries. It is argued that the Market economy will result in convergence of living standards of rich and poor nations. In support of this argument the protagonists of globalization cite the example of Chinaa communist country where liberalization is said to have doubled the grain production in five years. This phenomenon had demonstrated the power of market principles in no uncertain terms. Though market economy appears to have triumphed, discordant notes are not unheard of. With the spread of globalization, international aid that once flew from the first world nations to the third world countries as a tool for their economic development, was replaced by Foreign Direct Investment. It is also reported that for a majority of the developing and transitional economies, the income gaps have become greater today than before. Even within the countries wherever high levels of aggregate growth is experienced as a sequel to their embracing neo-liberal economics, the additional wealth has benefited only a select few. This obviously resulted in a stinging attack on the WTO and the IMF for the practices that they have advocated from a section of economists, notable among them being the Nobel laureate, George Stiglitz. All this, of course, also explains why the Cancun talks failed. Nevertheless, it makes sense to examine afresh what happened at Cancun. It is a simple burst-out of all the contradictions embedded within the WTO: unequal rights and obligations, fear about shrinking sovereign influence, and the hypocrisy of developed countries. To

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better appreciate the frustration inflicted by the hypocrisy of the developed countries, let us take a look at the recent episode relating to the US multinational, Chiquita. Chiquita is a leading international marketer, producer and distributor of fresh and processed fruits and vegetable products from the US. When the European Union decided to award a quota of less than 10% of banana imports to Chiquita, the corporation made the US government protest this restriction by lodging a complaint with the WTO charging the EU with a discriminatory approach. The US administration even threatened to impose a new 100% duty on the imports from the EU if it was not agreeable for a negotiated settlement on banana imports. Ultimately, when the EU refused to comply with even the WTO order, the US did impose punitive duties on EU imports. This story only highlights the bizarre willingness of the governments and even of the world bodies to oblige the corporates and their greed for business growth. Let us now juxtapose this episode with the recent responses of the US and other developed countries to a proposal that emanated from some of the worlds poorest countries at the Cancun meet calling for a level playing field in the global cotton markets. The West African countries, namely Chad, Mali, and Burkina Faso, are engaged in cotton cultivation for export market. But their cotton exports have of late been facing a major challenge from the US and EU cotton farmers who, owing to a high level of subsidies extended by the government of the US and the European countries $3 and $1 billion respectively were found pulling down global cotton prices. Given the lack of a level playing market, these countries asked the US and the EU to remove cotton subsidies. But, as the cotton growers of the US and European countries warned their respective governments against reducing subsidies, the US and the rest, instead of responding positively to the African proposal, unashamedly made a counter proposal.

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That is the level of maturity exhibited by the leadership of the developed countries: on the one hand, they advocate free trade for every other country, but when it comes to them what matters is their own interests and in the process, they do not mind flouting what they urge others to do. The buck doesnt stop here: in order to overcome the impact of delayed decisions at WTO, the US is toying with the idea of striking bilateral deals wherever warranted. It doesnt matter to them though such bilateral deals go against the very basic tenets of globalization. Similarly, the EU is reported to have proposed to limit the negotiations at the WTO to a small bloc of countries depending on their share in the global trade all to obviate such irritations as they encountered at Cancun. What does all this mean? Does it mean killing the rule-based multilateral trading system, or, does it mean a grinding halt for globalization? It doesnt matter which somersaulted the Cancun meet or the process of globalization. But what matters more is the bizarre exhibition of vested interests by the US and the EU countries: the West wants free access to the developing country markets but deliberately slows down in reciprocating the same to the poorer countries where they enjoy a competitive advantage. They do not mind even seeking exemptions from the very principles and rules they urge on others. It is time they realized what Adam Smith said: Society may subsist, though not in the most comfortable state, without beneficence; but the prevalence of injustice must utterly destroy it Justice is the main pillar that upholds the whole edifice. Doesnt it apply to the whole world?

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Why poor LIC, why not post office?

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TWENTY THREE

Why poor LIC, why not post office?


Parenting does not mean making unfair demands on the wards, that, too, when the turf is not the home.

ndia faces fiscal crisis. So warns the World Bank. It has predicted that Indias fiscal deficit could swell up to 11.8% of the GDP by 200607. It affirms: Indias large fiscal imbalances pose a serious threat to sustained growth and development over the medium term. If this negative cycle continues, a full-fledged fiscal crisis cannot be ruled out over the medium term. Given the likely scenario, it desires that the centre and the states be proactive in reducing fiscal deficit, in shifting expenditures into more productive areas and in removing structural impediments to higher private investment and productivity. Is this yet another technocratic prescription based more on ideology than economics? Routine stuff to come from the IMF/World Bank? Keeping that argument aside for a while, let us take a look at the recently launched Varishta Pension Bima Yojana by the Government of India for the benefit of senior citizens. The scheme, to be administered by the LIC, offers an assured return of 9% per annum to the policyholder against a one-time payment of a minimum amount
August 2003.

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of Rs.33,335 and a maximum of Rs.2,66,665. At the launching ceremony, the Finance Minister said that the declining interest rates had reduced the income of senior citizens. To compensate them for the loss, the minister observed that the Central Government had devised the scheme by committing itself to fill the gap between the returns earned by LIC on the premium collections and the assured return of 9%. The scheme offering an assured return of 9%, particularly in the current falling interest rate scenario, is no doubt a boon to the senior citizens. But it also has its flip-side: What if tomorrow the interest rate rises to more than 9%, which possibility cannot be totally ruled out, that too, in a long lock-in period of 15 years? The objective of stabilizing the net buying capacity of the senior citizens could have been fully achieved if the government had thought of a floating rate linked to a base rate, like treasury bills with a floor of 9% per annum. There is yet another dimension to this scheme. Assuming that the LIC, which administers the scheme, is able to deploy the funds in such a way that it yields a 7% secure return, the Government will have to bear a subsidy burden of 2% on the premium and this outgo works out to around Rs.55.33 cr if one lakh senior citizens purchase the policy for the maximum amount. Interestingly, as per the 1991 census data, senior citizens constitute around 9.4% of the population. In other words, the pension schemes target clientele would be around 10 cr. If even 5% of this target population subscribe to the policy at the maximum amount, the government has to shell out Rs.2,800 cr as subsidy. And this is what is already sending shivers down the spine of the fiscal managers of the country, more so in the light of the latest World Bank forecast about the imminent fiscal crisis. That precisely is the reason why schemes of this nature do not sound that good for experts called technocrats from the IMF. But economic policies cannot always be technocratic for there are always trade-offs that convey different values to different political

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doctrines. And quite often, the political choices do make economic sense, for after all there cannot always be an economic policy that is Paretian. Nevertheless, technical analysis is capable of bettering the outcome of political choices too, since it can facilitate promotion of both growth and equality. One such analysis questions the selection of the LIC for administering the Varishta Pension Bima Yojana as it involves higher costs, in terms of both agency and portfolio management cost. For instance, if the LIC has to earn a secured return from the premium collections sans credit risk, it has to obviously invest the collection in government securities involving transaction costs that ultimately raise the demand for subsidy. Instead, the government should have chosen the post office as a nodal agency to administer the scheme. India possesses one of the most extensive post office networks in the world with 1.55 lakh post offices/outlets spread all over the country. Almost 90% of the postal outlets are in the rural areas. The Indian postal system currently provides 38 services, which can be broadly divided into three categories of activities, viz., communication, transportation, and other services. The savings bank wing of the postal department is also offering a number of financial services in collaboration with the private sector. Postal network also sells life insurance. It is currently managing around 13,52,000 insurance policies. Such being its vast reach and experience in offering financial services in the country, the postal department could have been the ideal choice for administering the new scheme at a less cost. Unlike the LIC, the postal department can directly transfer the premium collections to the Central Government. Similarly, the Government can as well reduce its dependence on market borrowings. The net result would be less burden on the exchequer. There is an advantage to policyholders too: A post office being in

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their very neighbourhood makes pension withdrawal pretty simple. It also spares the LIC from the likely regulatory embarrassments. To that extent it keeps the LIC in good stead to edge out the competition from the newly entered private insurers. Doesnt it make the scheme economically more sensible?

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Why & how macroeconomic policies work and work on us?

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TWENTY FOUR

Why & how macroeconomic policies work and work on us?


Globalization commands that we respect the wisdom of ancient economists like Adam Smith and J M Keynes.

ficionados of the Keynesian school of economic thought are quite familiar with the fiscal and monetary policies that are used as effective tools for macroeconomic management by governments. However, with the advent of market-driven economics, governments have lost theoretical support for their active intervention policies. These pundits essentially perceive macroeconomy as a system of interlinked markets. They argue that disturbances in the economy may temporarily divert markets from equilibrium, but are predisposed to return to equilibrium without governmental intervention. They, for instance, by equilibrium in labour markets, mean that all unemployment is voluntary as it is decided by workers offerings or withdrawal from employment at different wage rates and hence in the absence of government or labour union intervention, wages are more likely to return to equilibrium. It is strongly prophesied that government intervention, however strongly it may intend to stimulate the economy or reduce unemployment, would only have a short-term effect since
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whatever illusion it can create through policy shifts becomes irrelevant or becomes relevant at a higher price level, once people and their expectations adapt to the new policy environment. Thus they are advocating giving off of fiscal policy initiatives while restricting the implementation of monetary policy to the extent of maintaining price stability. There is of course an obvious conflict in this argument with the ground realities. To better appreciate this, let us test-check the advocacy of the market economists via an Indian example. A couple of years back, some of the Indian public sector banks were reported to have incurred huge losses. In order to keep them afloat and arrest its contagion risk, the Government injected fresh capital into them by way of budgetary grants. This averted their bankruptcy, besides enabling them to successfully turn around and offer the much needed succour to the depositors. Instead, had the Government, being driven by the market economy philosophy, chosen to remain a silent spectator, these banks would have had their natural death. Secondly, the resulting contagion would have created a financial crisis in the country, subjecting millions of ordinary depositors to trauma. True, the system might have returned to equilibrium at a later date even without governmental intervention, but at what cost? The ordinary citizens would have paid dearly if the banks had gone into liquidation. This only reveals that some one or other has to pay the price for the market crisis if it is to be put on the rails once again. But such pay-outs by a select few are certainly prone to make the macroeconomic policies less sustainable, for it cannot ensure distributional equity in the system. Plausibly, this could be one reason why no government worth its salt is fully subscribing to the prescriptions advocated by the market economists. And this stands vindicated by more than half a century

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of worlds experience gained by implementing macroeconomic policies prescribed under the Keynesian analysis that are believed to ensure economic stabilization by avoiding excessive inflation or recession; distributional equity; achievement of broad social goals such as income security, education, health care; and a stable platform for economic development. It is hard to exaggerate here the benefit of the informedgovernment-intervention using fiscal or monetary policies as tools to set right the volatile markets that are often found to be socially and environmentally disruptive. It is also equally true that social goals cannot be achieved unless collective action is initiated via democratic institutions of governance. Government intervention thus becomes a must for not only achieving macroeconomic stability but also to accomplishing the well-being of the common man that cannot be serviced or can only be inadequately serviced by the market. Whether market economists are right or not is not what matters here: it falls far short of what is needed to accomplish the equity that is even acknowledged by the World Bank as the central concern of the state. It is only the Keynesian theories that place great emphasis on equitable distribution to build a stable society on which alone a stable macroeconomic system can rest and grow. This becomes imperative even from the perspective of the newly emerging concern for ecological stability the world over. In the expanding world of free-trade and globalization, the need to have controlled macroeconomic policies is gaining more importance as free trade is supposed to have negative impact on environmental and social balances too. Secondly, the emerging global and regional free trade regimes are potential enough to make sovereign control on monetary and fiscal policies ineffective as is currently being felt in the European Union, particularly with the launching of the Euro.

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The cumulative result is plain enough: To ignore the potential of monetary and fiscal policies to ensure fair distribution, social equity, ecological sustainability and ultimately the very sustainability of macro economy, would be an even greater mistake. It is high time economic theorists came out with a theoretical prescription that permits only a minimal but effective governmental intervention in managing macro economy with high transparency and least surprises to the investing community so that their long-range planning remains always in sync with the macroeconomic policies being pursued, for that alone can bring a semblance of certainty into the otherwise uncertainty associated with the future. Secondly, such transparent macroeconomic policy alone can pave the way for investments to take place in an orderly fashion and the economy to grow. Well, not so fast: this may not be the end of the conflict. As the concept of sustainable development is picking up momentum, many new perspectives on economic theory, such as natural capital, current and intergenerational equity, green accounting, green tax reform, growth and the environmental Kuznets curve debate have come into existence. Obviously, these introductions and the resulting overlap between environmental, social, and economic analysis will have a considerable impact on macroeconomic policies. However, very little research has so far been done on these lines. On the other hand, free market economy is bound to result in increased international and intra-national economic inequality and increased environmental destruction. Hence, to promote sustainability as well as efficiency, increased consumption and macroeconomic stability, environmental and social dimensions must also be well integrated into macroeconomic policies.

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Isnt it ironic?

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TWENTY FIVE

Isnt it ironic?
Giving with the right hand and taking away with the left hand kind of budget leads the economy that is on the move to nowhere.

ome February, Indians, wittingly or unwittingly, get swooped by the budget-fever. They indulge in all kinds of budgetrelated conversations animatedly. Actually, there is nothing new: it has been happening for the last five decades. Maybe, if one travels farther down the lane of history, one may trace such discussions to even Chanakyas period. Our ancient thinkers strongly advocated a kind of taxation whose implementation is not felt by the people. A king was ordained to take into account the oga Kshema of the Y taxpayers while levying taxes. He was expected to take into account all the conditions considered necessary for ensuring the Yoga (stability) and Kshema (welfare) of the taxpayer. It was said that a king, while collecting taxes from people, must act like a gardener, and not like a charcoal-maker. He should be wise enough to allow the growth of resources of the state before imposing taxes on the people. Taxation should be equitable and reasonable both the state and the people should feel that they have got a fair and reasonable return for their labours. It is also said that exemption of
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the un-affluent sections from tax burden and imposition of higher duties on luxurious goods was valued as a principle of progression. Kautilya advocated that taxation should be imposed in proportion to the paying ability of the people, else fiscal tyranny would lead to popular discontent. The Jatakas also reveal that oppressive taxation sometimes forced the subjects to leave the kingdom and migrate to other places. This incidentally holds good even today but instead of people, it is the capital that is migrating from a highly taxed country to one which offers either scope to avoid tax altogether or imposes least tax burden. From the yin and yang of the past, let us now move onto the current scenario. This is best accomplished by recalling the concluding but interesting remarks of the finance ministers budget speech: This budget is of an India that is on the move. An India that now rapidly advances to prosperity. It is about an India that banishes poverty, and builds on its great resource base, the strength of its human capital and the immense reservoir of its knowledge. Despite the high inspirational value of these remarks, nobody appears to have paid any attention to them. Or, is it that people are no longer moved by words, however inspiring they might be. Or, perhaps, they want to make a point Mere wishful thinking does not mean anything, particulary, when the reality is different. The hard reality is that 70% of the population still live in the countryside. During the current financial year, the country has been afflicted with the severest drought witnessed in the recent past. As a result, agricultural production is estimated to have fallen 3.1%. As against these realities, precious little has been done to give a boost to agricultural production except announcing a scheme for high-tech horticulture and precision farming. On the other hand, the budget has hiked fertilizer price while leaving subsidies under food,

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LPG and kerosene distribution untouched though they are slated to go up. Industry and services segments are reported to be growing at the impressive rates of 6.1% to 7.1% respectively. The current budget has offered it a host of concessions: Excise duties on cars, pharmaceuticals, soft drinks and liquor have been cut, ostensibly to give a boost to consumer demand. The concessions granted to the motor industry are particularly intriguing since the simultaneous rise in petrol and diesel prices will offset whatever gain a consumer might get out of the price cut on cars. But in the hype generated by the rate cut in car prices, consumers tend to ignore the impact of price rise under petrol/ diesel on their overall budget and likely to jump at acquisition of cars. Or, there may not be any rise in demand and even if there is, it will simply end up fanning undesirable consumerism. There is yet another attempt at giving a boost to consumer demand: Direct taxes are tinkered with here and there; raising standard deduction limit for salaried employees; elimination of surcharge for individuals; raising the exemption limit under income from other sources; etc. Taxing dividends in the hands of shareholders has been abolished. What is more, they can even enjoy these sops while sipping imported liquor at a much lesser cost than hitherto. As against these cuts, the finance minister tried to suck in more out of the purses of the people by raising service tax from the current level of 5% to 8%. And this would mean increased expenses for various services like catering, mobile phones, and banking services. The finance minister in his anxiety to put money in the purse of every housewife did precious little to bring down the fiscal deficit, no matter even if it continues to be the second highest consolidated fiscal deficit in the whole world. The revenue deficit itself stood at a whopping Rs.1,12,000 crore testifying to the inability of the

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government to effect any significant cut in non-plan expenditure. Secondly, there is no provision in the budget for the redemption of US 64 units in May, though the shortfall is estimated at Rs.6500. It simply defies the canons of prudence. The estimated fiscal deficit of Rs.1,53,637 or 5.6% of GDP relies more on the realisation of additional revenue of around Rs.3000 crore from service tax despite the current fiscals revised estimates being short of the budget estimates by more than Rs.1000 crore. It is proposed to buy back old domestic debt from banks to capitalise on the falling interest rates. Interestingly, government effected the rate cut under small savings schemes administered by it, by 100 basis points. Though the government argues that the real returns from these instruments would be around 6.3%, which is higher than what was offered during 1991-92 to 1995-96, one is not sure if this would hold good for long when the inflation rate has started climbing up in the recent past. More so with the kind of push being given to consumerism, savers may end up with lower real returns. This may ultimately affect national savings behaviour which in the ultimate analysis is in nobodys interest. Budget proposals talk about giving a major thrust to infrastructure: Plan outlay under power, roads, and national highways is being increased 22%, 39% and 23% respectively. But, it is not clear wherefrom the funds would flow in for its accomplishment; that too when we lack the required political will to frame policy guidelines that are capable of sustaining uninterrupted flow of private investment into infrastructure development. The situation looks more grim if we take cognizance of what a recent World Bank report observes: Growing fiscal deficit over the years resulting in higher inflation which can push up interest rates, further crowd out private investment, weaken the health of the financial system and increase vulnerability to macroeconomic risks.

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Dumped in bewilderment? Wondering if India is really on the move? Guessing its potential to rapidly advance to prosperity? Wondering if it could ever banish its poverty? Well! With the kind of resource base, the strength of its human capital and the immense reservoir of its knowledge it is no wonder if India achieves these goals but it certainly asks for a consummate leadership that is willing to take unpleasant decisions.

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TWENTY SIX

Walk the talk Oh! me? no way


If all the talk of leadership about prudence, governance, accountability etc., is only for others to practice, we may not succeed in the global arena.

he Federation of Indian Chambers of Commerce and Industry (FICCI) that was established in 1927 at the behest of the Father of the NationMahatma Gandhiwith the objective of garnering support for Indias independence and to further the interests of the Indian business community, recently celebrated its platinum jubilee. The celebration, as claimed by the out-going President of FICCI, was indeed a historic event. The deliberations were true to the occasion. The thoughts aired, though not fresh, made an apt reflection of the current scenario. They merit meditating for that may help the nation translate the thoughts into action. Let us first recall what the prime minister said in his address to the gathering of the captains of industry. He expressed his anguish at the persisting problems in fiscal consolidation both at the Centre and in the states: slow implementation of reforms in the power sector and on the labour front; and the pace of infrastructure investments.
January 2003.

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He said he was concerned that the systems, procedures, rules and regulations in the government had still not been sufficiently reformed to serve the needs of rapid economic growth. He called upon the industrialists to somehow increase the growth rate by a couple of percentages without any financial investments by carrying out necessary governance reforms at various levels. What a profound statement! And how rightly it captured the ills faced by the country! It makes one feel sick at the haplessness of the government. And, mind it, these statements have come from no less than the Prime Minister of the country. Now the question is: Are we to stay content with our learned helplessness? This bewilderment begets a battery of questions: who can ensure fiscal consolidation? Who has to hasten the reforms process in the power sector and pave the way for private investment? Who has to take the initiative to increase the growth rate with no additional investments? Who has and where from to start reforms in governance? Does all this mean that the Central and state governments do not have the willingness to make things happen? Are they so moribund that they cannot unshackle the nation from its inefficiency, waste and diffidence? It is not that we have lost everything: the very fact that the prime minister could so publicly air his anguish at the sluggish growth in reforms speaks volumes for our willingness to correct the things, to set the nation on the right course, that too perhaps through the chosen democratic process. And, in fact, that may be what the prime minister had at the back of his mind when he aired his displeasure at the tardy growth the nation has been witnessing. Let us now turn our attention to what the literature on fiscal policy and its influence on economic growth has to say. The neoclassical school states that fiscal deficits in a closed economy increase

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aggregate consumption leading to reduction in national savings resulting in higher real interest rates and this in turn, depresses investment and overall economic activity. In an open economy, higher fiscal deficits are reflected in higher capital flows and a real appreciation leading to lower net exports and again, a reduction in overall activity. In either situation, the net result is, crowded-out investments and reduced activity. But, according to the Keynesian approach, if the economy is operating at a less than full employment, expansionary fiscal policy is conducive to growth. Against these theoretical underpinnings, let us take a look at what is happening on our home front. In our anxiety to achieve fiscal consolidation, we have sacrificed social sector expenditure comprising mainly, education, medical facilities, public health, family welfare and sanitation. Similarly, the government has practically withdrawn totally from incurring any capital expenditure on infrastructure build-up. On the other hand, the OECD countries achieved fiscal adjustment during the 90s, mostly by way of expenditure reductions in areas such as wages, current transfers and interest payments rather than by tax increases. As against these cross-country experiences, we are today suffering from our inability to curtail revenue expenditures. The current expenditures are assuming a larger proportion of the government expenditure, mainly driven by consumption expenditures and transfer payments viz., interest payments, and subsidies. The deterioration in the revenue/GDP ratio has obviously affected the investments in productive sectors. Nor has the anticipated investment in the infrastructure come from the private sector. The net result is the deceleration of the economy. What this reality calls for is anybodys guess. It is time someone initiated the much-needed frontal assault on waste and inefficiency in government and business. When wastage in government is

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rampant, taxes become small. Secondly, be it China, Europe or the US, they all leveraged on their robust public institutions for growth. But our public institutes turned out to be ineffective, iniquitous, inefficient and a drain on the exchequer, all because of the lack of political will to keep these institutes at arms length from the political leadership. Now, the moot question is, who has to energize these institutes to improve their efficiency and effectiveness; and who would take the initiative to reform the governance of the national resources. This reminds us of what the outgoing FICCI president said at the celebrations: You cant build a reputation on what youre going to do but have to walk the talk. He then called for accountability in the system, pointing out that today we have no way to provide redressal or disincentives, leave alone penalty, if the systems are inefficient, or they do not deliver the right goods. The message is quite obvious: it is the government which has to take a bold decision on creating conducive atmospherics for private investment, both from within and outside the country in the form of FDI, by putting a once-for-all framework in operation. Intriguingly, at the end of the days celebrations, Sri Rajendra S Lodha passed on the baton of presidentship of FICCI to Dr. AC Muthiah, Chairman, SPIC Ltd to steer it through the year 2002-03. Utterly baffling?

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TWENTY SEVEN

To disinvest or not to.


Who owns the assets (PSUs) is less important than who manages them and how?

o disinvest or not to, has of late become, shall we say, the pastime of the intelligentsia in India. Look at any of the newspapers or magazines they are full of the Whys and Why nots of disinvestment and sets of prescriptions from the elite for managing the transition. The intelligentsia is arguing that the public sector is a drag on the Indian economy. Right from the former finance minister to the coffee-shop gossipers, public sector-bashing has become a fashion. How times have changed! These are the very same enterprises that were once referred to as temples of modern India but appear to have run their course. One school of economists attributes all the ailments afflicting Indian economy today, to the inefficient functioning of the public sector undertakings (PSUs). It is commonly perceived that PSUs are the personal fiefdoms of politicians and bureaucrats. They strongly believe that Indian politicians are the most undesirable agency to be assigned with the responsibility of controlling the countrys commercial assets.
December 2002.

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Admittedly, it may all be well-founded, for politicians are known to grab the earliest opportunity to appoint their cronies on the boards of companies in their domain and use the assets of those companies as their personal property. While the chief executive of a public sector undertaking can be fired overnight for the failings of the unit, the minister concerned cannot be held accountable. Given the option, these politicians would not let go the various perks that they could enjoy by being with PSUs and in the process make them less and less business-oriented and more and more accommodative in nature to the whims and fancies of the political leadership. That apart, over a time, one segment of the elite started labelling the public sector as inefficient and is clamouring for its immediate privatization. It is their firm belief that business is no business of the government. These zealots are therefore arguing that privatization is the only way to make the virtually defunct public sector units once again productive. In support of their argument they cite the example of China, whose competitiveness is claimed to have been enhanced by the large scale privatisation of State-Owned Enterprises and rationalisation of labour force that commenced sometime in 1995. But, it is pretty simplistic to think that everything relating to the public sector is bad. It is equally nave to think that the private sector is free from all these ills. As argued, if private ownership guarantees performance, how does one account for the mounting NPAs under the corporate credit that the banking system in India is saddled with? The slew of scandals breaking in corporate America does not speak any differently about private ownership. The accounting scandals in the US make it clear that when it comes to enriching themselves at the cost of shareholders, industrialists and managers in the private sector are no angels. The managerial greed to amass wealth among the executives of even reputed American corporates was reported to be of a monumental scale.

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This being the truth of a market that is considered efficient and highly transparent, being overseen by a powerful regulatory mechanism, it is hard to bite the thesis that private ownership in India will fare better. Even the existing literature on privatization suggests that wherever opportunities for tunnelling exist, mere transfer of ownership into private hands is not going to make much difference. Worse still, where there is a scope for siphoning of funds, there would be no incentive for even the private management to maximize shareholder value via improved performance of the company. Interestingly, what emerges from these two sets of arguments is that mere ownership of assets does not make them productive but it is the management efficiency that makes a corporates existence meaningful to its shareholders. To put it differently, efficient management is neither the property of private ownership nor of public ownership. In fact, we have enough evidence from PSUs themselves to support this argument. The spectacular success of PSUs such as BHEL, IOC, ONGC, HPCL, which were headed by quality leadership, is a testimony that ownership by itself cannot define the success. Here, by efficient management we mean subjecting the corporates to the discipline of capital market and making executives accountable to the shareholders; existence of a strong institutional framework that evens out the principal-agent conflicts inherent in the companies management and surveillance of the market by a powerful regulatory agency backed by an equally tough law enforcement mechanism. It is, altogether a different thing that the US with such institutional framework and acknowledged as an efficient market, functioning under the doctrine of capitalism, miserably failed to arrest the expropriation of investors funds by unscrupulous managements. Nevertheless, this hard reality posits a baffling questionWhat, then, is privatization for? The answer would perhaps be more baffling for

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we do not know what skeletons would tumble down out of the Indian corporate world if we had the same reverence for corporate governance and powerful market regulators as the US had. Even otherwise, mere transfer of ownership of the already existing assets to private hands neither adds to the nations wealth nor anything substantial to the GDP. There is yet another purpose for which disinvestment of government stake in PSUs is recommended to use the proceeds for narrowing our ever growing fiscal deficit. This recommendation sounds pretty suicidal. This only reminds us of what a 20th century Austrian economist, Ludwig von Mises, once said: It may sometimes be expedient for a man to heat the stove with his furniture. But he should not delude himself by believing that he has discovered a wonderful new method of heating his premises. To rein in the fiscaldeficit the government should curtail its revenue expenditure forthwith but not sell the stake in PSBs or shy away from investing in infrastructure development, education and healthcare. Lo! we are back to square one: disinvestment per se is not an end in itself. Whether ownership rests with the private or public, it hardly makes any impact on efficiency levels unless the government does what it alone can do, i.e., create conditions for growth through higher public investment in areas such as education, health, water supply, irrigation, infrastructure, and economy is made to learn and practise not to tolerate somnolence, sloth and non-conformity to generally accepted international norms and standards of macroeconomic management, disclosure, transparency and financial accountability.

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TWENTY EIGHT

Interest rates under deregulated regime and market dichotomy


The interest rate behaviour outside the banking system is sure to frustrate the monetary policy in accomplishing its objectives.

he recently announced mid-term review of monetary and credit policy has indeed brought cheers to bank borrowers but the depositors have nothing to cheer about. The cut in the bank rate by 25 basis points brought it to 6.25%, which is the lowest since 1973. This cut in the bank rate has set in motion the process of reduction in interest rates on bank deposits by more than 25 basis points. Ironically, the dividend paid today by some of the commercial banks is perhaps more than the interest rate of 6.5% being now offered on a deposit of three years maturity. That apart, what is more intriguing here is the reliance of the monetary policy on the Wholesale Price Index (WPI) instead of Consumer Price Index (CPI) for gauging inflation. True, inflation has been declining sharply in the past couple of years: Inflation rate measured as point-to-point variation in the wholesale price index fell from above 5.0% during the first five months of 2001-02
December 2002.

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(April-August) to touch 1.1% as on February, 2002, being the lowest in the last two decades. The rate of inflation during 2002-03 continued to remain low and currently stands at 3.27% as compared to 5.5% during the corresponding period of 2001-02. But, at the retail level, consumer prices diverged from WPI-based inflation. The annual point-to-point variation in the Consumer Price Index for Industrial Workers (CPI-IW) rose to 5.5% in 2002-03 from 2.5% in 2000-01. This difference between WPI-based inflation and CPI-IW compels one to suspect the present levels of inflation. Paradoxically, while the prices of luxuries have come down, those of necessities have not. Even if the official inflation rate is believed to be correct, which is currently above 4%, one has to say that the real interest rate of return has fallen sharply. Its impact on savings hardly needs to be stressed here. So, what is the net impact of these measures? One thing is certain: It compels savers to scout for better avenues that pay them more than what they can get from the banking system. Resultantly, savers may divert their savings towards stock market. Incidentally, immediately following the monetary policy announcement, BSE Sensex moved up by 1.8%. But, stock market behaviour being not rational always and with the kind of losses the investors have suffered earlier, its no wonder if the present rise in Sensex is only an announcement-effect. If that is true, the savers may ultimately move towards either undesirable consumption or move away from the banking sector. Either of these two is potential enough to erode the savings rate, should the current low interest rate regime remain unaltered in the mediumterm. Once the savings rate comes down, there is every danger of liquidity-crunch revisiting the system, making everything hot once again. How soon it would be, is the big question mark, but that is what really matters to risk managers in banks.

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Worse yet, the RBI Governors statement on interest rate cut categorically states that no useful purpose would be served by a further cut in the interest rates. Nor are the corporates likely to grab credit simply because interest rates have been reduced. Over and above this, the system is going to be replenished with additional funds to the tune of about Rs.2,500 cr by way of reduction in CRR. As against the falling interest rate scenario in the banking system, the unorganized sector continues to function merrily with high interest rates. Even in todays scenario of a liquidity overhang in the banking system, entrepreneurs from the unorganized sector, such as bus operators, building contractors, real estate developers, trade and commerce, are borrowing funds from the market at an exorbitant rate of 2.5 to 3% per month. Even small entrepreneurs are mobilizing funds at three or four times the bank rate from private moneylenders. The real rate of return earned from such investments is pretty mind-boggling vis--vis the return from the banking system. It is thus evident that we have two distinct sub-systems within the financial system, operating under two sets of interest rates. Incidentally, entrepreneurs are known to visit both the segments of the market for mobilizing funds to pursue their business interests, as the unorganized sector is almost functioning as a parallel economy under its own unwritten laws. Thus, it has the potential to frustrate the monetary policy initiatives addressed to check inflation and bring down interest rates. To make the interest rate channel an effective conduit of monetary policy, all interest rates in the economy, including small savings rates, should respond to monetary policy directives. But, the ruling prices on small savings schemes hover around 9% for a maturity of six years. As the expert committee appointed under the chairmanship of Dr. Y. V. Reddy, the former Deputy Governor of Reserve Bank of

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India, on small savings schemes opined, that if the 9% is risk free rate, commercial banks should offer this risk-free rate plus risk premium as their interest on deposits of similar maturity, if they have to wean away the savers from the post-office. But todays interest rate structure of commercial banks indicates that they have simply given the go-by to this basic principle of market-driven economy. It is of course a different matter thanks to Indian savers! that banks still continue to attract fresh deposits defying all the canons of risk return trade-off. There is yet another angularity in the market: Pass-through is asymmetric, i.e., the loan rates react faster to tight policy initiatives than they do when the policy is eased. The policy implications of this slow pass-through are that a smaller change in the policy rate will achieve the desired change in the lending rates within a short period and vice-versa. But what is desired is uniform pass-through policy signals across the entire spectrum of interest rates. In such a market, proactive institutions are likely to either suffer or gain from their instantaneous reactions to the policy initiatives. Lastly, inflation is another key macro economic variable that affects the rate of interest. The world over, the consumer price index is being used as a measure of inflation against our practice of relying on WPI. There are obvious reservations about using WPI, as it restricts the scope for a proper comparison of the inflation rate of two nations. Some time ago, Dr. Y. V. Reddy, Deputy Governor of Reserve Bank of India, while reiterating the need for a national consensus on the acceptable level of inflation, called for a change in the weightages of indices used in the calculation of inflation rates: It is now obvious that none of the existing measures provides a truly reliable gauge of inflation at any point of time; the issues relating to base year, coverage and weights have to be resolved. Although a move in this direction has been initiated, nothing substantial has been accomplished. There

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is also a criticism regarding non-inclusion of the service industry in the computation of WPI, as its omission distorts the real inflation rate in the economy. There is also no unanimity in the views on using the past or future inflation rate for measuring the real interest rate. Some economists are of the view that the future inflation rate should be deducted from the nominal interest rate for calculating the real interest rate. Similarly, the concept of core inflation has also been advocated. Under these dichotomies God only save the banks!

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Why gold is still good as gold?

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TWENTY NINE

Why is gold still good as gold?


Gold the safest asset, particularly in times of economic crisis is still considered as one of the worlds highly liquid assets.

ince time immemorial, gold has been one of the greatest weaknesses of mankind in general and Indians in particular. It holds a queer fascination for everyone. A great deal has been spoken or written about it, yet all these discussions and writings have generated only heat and hardly thrown any light on its price behaviour as is happening with its current bullish rally all over the globe. In its glittering past, many have glorified the yellow metal as the best-fit to play the monetary role. But Keynes and William Jennings had castigated gold by describing it as a barbaric relic of the past. Despite what people say about it, gold continues to remain as the ultimate hard asset that normally shines in times of financial turmoil. It often tends to take its traditional role as an asset of last resort as is currently happening, although it lost its monetary role long back. Historically, gold functioned as money. Till the beginning of the 19th century it was quite customary for the kings and queens of the continent to mint gold coins. They served as a medium of exchange not only for domestic transactions but also in trade and payment
August 2002.

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transactions with other countries. The par values of currencies of the countries in terms of gold standards were directly determined by their respective gold content. However, later this scene changed with countries finding gold coins/bars quite inconvenient to carry around for spending purposes and with governments issuing paper certificates that are redeemable in gold on presentation to the treasury or central banks. Subsequently, with the world gold production being found insufficient even in those days to meet the rising demand of gold coinage, there was a move among certain countries to use silver as a supplement. This move towards bimetallism marked the first step towards reducing the monetary role of gold. In post-World War II, with the declining economic and political strength of the UK, the USA emerged as the worlds greatest economic power and as a result, many countries have preferred the US dollar to gold and pegged their currencies to the US dollar. This was followed by other reasons such as declining gold component of world monetary reserves, deflated monetary stocks being exposed to further drain during speculative gold rushes, and the resulting move of central banks not to intervene in the private gold markets in the late 1960s. Creation of SDR in 1969 as a reserve asset, and the failure of monetary gold stocks of the central banks to arrest the spurt in the free market price of gold have ultimately stamped the gradual exit of gold from global monetary role. In the recent past, gold regained its lost lustre with the prices shooting up from dollar 255 to 305 per ounce, its highest level in nearly two years, in international markets. The plausible reasons for such a bullish rally are many: The ongoing global recession accompanied by worldwide stock markets melt-down; pessimistic outlook of Warren Buffet, a noted investor, on the world that is besieged by terrorism and his warning about the meagre returns from the stock markets over the next few years; shaky Japanese banking system that is plagued with uncertainties about their solvency, falling interest rates

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to as little as 0.02% per year, the trade-off between the ultra low interest rate and security and the recent withdrawal of government insurance on savings have shaken the faith of the Japanese compelling them to look for alternative secure places to put their money in and in the process gold became the Mecca of their investments contributing around 10% to world gold sales; Chapter 11 bankruptcy filing by Enron and the accompanying perception that there is no shortage of egregious conduct elsewhere in the corporate world of the US; Argentinas default on its sovereign debt; the September 11 terrorist attack on US; gradual decline in gold production in the last three years etc., have all cumulatively resulted in loss of faith in fiat currency resulting in a rush for gold. Secondly, analysts attribute the current rise in gold price largely to increased demand in the US where low interest rates have made bond and money market yields unattractive and fears of war in the Middle East have driven people towards safer investments. Gold is perceived as store of value as it still meets the function of money particularly in the context of free fall/collapse of currencies as is seen in the case of former USSR. Second, it offers hedging facility against inflation akin to taking an insurance policy against calamities as its price is strongly correlated to inflation. Third, it is one of the safest assets, particularly in times of economic crisis. Fourth, it helps in diversifying an investors portfolio. Lastly, it being one of the worlds highly liquid assets, offers high liquidity. So, there is no escape from its lure whatsoever and people cant but fall for it. Historically, gold has been used as a safe haven by almost every one who had access to it and could afford to own it. People own it because it has no risk unlike fiat currencies that could be wiped out should the fiat monetary system collapse. It is to hedge their bets against economic instability that investors buy gold. There is, however, a hitch hereas long as gold continues to function as money, and is quoted in US dollars, it will continue to respond to any change in exchange rates just like any other currency such as yen, euro. So the

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sustainability of its current price-rise depends much on the movement of the dollar exchange rate. Currently, US economic growth is slowing down, inflation is rearing its ugly head and the Federal Reserve is increasing the money supply to fight off recession. In the process, the heyday of dollar appears to be over and if this really happens, investors having no other alternative for safe parking of their funds, more so when yen and euro are languishing for their own reasons, would obviously resort to buying gold. In short, if the current gold price rally is to sustain, one needs to see a weakening dollar against foreign currencies, else the rally may well be a short-lived one. Its amazing that even after its diminishing monetary role, gold continues to sway the emotions of people with its scintillating and rewarding appeal and value to those who come to grip with its price behaviour. Despite 8000 years of experience, why gold is good as gold remains an intriguing question. Many have attempted to explain it in many ways but none to the satisfaction of the commoner except of course the Egyptians who have aptly said that golds value is a function of its physical characteristics and its scarcity. Many of the physical attributes of gold are quite incredible: its the most malleable of all metals; its ductility is amazing; its resplendent lustre allows it to be designed into the most coveted and exquisite jewelry that befits queens and kings. Its scarcity is more unbelievable than its physical characteristics for, the worlds holdings accumulated from time immemorial to the present are only around 1,20,000 tonnes. As against this, banks can create dollars and there are no physical limitations on the quantity that can be created. Similarly, they can disappear as easily as they were created while gold is almost indestructible. And thats why gold continues to lure mankind for good.

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CRR reduction-package: Is it really all that?

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THIRTY

CRR reduction-package: Is it really all that?


The Deputy Governors revelation about the intended reduction in the CRR from 5.5% to 3% is a radical departure from the set practices of central banks.

ts amazing. It is incredulous, for never in the past did any one from the countrys central bank ever attempt to reveal his or her mind before pronouncing regulations, nor ever share with the intended users, their perceptions about the proposed changes in the regulations. That is exactly what Dr. Y. V. Reddy, the Deputy Governor of the Reserve Bank of India, did in Chennai when he said, the central bank may consider announcing a one-time reduction in the cash reserve ratio from the present 5.5 percent to the statutorily prescribed minimum of 3 percent in one go. Elaborating on the package, the Deputy Governor said that the reduction in the CRR should be accompanied by several changes, such as change in the way banks at present maintain cash balance. He also opined, as CRR gets lowered and repo-market develops, refinance facilities may have to be lowered or removed altogether and the access to the non-collateralized call money market restricted
February 2002.

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with the objective of imparting greater efficacy to the conduct of monetary policy. This indeed is a great transformation in the mindset of regulators. Such loud thinking would no doubt go a long way in enabling the market players to get ready with the strategies required to manage themselves under the proposed changes. Thus far its pretty good, but its timing is disquieting. In fact, the sharp rise in the prices of government bonds immediately following these statements vindicates our anxiety about the injection of excess liquidity and its adverse impact on the system. This scenario gets worsen when one takes note of the fact that the commercial banks credit growth during April-December 2001 fell sharply to Rs.37,256 crore from Rs.49,615 crore recorded for the corresponding period in 2000. As of December 2001, the non-food credit grew 10.8 percent on a year-to-year basis as against 19.5 percent growth recorded the previous year. This poor credit off-take obviously forced banks to end up in having an average excess investment of 40 percent under SLR securities as against the required 25 percent. As ill-luck would have it, the Indian economys performance during the current fiscal is no better than the banks dismal performance on the credit front. The governments falling tax receipts, rising nonplan expenditure, bulging revenue and fiscal deficits are indeed quite disturbing. There is nothing happening on the macro-economic level that encourages one to hope for an early upturn in the economy. The fact that bond prices suddenly went up following the Deputy Governors statement on RBIs intention to reduce the CRR to 3 percent, is perhaps a forewarning of the scenario that is likely to unfold once the cut becomes a reality. Unless the government comes out with policy initiatives to give a push to economic activity that encourages private investment in

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infrastructure, there may not be any appreciable demand for credit from corporates. Perhaps, the only alternative for banks then would be to go all out for retail lending which again is not everybodys ball game. No wonder then, if PSBs, wittingly or unwittingly, once again end up in more SLR securities than what is statutorily required, and there appears to be no dearth of securities as the government has already surpassed the net market borrowings proposed in the budget by about Rs.3196 crore, while another Rs.7500 crore is to be borrowed to redeem the debt likely to mature during the current fiscal. As the proverbial last nail in the coffin, the Deputy Governor strongly desired that banks should use the call money window only to iron out their temporary mismatches in liquidity and not as a source of funding their normal requirements, that too on a sustained basis. Admittedly, it is a laudable objective. However, this kind of governance based on external control is more prone to fail, for in the long run it is only self-control that survives. Moving to self-control is not only a process of advancing to maturity not just among individuals but on the part of organizations too but it also helps regulators in reinforcing orderliness in the market. The most surprising thing here is that on one occasion or the other, similar apprehensions have been aired by all concerned, including the regulators. For instance, the RBI has been consistently pointing out that the monetary policy in terms of quick-fixes, like cutting interest rates, may not be very effective when the slowdown is quite structural in nature. The former governor of RBI, Mr. Rangarajan, once said, Lowering of interest rates need not necessarily stimulate output. Despite there being easy money available all around, credit off-take has been languishing for the last one year. It is against this backdrop that the present proposal to reduce CRR from the ruling 5.5 percent to 3 percent in the form of a package in one go makes it a riddle wrapped in a mystery inside an enigma.

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It is of course altogether different if the current articulation about the cut in CRR is part of a bigger gameplan of RBI that intends to experiment new ideas to promote economic revival and in the process obliquely suggest loosening of the controls on inflation to give a gentle push to the growth rate. And this is quite plausible as the RBI has been talking for quite some time about the adverse effects of the ongoing deflationary trends on the economy. To better appreciate the dichotomy of falling prices being not good for the GDP growth, it may not be a bad idea to spend a few minutes on inflation and deflation. Deflation is a situation where falling prices persuade consumers to defer their purchases in anticipation of a further fall in prices in the future. This deferment of purchases by the consumers results in a decline in demand leading to a further fall in prices and thus sets in motion the deflation cycle. This is what RBI, describes as bad for GDP growth and in its Report on Currency and Finance 2000-2001 suggests an optimum level of growth maximizing-inflation of around 5 to 6 percent a year. This line of argument leads to the obvious question: Is the present talk of reducing CRR in one go to 3 percent a part of RBIs overall strategy of manipulating monetary policy to push up inflation so that economy can be given a kick-start? If this is true, the current articulation about cut in CRR by the monetary authority deserves to be complimented as proactive besides of course being provocative, for there is every danger of these proinflationary measures going out of control owing to the infirmities inherent in our market. All this cumulatively makes monetary management complex and necessitates a quick test checking of various ideas well before the deflation hijacks the growth in economy as has happened in Japan and elsewhere. Wow! Its highly thoughtful of the RBI.

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Section II

Capital Markets

THIRTY ONE

Sense and sensex


Are they strange bedfellows?

ensex nose-dived by 826 points; Meltdown: investors lose Rs.225681 crore; Largest fall in BSEs 130 years thus screamed the market players on Thursday, 18th May 2006. Coming to the details: The market suffered its biggest single day fall of 6.8%. As the benchmark index fell from an intra-day high of 12217.81 to 11391.43, it wiped out a whopping Rs.2,00,000 crore of market capitalization all in a matter of a days trading. No support was witnessed even at 11400 levels, though; unlike on May 17th 2004 it did not trigger circuit breakers. Volatility is, of course, not new to stock markets, but what is disturbing this time is its extreme reaction. And, what matters more here is reaction to what? Market Pundits are, of course, ready with answers, though on hindsight: it is the global meltdown that tanked Sensex. Every market analyst sang in chorus that globalization is the prime cause for the current market crash. True, it is the globalization that has provided infinite liquidity in the form of FIIs that took the Indian stocks to dizzy heights. And it is the same globalization, which had knocked the Sensex off the cliff and crash-landed it in Chowpati.

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What more do you need to prove the force behind the crash than the fact that FIIs dumped Rs.2500 crore worth of stocks in one week? But, then, is it all that sudden, or that unexpected? No, its not a storm on a clear sunny day, for it was only on Monday, May 15th that the Sensex lost 463 points. For that matter, Dalal Street has been witnessing disturbances for the last two weeks. Nor did the turbulence felt in the global stock markets for the last one week make any sense to the market. Despite the signals about the impeding turbulence being so pronounced, no one prepared to tighten the seat belt; on the other hand, everyone preferred to cheer the sort of recovery noticed in Sensex subsequently. And that is the influence of hubris? Or, sense and Sensex cannot be cosy bedfellows? And that could be one reason why Keynes would have said: markets can be irrational for a lot longer than you can be solvent. The most egregious example is in recent times is the dollar and exchange rate: dollar rate rising from 99 to 147 in a matter of three years with little change in economic fundamentals. There is, of course, another story doing rounds as a cause for the historical crash. It runs thus: the CBDT issued a circular inviting comments from the interested parties by May 25th on a circular which was issued by it on 31-8-1989 prescribing guidelines to distinguish between shares held as investment by FIIs from stock in trade, and accordingly, tax their returns, for it now wants to issue supplementary instructions on tax liabilities. That is enough is what analysts said, to make the market that is on a bull run to get tanked. And see the timing CBDT chose to attract the attention of players to tax-related issues! That, too, in a market where a handful of words uttered even at a marriage party by those who are even remotely connected with regulatory establishments can count for so much. That being the reality, it doesnt matter whether CBDT is aware of the likely impact of its action on the market, or not, it would and it did rock the market

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till at last the Finance minister dispelled the fears by clarifying the position. But, once set in motion, the fall, in a bull market, as the theory tells us, cannot but run for long and thats what did happen. And, of course, it is not for the first time; we did witness such spooking by the government once in a while albeit unintentionally. Similarly, global events impacting the Sensex is nothing new, for we have been witnessing such falls ever since we have thrown open our markets to FIIs. Reports are agog about the underlying reasons for the current turbulence in the global markets: heightened fear about rising inflation rates, rising long-term global interest rates, falling dollar, record US trade deficit, etc., are all contributing their mite. Yet, we dont heed them. We still want to call ourselves rational. But, when markets rise we cheer, and when they crash we all moan in chorus. Does it mean that investors expect share prices to rise for ever? True, everyone is expecting India to record the strongest economic growth in the world this year too. But, isnt it a fact that our stock prices had risen too high, that, too, too fast? Can we afford to ignore the external and internal developments of the recent past that can impact our growth adversely? Isnt it true that for quite sometime everyone is talking about a correction? All this drives home a point: retail investors must keep watching stock valuations vis--vis economic fundamentals both internal and external. For instance, the recent election results in states made analysts forecast that the present incumbent at the centre may not deliver much under reforms. There are enough reasons for the market to behave the way it did. Even otherwise, can we forget the market dictum: Risk and return go together? But, what is more distressing is, that we refuse to change. This reminds us of a dialogue that Bill Watterson wrote for Calvin and Hobbes cartoon. While careering through woods in their red wagon, Calvin turns to Hobbes and says: its true, Hobbes, ignorance is bliss!

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Once you know things, you start seeing problems everywhere. And once you see problems, you feel like you ought to try to fix them. And fixing problems always seems to require personal change. And change means doing things that arent fun! I say phooey to that! In the meanwhile their wagon heading downhill picks up speed. Calvin turns to Hobbes and says, but if youre willfully stupid, you dont know any better, so you can keep doing whatever you like! The secret to happiness is short-term stupid self-interest! But Hobbes, peeping into the valley below utters in an anxietyfilled tone: We are heading for that cliff! Calvin putting his hands over his eyes says, I dont want to know about it. They fly over the cliff and crash-land. Hobbes then mutters, Im not sure I can stand so much bliss. Calvin responds, Careful! We dont want to learn anything from this. Any take-home from this? Yes, markets are changing everyday. Change could be triggered by any event: rising inflation rate in the US and the consequent rise in interest rates can simply mop up the free-flowing dollars from Asian markets, which means further fall in the market. Volatility will haunt the market so long it is in a growth phase. Investors must therefore change their investment plans with agility, while regulators should realize the significance of changing times in which, pronouncements are prone to deliver unintended results unless timed properly. So, any takers for willingly becoming change managers?

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Its all politics of economics!

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THIRTY TWO

Its all politics of economics!


Europe has its own definition for globalization and what is more, it longs to live with it.

r. Lakshmi Mittal, the India-born and London-settled richest individual of Europe, has, by bidding for Arcelor, simply thrown the continent into the blast furnace. How else can one explain the unprecedented reaction that emanated from Luxembourg and France to his offer to take over Arcelor that works out to Euro 28.21 bn 25% in cash and the balance 75% by way of share swap in Mittal Steel, which Mr. Lakshmi Mittal justifies stating that the offer provides a very attractive premium a generous cash element. Mittal Steel, the worlds largest steel company in terms of crude steel capacity and other related measures, made its grand vision for creating a giant steel corporation with a capacity of over 100 million tonnes by acquiring the worlds second largest steel company, Arcelor, so that the merged entity could be three times bigger than its closest rival, Nippon Steel of Japan. This move of Mittal, according to many analysts, is quite a departure from his known strategy of acquiring ailing steel plants, and turn them around into success stories.

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That aside, the current move of Mittal to acquire Arcelor, is an altogether different story: Arcelor is one of the most profitable steel companies in the world and is an icon of Europe. Arcelor considers itself as the world leader in the steel industry in terms of high quality products, technology, etc. It is after all the very steel industry of Spain, France, Belgium and Luxembourg. In the opinion of its management, Mittal can bring in no new technology to either improve its product quality or bring out niche products for catering to newer markets or access to key markets. All these countries in which Arcelor operates consider themselves having had a long history of steel-making and hence cannot stomach the fact of a relatively newcomer to the industry buying their Arcelor. The net result is: a spat for Mittal not only with Dolle but also with the governments of Luxembourg and France. The protests that are pouring out of Luxembourg and Paris caught every one by surprise. It is still understandable what Mr. Guy Dolle, CEO of Arcelor, said: We produce perfumes, whereas Mittal makes eau de Cologne but what is most wondrous is Mr. Jean-Claude Juneker, prime minister of Luxembourg which holds a 5.6 percent equity in Arcelor, rejecting the offer by saying that the hostile bid by Mittal Steel calls for a reaction that is as hostile. Nor could the President of France Jacques Chirac hold back his strong preferences when he said at the press conference in Delhi: It is purely financial. That is to say, without any industrial plan being known or conveyed and contrary to practice, without prior consultations. The Finance Minister of France went a step farther when he said that as a stakeholder, his government cannot keep quiet when a hostile attempt is made to take over a company that is important to their citizens. This is well reflected even in their other attempts to block the foreign bids for their companies, such as those emanating from

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the US earlier and Italy now. But French companies ironically have a different story to tell: They made a record acquisition of foreign companies last year. Its of course nothing new it was the same yesterday against CNOOC Ltd. that bade for Unocal Corp. of the US; today it is against the DP World and in between Mittal and tomorrow it could be any other company. The story will be the same. It is the question of acceptance. Today it is the businesses from an unknown corner of the globe that have suddenly emerged to take over the businesses ironically, of the erstwhile trendsetters of cross-border acquisitions. And obviously, xenophobic reaction is the result. Look! Here is a merger proposal which, according to many analysts, is well poised to offer certain strategic advantages. One, the merged entity by its sheer size can bargain for a better price for iron ore, coal, and other material that go into steel-making. Two, by virtue of its presence in all the segments of the steel industry and having plants in countries that are from both developed and developing countries, the merged entity can better face the threat of emerging economies flooding the markets with low-priced quality goods. Three, it can optimize on costs having multi-location operations which enables it to not only shuffle the product line across the centres but also to shut down the high-cost processing centres without sacrificing the product range. Above all, the proven ability of the Mittal group in managing widely disbursed steel plants producing all kinds of products with a focus on efficiency, cost reduction etc., would be available for the management of Arcelors plants too. Yet, it is the governments of Luxembourg, France, etc., that are revolting against the offer. Indeed, the market has greeted the merger announcement by jacking up Arcelors stock price 28% and Mittal Steels share prices

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around 6%. Even the sweet pill dividend of 1.20, an increase of 85% over the previously declared dividend, announced by Arcelor didnt make much difference to the markets. Incidentally, the dividend was again raised from 1.20 to 1.80, perhaps vindicating the fact of no effect of earlier announcement on the market. Yet, the management of Arcelor does not mind accusing Mittal of bringing political overtones to the deal, while the fact is that it is the Luxembourg and French governments that took the side of Arcelor. According to the International Herald Tribune, Mittal represents a challenge to Europe that is profoundly new: the emerging market not as a front of cheap talent, but as a springboard for new business models and new multinationals seeking to beat or buy Western companies. Isnt it a sheer exhibition of economic patriotism? Amazingly, these very countries do not mind preaching free trade and globalization to every other country, but when it comes to them, what matters is simply their own interests and in the process, they dont mind flouting what they urge others to do. Isnt it politics driven by economics?

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Thundering in the Indian skies?

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THIRTY THREE

Thundering in the Indian skies?


Mergers with little or no revelations on pricing are of late causing much consternation to investors in dividing whether to stay put with the mergers or not.

ndian aviation industry has at last come of age. First, it was the opening up of the Indian skies for private carriers. Then the development of green field airports followed by modernization of Delhi and Mumbai airports through private participation. The real thunder is, of course, Jet taking over its rival carrier, Air Sahara, for $500 million. Mr. Naresh Goyal, Chairman of Jet Airways, said that it wont take over Air Saharas liabilities, but merge Saharas brand into its own. With this acquisition, he hopes, to increase Jets market share to about 50 percent. Mr. Goyals anxiety to take over Sahara is quite palpable: with the advent of low-cost carriers, Jet has been experiencing stiff competition. Within two years of its operation, Air Deccan captured a market share of 11%. The recently started Kingfisher too could muster a market share of 6%, while it is 5% in the case of Spice jet. The net result was that Jet was losing its market share. The only way then for Jet to successfully face competition was to acquire size. And that precisely is what it did.
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That aside, the centre for Asia Pacific Aviation estimated the growth in Indian air travel industry at 50 million passengers by 2010. It also stated that the industry would be requiring 450 to 500 commercial aircraft, 2000 to 2500 new pilots and supporting logistics at the airports. But the Indian airports are already choked up with airlines gaping for parking lots, hangars etc. Analysts believe that the acquisition of Sahara will enhance Jets strength in every sense financial, commercial, operational, technical, HR, and infrastructure perspective. According to one section of analysts, the resulting monopoly in terms of parking lots in key metro airports like Mumbai, Delhi, and almost 50% share in the domestic market will simply enable it to price out many smaller players from the market. Against this backdrop, acquisition of Sahara by Jet makes great business sense: it gains just access to Saharas parking lots, ground crew, pilots, hangars, planes, and ultimately greater share in the domestic market. There is of course a flip side to it: some analysts are labelling the price of acquisition as quite high, given Saharas relatively small market and not-so-efficient operations. Some analysts wonder how Jet paid US$500 million for an airline that does not own a single aircraft and whose market share is steadily falling. They are even asking: is it that Jet paid US$500 million to Sahara for its parking bays, prime take-off and landing lots at major metros, hangars, pilots, other technical staff, etc.? In fact, Sahara is burdened with losses totalling Rs.145 crore. It is less profitable compared to Jet, as revealed by the net margins: Jet enjoyed a net margin of 9% during 2004-05 as against 1.45% of Sahara. Sahara is over staffed. Even aircraft utilization is high in Jet vis--vis Sahara. Jet has, indeed, made a name for itself in maintaining service standards on a par with established international airlines. That being the reality, some think that seamless integration of these two airlines may pose a challenge.

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It is in this context that some analysts reckon that Jet, in its anxiety to turn Saharas loss-making operations around, may even get distracted from ramping up international routes, which is a must for Jet to ultimately become strong. In fact, it should acquire international routes, particularly to the US, and operate to build strong brand, that, too, well before the other competing airlines become eligible to bid for international flights. It is of course another matter that its application for rights to fly to the US has been pending for long. That said let us now take a peep at two other associated issues. One, Asian companies are quite often found trading at a discount to western companies. Many analysts believe that this is an outcome of the historical focus of Asian companies on growth rather than on returns on capital. According to them, growth, though essential, cannot automatically create sustained shareholder value. In their opinion, what sustains the maximization of shareholders wealth is the return on capital and nothing else. In that context, the cost of growth tagged on to the price of an acquisition, as in the instant case, therefore needs to be taken note of. Two, acquisitions are today perceived by investors as causing consternation since they cannot make an informed decision whether to stay invested or quit upon a merger announcement owing to paucity of information. The present acquisition is no exception: Jet did not reveal how it valued its acquisition nor do the investors know the market value of Sahara since it is a non-listed conglomerate. Time alone can answer the question: is the acquisition of Sahara by Jet a thundering in the Indian skies or in the investors heart?

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THIRTY FOUR

Samvat 2062
The Indian capital market has certainly come of age but it is the perseverant lot who can get paid dividends.

amvat 2061, the year that witnessed many records tumbling the Sensex scaled the highest ever level of 8800, a record FII inflow of $8.6 bn and a whopping Rs.6 lakh cr of wealth generation, has finally come to an end. It was a year that is to be cherished at least for some time to come. Samvat 2062 thus began on an overall cheerful note. This positive mood was indeed vindicated by the happenings during Muhurat trading. The Sensex bounced back to 8000 on Muhurat trading but finally settled down at 7944. The session ended with an ultimate rise of 52 points in the Sensex indicating profit booking immediately followed by the stronger move witnessed in the initial phase of trading. The happenings at the Muhurat trading remind us of what has been happening during the last five years: Every year the Sensex has been rising followed by a fall, but the extent of the fall was found to be very large, and very sharpall in a couple of weeks. This cycle has almost repeated in the last five years but with a difference: Every bounce back in the Sensex has showcased a new set of stocks and a
December 2005.

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new set of sectors as the leading stars. What then is the inference that the common investors must draw? The underlying message is simple: Samvat 2062 will be like any other previous yearthe Sensex will rise, new set of stocks and new sectors will emerge pushing the Sensex forward while the rest of the stocks silently undercut these gains and suddenly pull down the mast. The investors therefore have to exercise utmost caution: their investment must be driven by a sense of vision, a sense of conviction and tons of patience rather than simply be carried away by the hype created by both the markets and its pundits. Their vision should enable them to foresee how macroeconomic fundamentals of the globe are behaving, what changes are likely to happen and ultimately how these changes are likely to impact the behaviour of domestic markets. And this is not a onetime affair: Markets, particularly stock markets which are in a constant phase of change, need to be analyzed repeatedly and strategies redrawn to shuffle the portfolios; otherwise yesterdays portfolio might prove fatal for today. For instance, till a couple of weeks prior to Muhurat trading, market pundits were saying that global liquidity was flowing into emerging markets and hence the markets were in an upswing. It is estimated that over the last two years FIIs have pumped in around $140 bn into emerging markets. But when the markets started sliding, everyone started shouting in a chorus: FIIs are fleeing the country as interest rates in America are poised for a rise. True, such experiences are not that uncommon. During 1995, on account of a mere 2% points rise in the federal interest rate, the FIIs moved out of the emerging markets, lock, stock and barrel, plunging these markets in dark at one go. And such recurrences can not be ruled out in the future. But such cyclical inflows and outflows of FIIs capital in and out of emerging markets will have their own

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underlying reasons, pointers and timings and anticipating them is what constitutes the vision. At the time of Muhurat trading, analysts were saying that the US interest rates will rise and with it FIIs will move their funds from emerging markets back home. This move, they argue, will suck out liquidity as a result of which the Sensex is all set for a slide. Some analysts have even argued that the current volatility in the crude oil market will only add fat to the fire. As against these predictions, the Sensex surprisingly made a fastest thousand-point recovery. Now the moot question is what contributed to this reversal. An interesting macroeconomic phenomenon is surfacing in the global economy: a glut in world savings. Among the Asian countries itself the savings have reached a phenomenal height. Japanese forex reserves stood at $841.79 bn while Chinas stood at $769 bn. The current savings rate of China is said to be 50% of its GDP, which is the highest in its recorded history. Over and above this, it continues to attract a good chunk of worlds FDI flows, which means more addition to its savings. Similarly, the soaring oil prices have catapulted Russian export earnings, resulting in a trade surplus of $113 bn. Owing to the booming commodity sales, even Brazil recorded a current account surplus of $12.5 bn. So is the case with other Asian countries such as Taiwan, Korea, Singapore, and India. The net result is: World is flush with savings which are obviously searching for profitable investment avenues. As against these requirements, world interest rates are ruling at historically low levels. In fact, interest rates in the US are said to be yielding negative returns. Secondly, the returns on stocks in the advanced countries are already enjoying a high price-earnings ratio which means limited scope for further appreciation. Thirdly, Europe is struggling to wriggle out of a poor growth rate which is more a

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result of its strengthening currency, while it is no different from Japans plight. In such a scenario, the global savings are obviously moving towards other assets such as real estate and stocks in emerging markets for a better yield. This could be one of the prime reasons behind the quickest recovery of 1000 points that the Sensex could make in hardly 12 trading days. And if this is true, there is no reason why the Sensex should not scale further heights. And that is where the investors need to exhibit a sense of conviction. They should pick companies that are sound in their operations and the macroeconomic fundamentals support them in achieving their sales volumes. Secondly, the investors must also be clear about the time span of their investment. Historically, it has been established that investments made on a long-term perspective have not failed the investors in accomplishing their goals for the ups and downs of the stock market need to have time to average out and bless the investors with a market plus return. As a conviction, investors may also explore contrarian investment which is nothing but looking beyond the obvious. In other words, it means skipping the over-hyped sectors/stocks and staying focused on value-oriented investment. Experiences reveal that when the market sentiment is upbeat, everyone craves to roam around index-stocks while ignoring those companies which are undervalued by the market but enjoy bright prospects on a long-term perspective. Investors must pick companies that are sound in their business as reflected in their low price-earnings ratios, price to book value, price to free cash flows, etc., with a courage of conviction. That is not enough. Once such stocks are picked, an investor should exhibit lots of patiencepatience to wait for the executed deal to deliver the results. Interestingly, Contrarian investment is more prone to deliver results when the bull run is quite secular, which is indeed being witnessed by Indian markets currently.

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To create wealth in Samvat 2062, investors should navigate with caution that is prompted by a sense of vision, conviction and patience.

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Transaction tax: No more deals, please!

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THIRTY FIVE

Transaction tax: No more deals, please!


Is it always the well-fed that end up with carrots from the masters, though unfortunate?

eforms always come from below. No man with four aces asks for a new deal. That was a point on which Irish Digest once asked its readers to ponder over. Logically, the statement besides sounding true, appeals to everyone. But in reality, what one often sees is the oppositethe holders of aces are found calling shots and making efforts to garner more tricks. The examples are not far to seek, for, we encounter such incidents everyday. Take, for instance, the current furore created by the stock-broking community demanding scrapping of the turnover tax imposed in the current budget. It is a strange situation! They have been spared the burden of the prevailing long-term capital gains, and granted the benefit of reduction in short-term capital gains by 10% but were asked to pay 0.15% transaction tax and they are on the streets demanding withdrawal of turnover tax! As against this, let us take a look at the plight of the Indian poor, who in the very words of the Finance Minister (FM) are in dire need of basic education for their children, drinking water, basic healthcare, medicines at affordable prices and jobs for their children. The FM,
August 2004.

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of course, observed in his budget speech, We shall ensure through higher and targeted investments that jobs are available to them. We are aware of what we have achieved so far under these heads and how disproportionate the budgetary allocations are vis--vis the mammoth task on hand and what we contemplate to accomplish under this head in the foreseeable future. Ironically, even in the current budget, except for allocating a greater part of his budget speech to agriculture, the FM hardly committed a plan outlay of 3% to agriculture and allied activities, which is inadequate to boost capital formation in agriculture. Intriguingly, these lesser mortals seldom took to the roads demanding fiscal support for ensuring that basic amenities are made available to them. But, in the recent past, the farming community has resorted to suicides to express their haplessness. Does this reality not make the statementNo man with four aces asked for a new deal sound pretty hollow, at least in the Indian context? To better appreciate the shallowness of the statement, let us scrutinize the turnover tax more deeply. The recent budget has scrapped the existing long-term capital gains tax; reduced shortterm capital gains tax to 10% and imposed a transaction tax of 15 basis points on all transactions related to financial market securities. Reports indicate that the industry itself proposed such modifications. In the words of the FM, the transaction tax is efficient, neat, nonregressionary, eliminates tax avoidance and ensures that everybody contributes to the exchequer. The reasons for its imposition are thus clear. Even otherwise, transaction tax is a very logical concept. It has proved to be successful in other developing countries such as Korea and Taiwan, which enjoy bigger market capitalization and higher trading volumes compared to India, where it is currently levied at 0.30%. Of course, the said tax in these countries is levied only on cash market transactions. There is no turnover tax on debt and derivative market transactions and no short-term or long-term capital gains tax.

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Despite these experiences of other countries, the turnover tax proposal has shocked all those associated with financial market transactions and drawn them to the roads. The brokers are protesting the move under the plea that the trade volume on day traders account will be adversely affected. But the question iswhat is the trading volume generated by these day traders even otherwise? They are wellknown to play only on select scrips such as those having very limited free floating stock in the market, stocks of MNCs or stocks in which FIIs are very active. In fact, they are known only to create volatility in the market by virtue of their playing on a select few stocks. Hence, they cannot impact market liquidity significantly. Their other complaint about the turnover tax is that a levy of 15 basis points is too much for investors. But if we recall the transaction costs associated with delivery as well as non-delivery-based trading through the erstwhile badla trading mechanism, which were as high as 200 basis points (bps), the current imposition of 15 bps sounds pretty meagre. Secondly, for a long-term investor and that too after the removal of long-term capital gains tax, 0.15% transaction tax does not sound hurting. Of course, when it comes to the speculators from the non-institutional segment, such as day traders, the transaction cost may double with the imposition of transaction tax but one has to choose between the long-term interests of the market and self-serving protests from the speculation-driven trading volumes/traders. Another school of argument draws attention to the current global trends that have attached greater significance for cross-border portfolio flows, which are coming handy in implementing growth plans of developing countries. It argues that imposition of turnover tax on financial market transactions will hurt the flow of FII investments into the country. This is certainly not a valid argument since replacement of long-term tax with transaction tax makes great difference to long-term investors such as FIIs who usually stay put with investments for a long period to realize profits and hence, it would be a welcome change for them. Similarly, it is easy for domestic

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long-term investors to manage their tax compliances under the changed set-up. They no longer need to bother about setting off the capital gains against the losses incurred and will be freed from the associated paperwork. There is a feeling in the markets that FIIs have not been comfortable in investing in India because of relatively high level of taxation in terms of capital gains tax. Under the new dispensation, FIIs would feel more encouraged to invest in India. There is, however, a need for the FM to re-examine the imposition of turnover tax on debt and derivative securities. It is a well-known fact that our debt market is based mostly on government securities and secondary market transactions are carried out at wafer-thin margins. Hence, imposition of tax on such transactions is more prone to kill the secondary debt market. Secondly, since traders under debt market are mostly government-owned banks whose profits are anyway taxed at higher rates elsewhere, removal of transaction tax on debt securities does not really matter. Similarly, imposition of transaction tax on derivatives securities does not augur well because it will simply increase the cost of risk mitigation by an average of 10%. Derivative securities being mostly structured for a period of less than one year, the question of long-term capital gain does not arise and hence, any profit derived out of derivatives trading is treated as short-term capital gain and taxed accordingly. It thus deserves to be kept outside the purview of the transaction tax. Lastly, citizens must recall that one of the biggest problems India faces is that of tax compliance. It is a fact that hardly a quarter of those who should pay taxes, do actually pay. And, when it comes to capital gains tax, the less said the better. Against this backdrop, the proposed transaction tax on equity shares would pave the way for efficiency that is glaringly absent in the Indian tax collection system. So, no more deals, and at any rate, how long will the government dangle carrots before the well-fed?

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IPOs rating: What for?

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THIRTY SIX

IPOs rating: What for?


The Asian currency crisis of late 90s has proved beyond doubt that ratings carry no meaning in an hour of crisis.

nce in a while, markets lure investors with a great business opportunity. The media also goes all out to highlight such opportunities as it happened during the time of the dot com era. And investors will as usual rush to support it, of course, in the greed for making more money. As the business opportunity is tantalizingly attractive, many firms will attempt to exploit it. The net result is more IPOs inviting public to subscribe to those shares. Each of these shares entitles its holder to an equal share amount of profits besides being entitled to a vote on matters of corporate governance. Of course, such shares represent a mere residual claim on assets of a corporation. In other words, if a company goes into liquidation and all its assets are sold, shareholders are entitled to receive only that part of proceeds which is left after meeting all the other liabilities of the company. That apart, the subscribers to such an IPO get return on the investment from two sources. The first source is the dividend paid in cash to the shareholder by the firm that issued the shares. This dividend payout is of course not mandatory like interest payment under
July 2004.

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a debt but paid at the discretion of the firms board of directors. The second source of return to the shareholder is any gain (or loss) that a shareholder can realize by virtue of appreciation (or depreciation) in the market price of the share over the period it is held by the investor. This kind of return is commonly known as capital gain (or loss). Both these returns put together constitute the ultimate return to the shareholder on his equity investment. This return is squarely dependent on the ability of a firm to perform well, that too, consistently in the future. The scope for making money on an equity investment always rests in future. Hence, no investor can be certain of his investment decisions in the equity markets and he has no choice except to run along with the herd into hot sectors that are promising good returns from time to time. It is no wonder, if over a period of time, the competition drives down returns of businesses that have come into existence under much hype as witnessed during the technology boom, and many of the new entrants may even be forced out of business. The problem investors face in standing back from such investments is that the cycle at times takes a long time to unfold. Whatever be the reason, the ultimate loser is the investor community. Perhaps, being deeply concerned about such embedded risks that investors face in equity markets, the Securities and Exchange Board of India (SEBI) recently announced its intention to subject IPOs for mandatory rating. The SEBI perhaps hopes that such mandatory ratings will help investors take informed decisions and thereby minimize the risks. Now, the moot question is: Can ratings mitigate non-systemic risks arising from factors external to exchanges, trading, and settlement mechanisms? We know how corporates work: the legal nature and structure of a corporation tend to exempt both corporation and its management from accountability for many of the costs of their activities; actual shareholders have no voice in corporate affairs and the board of directors and executives are protected from financial

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liability for their acts of negligence. The generous compensation of top management seldom has any relation to actual performance, and they are rarely prosecuted for the illegal acts of the corporation, which acts, if performed by anybody else, would have attracted imprisonment while corporates are allowed to get away with small fines. Against this reality, we must bear in mind that rating is not a general purpose evaluation of the issue, nor is it a one-time assessment valid for the future life of the security. Rating agencies are neither auditors nor regulators and, hence, have to depend on whatever data has been made available by the company. Ratings are either solicited for a fee by the company or unsolicited: Under a solicited form, the company gives the agency access to its top management and to nonpublic information; and when unsolicited, rating is free and based only on public information. Such a rating either by CRISIL or ICRA or, for that matter, any other rating agency can at best score a company coming out with IPO on important parameters such as business prospects, financial risks, governance, quality of reporting and management. How can a score of even four out of five on these parameters tell an investor whether he can make money or not? To quote the former chairman of SEBI, D. R. Mehta, Investment in equity shares is risky and its magnitude cannot be defined. Considering this, he observed that, We (SEBI) have no plans to make it compulsory for companies to go in for ratings before tapping the market. True, credit rating has become a well accepted norm for predicting default risk, simply because it only estimates the ability of an obligate to service a known repayment commitment or otherwise, which is essentially the worry of investors in the debt market. On the other hand, every investor in equity market comes with his own expectation about the money to be made based on the risk-perception of his own investment portfolio. But, it is impossible for anyone to rate the

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prospect of investors making money in an IPO. Rating can at best make an academic discussion on risk and reward potential associated with an IPO. A rating that is based on company fundamentals cannot attempt to assess the valuations and hence it is meaningless to the investors for all fundamental analysis in equity market is essentially a valuation since the price performance depends on the perceived discount to intrinsic value. So the obvious question is, What then is rating for? Let us analyze this analogy with an example. In the recent past, Biocon and PCS have come out with IPOs. As everyone knows, both companies are into hot sectors and their managements command market respect as evidenced by investment of VCs, their track record, prudential management and sound business models. Obviously, both IPOs were oversubscribed by almost 30 times. But PCS was listed on the stock exchange at below IPO price while Biocon was listed at premium. Now the moot question is why this difference? The answer is simple: It is the market perception. Biocon being into Biotechnology, a segment that is currently the darling of the market, was perceived by the investors as having high potential for growth and was traded at a premium. On the other hand, PCS, whose growth prospects are linked to IT and associated services, came under the cloud of outsourcing politics that surfaced recently and the weakening dollar across the globe and the market has accordingly discounted its valuation. These evolving perceptions which are external to the company that define the valuation prospects of a scrip are simply beyond the capacity of any rating exercise to capture and reflect upon. If these two were to be rated by an IPO and upon listing if they were tanked for similar sentiments, the investors would have simply discredited the ratings. They might have even alleged that they were misled by the ratings.

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There is yet another question to be answered: Who has to bear the cost of rating? Obviously, it is the issuing company and if so, what is so great about a rating that is solicited at a fee by the issuer for it can seldom be different from what the paying company desires to have, as has been witnessed umpteen times in the past. In a free market, every economic decision-maker must make his own decision, being fully conscious of the fact that he and he alone has to pocket the loss or gain out of it, if the markets are to remain efficient. What is then needed is not mandatory rating but a concerted effort by SEBI to educate investors about the changed dynamics of equity investments and, more importantly, ensuring that merchant bankers play their role with due diligence and integrity.

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THIRTY SEVEN

Imperfect information! Imperfect competition! Imperfect markets!


Its not economics that matters in making a country investment-worthy but its very fabric of culture values, ethics, and morals.

onday, May 17, 2004 is by now a pretty old date in the calendar. Yet, the events of the day are not that ordinary to forget so quickly. It is the Black Monday on which the Sensex witnessed the largest intraday fall of over 800 points in the 129-year history of BSE. It made investors poorer by Rs.1,33,602 cr by way of loss in market capitalization, despite the fact that trading was suspended for nearly three hours in two separate cool-offs. Before locating the underlying lessons, let us trace how the bleeding took place. It is by now a well-known fact that driven by Fridays experience, many investors were in panic to sell their stocks. But, there were no buyers in the market. With no buying support, the already panicstricken investors started frenetically pressing the sell button. The result was that with every share sold, the prices fell further. In the meanwhile, falling stock prices caused erosion in the value of the collaterals and other forms of safety margins that brokers maintain with stock exchanges as guarantee. This prompted exchanges to
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demand additional security or increased cash margins, neither of which could be attempted by the brokers in a falling market scenario. A similar situation arose among a few banks that had lent money under margin trading. The net outcome was that both exchanges and lending bankers placed sell orders in the market. Obviously, this move only hastened the price-slide. The market was so panic-stricken that most of the sell orders placed on Monday morning were reported to be at market prices. When there were no buyers in the market, the market orders had simply, as they should, dragged down the prices. To make things worse, hedge funds and a few major FIIs were reported to have exiting the PSU stocks in a jiffy. As the news about bigger players selling stocks spread, the rest of the players rushed to the market to let loose anarchy upon the world. There is no wonder if the program trades were also triggered automatically when the market was hitting lows consistently. The net result is that investors were bled white in hardly a span of two trading days. Today, it has raised a battery of questions: What triggered this run? How does it affect the economy at large? What, therefore, needs to be done to arrest such incidents from recurring? Let us explore answers to these questions. In a globalized market no one can afford to ignore the fact that money moves in and out of markets with an exclusive concentration on profit and nothing else. To generate that profit, investors do not hesitate from shifting their savings from one locale to another. The convergence in telecom and computational technology only made the job of real-time communication that much easier. In such a scenario, what matters in moving capital in and out of a locale is the better return that a market can offer with least uncertainty. Let us examine this phenomenon in detail. As every one of us remembers, at one point of time PSU stocks were trading at steep discounts despite their being fundamentally sound. The reason was simple: Investors,

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particularly FIIs, have no faith in the governments ability to behave as an economically rational owner. However, encouraged by the previous governments move for privatization as evidenced by the strategic sale of ONGC, etc., via IPOs, hedge funds had taken huge positions on PSU stocks. As the expectations rose about oil and banking PSUs making good profits in the free market arena, trading on PSUs picked up momentum, and indeed, over 40% of FII flows during the last 12 to 15 months were into PSUs. As against this market expectation, what have we done? The first big step in undermining this belief came in the form of left parties calling for halting privatization. Transition of power is in itself a big event for the market to take a view on the future economic prospects. Against this reality, by talking against privatization, the politicians have only stirred up a hornets nest. It hardly took two trading days for the investors to complete the rest of the job. The result was fall in market capitalization till LIC, GIC, banks etc., entered the market to reenact their traditional role of bailing out the market. One cannot, of course, rule out, if it is the usual rhetoric, that the left has to rollout. Well, whether perfect or imperfect, it is nevertheless information and we cannot blame the market that is futuristic for its reaction. The next question in line is, what is in it for the economy? The falling stock prices mean a fat lot worse for the economy. First, Mondays mayhem had simply shaken the confidence of investors who after a prolonged hiatus were just showing up. With the kind of losses they suffered in terms of erosion of their wealth, investors will be pretty scared to revisit the market at least for some time to come. The drop in stock prices forces investors to spend less. It adversely impacts the flow of capital into start-ups, expansion/ diversification projects, and there will be no fresh IPOs. It would not be a wonder if it even results in less foreign capital inflow into the country. It also means rising cost of capital for corporates. In

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economic jargon, it ends up in economic contraction. Its impact on economic growth, particularly when we have moved out of planned-economy and entered market-economy, is mind-boggling. Secondly, stock markets, being a forward-looking forecaster of a countrys economy, are good in allocating capital to various segments of the economy. With the flow of private capital into infrastructure projects and other services, there is little reason to suspect its impact, more so when the government has almost withdrawn from such investments. The moral is, having opened up our markets, we cannot adopt a stop-go-stop approach, since it only results in uncertainty which is most despised by the investing fraternity. All this is simply not a good indication for the economy. That apart, ambiguity in the pursuit of reforms would only drive away the investors from the market, for it generates uncertainty. At the cost of repetition, we must remember here that no investor visits markets for the love of it but does so to make more money. Even otherwise, our markets lack depth that was indeed felt on Black Monday. True, in a descending market, nobody would be willing to extend buying support. But if we had long-term investors like pension funds they would have played the role of market-stabilizers by staying invested in such scripts which are otherwise sound fundamentally. In the absence of such supporting systems, markets would obviously remain imperfect. As long as they remain imperfect, such runs as we have witnessed on Black Monday would keep revisiting us. Looking at the Black Mondays happenings it sounds so true that political culture, norms and habits are important determinants of not only the quality of social life, but also of economic progress and growth.

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THIRTY EIGHT

No contrarian fund: Only contrarian investors, please!


Investors must be left to themselves to enjoy the profits or losses out of their own decisions.

hat a transformation! Indians, too, can puff up their chests at the way their economy is shaping up and merrily say goodbye to 2003. As the year is inching towards its end, Indias foreign exchange reserves crossed the $100 bn mark. The healthy foreign exchange reserves, as the Finance Minister observed, can serve the country economically, psychologically, and diplomatically. The old economy, too, has consolidated its position and is witnessing a tremendous resurgence in profitability and valuations. Projections for the real economy are equally good for the coming year, too. According to an estimate of analysts, fresh capital of around Rs.110000 cr is committed for investment either in expansion of existing units or in new projects in the coming two years.The Sensex is all set to end the year at 5500 and the market capitalization of all the stocks traded across the exchanges has almost crossed Rs.1225000 cr. Good days are here again for the ordinary investors who have been lamenting at their shrinking wealth for the last 3-4 years. The global economy that ran
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through a blue patch for the last two years also started looking up. Everything looks good for the Indian economy. Despite all this hunky-dory image, an average Indian is still haunted by a nagging fear: Will the boom continue in 2004? Or, will we be back to where we were in 2002 by the end of 2004? These fears are not illfounded. It is by now common knowledge that the rise in share prices recorded in the past six to seven months is mostly FIIs-driven. The total inflow during 2003 is estimated to be well over $7.2 bn. Contrary to the commonly held belief that the FIIs stay away from the market during the year-end, the net inflows from the FIIs during December 2003 are reported to be around $1.07 bn. The market turnover in December is a whopping Rs.18000 cr as against the average monthly turnover of Rs.7000 to Rs.8000 cr for the past five years. India is reported to have emerged as the third biggest recipient of the FII inflows in Asia after Taiwan and South Korea. This very active role of the FIIs in the current bullish rally in the Indian capital market is perhaps causing concern on many counts. There is a widespread apprehension that under the garb of the FIIs, substantial non-institutional investments via promissory notes and hedge funds have entered the Indian market. Secondly, there are concerns about the herd mentality of the FIIs that can trigger their exit at the slightest provocation such as easy opportunities elsewhere, profit booking, political developments within India or outside. As against this fragile status, the Indian retail investors, institutional investors and speculators are only known as momentum players. Neither the market had the depth due to absence of such market players as pension funds or hedge funds that are known to take a longterm view of the market. The prime concern hence is how to ensure market stability against the known potential of the FIIs to tanker the market anytime. Even the market regulators appear to have been seized by this fear, else the Securities and Exchange Board of India (SEBI)

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would not have sought the governments advice on the creation of a contrarian fund to counter the rising inflow of the FIIs funds. The obvious question now is: How does the contrarian fund help us avert the market crisis? It is apparentbuy the stock and help the FIIs exit the market at their best opportune time and in the process, perhaps, afford a semblance of market stability, which incidentally is what the regulators are concerned about. The moot question now is what does contrarian mean? A contrarian is someone who is known to take an altogether different view from that of the other players, mostly guided by long-term perspective. But it doesnt, however, mean that a contrarian would enter the market when it is under the siege of exuberance, as our market is currently in, and be a buyer to the sellers who want to book profits. Contrarians are known to play more on the extremes of the market continuum. Incidentally, that is what the FIIs did at the beginning of 2003 when the Indian market was out of sheen. When the market was at its low, and there were no domestic buyers in the market, it was the FIIs who were the first to appreciate the underlying strength of the Indian real economy and buy the stock. They indeed took a contrarian view on the market and gave a tremendous push to the valuations. It is they who brought the index to the current level when the domestic institutional investors, retail investors and speculators were shying away from the market. It is a different matter altogether that some Indian institutional investors could encash, while the retail investors were, perhaps, watching the rally bewildered. True, for every seller, there must be a corresponding buyer in the market and it is in this context that a contrarian view becomes a must for markets to be efficient. But it does not mean that the government should establish a contrarian fund to keep the market get going. Here it is worth recalling the experiences of central banks that are commonly known for market intervention to deliberately

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establish a contrarian view on exchange rates. For instance, whenever the rupee appreciates beyond a point acceptable to the Reserve Bank of India (RBI), it is known to enter the market to mopup the excess dollars and thereby arrest the rupees appreciation and vice versa. But, such intervention has a known cost and a benefit, though limited. But with the globalization and the deregulations of markets, even central banks are less frequently resorting to such strategies, as quite often the accompanying costs have proved to be prohibitively costly and secondly, the market proved to be bigger even to the central banks for influencing their behaviour. The question now is: Are we to replicate it in the stock markets, too? Of course, public memory could be short, but we havent yet forgotten what kind of role the UTI used to play in the stock market in the past. Whenever markets were falling, the UTI used to, of course, at the subtle directive from the government, exhibit a contrarian view by willingly becoming a buyer to every seller in the market. We are also aware of the cost the UTI had to ultimately pay for such misadventures. The moral of this story is that such buying never allows the fund to cut its losses for it would be constantly averaging down in a bear market. Dont we have anything to learn from the UTI episode? Shall we not appreciate that the contrarian investment means not buying when others are selling, but buying when no other investor is buying as such a class of investors driven by a long-term perspective, hold a contrarian view on the market? This trait is what the regulators should strive to cultivate in the market by encouraging long-term players to stay invested with due support in terms of loan against stock etc., as a matter of routine. In the ultimate analysis, what the market expects from the regulators is not contrarian fund but encouragement that breeds and nurses a tribe of contrarian investors.

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THIRTY NINE

Nothing will come of nothing


If one has to have more of something, he has to necessarily give off something elsewhere.

globalized India has become a reality, at least in the context of capital markets. The 30-share BSE Sensex soared 120 points, all in a days trading. During the past six months, the Indian stock market has risen quite dramatically. From a low of 2900, the Sensex touched 4907 at the close of trading on October 31st. The rise of over 50% has taken every investor by surprise. It is indeed causing a lot of disquiet among all those concerned with the stock market, including the North Block, for reasons galore. The current rally is mostly fuelled by the active participation of the FIIs. They account for nearly one-third of the delivery volumes. It is reported that today almost an amazing two-thirds of the free floating stock in Indias leading quoted companies is held by foreign institutional investors. The current dramatic rise in the FII inflows into Indian markets is mostly attributed to the excess liquidity that is sloshing round the rest of the globe. The persisting weakness in the US economy, the falling interest rates all over the globe and the common perception that the Asian economies and currencies will

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strengthen further are the main driving forces behind the incredible inflow of the FII funds. The first time entry of the hedge funds into Indian markets has only added fat to the fire. Intriguingly, the hedge funds are the most feared investors across the globe for they are known to be the most leveraged entities promising investors a pretty high return irrespective of the market movements. In their obvious greed for hefty returns, they are known to take high bets unmindful of the accompanying high risks and move across the markets swiftly, once the greed is satiated. They are the potential source for inflicting volatility in the market. This is not the end of the story. Nearly 40% of the $5 bn portfolio investment made by the FIIs in the recent rally of Indian stock markets is reported to have come from the Non-Resident Indians through the participatory notes. In a way, it amounts to a return flight of the capital belonging to Indians and if it is really true, one may not get unduly alarmed about it for, it can sustain the current upswing in the market for quite some time. On the other hand, if it turns out to be otherwise, market fears would get vindicated. That phobia apart, what matters most here is the fact that today globalized India is quite firmly linked to the global cycles, with the result that whatever happens in New York, London, Tokyo, or Brazil, is potent enough to define the behaviour of the Indian markets as much as the domestic happenings do. Secondly, every decision relating to the FIIs investment in the Indian bourses is not made based on the domestic fundamentals but mostly on the happenings across the globe: the global interest rates, business cycle conditions in the industrialized countries, potential for making profit from different regional equity markets, credit ratings of countries, exchange rate movements, balance of payments position, etc. Market pundits also

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aver that there is a co-movement between the FII flows and the rally in the Indian stock market. The net result of these developments is an undeclared fear about the sustainability of the current rally. Everyone today is haunted by the fear: What if tomorrow the FIIs book profits, packup their bags and move out of India lock, stock and barrel? True, the key variables deciding their entry or exit being external in nature, there is no wonder if it becomes a reality. To avert such a crisis, some gurus are even suggesting creation of a contingent fund generated through domestic banks contribution to it, so that even if the FIIs exit, market stability can be ensured. Are the treasurers listening? What a suicidal proposition! And how diligently we refuse to learn from the past! When will we accept the truth that one can never have something for nothing? Having chosen to open our markets to global players, should we not be prepared to pay for the accompanying gains as well as the losses? The Indian banking system is already saddled with a plethora of ills: endemic NPAs, directed lending, liquidity over-hang and poor off-take of credit, etc. As though these were not sufficient enough to topple the banking system, another directed lending, that too, for stock market operations! Even assuming that the banking system would chip in and inject fresh funds into the stock market, where is the guarantee that it can sustain the market rally for, as feared by many, when it is fuelled mostly by fundamentals other than the economic ones? Are we not then offering the banking system at the altar for FIIs? And for what gain? Is it not true that, whether an FII or a trader, so long driven by the belief that ambition is a virtue and accumulation of profit as the most important business, they will find out the way over the mountains and under the graves to satisfy their avarice and lust for profit?

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What regulators are required to do therefore, is to educate the ordinary investors about the changed market mechanics, create a sense of awareness among them about the new risks that are dawning on the globalized Indian capital markets, and caution them to be cognizant of the underlying fundamentals while committing their funds for investment, while allowing the market to sort out the outcomes of the rally on its own. After all, every investor, be it FIIs, domestic mutual funds, high net-worth individuals or retail investors, must learn to be accountable to his decision. And as markets grow in size, no amount of contingent fund can hold a sinking market high. It is the market rally driven by the rationality of the investors alone that can sustain stable growth and thats what the system should proactively nurture.

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FORTY

Indian hermeneutics of suspicion


Free market and suspicion about market players do not gel well together.

t is often aired that as a clan, we Indians have an uncanny ability to weave a web around us and then struggle to wriggle out of it. We are also known to repeat it without learning from our own mistakes. Maybe, we are genetically wired to be so, but at what cost? Look at the current rally in the stock market: Sensex has gained about 66% from a six-month trough in late April; it once sprinted to a fresh 39-month high of 4900.92; Foreign Institutional Investors (FIIs) trade is reported to have accounted for about 35% of NSE delivery volumes; and in absolute numbers their trading volume has risen from Rs.9842 cr in April to Rs.19,066 cr in September. Interestingly, it is the local mutual fund industry and such domestic financial institutions as LIC and GIC who have cashed in on the current boom in the market. It is reported that in the current month, FIIs have been the net buyers of equity worth Rs.5385 cr, while the domestic mutual funds are the net sellers to the tune of Rs.376 cr. More than these numericals, the current rally has certainly given a big
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boost to the psyche of ordinary retail investor who has been languishing in an otherwise stagnant market for more than two years now. Amidst this hunky-dory, the Securities and Exchange Board of India (SEBI) is reported to have asked the FIIs to furnish the details of Participatory Notes (PNs) beneficiaries and clarify whether they are from a hedge fund or a corporate or a pension fund, suspecting that the PN beneficiaries are none other than the banned Overseas Corporate Bodies (OCBs). This makes an intriguing reading: the regulators appear to have stumbled upon certain information that made them infer that a slice of the current inflows from the FIIs could belong to Indians since about 20 to 25 companies holding PNs have Indian sounding names. Surprisingly, this suspicion has arisen not for the first time. During the early part of this year, the market was rife with rumours that the SEBI was contemplating a ban on FIIs who have issued participatory notes from market participation. As could be expected, these rumours had adversely impacted the market prices of several stocks, especially those having high foreign holding. The most affected stocks were reported to be from the technology sector. Yet, surprisingly, it was the FIIs and foreign brokerage firms who protested the move with a plea that SEBI did not have any jurisdiction over such instruments issued outside India. The SEBI was then reported to have decided to amend its draft code of conduct governing market participants and allow the FIIs to participate in our markets, irrespective of their dealings in derivative instruments, such as participatory notes issued outside India against the underlying Indian securities, provided they disclose details of such instruments. But, the contemplation to investigate the matter afresh only reveals that we have not learnt anything from the past experiences. That

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apart, what are these PNs that are causing so much consternation to the market regulators? PNs are like contract notes issued by registered FIIs to their clients located outside India, the underlying being Indian securities. These are obviously availed by institutions who do not want to go through the hassles of various regulatory processes and mechanics prescribed for market participation by the SEBI but want to have an exposure to Indian securities. Thus, PNs enable such institutes as hedge funds to trade in Indian securities through the registered FIIs. The next obvious question is, What if the Hedge Funds or OCBs participate in the market? The OCBs were recently banned from participating in the Indian markets, while Hedge Funds are the most feared players for they are often misconstrued as highly volatile that they place large directional bets on stocks, currencies, etc., and hence the commotion. True, hedge funds are highly leveraged and are known to be high-risk takers in anticipation of high returns and in the process, keep shifting from market to market. But, the role of hedge funds in the current rally in our market is well conceded by the market pundits. Technically, FIIs cannot be wronged for issuing PNs. Secondly, having once opened our markets for overseas investment, we cannot, perhaps, be choosy about the participants. We only need to put in place a robust control mechanism to maintain market stability. Prudence dictates that we should not poke our nose into market happenings at the slightest provocation, for it has the potential to play a spoilsport in the market. There is already an unstated fear among the domestic playersWhat if tomorrow the FIIs decide to pack off and shift their money to another market? Possibly it can tank our market, but the truth is they cannot leave us, at least in the short run, unless we drive them out; for no other market today is offering such returns as ours is. It is time we came out of our den hermeneutics of suspicion and accepted the

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reality that no investor will visit our market for sheer love of it. And frequent changes in the regulations that only makes foreign institutional investors scary of stay invested for long, which is not in the interests of our markets in achieving depth and volumes. Having expressed our desire to welcome foreign capital via reforms and get integrated with the global economy, we must nurture the trait of pursuing a chosen policy doggedly and work for sustainable growth in the economy, for knee-jerk reactions would only derail and delay the transition. Or, does someone have a better idea?

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FORTY ONE

Investment sans trading nirarthakam?


Realized investments alone enable an investor to grow and enjoy the fruits of investment.

The little house among the trees by the lake From the roof smoke rises. Without it How Nirarthakam would be House, trees and lake.

n this poem, the poet is very forthright in his assertion: Metaphorically he is implying that if there is no smoke, there is no life and if there is no life, the serene lake, the lush-green trees that circumscribe the lake, and the house are all Nirarthakam. How true it is! If there is no life, what difference does it make whether the trees are lush-green or denuded of leaves; lake is tranquil or turbulent; and it is a house or hutch. They acquire meaning, beauty and appreciation only when life is around. That is the worth of life and living. Leaving the trees, lakes, and houses behind for a while, let us move on to our stock markets. The stock market investors are of late
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reflecting quite a cheerful mood, for they are greeted by the rising Sensex. There is buoyancy in the market. It is duly supported by the responsible behaviour of individual companies. They have become conscious of costs. Companies have been divesting unprofitable units/ divisions. They are diligently working towards stripping-up of assets to reduce their capital cost. This new-found phenomenon is obviously getting reflected in the rising index. Indeed, the Sensex is reinventing its lost glory, having crossed the 4000-mark. First, it was public sector banks, whose stock stole the limelight. It is now the turn of the manufacturing sector to sustain the overall market momentum. Almost every scrip has risen in its market valuation. Everyone has forgotten the past and is writing an altogether new script. But all this up-n-rise in the stock market makes sense only to those investors who trade actively and capitalize on the market opportunities. This assertion of course raises a question: Why doubt investors desire to swap their scrips for a better price that the market is offering today? Yes, there is a reason, for psychologists have a different story to tell. They say that most of the investors have a tendency to place an extra value on scrips they already own. Think of a scrip you own, say, SBI: Would you swap it for the current market price, for it is three times more than your purchase price? The prospect theorists say that you will, most probably, not, for you are clouded by endowment effect. Daniel Kahnemal, who won the Nobel prize in Economics last year, says that due to psychological effects, individuals do not part with their earlier possessions, however trivial they may be. Research indicates that this strong desire to hold on to current possessions is equally prevalent among the stock market investors. And this factor compels us to believe that the majority of investors really do not make use of market opportunities thrown open to swap their holdings with

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a better price or swap cash for picking up a good stock even in a bullish market, at least with the required speed. This is obviously in stark contrast to what has been postulated by the hitherto acclaimed neoclassical thought that believes in people as rational economic agents, and hence states that preferences between two goods are independent of an individuals current entitlements. But, this theory has been directly refuted by the findings of the experiments carried out by Daniel Kahneman et al. (1990), and Ian Bateman et al. (1997). This anomaly has been attributed to psychological effects and the same is termed prospect theory by Daniel Kahneman and Amos Tversky (1979). George Loewenstein and Kahneman (1991) have reported that the main effect of endowment is not to enhance appeal of the good one owns but rather the pain of giving it up. The study carried out by Knetsch (1989) examined the trading rates among Cornell undergraduate students and found that 89% of those originally endowed with a mug choose to keep the mug, and 90% of those endowed with a chocolate bar decided to keep the chocolate bar. Despite the existence of laboratory evidence favouring the prospect theory, some economists still believe that the anomaly is merely the result of a mistake made by inexperienced consumers, which they argue would be overcome through the learning process and over a period of time, their behaviour will be on the lines of neoclassical models predictions. It was to resolve this controversy between the believers of the neoclassical model and those of the prospect theory and to unravel the truth behind these claims, that John A List, an economist from the University of Maryland, carried out three tests that pit the neoclassical theory against the prospect theory in a naturally occurring market condition. The experiments were conducted with 500 subjects consisting of professional dealers as well as ordinary consumers so as to capture the

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distinction between the behaviours of consumers having intense trading experience and those with less trading experience in a well functioning market. The findings established that the prospect theory had strong predictive power for inexperienced consumers behaviour across both the trading and auction treatments. Secondly, there is also strong evidence to say that experienced investors behaviour approaches the neoclassical prediction suggesting that agents with intense market experience have learned to part with entitlements. The study further suggests that attenuation of the anomaly appears to take place on the sell side of the market more quickly than on the buy side. This would otherwise mean that the green investors are quite slow in appreciating the current boom in the market. And our stock market is more endowed with such inexperienced retail investors. Secondly, it is commonly observed that the majority of Indian investors even otherwise do not trade on the stock once acquired. Further, the very fact that the current rise in the Sensex is driven mostly by FIIs and, to a certain extent, by the domestic institutional investors, itself vindicates this phenomenon. So, the moral of the story is that unless the novice investors who spread across the country learn the trick of the game quickly, the current up-n-rise in stock market remains nirarthakam. After all, who doesnt need life?

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FORTY TWO

Clarity-driven regulatory intervention alone makes sense


Intervention backed by knowledge alone leads to correction of any event.

here would one place the bubble that burst in public sector banks last week? That was the question raised by Business Line, June 9, 2003. It also provided the answer: Investors who bought public sector bank stocks on May 29, 2003 had lost around Rs.40 cr. True, it does not sound as big as the security scam of 1992, or the more recent K-related stock scam, but it once again confirms our inability, in no uncertain terms, to arrest such recurrences. It has perhaps become a national obsession to wake up after setting the house on fire and cry in chorus. As though to vindicate the growing belief about our regulators knee-jerk reactions, particularly those who are made accountable to regulate the behaviour of our stock market players, it is reported that the Finance Minister directed SEBI to look into the abnormal movement of public sector bank stocks over the past several weeks and submit a report. Interestingly, Mr. Jaswant Singh, the Finance Minister, speaking at a function, true to his profession, made an observation: The period between 1990 and 2003 has seen many fractures in investor confidence We have tried to make the system as transparent as possible. I am disappointed at what happened (in public sector bank stocks).
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True to the lan of political leadership, the minister did not bother to elaborate whether he felt responsible for the contradictory statements made by his ministry officials, which was reported to be the main cause of the unusual fluctuation in prices of some of the bank stocks. If we recall the happenings right from early May, it becomes clear that the share prices of most of the PSBs began to rally driven by reports that banks were likely to return a part of their capital to the government at par. At this juncture, had any authority from any government agency clarified the correct position about transfer of capital, this speculative rally could have been nipped in the bud. Instead, it was reported that during the peak of the rally the finance ministrys spokesperson and the finance secretary made contradictory statements at two different times. It was reported in newspapers that first an official spokesperson in the ministry of finance said that the government would accept return of capital from some of the banks at par value. This obviously led to wild fluctuations in the stock prices of some PSBs reaching unprecedented levels from late April to the end of May, all under the assumption that returning a part of equity to the government at par would automatically improve their earnings per share as also book values, which is what an investor is concerned about. That is not the end of the story, for the finance secretary was reported to have said on June 2nd that the government had no intention of accepting the return of capital by PSU banks at par when the market prices of those stocks were quoting well above par which indeed set the house on fire, and the prices have nose-dived. This episode reminds us of a study carried out by PricewaterhouseCoopers Endowment by assembling a panel of economists and researchers to study and develop a worldwide opacityindex and correlate it with the cost of capital. More than the findings of the study, what matters here is how they defined opacity and the key factors that determine it. The team defined opacity as the lack of

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clear, accurate, formal and widely accepted practices. They have identified corruption, legal system, government macro economic and fiscal policies, accounting standards and practices (including corporate governance and information release) and regulatory regime as the defining elements of the O-Factor. The expert team had ab initio accepted the fact that no country is likely to earn a perfect score under all these heads since there is every possibility of these elements deviating from the expected course such as there may be corruption in government leading to bribery or favouritism; economic policies may be vague or unpredictable; business regulations may be unclear, inconsistent, or irregularly applied; and accounting standards may be weak or un-enforced which makes it difficult to obtain accurate financial information. The study further revealed that a high opacity-index will adversely impact the cost as well as the availability of capital in several different ways. Lack of clear, consistent and reliable practices in the areas of legal disputes, regulation and national economic policy are certain to negatively impact the flow of overseas investments too. Particularly, international investors are prone to be reticent to invest in non-opaque countries. The net result of all this would mean a rise in the cost of doing business and difficulty in mobilization of capital for investment. Alas, we do not know how many more such scams and studies we would need to educate ourselves in effective management of the capital market. The moral of this analysis is that unless regulators cultivate the art of proactive regulation driven by clarity of purpose, market regulation is certain to remain a distant dream. This in turn makes the need for political bosses to cultivate professionalism sufficient enough to display boldness in accepting the slip-ups and charting a new course to arrest the recurrence of scams, quite obvious. May God help us realize this dream soon!

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Who is hedging who?

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FORTY THREE

Who is hedging who?


Risk and risk management through derivatives often tend to mimic Shankaracharyas Maya, unless one is adept at their usage.

erivatives trading that was launched in 2000 is viewed as a great hit in India: Trading has shot up from 21295 contracts per day in 2001 to 50000 plus contracts by December 2002, which is said to be the highest in the world. Further, analysts believe that in 2003 it is sure to witness growing volumes under futures and options trading; what is more, it would be driven mostly by retail investors. This forecast about active participation of retail investors in derivatives trading is sure to cause anxiety, for there is a danger of retail investors losing entire margin in one single day if they end up on the wrong side of a trade. That could be one reason why Warren Buffett said: derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal. It doesnt, however, mean that they are bad per se and hence to be shunned once for all, atleast thats what one understand from what David Bweinberger, Managing Director, Swiss Bank Corporation said: derivative instruments dont create surprises; they help to minimize them. This, of course, calls for a thorough clarity about
March 2003.

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the risk that one is exposed to, the hedging strategy one needs to adopt for achieving the objectives. The very word risk evokes different meanings for different people. Yet, its basic concept is very simple: In financial terms, it is the potential change in the price of an asset or commodity. Risk denotes both the upside and downside of the price movement. But, we rarely consider the upside movement as risk. In routine life we always use risk to denote the most undesirable and that is the loss. Risk always rests in the future. It is all pervasive and has a profound impact on mankind. Certain risks are known to have only downside but no chance of gain. Certain risks are diversifiable while certain others are not. But none of them are said to be extinguishable; at best they can be transferred. Risk retains its fullness, no matter who transfers to whom, who buys from whom or how much of it is bought or sold, until at least it extinguishes on its own. Risk is dynamic. It is an abstract parameter requiring a degree of intellect to measure it. Yet, it cannot be measured directly. It can only be calibrated for it is not a naturally occurring phenomenon. It requires the integration of at least two quantities vizthe chance and the type of event. It is also said that risk cannot be forecasted precisely for it is dynamic. Risk is also not straightforward for there is another dimension to it: The risk of opportunity loss. This very complexity and dynamism of all pervasive risk has perhaps made life more interesting to live by. It eternally challenges ones ability to fight it out, endurance to withstand it and ingenuity to circumvent it. Risk analysis, has thus become a natural and an innate characteristic of human nature. True, everyday, we use information to reduce our risks of perceived hazards by altering our style of living

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such as regulating our eating habits, avoiding smoking, using smoke alarms and so on for the purpose of reducing our risk of injury, disease or death. It is amazing how people take the best possible decisions to deal with this kind of inescapable trade-offs in life. In the equity market, volatility and risk are synonymous. Volatility is a great concern for every player in the equity market. Volatility is not only a concern of investors but also of regulators. In a way arrival of new information into market causes volatility. Market players reassess the true value of the firm continuously based on fresh information that flows in. In efficient markets, the price of the traded asset is pretty quickly adjusted to the fresh inflow of information and hence the volatility. It is thus not bad. But, if the price movement is not connected with any new information, the resulting volatility is bad. It is to minimize the exposure of a portfolio to this volatility/ price risk, investors resort to hedging the act of minimizing the exposure to the risk. One reason for the current hedging-mania could be our improved mental faculties and consequently the know of more. The more we know, the more evident risk is becoming. Indeed risk has become repugnant term in that it makes anybody shudder to think of what might happen. Verily, it has been an eternal struggle to create an element of certainty amidst uncertainty. This resulted in the emergence of derivatives. In financial terms, hedging is said to basically aim at reducing the variability of the corporate income/portfolio income. Another reason why companies or investors go for hedging their exposure to financial price risk is to improve or maintain their competitiveness in the market/ keep portfolio value intact. Let us see how it works. Assume that the current portfolio of Ram consists ACC stock whose price he expects to fall sharply in the near

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future. To hedge from this fall in price and the consequent loss, assume Ram sold individual stock futures contract of NSE on ACC at Rs.162, expiry date being March 26, 2003 under the assumption that any fall in the price and the consequent erosion in the value of ACC stock that he is currently holding will be off-set by the gain he will make under the futures contract on ACC that he sold. Now, Ram having achieved the objective of keeping his portfolio intact by going short on individual stock derivatives, believes that he has hedged his portfolio. But Rams example posits quite a few disturbing questions: When Ram anticipates a fall in ACC price, why has he not opted for the outright sale of ACC stock? Or, is it that he is not quite sure of it? Is selling futures contract a speculative move, then? Another most important question is, what prompted Rams buyer of the futures contract, to buy it? Is he speculating that the price of ACC will rise? If so, what is he trying to hedgehis future acquisition of ACC stock? Remember, all these questions merit examination in the context of what we have seen earlier: No business wants to suffer losses and so only goes for hedging. Yet another question: Why has not Ram gone for a put option on ACC? Why only futures contract? Is it because he has to shell down premium upfront, if he had gone for option contract on ACC? Or, is it a replication of our love for Budha - culture? In fact, if one watches the statistics pertaining to derivatives trading on Indian bourses, one gets wonderstruck as to why there is a big difference in the trading volumes under futures on index and individual stocks and within individual stocks between futures and options. All this begets the next logical question: Is trading in derivatives a speculative move? There is always a thin demarcation between speculation and hedging. In fact, speculation is often disguised as a

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trading for hedging for, after all, speculation is nothing but a bet on the future direction of price movements. Of course, it combines high risks with high potential rewards and thus the urge for speculation. And what speculation also needs is conviction of ones view of the price movement and lots of guts to spare and lose money, no matter borrowed or own. We are back to where we started offwho is hedging whom? And it is certainly pretty fuzzy! Or, is it that risk is in the mind of the perceiver as beauty is altogether in the eye of the beholder, driving people crazy in different directions? One thing is, however, certain: Risk is increasingly becoming bad and in the game of risk management, everything mimics Shankaracharyas Maya (illusion).

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FORTY FOUR

Socially responsible investing no more a fad


Whatever I dig from thee, O Earth, May that have quick growth again, O purifier, may we not injure thy vital or thy heart.

n the world of convergence, it is increasingly being felt that we are for sure metamorphosing into a learning society. This appears to be true as otherwise how else can one explain the suddenly acquired significance for the words: human-dignity, child labor, pollution, environment, and ecology. It is slowly but certainly dawning that we, in the belief of having solved the production problem, have drifted far away from the ancient wisdom. Driven by this new-found wisdom, western investors are becoming highly conscious of not investing their hard-earned money in companies that damage environment, use innocent animals for research, rely on tobacco or booze, etc., to make big money. This increased awareness among people has resulted in an unprecedented social change that brought Socially Responsible Investing (SRI) to the forefront. As SRI took its baby-steps forward, it no longer remained a fad, instead, even larger institutions have started incorporating screening policies to disassociate themselves from
July 2002.

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investments in companies that are not considered to be the followers of ethical practices. Till AD 1500, the dominant world view was organic: People lived in small cohesive communities and experienced nature in terms of organic relationships, characterized by the interdependence of spiritual and natural phenomena and the subordination of individual needs to those of the community. Ancient wisdom was anchored in reason and faith. This belief is well captured in the words of Carolyn Merchant: The image of the earth as a living organism and nurturing mother served as a cultural constraint restricting the actions of human beings. One does not readily slay a mother, dig into her entrails for gold, or mutilate her body . As long as the earth was considered to be alive and sensitive, it could be considered a breach of human ethical behavior to carry out destructive acts against it. They firmly believed that the whole of mankinds actions and desires are bound up with the existence of other human beings. A mans value to the society was judged from his feelings, thoughts and actions that were directed towards promoting the good of his fellow-beings. The health of society was considered to be dependent quite as much on the independence of the individuals composing it as on their close social cohesion. To be ethical, it was believed that ones behaviour should essentially be based effectually on sympathy, education and social ties and needs. But unfortunately, these cultural constraints disappeared as the mechanization of science took place setting decadence in motion. This medieval outlook changed radically in the 16th and 17th centuries. The notion of an organic, living and spiritual universe was replaced by that of the world as a machine and the world-machine became the dominant metaphor of the modern era. This replaced world-view was primarily responsible for the industrial growth that

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we are today witnessing and a significant manifestation of it is the emergence of corporations. The largest of them have transcended national boundaries and become major global actors. The assets of many of these multinational corporates have far exceeded the gross national product of many nations. Their economic and political power has surpassed that of even some national governments. Competition, coercion and exploitation have become the core of the activities of giant corporates, all meant for indiscriminate expansion. Profit-maximization has become the sole objective to the exclusion of all other considerations. They undertake an intense search for natural sources, cheap labour, and new markets, unmindful of environmental disasters and social tensions that have emerged as the offshoots of this indifferent growth. In the process, many corporates have lost their human face. Lack of responsibility towards fellow beings and pride in what one does, coupled with an insatiable greed for profit, have led corporates to pursue wasteful and unjustified production activities. Theodore Roszak has aptly captured this painful scene in the words: Work that produces unnecessary consumer junk or weapons of war is wrong and wasteful. Work that is built upon false needs of unbecoming appetites is wrong and wasteful. Work that deceives or manipulates, that exploits or degrades is wrong and wasteful. Work that wounds the environment or makes the world ugly is wrong and wasteful. There is no way to redeem such work by enriching it or restructuring it, by socializing it or nationalizing it, by making it small or decentralized or democratic. It is the ecological shortsightedness and profit greed of the corporates that is generating hazardous fumes. Corporations are known to vigorously oppose environmental regulation as they enjoy matching political power to prevent stringent controls, at least in the developing

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countries. There are companies that simply dump polluting waste products somewhere else rather than neutralizing them before releasing into environment, without caring that in a finite ecosystem there is no such place as somewhere else. Our obsession with economic growth and the value system underlying it have created a physical and mental environment in which life has become extremely unhealthy. Perhaps the most tragic aspect of this social dilemma is the fact that the health hazards created by the economic system are caused not only by the production process but by the consumption of many of the goods produced and heavily advertised to sustain their economic expansion. The more we study the social problems of our time, the more we realize that the mechanistic world view and the value system associated with it had generated technologies, institutions and lifestyles that are profoundly unhealthy. However, with the passage of time and having experienced the illeffects of over-dependence on technology, a new vision of reality is slowly, emerging. The world has become aware of the interrelatedness and interdependence of all phenomena physical, biological, psychological, social and cultural. As environmental and human rights lobby groups mobilized public opinion, the force behind their argument for the companies to behave, has started yielding results. They have succeeded in compelling companies and investors to take a clear stance on the issues relating to sustainability of the eco-system. Environmental issues today have assumed global perspective as the phenomena of green house effect, damage to the ozone layer and falling biodiversity are just showing how vulnerable the world is. As the Buruntlant Commission 1987 observed, meeting the needs of the present without compromising the ability of the future generations to meet their own needs shall be the guiding post for the business pursuits to maintain sustainability and that is what the SRI movement is all about.

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Being driven by this philosophy, the concept of socially responsible investment has evolved as a tool to boycott the securities offered by objectionable companies and thereby influence their behaviour. Now the moot question is, can mere avoidance of a companys stock affect its behavior? It is too premature to say yes, but such avoidance of a company for investment by a majority definitely increases its cost of capital and that is what is expected to wield influence on the behaviour of an erring company. Shareholders have thus arrogated to themselves the role of directing capital flows towards companies that are society-ecofriendly and ethical in their disposition towards their employees and consumers. The protagonists of SRI have also encouraged shareholder-activism which in turn threatened companies with passing of resolutions compelling a company to make decisions that promote the environment, the well-being of employees, safety of products and the ultimate health of the end-users. According to one study, during 1996 around 240 such social and environmental shareholders resolutions were passed in the USA. And that is how the concept of socially responsible investment has come to stay and wield power on the corporate world.

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Stock market behaviour: A method in madness

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FORTY FIVE

Stock market behaviour: A method in madness


Is it that rationality and irrationality are intertwined in mankind and so the wild swings in stock markets?

magine you are travelling by a train on a midsummer day. The train is bursting with holiday-going school-children, brimming with zest. The air is filled with the shrill voices of the kids, their laughter and merriment. Suddenly the train comes to a halt in the thick of a jungle. There are groups of monkeys in the nearby trees, quite restless, leaping from branch to branch. Children are amused at the sight of female monkeys leaping and jumping from tree to tree with their children hanging upside down, clinging tightly to them as they run. Some kids are running back to their mothers as monkeys, being attracted or perhaps distracted by everything, are trying to snatch away their colourful playthings. Grab and run appears to be the motto of monkeys. Amidst this hustle and bustle, there is a fat monkey frozen in the act of eating an orange-like fruit held in her hand, while the many rinds of the fruits she has eaten lie strewn all around. This scene might be taking you back to your childhood memories of those travels that you undertook during summer holidays. But
June 2002.

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thats not exactly what we are interested in right now. Does it depict a pungent satire of life or eat the fruits, discard and scatter the rinds dictum or a perfect allegory of a stock exchange pit. The orthodox financial theorists would obviously take an exception to this allegory for they strongly believe that investors, unlike monkeys that are attracted or distracted by everything that is colourful, are saddled with rationality. Economic models have all along been assuming that people behave rationally, that each would act in accordance with his values, make decisions that would take individual interests to further heights. Surprisingly, the expected utility theory survived all these years despite the society witnessing quite too often a wide range of irrational behaviour. For almost the last three decades, the discipline of finance has been enthralled by the concept of random walk cum efficient market hypothesis. However, the article Prospect Theory and Analysis of Decision Under Risk by Daniel Kahneman and Amos Tversky in Econometrica published in 1979, rattled the financial theorists forcing them to see beyond the financial horizon for explaining this irrationality. The authors challenged the basic tenets of the expected utility theory by stating that people underweight merely probable outcomes in comparison with outcomes that are certain; that decisions are made in terms of amounts to be gained or lost rather than differences in total end positions and the negative value of a loss is two to three times the positive value of a dollar-equivalent gain. This was followed by another path-breaking paper, Does the Stock Market Overreact? in which the authors, Werner De Bondt and Richered Thaler, challenged the efficient market theory. Thus emerged the theory of behavioural finance. During the last 20 years, behavioural finance, blending economics and psychology, has indeed grown into a new discipline exploring

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financial situations where emotional factors are often found to cloud reasoning, thereby making people behave foolishly, defying all the rationality attributed under the efficient market hypothesis. To answer the question Why investors behave so foolishly? Prof. Robert Shiller of Yale University has proposed four theories: prospect theory, regret theory, anchoring and over- and under-reactions theory. The Prospect theory says that people respond differently to equivalent situations depending on whether it is presented in the context of a loss or a gain. Typically, an investor gets highly distressed if he/she were to incur a loss of Rs.300, say, while selling Infosys scrip than he or she is made happy by an equal gain of Rs.300 in the sale of Wipro scrip. This typical aversion towards loss, behavioural scientists point out, makes an investor willing to take more risk to avoid losses than to realize gains. A typical investor owning a scrip whose price is falling, continues to hold it despite the apparent losses, instead of cutting the loss and using the sale proceeds to buy another scrip that is more likely to give a better return. The endowmenteffect of this theory explains why people set a higher price for an asset they own than they would be prepared to spend to acquire it from others. It is but natural that these individual idiosyncrasies of the investor group ultimately result in the incongruous market behaviour challenging the very efficient market hypothesis. The Regret theory talks about the emotional reactions of investors towards their judgments that turn out to be wrong, such as buying a stock that has gone down in value or not buying the one which has subsequently gone up in value. A category of investors, under the fear of being found wrong in their judgment, even refuse to sell the stocks that have gone down in value. To avoid the embarrassment of reporting losses, investors have often been found to resort to such behaviour. Such investors tend to find it easy to follow the crowd in

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buying a popular stock not because of its high intrinsic value but because it simply affords them an opportunity to excuse themselves from the resulting losses if any and to rationalize the loss by saying that so many others have suffered it. People driven by anchoring philosophy seldom care for historical evidences but get carried away by the immediate past experiences. They tend to extrapolate recent trends though they are at loggerheads with the long-run averages and probabilities and hurriedly decide upon taking a position. How else can one explain the rise in the price of Infosys scrip immediately following the announcement of results for the third quarter of 2001-02, when the owners themselves forewarned the investing public about the likely dip in the earnings growth of the company. This kind of overreaction from the investor group to recent market happenings, that too at the cost of other data, obviously takes the stock under question away from its intrinsic value which is nothing but a la affront to the efficient market hypothesis. Their overconfidence generates more optimism when the market goes up, while its downfall generates more pessimism. Thus prices fall too sharply on bad news and rise too steeply on good news. It is to be admitted here that the modern finance theories are often found wanting in explaining such sudden and steep rises and falls in the stock prices. This is where behavioural finance theorists chip in. Daniel Kahneman and Amos Teversky have offered an explanation to such irrational investor behaviours by citing two psychological theories, viz., representativeness-heuristic and conservatism. The former principle says that investors tend to see patterns in random sequences, while the latter says that people chase what they see as a trend and remain slow in changing their opinion even after the emergence of new data that contradicts the current view in no uncertain terms.

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Its not that only the general investing public is inflicted with irrational behaviour. Research has shown that professional analysts are remarkably bad in forecasting the earnings growth of individual companies. It is often observed that growth rate in earnings forecasted by all the research analysts is more prone to fall around a central point, for no analyst likes to stay away from the crowd. Analysts are also known to favour well-known companies with good forecasts, for they strongly believe that even if such companies under-perform, they are less likely to be fired. This herd behaviour is attributed to the fact that the analysts are often evaluated against their peers in deciding their pay structure and other perks and hence they do not want to be away from them. Having said that about analysts, let us now turn to institutional investors/fund managers. Evidence indicates that institutional investors behave differently. This could be so as being agents, they act on behalf of the ultimate investors. Agents are at times found to be reluctant to take risk, even when the chances strongly suggest that they should take a particular position in their clients interests. Here the culprit is fearthe fear of being fired. Secondly, they tend to favour investments in companies that are well known and popular as they are less likely to be fired even if they under-perform. The behavioural finance is thus revealing why we do what we do with our money, and there is a method in this madness which needs to be taken care of for better returns from the market.

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Section III

Banking

FORTY SIX

Recent rise in undesirable consumerism: Credit to credit cards?


Living today on tomorrows likely earnings is as suicidal as playing with a tiger.

ill a couple of decades back, wealth for Indians was verily material. Either one had it or hadnt. It was there in solid form. Even the less endowed used to see it, though from a distance. It was there in rock solid form to be seen, felt and of course craved for. Perhaps, by being there visibly in solid form, it motivated everyone to work towards it, if not for it. It was mostly used to purchase the essentials of life. The exchanges were also all in solid forms: Both giving and taking were in hard form. Whenever anyone thinks of such exchanges, what immediately comes to mind is the rustle of paper or the tinkle of coins. All this has, however, drastically changed with the spread of bank branch networks across the length and breadth of the country. With the spread of bank branches even up to the village level, the solid form of wealth simply metamorphosed into passbook entries. People slowly mastered the art of exercising their super-symbolic power of money through their bank cheques and passbooks.
August 2005.

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As against this scenario, look at what is happening in todays markets: You will find less of solid exchanges but more of lesser essentials. Today, under the new-found affluent conditions, most of us are looking for a new level of needs. Even we, the new Indians, are slowly but steadily moving away from a system meant for material satisfaction to a system meant for delivering psychic gratification. It is neither the manufactured goods nor even ordinary services that are looked for; but more of pre-programmed experiences that are sought after. Snow worlds, Ocean parks, Discotheques, etc., have thus become the centres of attraction as consumers are going out and out for collecting experiences as consciously and passionately as they once collected things. And at all these centres, it is mostly the youths that are seen. Symptomatic of this emerging trend are the plastic cards in the wallets that are tucked in the hip pockets of male and female urban consumers. Moneythe alter ego of men and women is no longer pegged to that guaranteed by the central government paper or coins. It is the card whether it is ATM card, Credit card or a smart Debit cardthat has become the link between money and the individual. Today, there are millions of cards that are being tossed out at retail outlets to restaurants; petrol bunks to pubs; colleges to clubs; malls to IMAXes and what not, as authentic media for exchange. A year before launching of economic reforms in 1991, there were hardly a few flaunting plastic cards. But by the end of 2003 their number shot up to 9 million. Venture Infotek, a consumer payment processing company, estimates the total spends in the credit card payment industry in 2003-04 at US $5 bn at merchant establishments. According to Electronic Payments International, their growth is projected at 10-14 million cards for 2005. According to another forecast put out by the Lafferty Group, Indias credit card spending is estimated to grow 34% in 2005.

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It is no exaggeration to say that with the emergence of new payment system, it is not only the very living style of the people that has radically altered but also the ethics and value systems of the whole society. Gone are the days when people, like drones, meticulously accumulated money first to purchase an essential at a later date. As against this, the emerging philosophy of life is: Todays gratification against tomorrows earnings. The net result is buying of experiences for the heck of it. What was once considered essential has become trivial or obsolete today. What was never thought of as essential, except in poetic illusion or delusion, has today become the centre of attraction. And its pursuit has become that much easier with the advent of plastic money. Credit cards are found to be inducers of compulsive buying behavioura behaviour that denotes chronic, repetitive purchasing as a primary response to negative events or feelings. Credit card is said to be the offshoot of the culture of consumerism, under which many consumers avidly desire, pursue, consume and display goods and services that are valued for non-utilitarian reasons such as status, envy, provocation, and pleasure-seeking. The easy access to credit through credit cards has simply acted as a catalyst to spread consumer culture in the Indian metros and towns. It is the people who are essentially driven by attitudes such as power, prestige, keeping up with Joneses and anxiety that are highly prone to compulsive buying behaviour. People driven by the attitude of power, prestige are prone to use money as a tool to influence and impress others and as a symbol of success. To them money is power and statusit is a means to buy control and domination. Such people do not look for real gain in satisfaction; they simply acquire goods just to flaunt them as status symbol and in that context, credit card simply acts as a treadmill of consumption. The second group of people that are driven by an attitude of anxiety perceive money as a source of protection from anxiety. Such people perceive compulsive buying as a quick fix for anxiety.

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These two groups of people tend to treat compulsive buying as a mechanism to increase their ability to match their subjective perceptions of socially desirable appearances. In fact, compulsive buyers often use shopping and buying as a means of relieving stress and its associated anxiety and credit card use is found to stimulate such spending. Compared with cash, credit cards are said to result in greater imprudence. For instance, research studies reveal that the introduction of credit cards into fast-food restaurants resulted in more sales and transactions that are 50 to 100% larger than cash transactions. Credit cards, by virtue of eliminating the immediate need for money to buy something, accelerate the habit of compulsive spending. Research studies also indicate that credit cards fan their irrational usage. It is also found that such irresponsible use of credit cards only results in disruptions in ones personal finances. Apropos of these societal transformations, the recent press release of the Reserve Bank of India about placing its draft guidelines on credit cards in Public Domain is a well-thought-out move. Particularly, its advice to banks and all others concerned with the credit cards business not to issue credit cards to students unless they have independent financial means is praiseworthy. It is also good of the Reserve Bank to make it mandatory for the card issuers to explain the most important terms and conditions such as fees and charges, interest free period, over due interest charges, charges in case of default, recovery procedure in case of default, procedure for surrender of card, drawal limits, billings and method of payment etc. It is also proposed that no bank should levy charge that was not explicitly indicated to the credit card holder at the time of issue of the card and obtaining his/her consent. Most importantly, card issuers were asked not to issue unsolicited cards and unilaterally upgrade credit cards and enhance credit limits. They were also advised to observe the extant instructions on Fair Practice Code for lenders issued by RBI while

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recovering dues. Particular mention must be made of the directive asking banks and their agents not to resort to intimidation or harassment of any kind, either verbal or physical, against any person in their debt collection efforts. Indeed, these are the issues which the consumers should have themselves demanded. Ironically, they have to put up with all the unethical practices such as issuing unsolicited cards, improper billing, collection of exorbitant charges/unspecified interest rates, etc. It is a wonder that consumers dont revolt against such abuse of the relationship? Is it their anxiety to hold the card that kept them silent? What is the root cause? Doesnt the credit for all this go to consumerism?

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FORTY SEVEN

Central banks trilemma


In an uncertain future, working for certainty in all the three dimensions is certainly non-achievable for the RBI.

hat a difference a month makes! The Foreign Institutional Investors, the major drivers of our stock market for the last two years, have suddenly become the net sellers. Market reports reveal that during the last two months, FIIs have become net sellers to the extent of more than Rs.2,300 cr. Thanks to the domestic mutual funds, who, having mobilized huge amounts through Initial Public Offers in the recent past, could pick up sell-outs of FIIs almost to the extent of Rs.4824 cr but for which the market would have witnessed a sharp reaction. Even to imagine such a scenario would have been shuddering. But it is commonsensical to say that if the present trend continues, mutual funds, as one market analyst has already said, cannot lend support to the market for a long time to come, which means a fall in the sensex. No wonder if such a predicament emerges, when we look at what is happening all around the globe: oil prices are soaring, currently being at $51.56 per barrel; sharp recovery that the dollar is witnessing against the Japanese yen and the euro; changing global investment
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scenario, etc. All these are pointing to a disturbing future. Over and above this, the impact of a clear Nee from the Dutch and the French Non to the European constitution treaty is already felt in the forex markets and it is anybodys guess what it would mean to dollar further. How does it matter to us? It matters to us a lot. The foreign exchange reserves have fallen from $142.5 bn to $139.6 bn a clean dip of $2.9 bn, that too all in a span of three to four fortnights. When viewed against the inflow of $7 bn and $5 bn during February and March respectively, the current fall sends a different signal. Obviously, everyone jumped at the conclusion that FIIs, being the net sellers in the recent past, are the main culprits behind the current fall in foreign exchange reserves. Here, one should also take note of the fact that during the last two months the Reserve Bank of India refrained from intervening in the foreign currency market allowing the rupee to appreciate, though marginally and that too might have had its impact on the fall in reserves as we practice the principle of mark to the market of securities. Another market development that has its own say on the reserves level is the appreciation of the dollar 3 to 4% against other currencies of the reserves such as Japanese yen, euro and pound. All these facts have cumulatively resulted in the reserves plummeting by $3 bn, all within a month. The story does not end there. The rupee tumbled and closed at 43.78 against the US dollar. The immediate reason for such a fall is traced to the sustained heavy month-end demand for dollars. But a whopping slide of 18 paise in a day cannot just be attributed to the sole month-end scramble, virtually from all quarters, for dollars. There is more to it than meets the eye behind the current appreciation. The dollar has become stronger against major global rivals such as euro; a slowdown in the FII inflows; apprehensions about dollar shortage in the futures market; rising global oil prices, etc., have all a role in depreciating the rupee by almost 26 paise in just two

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consecutive trading sessions. Obviously, the market expects the rupee to remain under pressure for some time to come unless huge dollar inflows are witnessed. Yes, these scenes have almost been recurring that, too, quite often ever since India put itself on the reform trajectory. The liberalization of exchange regulations that permitted flow of capital across the borders, though in a limited way, is obviously the driving force behind these oft-repeated Forex market scenes. Such sudden shifts in currency prices despite there being no change in macroeconomic fundamentals are only mocking at the underlying theories of exchange rate determination. This prompts us to believe that today what determines exchange rates is not trade deficit and economic growth that were once considered important determinants of exchange rates, but capital flows. In other words, it is the market equilibrium exchange ratethe one which balances demand and supply of the currency in the absence of official intervention, which is likely to define the exchange rates. What, however, matters here is not the determinants of the exchange rates but it is the trepidation resulting from such volatile market scenes which is throwing businessmen as well as policy-makers out of gear. Such repeated quakes in the economy pose a question is economic globalization as projected by its proponents really a golden straitjacket? The answer is probably no. The current scenario demands that we take a deeper look at the recently aired theory: Central banks in open economies are certain to face a macro-economic trilemma. The uninterrupted inflow of foreign capital with intermittent but sudden and huge outflows; the resulting exchange rate volatility; and the costs involved under sterilization programmes, etc., are all cumulatively nudging us to believe that irrespective of the limited or free mobility of capital, trilemma is inevitable for a central bank so long as foreign capital is permitted to move in and out of the country.

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Typically, a central bank in such a situation is confronted with three essentially desirable and yet contradictory objectives: One, to stabilize the exchange rate; two, to enjoy free international capital mobility; and three, to engage in a monetary policy oriented towards domestic goal. This trilemma will of course get further accentuated if we adopt full capital account convertibility. What trilemma means is that if we introduce full capital account convertibility, we can maintain no more than two of the following three conditions: one, a fixed rate of exchange between the rupee and other currencies; two, unregulated convertibility of our currency and foreign currencies; and three, a national monetary policy capable of achieving domestic macroeconomic objectives. For instance, if the Government and Reserve Bank desire to reduce unemployment in the country by raising aggregate demand for goods and services, the RBI has to cut down the interest rates for domestic businesses so that the economy becomes highly productive and more competitive in the global trade. However, this is not feasible if the exchange rate is fixed and arbitrage is unimpeded. In such a situation the Reserve Bank cannot reduce interest rates below those that are prevailing in the major global financial markets unless it gives up unregulated convertibility of its currency and foreign currencies by imposing direct controls over movements of funds across the exchanges. Alternatively, it may have to sacrifice the condition of fixed rate of exchange between its currency and other currencies. The trilemma drives us to conclude that exchange rate should matter only when it affects domestic inflation. But, in reality what most central banks do is something totally different from the theoretical optimum. The most common exchange rate mechanism adopted by the majority of countries is neither a currency board nor a free float but only intermediary of crawling pegs, fixed rates within banks, managed floats with no

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pre-announced path etc. So irrespective of the pure theoretical position of a Currency Board or a free float, the external value of the rupee continues to be a matter of concern to businessmen and policy-makers, besides the ordinary man on the road, though the reason is more psychological than real or more real than psychological. But one thing is certain: Nothing is certain in forex market.

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FORTY EIGHT

Here again PSBs are in the news, of course for a good cause!
Mergers as a part of business strategy may yield results but administration-driven mergers are certain to fail.

n todays globalized economy it is becoming evident that the current ways of doing business are not good enough to stay competitive in tomorrows marketorganizations have to invent new ways of competing. In the world of continuous redefinition of industry boundaries and commingling of the technologies, businesses have to strive for opportunity share in future markets. It thus becomes imperative to focus on new strategic management that fosters a longitudinal focus on processes rather than on static cross-sectional analysis with due attention to strategic choices, culture and organizational learning. Suffice it to say that what is needed today is strategic clarity based on established principles. Strategic decisions such as divestments, new product launches, acquisitions, consolidation, though in vogue for long, have become more relevant today than in the past for creating additional space for the existing firms to claim additional pie in the opportunity share. Mergers and acquisitions have thus become universal tools to attain greater market
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share, acquire additional brands, cannibalize competing brands, realize improved infrastructure, create new synergies, capitalize on efficiencies and economies of scale, globalize in shorter span of time, etc. Against this world scenario, it is heartening to listen what the Finance Minister said: Consolidation is the name of the game, which is happening in every sector. I am happy that banks have also taken an initiative in this regard. He further said that If two or more banks come together, we will support them and we need worldclass banks. We have to think global and act local. His comments are just in consonance with what theoreticians in finance have been often saying: Mergers and acquisitions are the best fit strategy for quick growth and in turn for maximization of shareholders wealth. Secondly, the timing of the announcement itself is pretty encouraging: With the opening up of the service sector under WTO agreements to global competition, it is essential to accomplish scale of economies in the banking industry to compete with the global players and this is possible only through mergers. Leaving aside the wishful thinking and coming to realities we encounter a question: Is the present move for consolidation businessdriven or administration-driven? If it is going to be business-driven, we need to leaf through the experiences of global players that consider two cardinal issues in differentiating a successful acquisition from the unsuccessful: One, doing the homework to select the right company and two, applying an effective and replicable integration process once the deal is struck. It also calls for a match between the vision of the acquirer and of the acquired firms, as otherwise they are prone to be at loggerheads and thus the generation of quick results and long-term wins for the shareholders, employees, customers, and business partners, remains a question mark. Experiences also indicate that as high as 60% of the mergers and acquisitions concluded in 1990s have failed to capture the expected value. This highlights the

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fact that although mergers as a strategy sound theoretically pretty good, their success demands ample ingenuity in their execution. As put by an analyst, A larger part of what makes a deal successful after you complete it, is what you do before you complete it. Against these experiences, let us analyze the pros and cons of the present consolidation drive. Efficiency theories under mergers suggest that mergers provide a mechanism by which capital can be used with more efficiency and the productivity of the firm can be increased through economies of scale. The theory of differential efficiency states that if the management of bank A is more efficient than the management of bank B, and if bank A acquires bank B, the efficiency of bank B is likely to be brought up to the level of bank A. According to this theory, the increased efficiency of bank B is considered the outcome of merger. So, if the proposed mergers are to be successful, there must be a set of well-managed banks which have the potential to upgrade the efficiency levels in the acquired/ merged bank that is said to be inefficiently managed. Now the moot question is how and who differentiates the well-managed from the ill-managed. And the answer is anybodys guess, particularly in the Indian PSBs. Another most important theory of mergers is synergy theory, which states that when two banks combine they should be able to produce a greater effect together than what the two operating independently could. It refers to the phenomenon of two plus two becoming five. This synergy could be financial synergy or operating synergy. The mergers in the Indian banking system are technically bound to give operating synergy, if not financial synergy. But there are a great many hurdles in the path to operating synergy. Today, all the public sector banks have branches in all the major towns and are in fact operating at many places side by side. There is thus a need to merge such branches if operational synergy is to be realized through

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bank mergers and such numbers could be pretty high. Looking at the current experiences, one wonders if such consolidation is feasible. Even if it is possible, that is not the end of the story. It leads to another problem: What is to be done with the excess staff? Are the merged units empowered to retire the excess staff? Or, are they to offer a Voluntary Retirement Scheme and if so, how to fund it? Is the acquirer to fund acquisition as well as the retirement scheme? This may be a tall demand on our present system, more so when we consider the level of capital adequacy the merged units need to maintain, including under the Basel II proposals. Do we have such strength? Or is the government planning to foot the bill? The next problem is the existence of Regional Rural Banks. They, having lost the very objective for which they were established, are serving no greater purpose as separate entities. Hence, they also need to be taken note of in the current drive for consolidation. That apart, every bank is after all unique defined by a bundle of unique resources, relationships, and a set of management practices. These differences are glaringly visible between the banks headquartered in Mumbai, Chennai, and Kolkata. When two such banks come together, the first conflict that needs to be resolved is that of cultural integration. Secondly, these banks have been hitherto fighting bitterly with each other for a share in the market and when such employees are brought together, it poses a great challenge to leadership to align their focus with the vision of the merged unit. This calls for professional leadership which has to necessarily flow from the board of directors. Despite these hurdles, there is no escape from the mergers, since What matters today most to run a business is neither capital nor knowledge but the ability to form powerful partnerships. This comment of Peter Drucker unambiguously tells us that a partnership between a strong market leader and a weakling makes more sense

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than a partnership between equals. A merger of two should always give five as no extra benefit accrues from becoming a four. This intuition innocently puts a question: Why not, as a first step towards mergers, raise private participation in the banks? Let the major players test the waters and mobilize equity and having proved their strength, may then find it easy to acquire a bank, purely on business-driven lines, for that is more likely to succeed. Mergers per se are good but to reap the full benefits the acquiring banks/government, being the owner of the major banks, should first eliminate the hurdles in the path of successful mergers. Else, mergers may tend to end up with the proverbial farcical result.

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FORTY NINE

GTB fiasco: A new lesson for the market economy?


No matter whether you are a man or a woman, how comfortable it would be if only one could escape from taking decisions?

t was in the early hours of Monday, July 26. An anxious face peeped into my cabin, intermittently. Perhaps, noticing someone or other sitting with me, she swiftly but reluctantly, withdrew. I could read the anxiety writ large on her face. Later, noticing me alone in the cabin, she hurriedly pushed herself forward and mumbled: Sir, I want to ask you about Global Trust Bank. Why, you had any deposits with it? Yes Sir, its a considerable sum. You need not worry about its safety but have to only wait till its merger etc., is decided by the Reserve Bank of India, said I. You say, I will get my money back? I made a sincere attempt to placate her: Yes, You will. Apparently, relieved of her tension, she started finding fault with the male members of her family for her present plight. She squarely blamed her husband, who appeared to have all of a sudden said: It is your money, so you handle it as you like. She lamented that but for her husband granting that freedom, she would not have ended up with GTB. I was taken aback: A woman, who is incidentally
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a holder of the highest academic qualification that a university can offer, was accusing her husband for granting her freedom of decision. A true evidence for Erich Fromms Escape from Freedom? More striking than this, however, has been the recent upsurge in the failure of finance companies/cooperative banks and now the Global Trust Bank. Essentially, banks are considered as the repositories of national wealth, and the backbone of the Nations Payment System. A bank deposit is basically considered as near money for a depositor is given to believe that on any given day he can tender a cheque and receive the cash. As against these decades of belief, look, what the Global Trust Bank has inflicted on its hapless depositors: a moratorium which means closure of normal operations of the bankmaking/ receiving deposits, except for a maximum withdrawal of Rs.10,000 from savings or current account and giving out loans till the regulator finds a solution to rejuvenate it. It is an altogether different matter that the moratorium is aimed at freezing the assets and liabilities of the bank so as to arrest its further deterioration but what essentially it did was to subject the depositors to a trauma. No one knows how many depositors like my colleague are passing through the pangs of uncertainty attached to their lifes savings put with GTB. The treachery is hard to live with by all those who have reposed faith in GTB. True, as Shakespeare said: Theres no art/To find the minds construction in the face but a regulator cannot get away with it. They are pretty aware that the GTBs net worth was wiped away two years back. There were also reports to the effect that its indiscriminate lending to garment exporters, diamond traders, share brokers, etc. had resulted in accumulation of huge bad debts. Indeed, it was known for quite some time that all was not well with GTB: the Reserve Bank of India vindicated this by asking the main promoter to step down from executive positions three years ago. The banks accounting year was extended. Its auditors were changed twice in the recent past.

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Its annual report for the year ended March 2002 was rechecked by new external auditors, as the RBI annual inspection team found the report incorrect. The proposals for injecting fresh equity have been taking an unduly long time to fructify. Earlier, its interim chief executive left the bank within a short period. All this speaks volumes for what is in store at GTB. Thats not the end of the story for, if we travel a little farther down memory lane, we notice many grave irregularities that are ordinarily potential enough to attract the regulators attention. Current reports reveal an alarming feature of its very establishment: The promoters are reported to have taken finance from a trader for infusing equity into bank by promising a minimum share price for the banks scrip. This, in itself, is a good enough reason for the regulator to decline the banking licence. It is no wonder if such linkages have ultimately led the bank to get caught in the stock market scam. There were also reports about the involvement of GTB in price rigging of its shares, prior to its proposed merger with UTI Bank. All these happenings compel one to conclude that GTB is a suspect player in the financial market. In fact, there were pretty good warning signals, at least to the regulators, if not to the depositors; who are supposed to be good at smoke detection. These signals could have prompted the regulatory authority to initiate corrective action long back. Instead, the Reserve Bank of India welcomed the decision taken by the GTB and its board of directors to clean up the balance sheet in its press release of September 30, 2003 but, imposed moratorium exactly 10 months after the said press release. The outcry of the demonstrating depositors is thus understandable. Ironically, the principal promoter of the bank, refuses to take the blame for Global Trust Banks failure as reported in the Business Standard on July 27, but holds his management style of total delegation of power to senior managers and his hands-off approach

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responsible for the banks collapse. In the interview, he categorically stated, I am not a failure but it is my new management style total delegation to senior managementfailed. What an assertion! What matters most here is when we juxtapose the act of GTBs promoter Ramesh Gelli transferring the responsibility down the line for the failure of his bank, with that of my colleagues attempt to transfer the blame for the uncertainty attached to her deposits with GTB and the consequent trauma that she had undergone to the act of her husband granting her freedom, it makes quite a revelation. Let us first take the case of my colleague for a detailed analysis: We cannot, though my colleague did, find fault with her husbands act of granting her freedom to decide how to invest her money for she did exercise it, presumably, happily too. But, it is only upon the decision turning sour, that she felt unfortunate that her husband, all of a sudden, left the decision of investing money to her. This entire episode interestingly reveals a lesson: Granting power with no prior training is dangerous, particularly to those who have not been allowed to handle money matters independently. No wonder if the executives to whom Gelli is reported to have delegated powers, air similar feelings if asked for the reasons for their failure in exercising the delegated power fruitfully. Intriguingly, this analogy leads us to another revelation even institutions, for that matter, even systems, cannot handle newness of anything that is granted all of a sudden. They perhaps need someone to watch from behind and guide them to chart a new path, till at least they strike their own roots. This is a lesson worth learning by all those who are associated with the march of the country from a regulated regime to a market-driven economy. But the moot question isat what cost? Yes, innumerable depositors of GTB have already undergone their lifes trauma but it is only to be hoped that such incidents do not recur though no one can guarantee it since

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economies in transition are vulnerable to such mishaps. This, however, imposes a tremendous responsibility on the market regulators to monitor the system with a great degree of alacrity. Let us fondly hope that the regulators act upon the lessons learnt, while the rest learn caution from others misfortunes.

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FIFTY

Is RBI a big brother or a helping hand?


Certain systems find it inconvenient to change with the changing times and adopt newer techniques and unfortunately it is the rest who get penalized for it.

t is often said that the primary objective of banking sector reforms launched by the Reserve Bank of India in the recent past is to essentially inject an element of market discipline into an otherwise lacklustre performance of the Indian banking system. In the process, the RBI has introduced many measures to make banks adopt prudent accountancy policies. It has introduced new norms for classifying loan accounts into bad debts. It has also stipulated stringent provisioning requirements. To fall in line with the international standards in maintaining risk-based capital, the RBI has also prescribed a capital adequacy norm. Banks are also advised to be transparent in their disclosures about operations and risks undertaken periodically, hoping that such disclosures would increase the credibility of the banks functioning by revealing their competency to measure and monitor the quantity and quality of their risk-exposure besides, enabling investors to assess a banks financial strengths and performance more accurately. With this, it is expected that banks
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visiting equity markets for capital would automatically be disciplined by investors. Even the Basel committee on banking supervision in its report on enhancing bank transparency opined that market discipline would function as a third pillar in the capital adequacy framework. It is also believed that in a liberalized environment, market discipline reinforces regulatory and supervisory efforts of the RBI and provides a strong incentive to banks to manage their business in a prudent and efficient manner. It is also hoped that good corporate governance will prevail among the banks paving the way for maximization of stakeholders wealth. Cumulatively, it is hoped that with prudential supervision and market discipline in place, the kind of financial crisis East Asia witnessed in 1997 could for ever be averted in India. Contrast these expectations with the recent directives issued by the RBI regarding dividend payout by commercial banks in India. The RBI has recently issued a fiat prohibiting banks with net non-performing assets above 3% and capital adequacy ratio below 11% in the preceding two completed years, from paying dividend without its approval. In addition, their dividend payout ratio cannot exceed 33.33% of the current years net profit. Based on the financial data for 2002-03, it is reported that only three of the 19 listed public sector banks and two of the 18 listed private banks will qualify to declare dividend without seeking the RBIs approval. Prima facie, the very need for the Reserve Bank to issue such directives reveals that neither the banks, which in the normal course of business, should determine how much dividend to declare to keep the investors happy while keeping the business strong, learnt to behave on their own, nor could the market discipline them as anticipated while launching financial reforms. That however, is not the only problem. Investors in bank stocks would certainly be unhappy with these directives, for no investor commits

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his funds to companies that do not pay dividend. During the last 12 months, banks stocks were actively traded on the bourses and indeed witnessed dream prices. This sudden move of the Reserve Bank will not only force investors to stay away from bank stocks but is certain to play prima donna with the plans of those banks which contemplated tapping the capital market for fresh funds to augment their capital adequacy. This in turn can derail the business plans of those banks whose future growth is solely linked to build-up of additional capital adequacy. The ultimate victim of all this is corporate governance. Intriguingly, the brazen intrusion of RBI into banks right to declare dividend posits two questions: one, is it the lack of confidence in bank managements ability to steer through the troubled waters, or two, is it the RBIs penchant for micromanaging the banks that prompted the current directives? The former question is more disturbing for 80% of banks are under the control of the government and it is very difficult to digest the idea that the government has abdicated its responsibility for supervising the managements. Of course, there is a discordant note among the analysts about the governments role in managing banks. The government being anxious to bring down its fiscal deficit by whatever means that are at its command and being the owner of major banks, may arm-twist the banks to declare dividend without minding its adverse impact on the health of their balance-sheets. Perhaps, looked in that context, the present move of the RBI may sound sensible. Of course, many in industry are citing a number of reasons to justify the current directives of the RBI. The analysts argue that unlike many other corporates, banks being financial intermediaries are prone to typically function with an embedded mismatch between highly liquid liabilities on one side and less liquid, non-marketable assets on the other side of their balance-sheets, and the consequences of embedded mismatch get further accentuated with the accompanying wide array of

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risks like credit risk, market risk, and operational risk. Secondly, banks being highly leveraged, these inherent risks could result in catastrophic losses unless managed effectively. The fact that banks today hold an increasingly large proportion of assets and liabilities signifies the dire need for prudent and effective management. Failure of banks, besides challenging the common mans very perception of banks as repositories of national wealth, being highly contagious, may pull down the very financial architecture of the country. There is yet another argument in favour of the current move of the RBI. In a scenario where banks are known to have invested about 40% of their funds in government securities, any upward move in interest rates that, too, when analysts opine that interest rates have already bottomed out, can inflict huge capital losses on their investment portfolios. Industry pundits argue that should such an eventuality arise, few banks would be in a position to tide over the crisis on their own; more so, if one were to believe the market reports that no bank has yet initiated action on the advice of the RBI to create an investment fluctuation reserve of 5% of their investment portfolio by 2006. Some others argue that the present move may be aiming at preparing Indian banks for the new Basel II Accord as less payout in terms of dividend helps banks shore up their capital adequacy. By and large, everyone related to the banking industry in the country has thus hailed the current move of the RBI as quite sensible and timely. So far so good, but it certainly fails to silence the cynics, if you wish to call them so, from posing a barrage of questions: What would RBI do if banks approached it for permission to pay dividend? Where is the guarantee that the RBI will not accede to such requests? And, if it accedes, what are the guidelines for exercising such discretion? Where is the guarantee that exercising such discretion will not defeat the very purpose of these directives? More than anything, would such

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a move not shift the onus of declaring dividend to the RBI from the shoulders of the real managers of a bankthe board of directors? Apart from these questions, should the RBI as a supervisor of the banking industry not appreciate the fact that issuing directives to hone the financial architecture of the country is one thing, and retaining the power to use discretion under the same rules that, too, when such exercising of discretion will amount to supplanting itself in the role of board of directors of respective banks, is quite another. It only reaffirms, though unfortunately, that even after a decade of financial reforms, the system has not transformed the bank managements from being tiny toddlers to professional managers, as devoutly wished for. The moot question is how long the RBI wishes to do hand-holding? Arent we yet ready for independent managements that could prudently handle their affairs in such a way that it keeps their business healthy and investors happy with market appreciation of their investments besides paying dividends? Against this backdrop, RBIs intrusion into micromanagement of banks sounds no good by any stretch of the imagination.

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FIFTY ONE

Shining NPAs: A reflection of national character?


Its not only human beings that have character but also corporates and it matters most in corporates for they thrive on the capital of many.

es, there is a lot of new-found confidence on display among the Indian companies. They have mustered enough energy to take on globalization confidently. The rising demand for consumer credit from the banking sector is a sure pointer towards the growing demand in the country for industrial output. Current happenings give a feel that corporates too are moving slowly but certainly away from their investment-shy posture to committing fresh investments for building new capacities and improving productivity and quality of products by fine-tuning the processes. They are even resorting to financial engineering: Today companies are enthusiastically moving forward to cash in on the prevailing historically low interest rates by borrowing afresh to retire high-cost old loans. They are gung-ho on restructuring their debt portfolios with a mix of foreign currency- and rupeedenominated loans so as to reduce capital cost and stay competitive in the market.
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That said, India has a lot to answer for. One such distressing phenomenon demanding explanation from the nation as a whole is the Reserve Bank of Indias stern warning to banks against attempting to evergreen their balance sheets for the financial year ending March 31, 2004. Here evergreening means managing the balance-sheet through means that do not violate banking laws in letter but breach them in spirit. Indeed, it is not for the first time that the Reserve Bank of India has aired such displeasure at the attempted evergreening by the banking system; doubts have been aired for quite some-time about banks camouflaging their balance-sheets at every financial closure. Controversies aside, let us examine why banks resort to evergreening at all. The need for evergreening has indeed arisen out of the stringent provisioning norms that the RBI introduced a decade back and the mounting pressure on banks for reporting profits. According to the instant norms on provisioning, banks are to identify a loan as an NPA if the instalments fallen due or the interest that was charged was overdue for two quarters or 180 days. One may wonder here: What is the big deal in it? It does make a difference: too many bad debts hit a banks balance-sheet in two ways. One, it reduces the current interest income and two, it demands provision from the earnings made elsewhere as a protection against the bad debts and both cumulatively affect the banks profit. Secondly, a high percentage of NPAs erodes its market credibility. It is to overcome these hurdles that banks are perhaps resorting to evergreening. Under this, bank A sanctions a loan to a firm whose account with bank B is becoming bad for recovery to enable it to deposit the amount thus released in its loan account with bank B and thus arrest its slide into NPA. This helps B bank to report fewer NPAs and also enhance its interest income. As a sequel to this, bank B sanctions a loan to a customer of bank A whose account is likely to become an NPA, to enable him to deposit it in his account with bank A, thereby

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avert its slide into an NPA. By resorting to such mutual help, banks are showing NPAs at a lower level than what they really were. Some banks are reported to have invented yet another route to evergreen their balance-sheets. They disburse too many loans at the end of the financial year in the hope that the credit portfolio thus inflated automatically reduces the NPAs in percentage terms. There is more to this conundrum. From the next financial year, banks are likely to be directed to identify a debt as a non-performing asset, if either the instalment or the interest was overdue for one quarter or 90 days. This is what is really causing more consternation to the Reserve Bank of India: It apprehends that evergreening may make deeper inroads. The RBIs anxiety over the episode is thus obvious, though banks say its apprehensions are misplaced by claiming that they are fully gearing up for the transition and related challenges. But the real tragedy behind the whole episode is that no one is willing to look at the root cause of the NPAs. It is the failure of the businesses to generate anticipated cash flows as projected at the time of committing fresh investment either for expansion of existing line of business or creation of new capacities, to service the debt. There could of course be multiple reasons for such failures: lack of entrepreneurship at the top in executing the project as envisaged; their undertaking ambitious projects in their anxiety to grab the early bird advantage or to prevent others from entering the competition that too with no matching owned-funds or internal accruals to realize the projected sales volume; unanticipated liquidity crisis owing to either non-receipt of owned-funds in time or hiccups in the release of loan by banks; blatant misuse of funds meant for execution of the project; deliberate default in repaying the debt and so on. Time also plays havoc with many projects: At times projects do not move at all; and on other occasions time flits away, like a wraith, as though the

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owner was not there. The adverse impact of time-overruns is proved to be as tempestuous as cost-overruns. There could also be instances where banks and financial institutions might have themselves contributed their mite, though unwittingly, towards NPAs accretion. They might not have displayed matching skills to assess the multivariate projects that have sought finances effectively, allowing the embedded risks to creep into their balance-sheets as NPAs. Or, it could be that banks have not exhibited the requisite resilience in locating the incipient weaknesses of projects well in time and initiate appropriate action in terms of restructuring the debt etc., that could have seen the project through with a little or no damage to the core. In the fitness of things, we must also examine the role of character of all those involved in the episode. Be it individuals or corporates, all live with reference to their character. It is the character that defines the fate of a person or a corporate. Suffice it to say that character and destiny are intimately welded together. Character as defined by its leadership is indeed the destiny of any company. It is the character of a corporate which encourages unchecked greed for wealth resulting in irrational expansion of existing lines of activities or diversion into an altogether new line of business, that too with no matching intrinsic strength. Such irrational commitment of investments to fresh projects coupled with a lack of sincerity of purpose obviously leads to failure in accomplishing the envisaged business objectives. Or, it is the very character of the company that drives it either to deliberately misuse the cash flows or wilfully default from repaying the debt. All this automatically leads to the crystallization of the much-shuddered defaultrisk and accretion of NPAs in the banking industry. In the final analysis, it is the character of the corporates that defines the level of NPAs in banks and the subsequent need for

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evergreening of banks balance-sheets. So, there is no logic in blaming the circumstances for all our ills. Remembering, The gods are just, and of our pleasant vices Make instruments to plague us, are we to collectively pray for build-up of character across the corporate corridors that enhances productive function of real resources which alone can mitigate NPAs and the associated problems?

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Queering flat pitch/curve

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FIFTY TWO

Queering flat pitch/curve


Be it a cricket field or a financial market, flatness is always shunned for there would be no challenge, which means no gains and in business sans gains there is no beauty.

owlers in cricket dread a flat pitch. It is dead and hence cannot assist the bowlers. Being placid, it neither offers cues nor supports the bowlers for getting wickets. On the other hand, it calls for a lot of ingenuity from the bowlers. They need to be highly disciplined in bowling wicket to wicket. They cannot afford to drift even for a while from line and length. Even a slight error of the bowler will be punished mercilessly by his opponent. Simply put, bowling on flat pitches is nightmarish. And so is the case with a flat yield curve: it offers no insights to investors in designing their investment strategies. To better appreciate this analogy, let us begin at the beginning. A yield curve is a plotting of the interest rate yields on bonds with differing terms to maturity, but with the same risk, liquidity and tax consideration. Simply put, it is a description of the term structure of interest rates. Normally, yield curves are upward sloping which mean the long-term interest rates are above short-term interest rates.
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Having said that, let us bear in mind that the yield curve could also slope downward or simply remain flat. Now, the fundamental question is what determines its slope. To answer this, let us take a deeper look at the underlying theory of the yield curve known as expectations hypothesis of the term structure of interest rates. It states that the interest rate on a long-term bond will equal an average of short-term interest rates expected to occur over the life of the long-term bond. This hypothesis is derived from the assumption that bonds of different maturities are perfect substitutes, as otherwise, the expected return from holding one period bonds will not match with the expected return from holding the n-period bond. It otherwise states that the entire term structure at a given point in time reflects the markets current expectations regarding the future short-term rates. For instance, a positively sloped yield curve implies that spot interest rates are expected to rise in future, while a negatively sloped yield curve implies the reverse. The expectation theory, however, is predicated on several assumptions of which the important one is that the investors and issuers have complete maturity flexibility. Historically, the slope of the yield curve has been one of the best single leading indicators of the economy. It demonstrates the overall level of current interest rates. Most of the time, analysts draw the yield curve in terms of government securities, since they are risk-free and thus eliminate all possible theoretical distortions in terms of creditrisk, etc. Its shape tells a lot about expectations of investors about future interest rate movements, which in turn will predict the rate of economic growth. It is a multipurpose tool with many applications: input for monetary policy application, a tool to measure market risk, etc. The shape of the yield curve is normally classified into four groups viz., normal yield curve, flat yield curve, inverted and steep yield curve, each conveying its own message.

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A normal yield curve, as the name implies, is lower on the left, and higher on the right side, indicating that the short-term interest rates yield less than long-term interest rates. A flat yield curve is formed when both short-term and long-term maturities are nearly the same giving approximately the same yield which indicates that the economy could potentially move into a pullback, contraction, or even a recession. An inversion of the yield curve results when investors rush to purchase long-term bonds shooting up their price of the bond and decreasing the yield. It reflects expectations that the central bank could be forced to decrease interest rates to provide liquidity to the slowing economy. The inverted yield curve is usually an accurate forecast of a slowdown or an economic recession. A steep yield curve is formed when an economy is moving from recession to growth. It is often characterized by long-term rates well in excess of short-term rates. In the waning days of recession, short-term yields will remain low, but long-term yields will begin to rise sharply in the expectation that the central bank will be forced to raise interest rates to fight back inflation. A steep curve is often found at the end of a recession. With this theoretical understanding, let us now take a look at what is happening to our yield curve: In the recent past, it has been flattening. The spread between the overnight rate and the 10-year sovereign yield has all along been declining. During 2003-04, it declined by 61 bps from 116 bps at the beginning of the fiscal. The yield curve is currently around 130 bps. It is perhaps the flattest yield curve we have had in the recent past. Another distressing phenomenon is that the yield curve has already turned inverted at the shorter end. This is perhaps obvious, for the 364 day T-bill yield has been below the official repo rate. By global standards, our yield curve is pretty flat. Intriguingly, the yield on ten-year G-sec is at 5.04%, almost in tune with the global average. But, the average

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overnight rate of 2.84% and the official repo rate of 4.50% are significantly above the global average. The answer to our flat yield curve is not far to seek. It is the rigidity depicted by the Reserve Bank of India (RBI) in fixing repo rate at the same level for long periods. Although the repo rate was once cut by 50 bps by the RBI, it could hardly make any dent on the yield curve since the fall in ten-year yields during the said period is over 110 bps. This rigidity exhibited by the RBI in fixing repo rate is making it incongruous with other short-term interest rates. Secondly, the present regulations prohibiting short selling of government securities are resulting in a long-only-market. A long-only-market does not afford an opportunity to market players to express their twoway views on the interest rates and thus the yield curve does not necessarily reflect the market expectations. Derivatives too play a great role in defining yield curve. They facilitate short selling without being actually short in the underlying cash market. But we have an ill-developed derivatives market. Similarly, skewed issuance of government securities towards the long end has shifted the secondary market activities towards securities with longer maturities. The resulting low appetite for short-term papers created ill-liquidity calling for factoring the liquidity risk premium into short-term rates. The resulting higher yields at the shorter end and softer yields at the longer end are automatically flattening the yield curve. Cumulatively, these factors are distorting the yield curve. As a flat pitch is nightmarish for bowlers, the flattening yield curve is certainly a cause for concern for the markets. The US experience teaches us something shuddering: its inverted yield curve of 2000 was followed by an extended period of economic downturn in the economy. Though the Fed Reserve has cut the interest rates 13 times since then, its economy is still wriggling to come out of the

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economic slowdown. Similarly, the inverted yield curve of Japan points towards an economic recession. An yield curve is an important input for policy-makers. It provides information on market expectations on inflation and GDP growth embedded in it. As against this, a flat yield curve, like a flat pitch, provides no insights to the central bank on these two issues that are essential for drafting an effective monitory policy. There is of course a caveat that one need to bear in mind here. In a very regulated financial market, the informational content of a yield curve is relatively less as the slope of the yield curve is partly determined by the deliberate policy of the central bank as it is indeed happening today in the struggle of RBI for managing the surging foreign currency inflows. This in turn makes the flattening yield curve more nightmarish to investors and planners than a flat pitch does for bowlers.

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FIFTY THREE

Out, lazy banking & in, resilience


Be it in business or in public life, in a globalized economy, laziness is penalized and resilience is rewarded.

uring 2003-04, banks are reported to have invested far more in government securities than what has been disbursed as credit. As per the latest release of weekly statistics by the Reserve Bank of India, non-food credit of banks stood at Rs.55,125 cr, while the investment in government securities stood at Rs.97,197 cr. It otherwise means that, as against the stipulated investment of 25% of incremental assets in Gilts, they have invested almost 66% during the current year. Of course, the reasons are obvious: it is pretty easy to dump the accredited deposits in Gilts since it calls for an assessment of neither credit worthiness nor the measurement and management of default risk. Maybe, that is one of the reasons why some are labelling it as lazy banking. But there is a glitch within this apparently good-looking investment. This could perhaps run all right so long as the interest rates continue to move southwards, but what if tomorrow the trend reverses? The current view on market is that interest rates have
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bottomed out, and once the demand for credit picks up, interest rates will only move northwards. It is expected that the prolonged span of under-investment will soon set the stage for a prolonged cyclical expansion. After all, it is capital expenditure alone that can fuel the employment growth, which in turn can give a push to sustained consumption. Once growth in domestic consumption is sustained over a long period, it not only reduces the dependence on the vagaries of demand from external markets, but also strengthens the export competency of Indian companies. It is after all commonsensical that many of todays multinationals have become global players only after having established themselves as strong players in their respective domestic markets. It is indeed their strength in the domestic market that affords a kind of cushion for these corporates from external shocks, if any, and sustains their global spread. It looks as if Indian firms were very much aware of this phenomenon and hence are reorganizing themselves professionally. It is heartening to note that during the last couple of years, Indian companies have made use of the recession to strengthen their balance-sheets quite impressively. They are today in a better position to make fresh investments out of their own funds. One set of analysts estimate the proposed commitment of Indian corporates towards the creation of additional capacities at Rs.20,000 cr in the form of equity in the coming twelve to twenty months. It means that there would be a demand ten to twelve times the size of the credit from banks. Such a development is bound to tighten the liquidity in the market and put upword pressure on interest rates. What would happen then? Banks would face a double-edged sword: rising interest rates will, on the one hand, result in fall in the investment income, while on the other hand, it raises interest expenditure on deposits. There is yet another danger lurking behind all this corporate hoopla of investment-revival. During such periods of investor enthusiasm, it often so happens that companies that are

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not quite fit enough, also join the bandwagon and make a demand for credit from banks. Of course, by now, banks would have become smart enough to outsmart such entrants. Nevertheless, they need to display their competency to handle the risks embedded in credit dispensation more visibly so that it acts as a deterrent to the bad guys to tinker with the financial system. The ground realities are, however, nowhere near these demands. Its a pity that even after a decade of financial reforms, the central bank has to advise banks to work out their PLR by factoring their actual cost of funds, operating expenses, a minimum margin to cover the provision requirement under the NPAs, dividend to be paid to the shareholders, and the required profit margin. Does this advice mean that banks were hitherto announcing their PLR arbitrarily? Another equally alarming feature is that banks are reported to be currently lending funds at the sub-PLR since they are drowned in liquidity that resulted out of poor credit offtake. This contingency raises two questionshow then are banks covering their costs? And how are they accounting for the costs associated with loans that have different maturities and the accompanied risks? Probably one can answer the first question through the fact of marginal cost of deposits coming down substantially in the recent past. But it is very difficult to find an answer to the second question except to say that banks are ignoring the risks associated with long maturing loans, provision experiences under different segments of lending, etc., however critical it may appear, from the point of view of their profitability. This double bind only drives home the need for product-wise PLRs. Or otherwise, having worked out a benchmark PLR banks should work out separate risk premiums to cover the cost of each risk such as maturity risk, product risk, portfolio risk, provision risk, capital risk, being entertained under different loans so as to ensure that every loan is properly charged to recover the underlined costs fully.

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There is yet another challenge which is not far off. Once real-time gross settlement becomes functional by June, the float which banks are today enjoying as interest-free deposit from their customers that comes handy for meeting banks daily payment requirementswill simply disappear. It means that transaction costs are going to be high for banks while they would become cheaper to customers. This emerging challenge demands from banks a new set of pricing strategies. The sum and substance of these arguments is that banks can no longer afford to be lazy, that too, when markets are fast becoming turbulent owing to a continuous change in interest rates. What is therefore needed is strategic resilience that can continuously help banks to redo their balance-sheets with more and more profit-generating assets. It is time that banks cultivated resilience across the hierarchy that would enable them to continuously anticipate and adjust to the constantly changing market scenario before the need for change becomes desperately obvious. But the moot question is how to nurse resilience in banks. How to sell the idea that the business models that have proved to be more or less immortal are no longer good for getting better? It is particularly difficult to sell this idea to executives who have enjoyed a benign environment all along where everything was taken for granted. Resilience is not about having an inventory of best practices, but more of a strategy of constant morphing that enables banks to be forever conforming to emerging opportunities and the underlying trends. The goal should therefore be not correcting the past deeds, but making its future. It is only resilience that can guarantee plenty of excitement sans trauma. Mistakes in identifying, measuring and managing risks cost money and so are the outlived strategies and laziness in correcting the past. So resilience matters and it is for each bank to choose a path for nurturing it in their organization.

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FIFTY FOUR

Reserve banks duvidha?


Most of the change we think we see in life is due to truths being in and out of favour.

ome April and the season of speculation on Credit policy, one gets emboldened to believe that Robert Frost might have penned those lines keeping economists in view. Leaving it at that, let us look at the ongoing slide in interest rates. True, high interest rates deter industrialists to commit funds for investment in new businesses or expansion of capacities or diversification. And so only the Reserve Bank of India reduces interest rates when the economy is on the downswing, to stimulate economic growth as also to ensure that deflation does not set in. Theoretically, such reduction in interest rates is supposed to assist new enterprises, at least temporarily, in getting cheaper credit to get started. But in the long run, it does no good to the economy as whatever gain it generates is likely to be offset by the resulting inflationary pressures on the business cycle. Apart from inflation, artificially synthesized low interest rates prove to be no good for the economy at yet another level. Common sense reveals that distorted prices lead to distorted use. Theoretically, cheap
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credit is known to encourage people to waste capital by making excessive investments in plant and machinery, real estate, etc., without weighing the productive value of such investments. Of course, in our context, thank God, that is not happening as is confirmed by the poor demand for credit from the industrial segment. But in the meanwhile, a disturbing development has silently crept into the system. Banks, in their anxiety to deploy their funds profitably, are aggressively enticing middle class employees to take personal loans. This is giving a giant push to consumerism. Intriguingly, a farmer may have to spend more time in getting a loan to purchase a tractor than an employee for buying an air-conditioner or Maruti Esteem. More than that, a farmer has to pay higher interest on a tractor loan vis--vis an employee or a professional for a car loan. Time alone can reveal where this leveraged-consumerism would lead the economy. Having said that, one cannot but lament at the short-termism that continues to rule the roost. There is yet another dimension to the fall in the interest rates. If the central bank, in its anxiety to kick-start the economy, continues to practice low-interest rate regime, then savers may loath to save. This trend is already surfacing: lowest ever growth rate of just 12% in bank term deposits in 30 years has indeed been reported for the fiscal ended March 2003. The lurking danger behind this development is restricted credit expansion, restricted investment in new enterprises and finally little or no employment generation. Cumulatively, all this means no rise in the purchasing power of the populace. Apprehensions aside, as at the end of March 2003, inflation has touched 6% which is almost 25 basis points higher than the interest rate offered at the shorter end by many PSBs today. It otherwise means that if one wants to maintain the present value of money intact, one has to keep his money in a bank for at least one year. If RBI, which is

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reported to be favouring a softer interest rate scenario, further reduces bank rate in the forthcoming credit policy, real returns to savers will simply turn negative. Then, what is the incentive for the savers to defer their gratification and save the capital?. Such fall in savings leads to poor capital formation domestically, which means nonavailability of capital to meet the increased demand for fresh investments at the other end of the business cycle. Some economists are of course arguing that the present rise in inflation is not a demand-pull but only a cost-push phenomenon. They predict that once the Iraq war is over, crude prices will come down and obviously the inflation. But if one factors the fall in agricultural production by as much as 3.1% during the last year, no one can dare expect a fall in prices of oilseeds, cotton etc. That apart, what if the monsoon turns out to be weak even during 2003, which indeed is the prediction. Though one shudders to think of another bad-monsoon year, one thing is certain: it will result in a further fall in agricultural production. It means there is little chance for inflation to come down, if not shoot up further. There is of course another closely related concept that merits our attention here: inflation might be good for growth. Empirical studies carried out by Fischer and Bruno and Easterly establish that inflation is negatively correlated with growth at least double-digit inflation rates. On the other hand, studies carried out by Barro and Sarel did not find any negative relationship between inflation below 8% and growth in economy. This is supported by inferential evidence, i.e., deflation is considered bad for growth. There is another important phenomenon that needs to be taken note of here. There is always a considerable delay between the Reserve Bank effecting a change in interest rate up or down and that change affecting the demand in the economy. Studies reveal that it

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takes almost a year and a half for an interest rate shift affected by the central bank to impact the economy. It would therefore be interesting to watch which truth the undesirable low-interest-rate- driven growth in consumerism or the rising inflation rate and the need to curb it or the continuing lull in the industrial output and the resulting need to give it a push through monetary initiation would be in and out of favour of the central bank.

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Section IV

Forex Markets

FIFTY FIVE

Capital account convertibility: Is India ready for it?


Looking to China that is sitting pretty with forex reserves of $850 bn, no one should get tempted to say that CAC is essential for attracting foreign capital.

very now and then, someone or other from India initiates a debate on Capital Account Convertibility (CAC). This time it was the Prime Minister who said: I have requested the Finance Minister and the Reserve Bank of India to revisit the subject and come out with a road map on CAC based on current realities. Before getting deep into the debate let us first see what economists have to say on CAC. CAC simply means freedom to a resident to convert his local assets, physical or monetary, into foreign assets and vice versa at marketdetermined rates of exchange. Market-oriented economists putatively advocate CAC for a plethora of benefits: it maximizes the efficiency in the use of capital across the world; it enlists macro-economic discipline and thereby makes capital markets behave and respond to such policy shifts; compels governments to supervise financial systems and regulate them well; eliminates discretionary powers of bureaucrats that in turn
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can eradicate corruption from the corridors of financial system and finally affords freedom to individuals to dispose of their income and wealth as they deem good in their interest. But the South-East Asian financial crisis simply put the Capital Account Convertibility on the backburner. It shifted the emphasis to caution. Critics, armed with the fall-outs of the Asian crisis, have argued that capital control is the most wanted mechanism to mitigate volatility in international capital markets and to maintain the autonomy/sovereignty, of national policy. Admittedly, the economic profession knows a great deal about current account liberalization, its desirability and effective ways of liberalization but knows very little or nothing about capital account liberalization. This school of thought is therefore asking for order both in thinking about and policy framing on capital account. It is also argued in many quarters that capital account liberalization has got many costs embedded in it, the shocks of which are beyond the capacity of the developing economies to absorb. Professor Jagdish Bhagwati, the noted economist of Columbia University, forcefully but persuasively warns the whole world not to equate the benefits that are likely to flow from free mobility of capital with the benefits arising from free trade, for they are not analogous. Obviously, all those benefits that flow to society from the principle of comparative advantage in production and exchange of goods do not readily translate into similar benefits from the exchange of currencies. He drew the attention of the world to the fact of availability of enormous quantum of historical database to establish the flow of benefits from free trade while it is abysmally low with regard to free flow of capital. Hence, he warns that the weight of evidence and the force of logic point towards a policy that restrains capital flows rather than allows its free flow.

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It is a commonly held belief that CAC makes a developing countrys economy highly vulnerable, i.e., when something goes wrong, then suddenly a lot goes wrong, as it happened during the Asian crisis. Free flow of capital from international markets into a developing economy is usually guided by a feel good or bad equilibrium of an economy. The good equilibrium created by the high confidence and growth in economy acts as a pull-factor for capital inflows as is currently happening with us while a reverse of it results in outflow of capital. Indeed, this is what happened in South-East Asian countries during 1997. Once the equilibrium is shifted from good to bad, owing to erosion of confidence in their pegged-rate currency system and fall in exports growth, nothing could stall the flight of capital from these countries. Neo-classical economists of course counter it by arguing that CAC is a welfare enhancing mechanism. Their contention is that, in a liberalized environment, international financial markets allow residents of different countries to pool various risks because of which a country suffering from a temporary recession or natural disaster can as well borrow abroad. This is also considered to be a boon to the developing countries which suffer from poor capital formation, as they can borrow from global markets to make investments and promote economic growth. In recent years, this neoclassical explanation is criticized on the ground that global capital markets are victims of adverse selection and moral hazard. It is therefore very difficult to know precisely when outcomes will switch from good equilibria of rapid growth fuelled by capital inflows to bad ones with the accompanying wide spread capital flight, precipitating deep recessions. Thus, it raises the crucial question: Whether the longer run macro-economic benefits of allocative efficiency outweigh the instability costs of capital account openness? Even the findings of Sebastian Edwards and Geoffrey Garrett reveal that countries can only reap the efficiency benefits of capital account

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liberalization without incurring its instability costs when they possess prudential financial sector institutions that establish regulations for capital adequacy, reserve requirements and the like, monitor closely the behaviour of actors in the financial sector, and are transparent to the outside world. The study comments that this type of prudential regulation has almost become a commonplace practice in the OECD, while it is woefully missing in the developing countries. Against these theoretical underpinnings, the current level of foreign exchange reserves gives a feeling of adequacy and lots of comfort since they are, as stated by Lawrence Summers, Chairman, Harvard University, in excess by 15% of our requirements, encouraging the idea of CAC. Secondly, India, as observed by the Prime Minister, having had free-trade agreements with SAARC, Singapore, Thailand, and ASEAN and working on similar arrangements with Japan, China and Korea, wants to capitalize on the new growth avenues opened up by simplifying regulatory and approval procedures and reducing transaction costs. In such a scenario, it is expected that by CAC lots of foreign capital can be attracted into the country which can be invested for improving productive efficiencies. These improved productive gains are expected to strengthen the Indian rupee, which in turn is expected to result in attracting further capital inflows and thus creating a virtuous circle of capital inflow. But the ground realities have a different story to tell: it is not mere liberalization of capital account convertibility but the sovereign ratings that determine capital inflows into a country. In other words, even by liberalizing exchange regulations, Indian corporates cannot access international capital at cheaper rates so long as its sovereign rating is below investment grade. Secondly, the economy should be strong enough to absorb the capital inflows once CACs is allowed, otherwise, it may distort the interest rate scenario in the country. For that to happen with no hiccups, we should have a robust debt market. It must have the

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strength to absorb the increased inflows or outflows of capital (owing to free convertibility) without causing excessive volatility in the yield curve; otherwise monetary policy implementation will get a beating. Thirdly, for the rupee to become convertible, it is not enough for the RBI to declare it as convertible; there must be willing holders of the rupee from outside India. There must be a demand for the rupee from external sources for legitimate purposes, such as trading and investment either in India or in other countries. Admittedly, full convertibility status brings India to the end of globalization but its success depends on the strength of domestic economy and the institutions that keep it orderly and robust. This reality now raises a question: why then are the Prime Minister and the Finance Minister making a proposition for full convertibility? Is it that they want to use it as a platform to give an aggressive push to further reforms in the country? Logically, it looks so, for even the RBI holds an opinion that there are many other reforms that are to be put in place before going for full convertibility. For instance, fiscal deficit needs immediate correction. And above all look at the share of vulnerable liabilities (FII inflows and FCNR deposits) in the reserves and the past experiences thereunder! It does not offer the comfort one wishes to have while going convertible on capital account. Indeed, a lot needs to be done on the fiscal and monetary fronts before we really open up for free flow of capital across the borders. In the meanwhile, it may make sense to use the excess reserves for infrastructure development, as suggested by Lawrence Summers.

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FIFTY SIX

Who is great: God or the economist?


In the beginning, God created the sterling and the franc. On the second day, He created the currency board and, lo, money was well-managed.

e do not know if God really created the currency board, but they certainly seem to be a godsend when we consider what Sir John Hicks (1967) said, On strict Ricardian principles, there should have been no need for central banks. A currency board, working on a rule, should have been enough. History tells us that the first currency board was established in Mauritius in 1849, and by the 1930s they spanned across the British colonies of Africa, Asia, the Caribbean and Pacific Islands. Intriguingly, a currency board was established in North Russia on 11 November, 1918 and its architect was none other than John Maynard Keynes. History testifies to the fact that prior to the World Wars, growth in the world economy was abysmally low, since it remained essentially provincial. The cross-border flow of goods was minimal and capital investments were mostly within sovereign boundaries. Obviously, this resulted in orderliness in the management of money. But, this inflicted
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silent suffering on those who were not endowed with natural resources. Yet, people have lived haplessly with whatever has befallen them On the third day, God decided that man should have free will and so He created the budget deficit. On the fourth day, however, God looked upon His work and was dissatisfied. It was not enough. So, on the fifth day, God created the central bank to validate the sins of man. On the sixth day, God completed His work by creating man and giving him dominion over all of Gods creatures. Then, while God rested on the seventh day, man created inflation and the balance-of payments problem.* Stricken by misfortune, man started questioning: How to make growth take place? Whether God allowed it or the constant search of man for a better tool to achieve quicker growth enabled it is not certain, but one thing did happenman stumbled upon the budget deficit. Slowly but intelligently, he started realizing that budget deficits do not matter as long as they create additional employment and wealth. Man got emboldened by his experiences and theorized: As long as the return on investments through deficit is higher than the cost of borrowings, the economy can well-afford budget deficits. Man researched further and
* Peter B Kenen (1978) as quoted in Currency Boards by Steve H Hanke, Annals, AAPSS, 579, Jan 02.

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refined his theories: Persistent deficit in revenue accounts cannot be accepted under the principle that as long as the cost of borrowing is less than the returns from investments, deficit is all right. In other words, the cost of borrowing matters in situations where deficit is revenue-driven, as it could become a major cause of future deficit by itself. It is again not known if central banks were sent by God or man created them. They, however, gained significanceor notorietyas financiers of deficit. They were also pretty handy to governments in managing the maze of problems emanating from deficit financing. Central banks have slowly but firmly established themselves as lenders of the last resort. A look at their balance-sheets gives a better picture of this role. The asset side of the balance-sheet of a central bank contains net domestic assets and net foreign reserves. This enables the central banks to undertake a discretionary monetary policy by buying and selling domestic bonds and bills. This automatically changes the monetary basismoney circulation increases when a central bank buys bonds and bills from the market and decreases when it sells bonds and bills. As a part of their monetary role, central banks also manage exchange rate policy and thus emerges a conflict between exchange rate policies and monetary rate policies. For instance, when foreign capital inflows are excessive, a monetary authority quite often neutralizes their effect by contracting the domestic component of the monetary base. Similarly, when capital outflow increases, the central bank attempts to reverse the changes by increasing the domestic component of the monetary base via purchase of gilt securities. This results in a balance of payments problem. It is these policy conflicts and the resulting problems that forced man to search for a better alternative again. It ended in a revisit to the God-created currency boards. Currency boards are designed

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with no discretionary monetary powers to engage in the fiduciary issue of money. Their sole function is to exchange domestic currency for an anchor currency at a fixed rate. Thus, the quantum of domestic money in circulation is being dictated by market forces, i.e., the demand for domestic currency. They maintain reserves in the form of low-risk, interest-bearing bonds in the anchor currency, and are mandated to hold reserves equal to 100% or a little more of their monetary liabilities. Therefore, they cannot practice discretionary monetary policy. This rigid structure of the currency board has obviously generated a lot of opposition, although currency boards proved their efficiency in realizing price stability, a respectable growth rate, and most importantly, fiscal discipline. In fact, currency boards fit well into Karl Schillers definition of a sound monetary system: Stability might not be everything, but without stability, everything is nothing. Ironically, it is felt that a currency board is unlikely to be successful without the solid fundamentals of adequate reserves, fiscal discipline and a strong and well-managed financial system, in addition to the rule of law. However, supporters propose currency boards to be an antidote to these very evils. Another strong argument against currency boards is that they do not permit maintenance of competitiveness among countries. The other most populist argument against them is that they result in loss of monetary sovereignty. That apart, another interesting development surfaced from the so-called intellectual debate on economic growth: the division of the world into developed and developing countries. Developed countries believe that the rule of law in developing countries is weak. They argue that a principal-agent problem emerges because of the principals (voters) inability to exercise power on the agents (politicians), once elected. To rectify these problems, economists are

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now prescribing currency boards to these countries so that their fiscal regime will be subordinated to the monetary regime. The net outcome is: He created the currency board, but Western economists prescribe it for the developing countries. Now, who is great: He or the Economist? Perhaps whoever can dictate is great!

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Forex reserves and infrastructure investment: Strange bedfellows?

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FIFTY SEVEN

Forex reserves and infrastructure investment: Strange bedfellows?


When the chips are down, it is only the out-of-box thinking that can take one out of the mess.

ver the past four months or so, we have been listening to a nationwide debate on whether or not to use the surging foreign exchange reserves that are lying idle for infrastructure development in the country. One section of the economists led by the Planning Commission believes that the current level of foreign exchange reserves that stood at $142.5 bn is pretty good to meet the import requirements and all other external payment obligations of the country for more than normally accepted periods. Secondly, maintenance of reserves of such magnitude is also costing the country dearly. On the other hand, it is becoming difficult for the Planning Commission to mobilize sufficient resources to propose a reasonable capital-outlay under the Tenth Plan that can ensure enhanced economic growth. It is also feared that any further rise in fiscal deficit would only increase drawings from the private savings and thereby push the interest rates northward which in effect means crowding out of private investment which is currently already at its lowest. Amidst these contradictions, one section of economists led by the Planning Commission opines
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that usage of foreign exchange reserves to augment infrastructure development in the country is a viable alternative. Of course, this move poses an obvious question: Are the reserves the savings of India? The answer is an unequivocal No and so another school of economists are airing apprehensions about its prudence in using them for infrastructure development. According to them, it is nothing but usage of short-term funds for long-term purposes that too, for investments which do not ordinarily generate foreign exchange earnings. Such a move is considered potential enough to create liquidity crisis should FIIs withdraw their investments from the capital market. As evidence to their argument, they draw our attention to what happened in East Asian countries during 1997. These countries borrowed short-term funds from international financial markets and invested in long-term non-foreign exchange earning projects such as real estate development, as a consequence of which they ended up in a liquidity crisis. They have another line of argument: The current level of poor private investment in infrastructure project is not due to lack of funds, it has more to do with the lack of clarity in our policy initiatives. How else, they ask, can we explain the high inflows of private capital into sectors like telecom while little or nothing has flowed into roads, power transmission etc. Probably, infrastructure sectors such as roads, power generation and transmission are not making business sense, either due to frequent shifts in our policy stances or the embedded social obligations of those projects, where non-enforceability of toll collection on all, free supply of power to certain sections, etc., is in vogue. In other words, what is being argued is that it is not lack of funds, but the conducive atmospherics which is holding back private investments in infrastructure projects. Accordingly, it is concluded that usage of foreign exchange reserves for creation of infrastructure is less prudent.

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They have another question: What is the big difference between committing fresh investment for infrastructure development through deficit financing and using forex reserves, for both are known to result in increased money circulation in the system. And expansion of money supply is generally despised by institutes like IMF, World Bank and monetarists, like Milton Friedman, who generalized that any increase in money supply will eventually result in increased prices. Hence, they strongly argue that capital for investment has to come from real resources and therefore take a strong exception to the usage of forex reserves for encouraging investment in infrastructure. This argument necessitates that we take a close look at what David Hume once said based on his experiences in European countries. In every kingdom into which money begins to flow in greater abundance than formerly, every thing takes a new face: Labour and industry gain life; the merchant becomes more enterprising; the manufacturer more diligent and skilful, and even the farmer follows his plough with greater alacrity and attention. This is not easily to be accounted for. He is of the firm conviction that money supply stimulates industrial as well labour activity as money integrates less monetized and less developed areas with more developed regions of the economy. He therefore advocated a policy of keeping alive a spirit of industry and increasing stock of labour in which consists all real power and riches. Hence, he concludes: Although the absolute quantity of money is a matter of great indifference, there are only two circumstances of any importance the gradual increase (of money supply), and its thorough concoction and circulation through the state. Hume thus proposes that it is not the absolute quantity of money in circulation that matters, but its wide circulation throughout the economy that increases economic activity by bringing in a larger proportion of society into the exchange economy. In view of what Hume said it makes a great sense for the sovereign to stay focused in

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ensuring wide circulation of money throughout the economy by eliminating the scope for its accumulation rather than getting perplexed by the fear of excess money in circulation. If we juxtapose the current move for using forex reserves for infrastructure investment along with the foregoing argument of Hume, one gets emboldened to say that it is a right move for a right cause at a right time; more so, when we are attempting to move away from a developing stage to a developed state. It is the right time because we are endowed with more reserves, better skilled labour, and a more robust economy than what we had a decade back, and are thus in a better position to consciously practice expansionary fiscal policies for sustaining improved growth rate. The one thing that all schools of economists have in common today is the idea that infrastructure in the country must be augmented. It is argued that such investments must be made immediately and the country simply cannot afford to wait for policy corrections that could ultimately encourage private investments in infrastructure development. The much-debated question today is: What will happen if we dont augment our infrastructural facilities immediately? The answer is pretty obvious: As time passes, the infrastructure bottlenecks become so acute and powerful that they simply pull down the growth rate and there is no wonder if the spectre of inflation will rise and make its dirty existence felt either through a cost pull or demand push mechanism. Such a predicament is most undesirable when we are getting more and more integrated with world economy. The message therefore is to accelerate economic growth, reduce poverty, and bridge the gap between haves and have nots of the society by increasing infrastructure investments immediately. In the larger context, it doesnt matter if the increased infrastructure investment by the government through borrowing is inflationary. It is simply a question of belief: All cholesterol is not

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bad; it is only low-density lipid that is a bad cholesterol. Similarly, it is for what the deficit is used that makes an investment good or bad. Yes, if the deficit is for hiking government employees salaries, it is bad and should be avoided. But when it is meant for investing in infrastructure development it doesnt matter even if it leads to temporary price rise for tomorrows will be brighter. Such a bold initiative is bound to result in economic transformation of the society. Hence, it makes no sense to follow the much prescribed theology of the International Monetary Fund or that of the World Bank for fiscal discipline. Even otherwise, there is a substantial difference in augmenting infrastructure through direct government borrowings and borrowings against foreign exchange reserves through a special purpose vehicle, the former by virtue of becoming a part of budget results in monetization while the latter becomes a contingent liability. Secondly, as long as the borrowings against reserves are used for import content of infrastructure development, there will be no increase in money supply and hence, no impact on domestic prices. All things considered, it is time for the government to take bold initiatives for improving infrastructure and thereby give a boost to economic growth which in turn can generate more employment and arrest the ills of poverty to a tolerable level of a civilized society. Are we not entitled to leverage on the current strengths of the economy?

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FIFTY EIGHT

Forex reserves for domestic investment: A bold move


The world is yet to know making of wealth without taking risk.

he Prime Ministers Office is reported to have instructed Finance and Planning Secretaries to find ways to use the countrys foreign exchange reserves to run up a current account deficit, instead of the current account surplus that has been the status for the last few quarters, and absorb a sizeable chunk of external savings to boost domestic investment and growth. Looking at the current rise in inflation that is partly attributed to excess money circulation resulting from Forex reserves, there appears to be no alternative for the government. That aside, it is a good move: We have for once shown gumption to use the accumulated forex reserves that stood at US $112 bn for the week ended by September 3, 2004, for the good of the Indian economy, instead of hoarding them abroad. To better appreciate the current move, let us take a look at a few basic economic principles. International trade is essentially driven by the principle of comparative advantage. It means countries export goods in whose manufacture they enjoy a relative advantage. Similarly, they import goods in whose manufacture they face certain
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disadvantages. Secondly, if a country has to accomplish faster growth, it has to essentially invest more than what it saves, which means external borrowings. The counterpart of it is trade deficit. Technically speaking, a developing country like India, ideally, should have a current account deficit of 2 to 3% of its GDP to grow fast. This is all the more important when our domestic savings are not sufficient to fund the investment requirements in proportion to the desired growth rate. Instead, we have had a current account surplus of 1% of the GDP for the last couple of quarters. In other words, we have been consuming fewer goods than what we have been producing and in the process lending our savings to outsiders. This is certainly against our growth interests. And that is what the current move is likely to correct. Economic principles aside, every central bank is driven by its own concerns in managing its foreign exchange reserves and the RBI is no exception. One such concern could be that RBI finds it difficult to allow the rupee to find its own value. It perhaps fears that such inaction on its part exposes businesses to exchange rate riskwhich is the sensitivity of the real value of a firms assets, liabilities, operating income, expressed in its functional currency, to unanticipated changes in exchange rates that cause the loss. Secondly, an appreciating rupee may make our exports less competitive in the international market, with the result the exports may fall. Thirdly, an appreciating rupee equally impacts the future cash flows and profits of a firm that is operating even within the domestic market. The economic risk is increasingly becoming significant in the globalized economy where the ripple effects of economic changes in one corner of the globe are being felt everywhere else. There is of course a positive side too for an appreciating rupeeit makes imports less expensive in rupee terms. Secondly, an appreciating rupee makes imports a cost advantage for those exporters whose imported raw material constitutes a sizable component of their exports.

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Perhaps, to obviate these risks, the present exchange rate policy of the RBI essentially aims at stabilizing the exchange rate through market intervention. Hence, the RBI has been purchasing dollars against rupees. This act obviously puts more domestic currency into the market. So, to contain the money supply growth within the acceptable level of 16 to 17%, the RBI sucks out the excess rupees by selling its holding of government bonds. This act of RBI ensures that reserve money does not grow at the rate at which the reserves of foreign exchange grow. However, many fundamentalists are of the opinion that the current level of reserves are more than adequate to meet import liabilities of near future and hence argue that such reserves involve an opportunity cost. Indeed, the RBI sustained a loss of Rs.1,500 cr under this operation during 2002-03. This cost is likely to go up with the hardening of domestic interest rates. So, the present exchange rate policy posits a battery of questions: Is it worth incurring cost to sterilize dollar inflows? What if inflows continue unabated and demand more MSBs to sterilize them? Is that not potential enough to push domestic interest rates further northwards? Instead, why not use these reserves for domestic investment? The present move is a clear answer to some of these questions. Here again we need to understand the intricacies associated with the usage of foreign exchange reserves for domestic investment. There is a lurking fear that the foreign exchange reserves, which are mostly in the form of NRI deposits and FII investments, may move out of the country at the slightest provocation. And no one is interested in revisiting the 1991 crisis, for it is quite scary to think of the trauma that the country experienced then. Against this background, the present move sounds brave and thus laudable. But the route chosen to create trade deficit, i.e., encouraging public sector enterprises to import capital goods, does not sound encouraging, for a variety of reasons. It is commonly

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perceived that public sector undertakings are treated as the personal fiefdoms of politicians and bureaucrats. It is also strongly believed that politicians are the most undesirable agency to be assigned with the responsibility of controlling the countrys commercial assets. Essentially, what matters in businesses is management efficiency. It should make a corporates existence meaningful to the shareholders. To put it differently, efficient management subjecting corporates to the discipline of capital market and making executives accountable to the shareholders; existence of a strong institutional framework that evens out the principal-agent conflicts that are inherent to the companies management and surveillance of the market by a powerful regulatory agency backed by an equally tough law enforcement mechanismis what is required to generate wealth. It is also essential that corporates learn not to tolerate somnolence, sloth and non-conformity to generally accepted international norms and standards of macroeconomic management, disclosure, transparency and financial accountability. But all this is evident more by its absence than presence in public sector enterprises. Hence, it makes greater sense to float a Special Purpose Vehicle to borrow against the foreign exchange reserves under the aegis of a Public Sector Bank and lend only to such corporates as are known for efficient management of assets to generate wealth quickly irrespective of private or public ownership. Let us hope that the current move sees its logical end and the country stands benefited.

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FIFTY NINE

Wrestling to manage the swamp of plenty?


It doesnt matter whether you are an individual or an institution the eternal challenge is to exercise choice.

uring the British regime and even during our early independence days, there was an axiom doing the rounds among the Indian farmers that aptly captured the flight of Indian agriculture: Athivrishti ya Anavrishti which means either too much or too little of rainfall that inflicted innumerable woes on Indian farmers. This syndrome appears to have now shifted to Indias foreign exchange reserves: They rose to $116.06 bn by April 9,2004 from a minuscule $5.83 bn as on March 1991. We have since travelled from a very precarious position of defaulting on our external payment obligations to a most solvent position among the emerging economies. Indeed, the athivrishti of dollars is so much that in a single week the dollar accretion is reported to have been $3.70 bn. The Reserve Bank of India (RBI), in its anxiety to arrest the downpour of dollars in the Indian market, has further reduced the interest rates on NRI term deposits and savings deposits so as to
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eliminate the scope for arbitrage. But looking to the kind of inflows we have witnessed in the recent past, it is doubtful if this measure is in any way going to influence the inflow of dollars. The latest weeks data on balance of payments released by the RBI indicates that a major chunk of inflows are in the form of FII investments and proceeds under service exports. Secondly, if the rupee continues to appreciate at the same rate of 9% as witnessed during the last fiscal, it makes great sense for NRIs to maintain rupee deposits irrespective of interest rate offered as no investor would like to miss the opportunity to make a few dollars extra from the appreciating rupee in addition to whatever interest rate these deposits offer, which incidentally are tax-free. Thus, there appears to be no readymade solution to the RBIs problem of dollars athivrishti. In fact, it is a challenge more to the business acumen of Indian corporates that becomes obvious if one takes a deeper look at the swamp of plenty. Of course, prima facie, the nightmare of surging dollars and the resulting strengthening of the rupee against the dollar, the euro, and the pound sterling will haunt the RBI for some time to come or at least till the Indian corporates, particularly exporters, come to terms with the ground realities and start doing their businesses with a newfound game plan. Encouragingly, this time around, the Indian exporters have of course not made much noise over the rising rupee as in the past which is quite an encouraging phenomenon. One proof for this courageous display of exporters could be that despite a rising rupee, exports have risen by 15% during the first 11 months of 2003-04 and a staggering 35% during February, 2004 over the corresponding month of the previous year. Of course, this could not be taken as a final proof of the appreciating rupee having no impact on exports, for there is a valid argument to the effect that exchange rates affect trade flows with a lag of around 6-12 months.

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Before examining why exporters are chary about the rising rupee, let us take a peep at how the currencies of those countries which are our traditional competitors in the export market are faring vis--vis the US dollar. It is reported that between April 2002 and April 2004 the Thai baht appreciated by almost the same percentage as the Indian rupee, the Korean won rose 13.5%, the Japanese yen 20.4%, the British pound 21.4% and the euro a whopping 27.1%. This phenomenon of simultaneous appreciation of competitors currencies vis--vis the dollar indicates that Indian exporters are no worse off than the exporters of these countries and if at all there is any fall in Indian exports, it must be for reasons other than adverse exchange ratei.e., for reasons such as differences in inflation, productivity and quality of goods. There is, however, a distinctive disadvantage for Indian businesses vis--vis those of China and Malaysia as these countries intelligently pegged their currencies to the dollar, which means these currencies move in tandem with the dollar vis--vis other global currencies such as euro, yen and pound sterling, and thereby ensure that its price-competitiveness is intact in global markets. In view of this, China is likely to pose a threat to Indian exports, particularly in segments such as textiles and other manufactured goods. There is yet another dimension to the appreciating rupee which needs to be taken note of seriously. An appreciating rupee will enhance the economic risk exposure of even those Indian companies which are marketing their products in the domestic market. The appreciating rupee simply makes imports cheaper thereby encouraging traders to import goods from abroad to meet the local demand. To that extent the demand for locally manufactured goods is adversely affected. In a globalized economy, where tariffs on cross-border goods are falling at a faster rate, this phenomenon poses a great threat to the local market players too. In such an evolving scenario, China poses a great threat to the Indian manufacturers in the domestic as well as in export

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markets. But ironically, today, nobody is paying the required attention to this prospective silent killer. As against these emerging threats, the macroeconomic fundamentals of India that are iced with over 8% GDP growth per annum are likely to attract more inflows of foreign exchange. As long as imports continue to remain as subdued as they are now, there shall be no dearth of dollars flooding the Indian market. The net result of all these factors would be an appreciating rupee. Of course, it is beyond anyones comprehension as to by how much the rupee would appreciate. It all depends on supply of and demand for dollars and ultimately the willingness of the RBI to purchase the dollars and sterilize the rupee-equivalent through sale of government securities or via the recently launched market stabilization scheme. But, there is certainly a limit to market intervention of central banks as a measure to maintain the exchange rate at a desired level. And the RBI is no exception to this universal phenomenon, particularly when the economy is opening up at a faster rate and capital flows are swelling. The recent steep appreciation of the rupee owing to sudden withdrawal of the RBI from its dollar-purchasing activity is perhaps a pointer towards the likely future. So, what then should Indian corporates do to wriggle out of this swamp? There is of course no definite answer. Each company has to invent its own strategy that keeps it on a competitive trajectory. Corporates, whether exporters or domestic players, must accept the fact that insulated-markets and stable exchange rates have been fossilized, and hence be prepared for a continuous appreciation of the rupee with accompanying reduction in import tariffs by around 5% per annum. Factoring these assumptions into their business processing, they must build up appropriate competencies to cut down production expenses and ensure a return on capital greater than the cost of capital. And that is the only mantra by which corporates can

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wriggle out of the impact of exchange rate volatilities of globalized economy where sovereigns have almost lost influence on their economies. Athivrishti or Anavrishti (of either dollars or rain), it is only the all-round competency that can steer us out successfully.

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SIXTY

Blossoms sadder than tears on griefs eyelids


In a boundaryless market, integrated approach vis--vis event-specific administration alone betters the scope for good results.

t last, the Reserve Bank of India (RBI) could muster courage to issue operational guidelines to banks permitting them to sell foreign currency to resident Indians to invest up to $25000 a year in the international markets. The Finance Ministers announcement has indeed generated a lot of fanfare but, should we say, failed to enthuse instantaneous action from the RBI. In the meanwhile, many economists, as usual, aired their feelings for and against the Finance Ministrys move. We do not know if the RBI too contemplated for a while on the commonly held economic belief: Large unsustainable fiscal deficits and open capital markets make uncomfortable bedfellows, and lost in wilderness. Is the delay in operationalizing the Ministers declaration, a consequence of it? One cannot perhaps brush it aside as one of those administrative glitches. Interestingly, the RBIs report on currency and finance states that there is considerable merit in using a regulatory mechanism for moderating the ebb and flow in capital movements to avert highly
March 2004.

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speculative or motivated attack on the currency, as otherwise, it can lead to destabilization of economy. The report also observes that the beneficial effects of capital account liberalization on growth are ambiguous. It further affirms that there is no evidence that countries without capital controls have grown faster, invested more, or experienced lower inflation. The best example that one could cite in favour of this argument is China that has no capital account convertibility nor current account convertibility but could grow @ 8.6% per annum since 1990, accumulate whopping foreign exchange reserves of above US $420 bn, and attract Foreign Direct Investment (FDI) in double-digit billions against Indias ability to attract an FDI of a paltry $2 bn per annum. We are not sure if these ground realities have had anything to do in delaying the framing of foolproof guidelines by the Reserve Bank for operationalizing the announcement. Arguments apart, let us take a peep into what the current capital account liberalization means to individuals. It simply means that Indian investors can now buy global assets by opening foreign currency accounts and remitting $25000 per year. As usual, it is Citibank and ICICI Bank, who are the first to come forward offering short-term deposits on quite a few global currencies iced with fancy LIBOR plus returns. Given the ruling interest rate of 3.5% per annum on a 90day rupee deposit with domestic banks, and returns on foreign currencies such as Australian dollars etc., being 6%, there is a huge temptation for a wealthy and sportive Indian to jingle his savings in dollars and cents. Indeed, quite a good response was reported to these plain vanilla deposits, if press reports about Citibank mopping up one million on its very first day of offering the facility, are any indication. Interestingly, in the recent past, the Australian dollar has appreciated almost 9% against the Indian rupee. If this trend continues for another three months, a three-month Australian dollar deposit can earn an annualised return of more than 40%. Similarly, in the

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past three months Sterling is reported to have appreciated more than 12.5% and if it repeats the same in the coming three months, a resident depositor sloshing his savings in pounds at the ruling interest rate of around 4.3% can simply make a killing with an annualised return of 50% plus. Certainly, the opportunities thrown open by the Finance Minister are attractive and exciting. Pretty blossoms! But, there is a flip side to this opportunity: Risk. It is always probable that these foreign currencies instead of appreciating may actually depreciate, which means realization of fewer rupees against the foreign currency deposit. Should that happen, even the higher interest rates offered on these foreign currency deposits cannot save the investor from the possibility of losing the principal. Now, the moot question is, should an Indian investor seize the opportunities thrown open? A simple answer to this question is an effective Yes and No as well. If you have the wherewithal to constantly monitor deposits and move out from a falling currency vis--vis the Indian rupee and relodge in an appreciating currency, you can still make higher returns. But one thing is certain: You cannot switch currencies as freely as a dealer can do, for your deposits have a maturity period. Even if banks tomorrow allow premature withdrawals and switching of currencies, the service charges thereon may be pretty discouraging. This argument naturally leads us to the no answer. There is yet another dimension to this no: As usual, the current reform too is episodic. The management of surging foreign exchange reserves that involved a huge stabilization-cost for the Reserve Bank perhaps prompted the Finance Ministry to liberalize capital account transactions. Being episodic, it has obviously not taken cognizance of rules under the Foreign Exchange Management Act (FEMA) which do not permit a resident to hedge foreign exchange exposure arising from financial investments. Till such time the rules under hedging

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are liberalized, every investor in foreign currency sits like a lame duck fully exposed to the vagaries of volatility associated with global currency markets. All this downside-related talk of course should not dampen the spirits but caution the investor in building a globally diversified investment portfolio. To overcome these risk-related hurdles, the investors could as well seek the mutual fund route, as technically they are better equipped to handle the risks thereof. Usually, to cater to such needs of global investors, global fund managers often float what is known as feeder funds. A feeder fund conducts virtually all of its investing through another fund, called the master fund. This is similar to a fund of funds arrangement, except that the master fund manager is responsible for managing the underlying investments. However, as the current regulations do not permit floating of such specialized funds in India, resident investors cannot avail this route too. The latest banking business figures released by the RBI reveal that credit offtake has recorded a growth rate of 5.7% since December to February 6th, as against 3.4% for the corresponding period of the previous year. That apart, analysts project a private investment of around of Rs.20,000 cr under new projects in the coming 12 to 15 months and if this turns out true, the fresh demand for credit may be above ten times of the proposed equity investment. All these estimates are likely to mop up whatever liquidity-overhang the system is facing today, leading to an upward push in interest rates. Should that happen, investors in global markets may have to bear a heavy opportunity cost. Over and above all, the current liberalization in the capital account transactions is bound to adversely impact the availability of domestic savings for investment purposes. Suppose, 400,000 investors come forward to sell domestic currency and buy dollars for investment in overseas markets, they would simply erase not only US $10 bn from

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the foreign exchange reserves but also suck out liquidity from the domestic money market by around Rs.450 bn. And India is certainly richer than that number. Unless our very economic performance improves correspondingly, the current relaxations may end up as blossoms sadder than tears on griefs eyelids, for the nation at large.

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SIXTY ONE

Hail thee, Jalan and thy rustic wisdom!


Taking decisions in the thick of battlefield is what distinguishes a leader from the rest.

es, as he desires Bimal Jalan, the outgoing Governor of the Reserve Bank of India, will be remembered simply as Bimal Jalan, for in the words of Narasimham, the former Governor of RBI, Jalan, has been a great RBI Governor. It is reported that Narasimham in his farewell letter to Jalan wrote: You have not merely been a successful Governor but, if I may say so, a great governor the likes of whom we have not had over the last 50 years. I believe you will take your place in the pantheon, along with the likes of James Taylor and C D Deshmukh. What more can one say to an outgoing central bank governor who leaves behind a legacy of a record level foreign exchange reserves, a low rate of inflation, lowest ever interest rates, an appreciating rupee besides a stable exchange rate and a money supply well within the desired levels? Apart from the present, there is much to talk about the past what he did, and how he handled the monetary management immediately after taking over the reins of central bank. At the time of
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his assuming governorship, the rupee was on its free fall, having reached a peak of Rs.39.30 to a dollar. On the other hand, the aftermath of East-Asian crisis was still holding back fresh FIIs flows into Indian stock markets. Nor was there scope to improve forex inflows either through external commercial borrowings, as they were simply made expensive by the East-Asian crisis, or via ADRs, GDRs, as emerging markets paper was then considered untouchable. Amidst this chaos, Jalan is reported to have spent around $3 bn to arrest the fall of the rupee, without of course targeting maintenance of a particular exchange rate. It was not that easy for a Governor to spend the meagre reserves of around $28 bn for defending an otherwise sliding currency, particularly, when the country was passing through political uncertainties. Nevertheless, this dare-devil act did halt the fall in the rupee rate temporarily. But with the announcement of elections, the rupee reached 40 per dollar, pulling the rug from under the feet of the Governor. To combat the market onslaught, he quickly hiked the bank rate by 2% making refinance from the central bank expensive on the one hand, and increased the cash reserve ratio by 2% to suck out around Rs.2400 cr from the market. He did not stop there. He reduced export refinance and forced interest rates on rupee loans to climb up. With tight monetary regulations, he made imports expensive and induced exporters to repatriate sale proceeds quickly. Thats not the end of the story. He went ahead with the decision to float Resurgent India Bonds offering a market-related interest rate on the bonds to augment the flagging exchange reserves. And all this when the world is yet to come out of the trauma inflicted by the East Asian crisis. Cumulatively, however, these acts have arrested the further slide in the rupee exchange rate. Today, looking back at what has happened, armchair economists may dismiss them as mere textbook monetary prescriptions. But, to take a decision in real-time situation, and that too when the chips

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are down and whatever one knows at the time of taking the decision being a faint hope for a positive outcome, calls for nerves. And that is leadership in action! In Jalan we have seen a Governor who didnt go by the established fad of the day in terms of economic policy. He was not overtaken by all the talk about fixed exchange rate, flexible exchange rate, appreciating exchange rate, capital account convertibility and so on, but stuck to his own decisions and, in the process, could generate a feel-good atmosphere in the financial markets with surging foreign exchange reserves of $85 bn plus. As Jalan himself said: As long as there is money, the central banks agenda remains unfinished. Having built the reserves, it is now for his successor, Yaga Venugopal Reddy, to work out a strategy to use it profitably. He should not let the market be carried away by the massive reserves but insist on prudent behaviour. Financial press has begun reporting about the rise in imports describing it as welcome news. It is a different matter if the imports are related to capital goods, which is likely to raise the production capacities leading to market growth. But expending the arduously built reserves on the import of consumer durables, may not be in the best interest of the country. Instead, the reserves need to be used for creating additional capacities or for creating fresh markets for Indian exporters by way of granting credit lines to overseas buyers. At the same time, the cost of additional reserves cannot be brushed aside easily. Anyway, all this is going to pose a serious challenge to the incoming Governor. Looking to the past and the future, one cant but agree with Jalans assertion: Isnt this the right time to go? You are absolutely right, Mr. Governor! As you move on to your new job, we salute you for not being carried away by isms and sticking to your native wisdom in delivering whatever is being acclaimed today by the nation as well done!

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What does an appreciating rupee mean?

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SIXTY TWO

What does an appreciating rupee mean?


Anything that appreciates not only becomes dear but also makes all others associated with it dearer.

xchange rate changes expose corporates to a variety of risks. In the financial context, risk refers to the probability of loss. In basic arithmetic terms, a company makes loss whenever its income is less than the expenditure incurred for generating that income. So long as one records income and expenses in rupee terms, working out profit or loss is no big task. But, if a business has receipts and payments in two different currencies, profit or loss calculation gets complicated. One way of overcoming this problem is to convert foreign currency receipts into rupees so that revenues can be compared with the rupee cost of production and profit/loss can be arrived at. And that is where the exchange rate of the rupee against the foreign currency becomes a key variable in determining the profit or loss. Therefore, one can say that changes in exchange rate can convert a business units profit to loss and vice versa. Interestingly, these losses are not the outcome of operational inefficiencies or managements bad practices. These have purely emanated from change
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in exchange rates. It is the sensitivity of a firms operating income, expressed in its functional currency, to unanticipated changes in exchange rates that causes the loss. This probability of a business incurring loss on account of changes in foreign exchange rates is known as foreign exchange rate risk and that is what in effect Indian exporters are experiencing today with the rising rupee. It is the IT sector which was the first to feel the pinch of rising rupee value. It is reported that Infosys is anticipating a fall in its revenues of around 0.5% for every 1% appreciation in the rupee. It would be worse in the case of textile exports as they are already working on wafer-thin margins. One way of overcoming this risk is perhaps to buy a forward cover but it is only a short-term measure. The real effective alternative to beat the negative effects of rising currency is to improve operating efficiencies and quality standards. Exporters have to simply move up the value chain. The need to make exports price-inelastic appears to have already dawned on Indian exporters, for this time around the usual whimper from exporters that used to accompany every episode of rising rupee is very much absent. Its not that the adverse impact of rising currency value is confined just to exports. It would equally impact the future cash flows and profits of a firm that is operating even within the domestic market. It is commonly but wrongly perceived that companies having no direct foreign currency exposure are not impacted by the changing exchange rates. The truth, however, is that if competitors within or outside the country derive a profit opportunity on account of movement of exchange rate, it is bound to influence a companys cash flows irrespective of its forex exposure. It is obvious that with the domestic currencys rising value, a domestic firms local sales will decrease as its customers could buy foreign substitutes that are available at less price.

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The economic risk is increasingly becoming significant in the globalized economy. Yet, its management is failing to draw the attention of corporate mandarins to the extent desired. One plausible explanation could be that unlike in the context of exports, losses under economic risk are not distinctly visible. One report indicates that the overall corporate earnings growth would fall 10% in the current fiscal if the rupee appreciates 5% against the dollar. The more the competition from the global players the more would be the impact on the sales of domestic companies. True, exchange rates can move both ways and thus can lead to profit as often as to losses. It is also true that the extent of profit or loss owing to exchange rate movement should average out over a period of time. But the danger with forex risk is it could result in a loss large enough to wipe out the business in one stroke, and the company may not have a second opportunity for the probability of making an equally large profit. The need has, therefore, arisen for the corporates to measure economic exposure by collecting historical data on how local sales were affected in the past and using it to simulate future sales under different exchange rate scenarios. Alternatively, a firm can assess its economic exposure to exchange rate movements by applying regression analysis on the historical cash flows and exchange rates. Whilst on this, it is worth remembering what Alan Greenspan said, There may be more forecasting of exchange rates, with less success, than almost any other economic variable. Hence the game plan should be: Become leaner and fitter, and improve the operating efficiencies, else the economy as a whole may end up in a big mess.

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SIXTY THREE

Is rupee strong enough to go in for Euro-loans?


It does not matter whether the rupee is strong or weak so long as one has a natural hedge.

ewspaper headlines such as Emergence of Strong Rupee; Forward premiums at Life Lows 3-, 6- and 12-month forward premiums stood at 0.25 0.48 and 0.36% respectively; Time for Indian corporates to go in for Foreign Currency Loans, have yet again made Indian corporates wrinkle their foreheads or raise their eyebrows. To the passive corporates, these headlines may of course sound like another shot at journalistic jingle, but to the active, it is much more, for there is a scope to harvest the full benefit of prevailing rock-bottom interest rates in the global financial markets, should their market readings prove to be correct. All this has put the CFOs, endowed with the responsibility of making judgments that reflect the best interests of the company, in a quandary. They are struggling to wriggle out an acceptable answer to the barrage of questions such as: Is the current swing in favour of the rupee momentary or sustainable? How long will low forward premiums rule the market? Will forward premiums go up? Is it wise
June 2003.

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to rely on predictions of newspapers when exchange rate behaviour is known to defy all canons of predictability? What, after all, moves the exchange rates? Can a reliable prediction be made out of such a knowledge? Theoreticians in exchange rate economics often proclaim with a dash of confidence, that monetary fundamentals are the best means to predict exchange rate behaviour. They propose three alternative fundamentals in predicting exchange rates: purchasing power parity, uncovered interest parity, and flexibility-price monetary model. But the survey of literature on the understanding of exchange rates behaviour tells a different story. Meese and Rogoff showed that the exchange rates could not be forecast from monetary fundamentals. Mark and Sul say that even by using modern sophisticated tools, such as econometric techniques, panel data, one can predict exchange rate movement at best over a period of 3-4 years. The literature on exchange rate forecasting has shown that the amount of exchange rate variations forecasted by monetary models is very insignificant, particularly for short periods. The net emerging wisdom out of the research is that exchange rate changes cannot be forecast or cannot be forecast using macroeconomic fundamentals. There is yet another important aspect worth bearing in mind here. A decade back, the total trading in the US dollar was just around 190 billion, whereas today, it has reached an alarming level of US$1.3 tn. When the Bretton Woods system was in vogue, the international flow of capital was severely restricted. But when it broke in the early 1970s, capitalistic countries scrapped their capital controls with the result that larger sums of capital started moving across borders. This free flow of capital across borders, that too not being backed by any merchandize movement, is often believed to be the prime cause of the

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growing financial markets instability. As long as there is no world interest rate, there cannot be a single global capital market, which means the uncertainty associated with exchange rate movement is bound to be an eternal feature. There is yet another proximate reason for foreign exchange crisis: Foreign exchange rates are not always determined in a free market. Central banks are often found intervening on a grand scale in order to influence the price of their currencies. In the process, while losing substantial amounts, they have been successful in maintaining artificial exchange rates for substantial intervals. And such interventions are just beyond anybodys guess or prediction. A study carried out some time back by a research organization on how currency-traders think their markets behave, revealed that most dealers consider macroeconomic fundamentals irrelevant in intra-day trading. Currency dealers today strongly believe that its the news, bandwagon effects, and speculative effects that move the intra-day market. It is the speculative forces which traders measure from the order-flows through the market that are now considered to be highly responsible for intra-day and medium-term trading behaviour. Some currency traders have gone further by asserting that it is now the behaviour of the traders that is moving the foreign exchange market. That being the uncertainty associated with the exchange rate movement and its prediction, no wonder that any gain made out of low interest rates is wiped out by adverse exchange rate movement at a later date. Secondly, it is worth bearing in mind here that international borrowings are usually governed by the floating interest rate mechanism. As the effective interest rate is periodically reset with reference to the base rate, there is no guarantee that the effective cost of capital would remain low vis--vis domestic rates forever, that too when we know that there is no world interest rate.

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So, get it all out and try to move on with the conventional wisdom: It makes a lot of sense for companies having natural hedge to borrow from international financial markets. Others must be cautious of availing foreign currency loans unless they have a thorough understanding of identifying, measuring, managing and monitoring foreign exchange risk. Else, the risk may prove to be too costly to bear.

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SIXTY FOUR

Do forex reserves serve those who only stand and wait?


Savings as a whole lead to growth of the nation while hoarding results in stagnation.

nxiety, emotional excitement, and extreme attitudes on all sides are what today surround the surging foreign exchange reserves in quantities that had never been witnessed in the past. Market-watchers observe that the system is awash with cash, and worry that it may lead to the risk of higher inflation and asset price bubble with pressure on bond yields and other market-determined interest rates. Hence, they expect that the Reserve Bank of India would continue to contain liquidity and thereby limit the risk of asset bubbles by intervening in the foreign exchange market. Some are very strongly advocating reduction of the cash surplus in the system by sterilization of foreign exchange inflows, more so, in the light of the current annual inflation of around 6%. As it ought to be, the Reserve Bank of India too is quite concerned about the strong foreign exchange inflows and the associated problems. Being driven by this concern, it has indeed set up a working group to identify new instruments for sterilization. The committee proposed that the Government of India should issue
March 2003.

Do forex reserves serve those who only stand and wait?

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Market Stabilization Bonds (MSBs) to augment the RBIs ability to sterilize foreign exchange inflows. It is also made abundantly clear that the money borrowed by the Government of India under the MSBs would not be available for the governments spending, but is to be used exclusively for sucking the liquidity out of the system. Recent press reports indicate that the Reserve Bank of India intends to issue MSBs worth around Rs.60,000 cr in the coming 12 months to suck out liquidity from the market resulting from the inflow of foreign exchange. Market pundits consider it a good move since the Reserve Bank does need an effective tool to suck out the liquidity arising from strong foreign exchange inflows. Such a fund is also anticipated to offer the RBI a better leeway to shape repo rate as a key monetary signal to smoothen kinks at the short end of the yield curve. True, that is what in fact the Reserve Bank is doing today, albeit with its own funds. But its influence appears to be waning as the excess cash in the system continues to distort the yield curve by making available overnight-unsecured inter-bank loans at less than the repo rate of 4.5%. So, it is argued that by issuing MSBs, the Reserve Bank can effectively reduce liquidity, eliminating these distortions in the yield curve and thus make the repo rate a credible signal to the market. Now, the moot question is what difference does it make whether the Reserve Bank sells its own securities or the Government of India sells the MSBs in terms of the cost of sterilization of foreign exchange inflows to the country at large. The immediate benefit that the Reserve Bank could gain by making the Government of India sell MSBs, instead of its own bonds, is the transfer of loss being suffered by it today, under the ongoing sterilized intervention to the government account directly. To better appreciate the other benefits that may accrue out of the proposed move, let us first take a look at how sterilization works.

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Under sterilized intervention mechanism, the Reserve Bank buys the foreign exchange inflows against the rupee. This obviously enhances the reserve money base. So, to contain the money supply growth within the acceptable level of 16 to 17%, the Reserve Bank sucks out the excess rupees put into the system by selling its holding of government bonds. It thus ensures that reserve money does not grow at the rate at which the reserves of foreign exchange grow. But, over a period of time, as its holding of net foreign exchange reserves becomes equal to the monetary base, the Reserve Bank could no longer contain the reserve money growth. It is in such a situation that MSBs help the Reserve Bank suck rupees out of the economy without leaving any monetary impact since the government, instead of spending the money so collected as under other borrowings, deposits with the Reserve Bank of India. But, if the inflow of foreign capital continues, even this mechanism could prove pretty expensive. Assume, for a while, that the foreign exchange inflows continue unabated. Then, the government, being in need of more funds for sterilization, has to obviously encourage the public to subscribe more to MSBs by offering higher interest rates. This may ultimately push market-determined interest rates upward which, in turn, can unwittingly, lead to more foreign capital inflow. Should that happen, the need for MSBs simply spirals up and so goes on the vicious circle. There is yet another danger: If the Reserve Bank, under one or the other monetary predicament, gives up this game-plan half way, it may send a wrong signal about its ability to sterilize inflows any longer. Such an eventuality is fraught with the risk of reverse speculative attack. Either way, we are in for trouble. And the trouble is more out of our hoarding the reserves than from using them for further generation of wealth. To better appreciate this subtle but distressing feature, let us first see how savings differ from hoarding. According to John Stuart Mill, savings, does not

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imply that what is saved is not consumed, nor even necessary that its consumption is deferred; but only that if consumed immediately, it is not consumed by the person who saves it. On the other hand, hoarding, according to Mill, means savings laid out for future use; and while hoarded, it is not consumed at all by anyone. It otherwise means savings never lie idle but are borrowed by one or the other in the system for consumption, while in the case of hoarding, the accumulated money is not consumed at all. It thus reveals that the value of savings lies in their utilization whereas hoarding, like in the form of precious metals, results in opportunity costs. In other words, it is our inability to put the current inflows of foreign capital to domestic use that is costing us pretty dearly. Our inability to use these foreign exchange reserves for giving a push to the growth of domestic economy gets reaffirmed by the permission granted by the Finance Ministry for resident Indians recently to invest US$25,000 per annum in overseas securities without any questions being asked. Of course, this move is no doubt meant for reducing the pressure on RBI in managing the inflows as also the sterilization costs thereon. There is of course yet another dimension to this conundrum of swamping plenty. A plausible reason that one could offer for the current hoarding of foreign exchange reserves is that they are neither our earnings nor savings. They, being the savings of others, are liable to be withdrawn any time. So, like our ancestors who in the anxiety of putting aside a buck or two for a rainy day, and there being no banking facilities, used to hoard the current receipts under the earth in the form of coins or precious metals, we are today hoarding it either in the US treasury bills or in the near money securities issued by central banks of other developed countries, while those countries are transforming them into their dynamic investments to give a push to their economic growth. When are we to learn to practice these simple economic fundamentals?

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In the ultimate analysis, it is not the huge Forex reserves that matter in accomplishing economic prosperity but the entrepreneurship of the self confident type that can and is willing to take risks. Indeed, this trait should reflect more in the governance of the country than in individual investors. Ironically, that is glaringly missing today. What is therefore needed is not to feel shiny about the swamping liquidity, but to invent newer ways of using these inflows for the growth of domestic economy, lest India Shining should remain ephemeral.

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Mere expression of exuberance and abundance?

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SIXTY FIVE

Mere expression of exuberance and abundance?


When one is suddenly flooded with fortunes, it is but natural to lose, though momentarily, the sense of proportion.

he New Year has brought cheers for the investing clanboth individuals and corporatesin India. The Finance Minister recently announced that individual investors and listed Indian companies would be permitted to invest in listed companies in overseas stock exchanges. Simultaneously, the Government has also doubled Mutual Funds investment limit abroad to $1 bn, abolished retention limit on ADR/GDR proceeds, allowed firms to acquire immovable property overseas and abolished the cap of $20,000 for remittances under ESOPs. There is of course a caveat for investing in overseas listed companies: Companies in which individuals, listed Indian companies and mutual funds proposing to invest should each have a shareholding of at least 10% in a listed Indian company as on January 1 of the year of investment. Further, in the case of listed companies investing abroad, their investment should not exceed 25% of their net worth as on the date of the last-audited balance-sheet of the company. To cap
February 2003.

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it, the Government kept this window open for a six month time at the end of which it proposed to review the matter afresh. Hype apart, what matters here is the caveat that accompanied the investment relaxations and secondly, their timing. Given the 10% investment requirement in the Indian companies by overseas-listed companies, how many foreign companies are eligible for investment by Indians? This requirement would prune the eligibility list, more so when close to 30 multinationals have had their stock delisted from the Indian bourses during the last two years and many others are on their way to get theirs delisted. The next question is: Are the relaxations workable in the present state of economy? These two put together raise another fundamental question: Why would anyone want to invest in an unknown market, that too when FIIs are rushing into India considering it as the safest place to invest and earn a decent return? Theoretically, investing internationally reduces the portfolio risk for it enables building up of portfolios with low correlations to domestic holdings, resulting in lower volatility of the portfolio. It makes great sense to invest in markets that behave differently, for different countries go through different economic cycles, so that even if one market underperforms, the other may provide a cushion. But in the wake of globalization, the resultant convergence of financial markets, and the movement of markets in tandem with each other, one is not sure how long these theoretical underpinnings would hold good. Secondly, are the individual investors and corporates for whom the core business and the accumulated experience is certainly something other than management of investments, competent enough to invest in overseas markets and simultaneously manage the embedded prices and currency risk thereof? If this is true, is it not right to say that the present relaxation will only distract the corporates and individuals from their main businesses?

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Let us pause here for a while and guess what then has really been aimed at by the fresh bout of relaxations. Are they meant to trigger private demand for dollars and encourage individuals and corporates to manage the surging forex reserves that have recently crossed US $70 bn, by investing in the overseas stock markets, so that the RBIs job of liquidity management is made less strenuous? But it begets two arguments. One, given the ruling LIBOR of 1.4% and the forward premiums of 3.0 to 3.5%, it still makes sense to international players to borrow funds from the global markets and remit the same to India where interest rates are ruling around 6.0 to 7.0% to pocket a neat arbitrage gain of 2.0 to 2.5%. This would simply mean that forex reserves are likely to grow till at least markets return to equilibrium. Two, presuming that, as assumed by the Government, the individuals and corporates being carried away by the hype generated by the announcement, ignore the ground realities of the economic conditions in the West which is under prolonged recession that is currently further endangered by the impending Iraq war and India where the economy is set to be doing well with a GDP of around 5.5%, invest in overseas stocks and hopefully earn good return. But this hype may not last long for the returns on such investments are greatly influenced by the currency rate fluctuations. If the rupee continues to appreciate vis--vis the dollarthat of course cannot be ruled out looking at the current trend of the dollar falling precipitously against the Euro and even the Rupee, the future returns from the overseas investments are more likely to fall in rupee terms. This automatically drives away the prospective customers from such overseas investments. The net of these two arguments would be: rise in forex reserves and no growth in overseas investments. So, we are back to square one. There is of course a redeeming featurerelaxations are subject to review after six months. This shall facilitate a watch on how inflation behaves, for so long it

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remains below 2% whereby the rupee continues to appreciate unless of course RBI tinkers with itunlikely in the present context as it would cost it dearlythere is a chance of enjoying continuous inflow of foreign exchange. But the moment inflation raises its ugly head, which would not be surprising with the unabated growth in fiscal deficit and the resultant debt trap, capital flight from the country is likely to be triggered. Secondly, much of our forex reserves being borrowed money, it is highly mobile. As CMIE puts the ratio of vulnerable liabilities to the total forex reserves as on March 31, 2002, at as high as 92%, there is hardly any wonder if any minor deviation in the market parameters triggers capital flight. And that is the real danger lurking behind the current relaxations. Of course, it is a different matter: Looking at the past investment behaviour of mutual funds under earlier relaxations, no one is expecting any investment worth mentioning under the current relaxations too. Thus far it is good. Does it then mean that all this is a mere expression of exuberance from a feel of abundance? Let us fondly hope: Its that!

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Can removal of regulations build a market for swaps?

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SIXTY SIX

Can removal of regulations build a market for swaps?


Without a well developed yield curve it is suicidal for market makers to take proprietary positions under swaps.

he Reserve Bank of India has once again allowed Authorized Dealers in foreign exchange to offer Rupee-Foreign Currency swaps without its prior approval. It has also allowed banks to undertake swaps on an unmatched basis upto US$25 mn, of course with a rider. Some treasurers have acclaimed these relaxations as partial restoration of what banks have been doing a year back. Some others have commented that it is yet another proactive step towards the full convertibility of rupee. As the market reactions are dying down, the same old issues that bothered the treasurers when the Foreign Currency swaps were introduced for the first time in 1997 are once again emerging as a big question mark. No doubt, the present product relaxations have simplified the corporates access to this derivative product. It is, however, still not clear how the corporates are going to surmount the hurdles that indeed didnt allow the market to take off in the past. This old question Is it just by removing the regulations that the markets will evolve for foreign
January 2002.

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currency/rupee swaps, or are there any underlying factors which need to be addressed before making the policies is still haunting the treasurers. In order to arrive at the right answer to this question, let us first examine how a currency swap works, who the parties are, what needs they have, how their needs are met by swaps and what factors the market players, market makers and regulators need to collectively work at to reap the full benefits of the product. It simply involves the exchange of interest obligation or foreign currency exposure or a combination of both by two or more corporates or a corporate and a bank. It may not necessarily involve the legal swapping of actual debt but an agreement is made to exchange cash flows under a particular loan. Swaps enable a corporate treasurer to manage currency exposure by switching over liabilities from one currency into a fully hedged liability in another currency. Secondly, special facilities available to a particular borrower but not to all can be arbitraged upon for further gains. Thirdly, it can obviate the scarcity value resulted in the market by too many floatations. Fourthly, swaps being instruments that allow the user to hedge, i.e., to offset risks, are also used by the speculators to take risks deliberately in the hope of making a profit. Finally and importantly, swaps can also be used to reduce the cost of loans. Banks, being authorized dealers and as market makers, arrange the swap and ultimately take swap exposures in their books. A bank would enter into a swap transaction with a corporate and then enter the market to find another party with a matching opposite requirement so as to hedge itself against any market fluctuations. Swaps have basically zero value. The two cash flows exchanged under a swap will have to be identical in their discounted present values if the bank has to remain unaffected by the transaction. The swap rate thus arrived at is appropriately modified to quote bid-offer rate to the customer so that at the end of the day it gets paid for arranging the swap.

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It is the pricing of the swap that is very critical in the entire transaction. A bank takes into consideration many factors like prevailing market conditions, i.e., term structure of interest rates, structure/duration of the swaps, current position of the company, ready availability of off-setting swap, credit quality of the counterparty, regulatory constraints like risk capital requirements etc. So, what really matters here is the scope to foresee interest rate movement, exchange rate movements, the inflationary behaviour in domestic as well as key trading partner countries and transact with market players having a sound understanding of derivatives. A well established legal structure that makes enforcement of contracts easy and a standard accounting system that affords transparency are the other two important requirements for sound operations in the market. Now the moot question is, are we having these comforts to make the foreign currency rupee swaps to take off? Let us examine each one of them in detail for a rational answer. Interest rates are forecasted looking at the Yield Curve of the long-term bonds and the macro economic variables like inflation, fiscal deficit, governments nonplan expenditure etc. Against this requirement, it is safe to say we have no term money market of any worth where two-way quotes are available. Unless there is an active term money market that integrates money, capital and forex markets, it is difficult to plot a yield curve. This obviously makes estimation of long-term interest rate on rupee a far cry and to that extent swap pricing becomes a mere hunch. Secondly, the parties need to have a view on the movement of the exchange rate. In a free market, exchange rate movement is defined by interest rate differentials of the currency pair involved. But in our market where, regulations still control inward and outward flows, exchange rate movement does not strictly obey the principle of interest rate differentials defining the exchange rates. Secondly, the RBI is known

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to frequently intervene in the market to regulate the price volatility. In such a market, it is the supply and demand position of the foreign currency that defines the exchange rate movement. In this scenario, it is difficult to take a firm view on the likely exchange rate movement in the near future and to that extent it weakens the swap pricing. The interest rate movement and in turn the exchange rate movement ultimately rest on the economic fundamentals of the country as reflected in the prevailing inflation rates. Despite this economic truth, interest rates in our markets are far away from the idealistic situation. Although we are inching in that direction, our interest rates continue to be arbitrarily fixed. Secondly, our inflation rates are calculated based on the wholesale price indices. It thus always leaves a scope for poor relationship between the inflation and interest rates. It is evident from the foregoing that the existing gaps in the system cannot facilitate determination of a dependable swap cost. The market players, market makers and regulators have to therefore first work collectively to fill these gaps in the system. There is an urgent need for the market to develop Yield Curve. Till such time, it would be venturesome for any market maker to strike a swap deal even under the lure of momentary high spreads. It would be suicidal to take open position with so many inadequacies all around though regulations permit.

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Section V

Governance

SIXTY SEVEN

Indo-US nuclear agreement: The road ahead


Clinching a nuclear deal with the US in business style is one thing and carrying it forward for the good of the nation is another. It calls for statesmanship.

fter nightlong hectic parleys leading to the signing of the muchlonged-for nuclear cooperation pact, both Prime Minister Manmohan Singh and President Bush walked into the gardens of Hyderabad House to address a joint press conference. It was 12.20 p.m. Prime Minister Singh asked: Shall I start? and President Bush (said), Please. Then Prime Minister Singh said: We have made history today, while President Bush preferred to say, We have concluded an historic agreement today. The statements were greeted with rapturous applause. As the details trickled down, it became clear that India had offered to separate 14 of its 22 reactors as civilian and place them under the international safeguards perpetually. The Fast Breeder Test Reactor and the Prototype Fast Breeder Reactor, and Bhabha Atomic Research Centre are out of safeguards; CIRUS reactor shall be retired by 2010, against which the US will ensure supply of natural uranium from
April 2006.

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outside by amending its own laws thereunder and also making other Nuclear Supply Group countries fall in line. Robert Blackwill, the former US Ambassador to India, aptly captured the significance of the deal when he said: It is a historic day for Indo-US relations. Rhetoric apart, no one can better describe the significance of March 3rd agreement between Mr. Bush and Mr. Singh than what Prime Minister Singh himself said to Parliament: As India strives to raise its annual GDP growth rate from the present 7-8% to over 10%, the energy deficit will only worsen. This may not only retard growth, it could also impose an additional burden in terms of the increased cost of importing oil and natural gas, in a scenario of sharply rising hydrocarbon prices. While we have substantial reserves of coal, excessive dependence on coal-based energy has its own implications for our environment. Nuclear technology provides a plentiful and non-polluting source of power to meet our energy needs. However, to increase the share of nuclear power in our energy mix, we need to break out of the confines imposed by inadequate reserves of natural uranium, and by international embargos that have constrained our nuclear program for over three decades. As the prime minister put it so emphatically, the deal, if it gets through the US Congress, can simply dismantle international restrictions, which when achieved, could unleash our scientific talent by enabling our scientists to interact with research institutions and scientists engaged in advanced research on various facets of nuclear power generation such as fast reactors being developed based on concepts such as gas-cooled fast reactor, molten salt reactor, and superficial water-cooled reactor. Acceptance of India into the Nuclear Group shall also enable our scientists to participate in the International Thermonuclear Experimental Reactor being set up by the US, EU, Japan, South Korea, Russia and China which in itself will be a rich learning experience in the cutting-edge technology besides keeping

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them abreast of the global technological developments. All this shall just increase our commercial potential in the nuclear power and related sectors. The significance of this agreement can be gauged from the fact that no sooner it was inked than the US Department of Energyfunded Fermi Labs, Chicago, reported to be convincing India to take a big lead in designing and building the International Linear Collidor, a project that would cost around $8 billion. As Dr. Amit Roy, Director of the Inter-University Accelerator Centre, New Delhi, stated, The country can be a key player in this challenging sector where technology is guarded. Such exposures not only remove the isolation Indian scientists have been in since 1974 but also boost their confidence to think big and use the knowledge so acquired in furthering the cause of the institutions they represent, more so when the largest accelerator in India is the pocket-sized 172 meter Indus at Indore Lab. There are of course many Indians who watched the joint press statement on TV with a scowl on their face fulminating against the US interest in the scheme. They are perhaps haunted by a barrage of questions: why is America so much interested in the deal? Is there anything that America wants to take away from us? Is there any benefit that they are deceitfully aiming at? In international relations and, for that matter, even in the life of an individual, nothing comes out of nothing. For a nation or for an individual, what matters is what is there in it for me?. It is, however, to be remembered that in this world of connectivity, if one has to have more of something, one has to necessarily give up something elsewhere, proportionately. The President himself cited many reasons for their interest in the deal: It is in our (American) economic interests that India has a Civilian Nuclear Power Industry to help take the pressure off the

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global demand for energy And so, to the extent that we can reduce the demand for fossil fuels, it will help the American consumer. Secondly, as Alyssa Ayres and Sumit Ganguly from the University of Pennsylvania and Indiana University respectively, observed in the Wall Street Journal, Civil nuclear cooperation with India will advance the long-term strategic goals of the US rather than threaten the global order. It offers an opportunity to re-address inequities within the global nuclear regimeoffers an unprecedented opportunity to get on to the right side of history. That, at least apparently, is what America is aiming at. Now, coming to our strategic needs, critics say that keeping the fast-breeder reactors under military control, without inspections, would allow India to develop far more nuclear arms, and more quickly, than it has in the past. The same feasibility is amply decipherable from what Robert J Einhorn, a senior adviser at the Centre for Strategic and International Studies in Washington, said: Its not meaningful to talk about 14 of the 22 reactors being placed under safeguards. Whats meaningful is what the Indians can do at the unsafeguarded reactor, which vastly increases their production of fissile material for nuclear weapons. Even otherwise, what is the safe stockpiling that deters others from quarrelling with us is anybodys guess. Hence it needs least attention. Prime Minister Singh has once again proved his ability to launch India on a new trajectory: He opened up a new opportunity to our nuclear scientists by plucking them out of nuclear quarantine, to integrate themselves with the major global players and gain scope to push forward their technical competence in ensuring energy security for the country. Now it is a question of how we carry it forward and utilize it for the best interests of the country. It is not going to be easy: the new-found status throws many challenges in handling our relations with neighbours, far and near.

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The first thing that we must learn is not to repeat mistakes. For instance, we committed the blunder of not stockpiling nuclear fuel before exploding a nuclear device in 1974, the consequences of which are haunting us till date. We must stop reinventing the wheel under the folly of self-reliance, and instead grab the technology available in the market immediately and build the nuclear power plants with least cost and time overruns that were once synonymous of our reactor building. Once the technology available globally is imbibed, it could be used as a platform to probe newer domains of science, particularly take forward the fast breeder program that ultimately leads to using our abundant thorium deposits. Thanks to our exclusion from the global nuclear club, our cost of nuclear power production remained pretty high. To beat it, we now need to capitalize on the new opportunity to import reactors from abroad. Now, the question is: where is the capital? Encouraged by what Mr. Ratan Tata said the other day, the Government may explore the scope for private participation in nuclear power production. Once the reactors are kept under international safeguards, it does not matter whether the power plants are under public or private management. In this endeavour, our behaviour should exhibit, needless to say honestly, that we are not crazy about stockpiling nuclear weapons, for there is already a lot of dissonance going around, both in and out of the country, against the deal, and any let-up may derail the whole prospect. In todays context national interest is the only guiding post and everything else becomes secondary to it and the sooner we practice it, the better it would be. God alone save us, if we do not know what is in our interest!

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SIXTY EIGHT

We all have to act on it!


The fear of being caught in the public acts as a powerful deterrent even to a beastly personality.

t was like any other late-night drive to the workplace. At least, that was what the 24-year-old Pratibha Srikant Murthyan employee of Hewlett Packard Global Delivery Application Services in Bangaloremight have thought while leaving the house for work in a replacement vehicle driven by a new driver around 2 a.m. on that fateful night. No one in the BPO industry had ever imagined that such a fate awaited her. Even Pratibha, for sure, didnt suspect any foul play when she called her colleague Pavan to the office to confirm that she was on her way to log in at the scheduled time of 3.30 a.m. But fate willed otherwise: Pratibha was raped and murdered by the cab-driver. Only a couple of days back, the Nasscom-McKinsey report announced that the Indian ITeS sector had grown from $4 bn in 2002 to $17 bn by 2005. The report cheered everyone in the industry by stating that offshore IT and BPO exports had tripled over the last five years. The industry is agog with predictions that India will soon become the preferred destination for global BPO and jobs will grow from one million to 10 million. All those connected with the BPO
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industry in one way or the other were indeed getting ready to capitalize on the prospects. Amidst such high spirits, the news of the rape and gruesome murder of Pratibha by the taxi driver was least expected. It sent a chill wave across the country. It aroused loud protests, and of course, rightly. Call centre employees took to the streets protesting against the horror inflicted on the sanity of the nation. They all demanded adequate measures for security, particularly for women employees who, incidentally, are said to constitute around 40% of the total BPO employment. Accusations and counter-accusations were galore. Employers alleged that the police were lax in their night patrolling. The police countered saying that it was the responsibility of the employers to check the antecedents of the drivers before hiring them for such sensitive jobs. Indeed the DCP of South Bangalore commented on Pratibhas murder: It was a clear security lapse by the company. In the maze of these accusations, what distinctly surfaced was that the reaction of our society at large is not in proportion to the heinous crime inflicted on the fair face of humanity. To be honest, we must admit that a majority of us received the news as passively as we do any other bad news of the day. And this is very unfortunate of a society in which its members are known to greet each other with Namaskar which implies God in me welcomes the God in youa physical, mental, and intellectual surrender to the Supreme Being and it certainly does not even economically augur well for a country which wants to come to grips with itself. Having said that, let us see how the families whose children working in BPOs are reacting. Many parents whose daughters are today venturing out in the nights for a decent earning are whispering/ questioning themselves: Is it wise for women to work in BPOs? Every concerned citizen of the country is wondering: How safe are our cities for women to go out at night? And there could be many

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other whispers that might have been drowned in silence. In the entire aftermath, the real need of the hour is lost sight of. It is time we realized that policing alone cannot annihilate such bestial intentions of mankind. It is only an ardent effort towards civilizing the society by proper education that citizens can be made to respect each others personal space and esteem. And policing can only supplement such societal initiatives in arresting the recurrence of such brutal acts. True, it is not an easy path, nor a quick provider of relief. Such education needs right atmospherics for bearing fruit. It is certainly a giant task. But it can be addressed by all of us collectively. To begin with, let us first see what families can do. In this whole exercise, there is a greater responsibility thrust on the parents. They alone can better police their wards by educating them about human values right from early childhood and insisting on their adherence to these basic values in their behaviour. It is not only a social responsibility that is thrust on them but also essential in their own interest, for every family in the society today houses a potential Pratibha and a potential transgressor of human dignity. We are today passing through a kind of cultural transition where men and women are moving away from their native habits and embracing the western lifestyle in terms and speed that were never experienced in the past. It is, of course, certainly heartening to see todays youththe freely intermingling male and femalemarching forward with ease and confidence as though to build a new India that is distinctly different from the colonial past. But the events such as those reported from Gurgoan and Bangalore not only shatter this hope but also pose a battery of questions: Is all this modernism witnessed at todays workplaces only ephemeral? Or, is it that what has changed is only our attire and not our respect for the fellow female traveller? Is it that our mental make-up about the feminine gender never changes? But then what does all this mean to the society?

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It only means that women must be sensitized not to get carried away by the so called modernism witnessed in Malls and call centres and to be on their guard. That is where socially active groups can chip in and supplement parental efforts in not only civilizing the society, but also guarding it from insanity till sanity prevails on its own. Let us now turn our attention to what employers in the BPO industry can do. It is indeed heartening to note that for the first time in the country, an industrylevel response to counter such challenges has come immediately after the incident. The Nascom has responded to the event by offering to broaden the scope of the National Employee Registry to include vendor employees as well, hoping that it will help call centre companies to make verification checks on the employees of transport and security agencies they hire. Yes, such quick responses do provide the much-needed succour to the wounded feelings of the employees immediately, but are not a long-term solution to the problem. Now, the question is: Is there anything that the BPO industry can do to obviate these problems on a long-term basis? One that immediately comes to mind here is what Roger Nolla Professor from Stanford Center for International Development, said: If India wants the benefits of ongoing reforms to spread across the country, each State should establish facilities for development of business enterprises in more than one city. As rightly said, it may be the time for the BPO industry to move out to our 2nd- or 3rd-tier cities/towns to reap advantages. One, such a spread of BPO units across the geography eases the pressure on the already inadequate infrastructurein terms of housing, roads, transportation security etc.,of the metros. Two, their spread to less densely populated towns affords scope for BPOs to house themselves amidst centres of human habitation. This eliminates travel on long stretches of roads that are sparsely populated besides minimizing travel time. Cumulatively, it acts as deterrent to the prospective offenders of human dignity. Three, small towns, by virtue of affording greater scope

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for the neighbours to know each other well, do not breed the syndrome of strange familiars that a metro does. That sense of identity with the community in turn lessens the scope for crimes as everyone fears to appear immoral in the eyes of the neighbour. The very fear of being caught by the neighbours while doing a wrong deed is a great deterrent to such crimes and this is more possible in close-knit communities of small towns than in metros. Four, policing of such narrow confines can afford even greater security against erring beings. More than anything else, such dispersal of growth centres across the geography minimizes migration of people from their known neighbourhoods, which is again a great deterrent to evil deeds. Finally, such distribution of growth centres across the country ensures regional equity in the distribution of wealth and in turn generates better atmospherics for social consciousness to emerge. And all this at no extra cost; indeed it reduces the operating costs of BPOs substantially. Then, what are we waiting for: Let us together act at once to make our country more civilized!

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Indo-US nuclear deal

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SIXTY NINE

Indo-US nuclear deal


From the Known to the Unknown: when an unanticipated good happens, even countries find it difficult to swallow it.

he debate on the Indo-US nuclear deal of July 18th, 2005 has reached its zenith with a group of former ambassadors urging the government to share with the people of India all that they are legitimately entitled to know about it. Given the heated discussions it has generated, the deal merits businesses attention. Under the deal, the US will work to achieve full civil nuclear energy cooperation with India as it realizes its goals of promoting nuclear power and achieving energy security. The US President would seek agreement from Congress to adjust domestic laws and policies, and it will work with allies to adjust international regimes to engage in full civilian nuclear cooperation and trade with India, including, but not limited to, expeditious consideration of fuel supplies for safeguarding nuclear reactors at Tarapur. On its part, India agreed to identify and separate civilian and military nuclear facilities and programs in a phased manner and file a declaration regarding its civilian facilities with the International Atomic Energy Agency (IAEA); take a decision to place voluntarily
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its civilian nuclear facilities under the IAEA safeguards; sign and adhere to an additional protocol with respect to civilian nuclear facilities; continue its unilateral moratorium on nuclear testing; work with the United States for the conclusion of a multilateral Fissile Material Cut Off Treaty; refrain from transfer of enrichment and reprocessing technologies to states that do not have them and support international efforts to limit their spread; and ensure that the necessary steps have been taken to secure nuclear materials and technology through comprehensive export control legislation and through harmonization and adherence to Missile Technology Control Regime and Nuclear Suppliers Group guidelines. Some have hailed the deal as Indias nuclear triumph since it confers on it a nuclear weapons power status, besides enabling it to procure advanced nuclear technology, machinery and, most importantly, uranium supplies. The civilian collaboration is expected to offer energy security to India. There is a flip side to the deal: Some allege that it compromises with Indias strategic nuclear autonomy, as though it was once independent of external assistance. Even the American elite have voiced their concern against the deal. Strobe Tall bottPresident, Brookings Institution and former US special envoy to South Asia, cautioned that the decision to recognize India as a legitimate nuclear power does not bode well for world security. He also said that the Indo-US agreement effectively granted India nuclear legitimacywith little in returnthat will completely undermine the global non-proliferation regime, while some others hailed it as a reflection of what US Secretary of State Condoleezza Rice argued in one of her articles during the 2000 election campaign that the US should regard India as a strategic counterweight to China. But this apparently good-looking deal ran into a barrage of criticism during its implementation. It is alleged that the US repudiated the very core of the deal that India would assume the same responsibilities

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and practices and acquire the same benefits and advantages as other leading countries with advanced nuclear technologies, such as the US. Secondly, although identification and separation of civilian and military nuclear facilities and programs in a phased manner is at Indias volition, the US is reported to have insisted that such separation plan be credible, transparent, and defensible. Thirdly, though the deal is of a reciprocal nature, the State Department appears to have made Indias act of separating its nuclear establishments into civilian and military as a condition precedent for the US to seek approval from the Congress for changing laws. The controversies aside, it is worth recalling here what our Minister of Defence said at the Carnegie Endowment for International Peace on June 27, 2005: India is a heavily energy-deficient country. Energy scarcity is the most serious hindrance for Indias economic progress. With the anticipated growth rate of 8% under GDP per year, the growth of oil demand is projected to be 6% per annum, which means oil imports could rise to 85% over the next two decades. If, indeed, India is to realize its economic potential, it needs alternative sources of energy. Though it has indigenously developed technologies for nuclear energy, it faced serious impediments in accessing materials and components and easing of these constraints will impact favourably on our economic prospects over the next two to three decades. There is yet another interesting observation that merits our attention here: George Perkovich, Vice President for Studies at the Carnegie Endowment for International Peace, said that the issue is not one of (India) succumbing to outside pressure (for separating civil nuclear programs including fast-breeder programs); it is one of paying to get something in return. Even otherwise, if we peep into the history of our Nuclear Establishment, it becomes evident that though we established the Atomic Energy Commission in 1948 to indigenously harness atomic energy we could, as observed by Zia Mian and M V Ramana elsewhere,

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accomplish no progress till the UK assisted us to design and build the first reactor Apsara that went critical with the enriched Uranium fuel supplied by it. Similarly, the CIRUS reactor was supplied by Canada and heavy water by the US. As stated by Perkovich elsewhere, around 1100 Indian scientists were trained at various US facilities. That is how we began our journey into the Nuclear Fuel Cycle, but of course progressed well within the given monetary and technological constraints till at least we were ostracized from the global nuclear group of countries after we exploded a civilian nuclear device in 1974. Thereafter we could not of course carry forward the nations energy security and self-reliance policy that was drafted by Homi Bhabha way back in 1950 which constituted a three-stage nuclear power program to use our natural uranium and thorium resources to establish a totally indigenous technology base. There are of course reasons galore: To accomplish the vision

Nuclear Fuel Cycle


Recovery from ore as Uranium oxide/Yellow cake Conversion into Uranium hexaflouoride U-235 is 0.7%

Enrichment fed through gas centrifuges to increase the proportion of U-235 to 3.5% for use in reactor

Weapons Weapons

Fuel Fabrication Enriched U-235 is converted to U.dioxide powder and inserted into tubes Reactor U-235 isotape splits in the core of the reactor producing heat which is used to generate Electricity Storage spent fuel stored in ponds to decrease temperature and radioactivity Reprocessing reprocessed to recover unspent uranium which can reenter the cycle at conversion stage or Plutonium can be blended with enriched uranium at fabrication stage Storage and Disposal Left out is sealed in corrosion-resistant material and buried deep under stable rocks

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of Bhabha we were required to build a sufficient number of Pressurized Heavy Water Reactors first to produce adequate Plutonium so that we could migrate to the second stage breeder program. But due to shortage of natural uranium we could not even fuel the existing PHWRs. Nor have we any encouraging news from the mining front: The known uranium sources in Jaduguda mines are depleting fast while local opposition held up uranium mining in Domiasiat in the North-East and Nalgonda in A.P. The net result is that we are cumulatively far behind the projections under nuclear power generation. Though in terms of what Mujid Kazimi of the Massachusetts Institute of Technology said: Everything they (Indians) have reported (on their research about fast-breeder reactions) to date indicates they are on course, we appear to be making inroads into this new field, we still could not make the technology available for commercial exploitation, due more to our isolation from the NSG countries. It is thus increasingly becoming evident that unhindered access to nuclear material, equipment, technology and fuel from international sources, is a must for our further progress. The current electricity projections put the countrys need at 400000 MW by 2025. Given the scenario and from what Dr. Anil Kakodkar, Chairman, Atomic Energy Commission, said, The growth constraint would, by and large, be removed for civilian nuclear power if the agreement goes through as we have envisaged, the deal per se assumes importance, for it considerably eases the nuclear fuel supply for newer plants. If what George Perkovich said India is running out of fuel, the need for electricity cannot be met by the nuclear program, especially if there is no international cooperation, is true, which, of course, the government alone knows, it becomes all the more essential to work towards implementing the deal for a win-win outcome.

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SEVENTY

Religion vs. ghastly acts of the angry apes


Culturally organized anger accomplishes militaristic perfection in its violent lifestyle.

hursday, July 7. It was 8.40 a.m. when I boarded the train to work at Finsbury Park. The train was so full that I had to walk to the first carriage. It was absolutely packed. Even more people got in at Kings Cross. It felt like the most crowded train ever. Then, as we left Kings Cross, at 8.55 a.m., there was an almighty bang. Everything turned totally black and clouds of choking smoke filled the carriage. It was so dark that nobody could see anything. I thought I was about to die, or was dead. I was choking from the smoke and felt like I was drowning. Air started to flood in through the smashed glass and the emergency lighting helped us see a bit. We were OK. A terrible screaming followed the initial silence. There was screaming and groaning all around. God alone knows how, but we somehow calmed each other and tried to listen to the driver. He told us that he was going to take the train forward a little so he could get us out, after he had made sure the track wasnt live. We all passed the message into the darkness behind us, down the train.
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After about 20 minutes, we escaped from the smashed carriage. We walked carefully through the semi-darkness, wondering if the tracks were live. We walked in a single file to Russell Square Station, where we were lifted off the tracks to safety. My mouth was so dry. My lungs felt full of choking dirt. I suddenly became aware of a huge bleeding gash full of glass in my wrist. I could see the naked bone in my arm. I staggered about outside the tube and no one, least of all me seemed to know what to do. I knew others behind me were so much worse off than I was. I was so very lucky! These were the outpourings of a victim of the series of terrorist attacks in the London Tube. That ghastly act of angry apes had once again brought religion to the centre-stage. The thinking minds of the world were agitated with a battery of questions: What is this religion? Is religion meant for maintaining a semblance of orderliness in societal function or is it meant to destroy the social fabric? Is it meant for living in harmony with each other or to create/perpetrate hell for the neighbour? Is it meant for indoctrinating minds with hatred against outsiders or for filling them with warmth for everyone? Does religion mean being human or devilish? Yesterday, it was 9/11. Today, it is 7/7. And in between it was Madrid. What will it be tomorrow? What is this religion? What is it aiming at? Etymology says that the word religion is derived from religio in Romance language. Does romance mean killing one another? Hating one another? Or living together? Incidentally, the true etymology of this word connects it with relegere to recollect, to recall, and to reflect; all with a shade of concentration and anxiety. The current etymology, however, seeks to relate religion with religare to bind, join, unite, though philologically inexact, but this certainly enjoys the benefit of expressing far more vividly the actual and the living

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meaning of the word. Morris Jastrow summed up the definition of religion proposed by his predecessors thus: Religion consists of three elements: One, the natural recognition of a Power or Powers beyond our control; two, the feeling of dependence upon this Power or Powers; and three, entering into relations with this Power or Powers. Uniting these elements into a single proposition, religion may be defined as the natural belief in a Power or Powers beyond our control, and upon whom we feel ourselves dependent; which belief and feeling of dependence prompt (1) to organization, (2) to specific acts, and (3) to the regulation of conduct, with a view to establishing favourable relations among ourselves and the Power or Powers in question. This synthesis sounds like a pretty good description, but nonetheless, it has a serious defect: It does not bring out the importance of the transcendent quality of all religions. Is this missing of transcendence in any way responsible for what is happening today in the name of religion or for the sake of religion? What if religion is perceived like what Huxley said: Reverence and Love for the Ethical Ideal and the desire to realize that ideal in Life? Would that reverence and love for the ethical ideal in the name of religion have made any difference in practising the religion as a tool for sublime living? That is perhaps what Kant meant when he said: Religion consists in our recognizing all ones duties as divine commands. Doesnt it then want us to realize that religion is the sum total of beliefs, sentiments, and practicesindividual or social which have for their object a power which man recognizes as supreme, on which he depends, and with which he can enter into a relationship. Yet, man, like an angry ape, plays such fantastic tricks before high heaven; As makes the angels weep. Does it mean that religion, by itself, is no good unless it encourages its practice in reverence to moral rights of a man and others. Most of all, it is about whose

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commands we are following: Is it the commands of that divine power or the commands of the powerful mortals? Only religion is vociferously yelling to stop this insane behaviour of man against man. Elders in the families should now undertake this teaching. They should teach everyone in their families how shameful it is to inflict injury on othersthat, too, wantonly. And they must practice it relentlessly, because in todays world, money has emerged as the visible Godhead of modernism, transforming all human and natural qualities into their opposites. Unless they strive for this noble teaching as a life-long pursuit, and deliver it, nothing substantial can be achieved or changed. It has to be borne in mind here that, however anxious a man may be to get at the right thought, he can only understand it by bringing it into relation with his own mind; and this is not an empty mind, but a mind already stuffed with personal categories and a content of its own, and disposed therefore to look at things in a particular way. He must of necessity, therefore, read this mental character into any new facts that are brought before him, estimate them by its canons, appropriate and assimilate them, turning them round, as it were, till he can see them in the light of his own habitual modes of thought. This assertion poses a big challenge to all those religious leaders who are sincere about correcting the digression that religion has taken from the divine path by landing into the lap of powerful mortals in the recent past. It is a big challenge! But there is no escape from it if we believe that we all are the subordinates of that absolute Power and we have no ethical ground to supplant the Power. Everyone who has faith in the future of mankind should denounce anyone who, knowingly or unknowingly, indulges in any act of destruction. It is not only necessary to put them to shame, but also to make them understand that the whole society shames them.

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Therefore, what is needed is not sectarians with axes to grind, but rationalists of moderate temper and perfect good faith who can analyze religious facts and interpret them on rationalistic lines, and accordingly educate the society to remain decent to themselves by being decent to others. So, elders and pontiffs have a responsibility, that of educating the society through rightly and ardently practising religion.

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Clause 49: A step towards good governance

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SEVENTY ONE

Clause 49: A step towards good governance


Its not only a constant endeavour that is essential for nurturing good governance but also an assertion for it.

orporates usually have an apex policy-making body known as Board of Directors (BoD). The members of the board exercise their authority collectively. Hence, the professional credentials and commitment of members have an extensive impact on the fortunes of businesses. Yet, the Indian Companies Act does not offer a definition of Board of Directors. Even the designation Director has a bland definition: It includes any person occupying the position of director, by whatever name called [Section 2(13)]. Of course, from this, one may infer that the BoD is a group of individuals, each of whom is labelled a Director. In much the same way, the Act does not tell what a BoD is supposed to do. Here again, we have to infer from the definitions given under Section 2 of the Act, as also Sections 291-93, that a BoD is expected to perform the role of overseeing the running of the enterprise by its Chief Executive. The majority opinion is that the BoD must direct the affairs of the company and not manage them. That being the law, it is no wonder that many Indian boards normally have a CMD, and two directors, i.e., a husband, a wife, and
May 2005.

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a daughter. On top of it, the real problem is the one of noninvolvement of the board in the affairs of the companies. No wonder then that it is the CEO or the promoters who choose the directors and get them elected, not because of their knowledge specific to the company, but because of their compatibility. As against this, todays market economy elsewhere is strongly working towards fixing of the problem of governance by inducting more independent directors on board. With the enactment of the SarbanesOxley Act of 2002, the erstwhile near monarchical status of CEOs within the corporations is getting rattled, and for good. With increased number of independent directors on the boards, they are flexing their muscles to assert their right to democratize the corporations, where hitherto the writ of the CEO alone ran unquestioned. In the recent past, boards in the US sought the ouster of even such legendary CEOs as Michael Eisner of Walt Disney and Maurice Greenberg of AIG an act which was unthinkable even a couple of years ago. Now the question is, can Indian boards ever emulate such assertion? The trend is perhaps catching up with us tooat least in discussions, if not in actions. Today, lenders and investors who have become global, are looking for less governance risks. Indeed, with the increased capital inflows into our stock markets, we too have become conscious of the need for good governance. The regulators have appointed committees to suggest a suitable template of governance that matches with the best practices elsewhere. The need for independent directors who could ask critical questions, throw in new perspectives in risk management and business strategy and metamorphose board meetings into brain-storming sessions that add value to the companies is multiplying. In fact, it is common knowledge that good corporate governance ensures better ratings, higher growth and higher valuations for a company. Perhaps, prompted by these requirements, Sebi has recently directed exchanges to amend the listing agreement with the revised Clause 49.

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According to the clause, companies where the chairman of the board is a non-executive director must ensure that at least one-third of its board comprises independent directors, and in case he is an executive director, at least half the board should comprise independent directors. But the problem is that whenever ethics and consensus are sought to be enforced by law, that too in businesses, it will be followed just as other laws are followed to the letter and not in the spirit. And obviously, the compliance could be only to the extent to which one could get away with. So, the first compliance from the corporate world with the amended Clause 49 is the request for deferring its implementation under the plea that we do not have the requisite reservoir of independent directors. True to our tradition, the regulators have deferred the implementation and the obvious victim is governance. The whole episode compels us to recall what Chhandogya Upanishad (1.1.10) ordains us: Yadeva Vidyaya Karoti,/ Sraddhaya, Upanisada,/tadeva Viryavattaram Bhavati (whatever work is done with knowledge,/Through faith and backed by meditation,/that alone becomes most effective). The stanza states that Vidyaknowledge of work, the theoretical and conceptual clarity of subjectis the primordial requirement for efficiency in work. Knowledge sans Sraddhafaith, remains static, remains as a mere possession. Sraddha evinced by the seeker alone energizes Vidya and ensures its transformation into Karma, i.e., action. Swami Vivekananda once said, What makes the difference between man and man is the difference in this Sraddha and nothing else. He who thinks himself weak, will become weak. Sraddha simply generates the belief; and belief in ones knowledge-power alone makes things happen. Sraddha Sraddhamayoyam purso yo yat Sraddha na eva sah(whatever be the measure of his Sraddha, that will be the measure of his life as well), says the Gita. Therefore, one needs to acquire Sraddhadeep faith in the self, so that one may develop into a dynamic character.

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Knowledge can be imparted but no training can impart Sraddha. Sraddha has to be captured by oneself. Sraddha is more of a spiritual value. It moves a man from within. It is simply a reflection of the richness of the personality of the Board of Director or a simple worker. It imparts an artistic quality to ones life and work. Faith in oneself, in the divine within, is the greatest source of enrichment of a personality. Such a person works out of the fullness of ones heart. This Sraddha (faith) however, needs to be properly channelised. Upanishad (calm meditation) helps in properly directing and disciplining ones knowledge. It makes ones actions meaningful, Sarvopakari (good for everyone). This flow of energy from faith, Sraddha through knowledge, Vidya to Karma is the basis of efficiency. But this flow is prone to suffer shutdowns due to the ups and downs in the emotional life of the worker. Inner disintegration or want of integration results in outer disorganization. This automatically lowers the efficiency. Upanishad helps in arresting these disturbances. Meditation gathers the mind into itself. When the mind takes leave of the body, thought is the best. Upanishad fortifies the worker and his work. That fortification spreads fearlessness, love and peace all round. It simply unites philanthropic efficiency with philosophic calm. That alone makes the governance a Sarvahit (omni-benevolence). A governance that is driven by these values of Vidya, Sraddha and Upanishad can simply excel in its effect, efficiency and acceptability. It otherwise means that before accepting a responsibility, we need to question ourselves if we have these qualities, otherwise, we should not. This personal longing for deserving a desire alone ensures ethical conduct in any walk of life. It alone can result in good governance, even better than by law. What a blessed insight! But, are there any takers?

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India Pharma Inc.: What is in store?

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SEVENTY TWO

India Pharma Inc.: What is in store?


Todays success cannot guarantee tomorrows performance unless the pharma industry wakes up to the emerging demands and reconfigures itself at the earliest.

t is heartening to note that in the recent past, our pharmaceutical companies are trying to assert their presence in the global markets. Quite a few Indian pharma companies have made overseas acquisitions: Wockhardt acquired CP Pharmaceuticals in the UK; Ranbaxy acquired RPG Aventis in France; and Zydus Cadila has finalized its acquisition plans for acquiring Alpharma SAS of France, etc. On the other hand, we also see many major pharma multinationals looking at India for striking profitable partnerships with Indian companies in research and drug development. As we inch forward towards post-WTO (World Trade Organization) scenario, it is feared that many drastic changes are likely to occur. Ernst & Young, in its Global Pharma Report 2004, observed that Indian pharma companies topped drug filings with USFDA for 2003. We have filed a total of 126 DMFs, accounting for 20% of all drugs coming into the US market. This phenomenal accomplishment
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of Indian companies made several MNCs to recognize the capabilities of Indian firms in the process chemistry and compelled them to move close to India for their bulk requirements. Many of them have already outsourced their manufacturing that, too, of complex and difficult to make molecules to Indian companies. The mindset of Indian pharma industry has in the recent past changed drastically. Encouraged by the approval accorded by the US FDA for Indian manufacturing facilities, drug majors have been looking at global markets backed by cutting edge technology and cost-effective excellence in drug manufacturing. However, post-2005, domestic drug majors will be facing great challenges from product patent regulations as the research and development facilities owned by these companies are insignificant vis--vis those of the multinationals. The drug discovery and development being a very expensive preposition, it is only the major multinationals who are in this business for a long time and process formidable size, scale and experience at their command, that are going to rule the roost in the future. In such an emerging scenario, research and development will be the backbone of the growth. This obviously calls for huge investments in R&D. But none of our existing players is in a position to make such huge investments. Even our major players cannot do much in this area as they are constrained by lack of investment capabilities. There is however, a ray of hope: the success in discovery of new drugs need not necessarily be associated with bigness of the organization. Indian chemists are well known for their research capabilities. They are occupying leading positions in global research centers of various multinational pharma companies. Although they are working outside India, their knowledge could still be tapped by the domestic pharma companies provided they know how to access and harness such knowledge. It is the entrepreneurship of domestic firms and the speed with which they address the issue of discovering

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new drugs that defines their success. As a part of this new game plan, Indian companies must strive to strike collaboration among the major domestic players, particularly in areas of research and development of new drugs as it enables them to fill the gaps in individual companys strategies with speed and in a cost effective manner. In the intervening period, to sustain their growth, domestic firms may have to position themselves as leading bulk drug and generic players. Many of them have to mold themselves into specialized players offering customized pharmaceutical services to global players such as contract research; custom chemical syntheses; clinical research trails, etc. Such an involvement not only generates and sustains cash flows during the transition but also offers them enough experience that is necessary to build their own competencies to discover new drugs and compete on equal terms in the global markets. The spread of convergence across various sectors in the recent past has only intensified the need for partnerships and alliances in manufacturing industries too. The rising global competition, and the resulting downsizing have only intensified the necessisity for collaborative arrangements. Hamel, Doz & Prahalad have prescribed Collaboration for improving a firms competitive profile since it strengthens both the companies against outsiders and creates value for them as leader, rule setter, and capability builder. Collaboration is indeed competition but in a different form. Collaborating parties enter alliances with clear strategic objectives. They understand well how partners objectives will affect their success. Learning from partners is of paramount importance: they need to view each alliance as a window on their partners broad capabilities; use the alliance to build skills in areas outside the formal agreement and systematically diffuse new knowledge throughout their organization. Harmony is however not the most important measure

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of success: occasional conflict may be the best evidence of mutually beneficial collaboration; few alliances remain as win-win undertakings forever; a partner may be content even as it unknowingly surrenders core skills or one may pursue independent path once it built up competency to sustain on its own in the market. Of course, collaboration has its own limitations: it must be defended against competitive compromise; involves a constantly evolving bargain; must keep employees at all levels well informed about what skills and technologies are off-limits to the partner and monitor what the partner requests and receives. Collaboration is well suited for activities such as new product development; improving a product design for manufacturability using competencies within supply chain network; reducing time to market for new product introduction; reducing the manufacturing cycle time for designated partners; improving logistics costs across supply chain network, etc. Managing and improving time and capital involvement to develop and bring a new product on to the shelf is a critical constituent of pharmaceutical industry, and it is to overcome these hurdles collaboration among the competing businesses comes quite handy. Post-WTO, our pharma industry will witness a tough competition from multinationals in offering new drugs to consumers. This obviously demand thorough professionals to man diverse operations such as research, development of new drugs, conducting clinical trials, their synthesis through complex processes, and marketing all call for thorough professionalism. This can only be ensured by hiring right pharmaceutical researchers with sound professional qualifications. Even that is not enough they need to be constantly retrained to keep them abreast with current developments in the industry. It is only such thorough professionalism and its constant upgradation that can sustain competency in the organization.

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Secondly, to stay ahead in the competition pharma companies must inspire its professionals to innovate to innovate new processes for cost effective manufacturing of existing drugs, innovate new molecules, new drugs, etc. In fact, innovation should become the very culture of the organization. But innovation calls for many things: finance, professional education, training, retraining and an organizational environment that nurtures innovation. Innovation flourishes in organizations only when funds are plentiful and are liberally available. Along with plentiful funds, there must also be availability of professionals who had the backing of requisite education, intelligence and zeal to innovate. It makes great sense for the industry to enter into collaboration agreement with some of the nations leading educational institutes for offering courses in pharmacy, chemical engineering and biotechnology with a curriculum that best caters to the current as well as prospective demands of the industry. Similarly, they may even strike collaborative agreements with university laboratories for undertaking drug discovery related research. No doubt, Indian pharma industry has come of age, but postWTO it will find it difficult to maintain profit margins, unless they invent new drugs for which they have to gear up. There is no time; they have to literally gallop!

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SEVENTY THREE

PV: The prime minister who empowered his colleagues to dissent


A leaders strength reflects more in his ability to absorb the critics and march forward than in silencing them under the threat of power.

courageous and wise statesman who put India on the path of reform is what PV Pamulaparti Venkata Narasimha Rao was in the words of Lee Hsien Loong, the Prime Minister of Singapore. For Goh Chok Tong, the former Prime Minister of Singapore, Rao was an international statesman, a quiet but visionary leader of India and India is blooming today because of the foundation he laid. In the words of Rao himself, as stated in his book, The Insider, he climbed ladders and more ladders feeling all the while that he was on level ground from patvari to Prime Minister: A long journey from a small Indian village to the capital with no celebration at any stage. And thus remained a modest man, may be consciously believing that he has much to be modest about. It is destiny that he, a semi-retired politician, was all of a sudden catapulted to the PMs seat as well as made the president of the
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Congress Party by the power centres led by Sonia Gandhi, of course not without a reason: His sobriety and the perceived no threat from him to the people who were already in commanding positions. Once in the saddle, he proved to be a great commander having a sound grip on the task of steering the country through turbulent times, despite inheriting a nation that was facing great threats from insurgents in Punjab and Jammu & Kashmir and which, economically, was on the brink of bankruptcy. As Deng Xiaoping steered China away from the Maoist policies to market economy during the early 1980s, Rao mustered courage to gently push India away from Nehruvian economics to a path of liberalization that freed India from the shackles of socialist ideology-driven inwardlooking growth path. The reform process that was launched under him made far-reaching changes: Foreign trade, foreign investment and exchange rate regimes were all redefined. The financial sector was totally overhauled. Of all these reforms, the devaluation of the rupee and the shift in the very exchange rate regime were the fundamental ones, which could not have been achieved but for the wholehearted support from Rao. In the words of C Rangarajan, the then Governor of Reserve Bank of India, Rao stood solidly behind the Finance Minister extending all political support needed for putting India on the right economic course. As the ex-Governor observed, he was not a reluctant reformer although he didnt sound that enthusiastic while these path-breaking reforms were successfully executed. He did just what he was supposed to dowatching their implementation from a distance without poking his nose, simply as an elderly statesman. Unlike the common ilk of politicians, he didnt make too much noise in implementing these reforms attracting the otherwise avoidable resentment from the staunch followers of the erstwhile regime. He had thrown open the door to Foreign Institutional Investors to invest in Indian capital markets and Foreign Direct Investments in

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many sectors despite strong opposition from powerful industrial houses to such initiatives. The Colas and the likes of IBM who had been banished from India earlier were welcomed back. Being fully convinced himself about the need for fundamental economic changes, he stood like a rock behind the various reforms that were launched and executed. Rao reformed the country in such a way that he could finally reconfigure the Hindu growth rate and, to the surprise of everybody, leapfrogged GDP to 8% plus. He accomplished all this in a pretty subdued way, and yet, lost his job. To quote him: I lost one job trying to implement a socialistic program (Chief Ministership of Andhra Pradesh while implementing land reforms in the early 1970s) and as if to balance it, I have also lost another job trying to liberalize what had tended to become insensitive somehow after the socialist process, though not because of it, and that was the irony which even statesmen of yore could not escape from. This side of PVs personality is well-known to everyone for that was what often prized in public or private. But what our younger generation, which is attempting to whisk out of the colonial moorings, should know about PV is the other side of him which is unfortunately spoken of less, be it in public or private. To appreciate it better, let us first take a look at what the Congress party is known as, or for that matter, the predominant tilt we as Indians have towards mai-baap culture, where everyone is afraid to air his feelings freely. While intervening in the debate on the resolution moved by Morarji Desai on purity and strengthening the organization at the Congress Subjects Committee meeting at Satyamurty Nagar, Avadi on January 20, 1955, and the suggestion by Algurai Shastri that the resolution should not publicize the malpractices that had crept into the Congress since self-criticism in public simply would put the noose round the necks of Congressmen which other people might use to drag them with, Nehru said: I have been president of the Congress

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and I know from personal experience that there is a lot of impurity in the Congress and even some of the biggest Congressmen are a party to it. Why should we hide these things? Are we to live behind purdah and wear a veil? Algurai Shastri has himself talked to me several times about these impure trends in the Congress and expressed his regret about them. If any member wants to suggest an amendment to the resolution, by all means he can do it, but we must face our weaknesses and drawbacks and the impure trends that have crept in, truthfully and honestly. No one would perhaps disagree if I said that Nehrus lamentation remained all along a distant dream, till at least PV landed on the Prime Ministerial gaddi. It is not known if it was to compensate for his act of nudging India away from Nehruvian economic policies that Rao wanted to push the Congressmen gently towards what Nehru desired to happen, but he did grant allowances to his detractors to air their feelings, views contrary to the partys stance and, for that matter, even criticize the leadership without fear and hang-ups. Else, the Tiwaris, Singhs, et al., would not have had the courage to openly question the wisdom of Rao or criticize his acts from public platforms. PVs grace simply radiates from the fact of his maintaining silence over such criticisms. We, however, do not know if this empowering of his colleagues to freely air their opinions which could be quite embarrassing to the power centres and maintaining stoic silence over them was by design, believing in Machiavellis principles: Scorn and abuse arouse hatred against those who indulge in them without bringing them any advantage and Prudent Princes and Republics should be content with victory, for, when they are not content with it, they usually lose, or by default. Nevertheless, he did reform the mindset of Indians. He simply emboldened the people to question the authority and seek answers. Whether this reform has taken roots as firmly as the economic reforms or not is a different question.

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What matters here is, a beginning had been made and Rao walked away with that credit. As though a testimony to that grand beginning of Rao, we witness today even the executives of public enterprises airing their candid opinions, though contrary to the established positions, on national issues. We must salute Rao for watering Nehrus longings to germinate at least after 40 years. And that is what metamorphosed PV, a politician, into a wise statesman.

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Our quarrels are ours, their ends none of our own

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SEVENTY FOUR

Our quarrels are ours, their ends none of our own


Even one is enough to build world-class assets but two are a must for any quarrel.

urtains were raised. Act I began. The King entered the stage and stated: There are ownership issues but they are in private domain. Since Reliance is a professionally well managed company no one, two or three individuals including myself can make any difference to Reliance, said Mukesh. Act II: On return from the US, Mukesh Ambani, the Chairman and Managing Director of Reliance Industries Limited, clarified that what he had said earlier had been taken out of context and thus wrongly interpreted. According to him, what he actually meant was that ownership issues are only future-initiativescentric and had little to do with the existing units since Dhirubhai had settled them before his journey to the heavenly abode. He further asserted his authority over the group by mailing the message to group employees: There is no ambiguity in his (Dhirubhais) legacy that the CMD (Mukesh) is the final authority on all matters concerning RIL. In between these two acts, the poor audience had the trauma of their lifetime: There was a hectic day of frenzied selling of Reliance Groups shares in the stock market. On a single day of trading, RIL lost 3.4% of
January 2005.

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its price; Reliance Energy fell by 1.2% and Reliance Capital by 5.9%. Act III: Anil Ambanis (Vice-Chairman and Managing Director of Reliance Industries) e-mail sent to the Chairman and Managing Director (his elder brother) of RIL informing him about his firm view that RIL should abide by the highest standards of corporate governance, and this should first be reflected at the proceedings of our board of directors has been made public. The current battle Royal (Reliance!) is not confined to the two brothers but involves a bigger castambitious advisers and spin doctors, battling bahus and a mother struggling to bring together her two sons to make them see reason. Interestingly, after the death of Dhirubhai Ambani, Mukesh said: Anil is like my son. How sad it is today to see that relationship being driven as though by intrigue and visceral hatred! The evolving rivalry between the brothers, duly accompanied by a host of advisers on either side, is drawing us closer to Shakespearean drama: Friends now fast sworn,/Whose double bosoms seem to wear one heart Break out/To bitter enmity. All this smell of lingering dispute over ownership between the brothers is bound to impact the performance of RIL. Reliance is Indias biggest private sector enterprise. It is the very embodiment of the confidence of Indian industry. It has all along reflected a spirit of can do amidst an otherwise sulking Indian entrepreneurship. Being dynamic, it had so far tasted only success. And any feud between the brothers is not confined to Reliance alone: It simply impacts the very future of Indian stock market and also affects a major chunk of government revenues, besides the fate of around 80,000 employees and their families. Though their quarrel is their own, its ends are not just theirs; it pervades a bigger canvas. The fall-out of the quarrel is bound to shake the very faith of investing public in family businesses of India. The IPO market is almost dead except for a couple of issues in the recent past. The recent annual report of the Reserve Bank of India

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brings out another alarming feature to light: Investment of household savings in shares and debentures has slid to 1.4% of total savings in 2003-04 from 7.7% recorded in 1999-2000. It is quite intriguing to note such a fall even when the interest rate scenario in the country has not been that encouraging for the last two years. Universally, it is believed that when bond rates are low, investments largely move into stock markets. Contrary to this generally held belief, retail investors in the country are shying away from the stock market. The reasons are of course not far to seek: Frequent scams in the stock market, price manipulation by vested interests, poor corporate governance, pursuit of personal agenda of promoters at the cost of company, etc., have become some of the common experiences of retail investors. The survey carried out by the Society for Capital Market Research and Development during 2002 revealed that almost 40% of the sample investors cited volatility and price manipulation as the most disturbing phenomenon of the Indian stock market. As against these ground realities, a healthy capital market craves for a large number of individual investors with active participation since that alone can facilitate better price discovery. Secondly, active participation of retail investors in stock market operations can act as a counterweight for institutional investors such as FIIs, who are known to swing the market in tandem with their desires. Given such a scenario in India, feuds of Reliances nature are the least expected. It is time Indian businesses and their leaders bore in mind and be guided by what Shakespeare made the player-king in Hamlet say: Our thoughts are ours, their ends none of our own. Ends are the real issues of thoughts that human beings entertain. While pursuing their ideas, people often unwittingly tend to strike into the existing order of things. As seen in many of the Shakespearean tragedies, people in search of power become pawns to the designs of others and fight blindly in the dark. They act freely, but in the end get tied down to its consequences irrespective of their thoughts being

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noble or ignoble. Lady Macbeth, driven by the courage and force of will, fancied that she can dash the brains out from even a suckling baby, finally finds herself hounded to death by the smell of a strangers blood. Othello, being driven crazy by motiveless malignity of a scheming friend, and assuming that he is executing solemn justice, strangles love. Brutus, in the interest of his country, felt right in asking for Caesars life, but engineers misery to his country and death to himself. To gain the crown, Macbeth killed the king whom he revered so much till then, and finds that the crown had only brought him all the horrors of life. In this tragic world, mans thought, translated into act, often finds itself transformed into the opposite. Whatever one may dream of doing, one finally achieves the opposite of what one yearns for. All this may suggest that men are helpless. But, that is not true, since man is often found to be the cause of his own undoing. That is what is to be essentially remembered here: It is the human action that becomes the ultimate cause of the catastrophe. And this critical action is quite often found to be bad or wrong. These thoughts are worth being meditated upon by every leader of public or private governance. Coming back to Reliance, it must be stated that after a point, Dhirubhai certainly did not work for amassing wealth, but to actualize his potential potential to build world-class assets in a country that is plagued with all sorts of constraints. He built the assets simply to build them. How could his progeny be different then? Would somebody please tell the warring brothers that their feud is making Reliance fall apart fall apart not only that which had been built so assiduously by Dhirubhai, of course, in association with four other hands, but also the newfound can-do spirit among the budding entrepreneurs of India?

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Thank you, Anil Ambani!

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SEVENTY FIVE

Thank you, Anil Ambani!


At times, quarrels too prove to be beneficial, at least for the rest at large.

ver since civilization dawned, words like governance and government have been engaging the best of minds in the world. Historys greatest personalities like Kautilya, Aristotle, and Confucius have eloquently theorized governance and government but all that appeared to have been lost in oblivion till at last the World Bank evinced an interest in governance. During the early 1980s, of course, in its frustration about handling the problems associated with the execution of projects financed by it in African countries, the World Bank revived governance by defining it as nothing but exercising of political powera kind of power that solidly rests on a strong legal foundation, maintenance of a non-distortionary policy environment with macroeconomic stability, investment in basic social services and infrastructure, protecting the vulnerable, and protecting the environment to manage a nations affairs. Over a period of time, this convergence of mega trends in administration brought out by the World Bank began to take shape as the form of governance which envisages participation of all those who have a stake in decision-making, transparency in whatever is done, accountability for every action undertaken, and an appreciation
December 2004.

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of human rights. However, with the advent of globalization, the debate initiated by the World Bank has slowly become the catchword of the corporate world, not because of their love for participation, transparency, accountability, or human rights but because of issues specifically relating to the economic aspect of governance that have come to the fore. This debate got further accentuated in the western corporate world with the submission of Cadbury Committee recommendations. The committee was constituted in the UK in 1991 to address and report the financial aspects of corporate governance by the Financial Reporting Council and London Stock Exchange. The committee made far-reaching recommendations and as a result corporate governance has become much broader to include fair, efficient and transparent administration to achieve certain well-defined objectives. Over a period, it has become synonymous with a system of structuring, operating and controlling a company in such a way that it can achieve long-term strategic goals that satisfy shareholders, creditors, employees, customers and suppliers while complying with the legal and regulatory requirements and caring for environmental and local community needs. Today, corporate governance simply means making a corporate both a powerful economic entity and an important social institution that uses its economic power to add value to society generally, and to peoples lives individually. It simply ordains an open decision-making process involving boards and shareholders as that alone can result in stability besides lessening the likelihood of convulsive decisions and contentious changes. It is strongly believed that such an approach to decision-making will create healthier, more self-renewing and more flexible corporations. This new moral contract between the corporate, the individual and the society is basically aimed at transforming corporates into value-creating institutions.

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That was the story of corporate governance and its evolution. India too had its own share of committees drafting corporate governance guidelines and its own moves for adopting it across the corporate world. That is perhaps what Anil Ambani, in his letter of November 27, attempted to remind his brother Mukesh Ambani, Chairman and Managing Director of Reliance Industries, the flagship company of the group whose collective shareholder wealth is estimated to be in excess of Rs.85, 000 crby saying: It is my firm view that RIL should abide by the highest standards of corporate governance, and this should first be reflected at the proceedings of our board of directors. To better appreciate these cravings of the younger Ambani for corporate governance, let us begin at the beginning. It is reported that Ambanis hold around 46% of equity in Reliance Industries which in turn holds around 45% in Reliance Infocomm, around 35.5% in Reliance Energy and a similar holding pattern in other subsidiaries like Reliance Capital and Reliance Infrastructure. However, the direct holding of the brothers in RIL is reported to be hardly 5.13%, while the family-managed Petroleum Trust holds another 7.5%. The rest is reported to be held by a motley of investment companies. And intriguingly, the market knows little about the ownership of these investment companies. But one thing is certain: Whoever controls these investment companies would automatically own Reliance Industries. So, the million-dollar question is: Who is it that had his hand securely on these investments/front-companies? That aside, what is shocking to note here is that even after a decade of market reforms we are still to come out of our old habits. This incidentally reminds us of a pathetic admission of ignorance by a former cabinet minister, made a couple of months back, about the ownership of a company that operates in the Indian skies. And, that is perhaps what transparency meant for India Inc.

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That is only the tip of the iceberg: Even a cursory glance at Anils letter throws more light on how our boards govern the affairs of a company. To quote Anil fully, he said that Item No.17 (of agenda of Board meeting dated July 27, 2004) was introduced as a supplementary agenda without my (Anil AmbanisVC&MD of RIL) knowledge and/or consent, and keeping me completely in the dark. He said: This is contrary to all past practice, whereby supplementary agenda items, like the main agenda, have always been pre-circulated, pre-discussed and pre-agreed between the two managing directors, before any board meeting. This is all the more surprising, as I have subsequently learnt that some of the other RIL directors, and several RIL employees, had been taken into confidence on the supplementary agenda, and the contents and objectives of the same, while I, as VC&MD, was not even informed of the same! He goes on to say, The clubbing together of a very substantive proposal on redefinition of the powers of the managing directors, etc., with this unrelated subject of the HSE committee, obscured the real purpose of the agenda item, and prevented a proper appreciation of the consequences thereof. Specifically, the proposed redefinition of powers of the managing directors reflected a substantial and material variation of the equation as has existed in RIL for the past more than two decades, and this clearly required intensive discussion and consideration of the board of directors, based on full facts and circumstances being presented to the board. None of this has happened. The incorrectness of the minutes is evident from the fact that even I am supposed to have voted in favour of the proposed resolution. Clearly, I, as VC and MD, would not vote for the prejudicial variation of my existing authorities and powers! That is how, if Anil is to be believed, our boards function. They are quite often found not doing what they are supposed to do and doing what they are not supposed to do. All that corporate governance

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asks for is that nothing important is missed and nothing trivial included in the board agenda and the directors appreciating their dual rolethe role of respecting the gravity of issues put forward by the management and deliberating upon them with sraddha and requisite jnana of the issues and discharging their responsibilities towards the companys shareholders and creditors by taking nonconvulsive decisions that ensure healthy sustenance of the company. It is only a governance that is driven by the values of vidya, sraddha and upanishad that can excel in its effect, efficiency and acceptability besides being sarvopakarigood for everyone. As against this, what has been quoted by Anil Ambani is only an antithesis of corporate governance. If this is the plight of a Fortune 500 company which is also considered as one of the best managed corporate institutions in India, one can as well visualize what scant regard we Indians have for corporate governance. In this context, the investing public of India must thank Anil Ambani for having made the sordid governance public and thereby sensitizing everyone for a governance, that is, as quoted in Chhandogya Upanishad, sarvopakari.

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SEVENTY SIX

Solving negotiation problems


Every exchange calls for a payment and every payment demands a fair exchange.

emember childhood? The time when you were crazy about getting a Camlin watercolours box, the agonizing negotiations, the deals and counter deals, perceived and real that you had with your dad or mum and the accompanying trauma for its acquisition? And how special you felt once you pocketed it? Any parallel with the recent acquisition of L&Ts cement division by Grasim? Whatever may be the twists and turns that Grasim and L&Ts deal had undergone, its ultimate success had certainly signified the centrality of the art of negotiation in todays inorganic growth of corporates. It is not that corporate executives are not aware of the basic tenets of negotiation: Many a time, even experienced negotiators end up in a deadlock as it initially happened in the Grasim case, damaging relationships and in the process allow conflicts to spiral, leaving sour feelings among even those who are in no way directly related with the deal. However adept the executives may be at negotiation, they often fall prey to petty mistakes, observes James K Sebenius. A sense of awareness about ones propensity to fall prey to such mistakes is therefore essential for every corporate negotiator.
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Let us now take a look at the basic tenets of negotiation. It is a process involving two or more people of either equal or unequal power meeting to discuss shared and/or opposed interests in relation to a particular area of mutual concern. It is essentially a process of coming to terms with and, in so doing, getting the best deal possible. It involves four steps: Determining objectives of negotiation; preparing for the negotiation; conducting the negotiation, and reviewing the negotiation. All these four steps are in turn influenced by the situational as well as institutional views as applicable to the issue under negotiation. It is very essential to get at least the institutional views under these heads clearly articulated before going to the negotiating table. Such a prior articulation makes it abundantly clear as to what could be expected from the negotiation process and to that extent it paves a smooth way for its success. True, in any negotiation, each party can ultimately choose only one option from the available two: accepting the deal or staying put with the best no-deal option, i.e., the course of action it would have taken had there been no deal. Despite this hard reality, every negotiator tends to advance his or her full set of interests. Indeed, he or she would persuade the other party to say yes to a proposal that best fits into his scheme of things better than the best no-deal option does. Now the moot question is why should the other party say yes? It is often forgotten at the negotiating table that the best one party wants to have has to come from the other party who, incidentally, besides controlling it, had different wants of his own. It is thus selfevident that every negotiating executive must not only review his own wants and expectations from the other side but also understand what the other side wants to have from the deal, for in it lies the key to create and sustain the value outcome from a negotiation. Hence, the pursuit of ones own best-fit from a negotiation is a blunder.

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Sebenius further observes that even experienced negotiators make six common mistakes: Neglecting the other sides problem, letting the price bulldoze other interests, letting the positions drive out interests, searching too hard for the common ground, neglecting BATNAs, and failing to correct the skewed vision that keeps them away from the solution to the problem. Amongst these, neglecting the other sides problem is the most critical. At the least, one should understand the problem from the other sides perspective, since that makes it easy to work out a solution for the other sides problem as a means of solving ones own problem. But, social psychologists point out that it is very difficult for most people to understand the other sides perspective. Sometimes, the negotiators may see the other sides concerns and yet dismiss them as their problem. They say, let them handle their problem, while we look after our own problems. This self-centred tendency will always undercut the ability of the negotiator to effectively influence how the counterpart sees its problem. If one wants to change the mind of the other party, one should first know where his mind is. One can then try to build the bridge to cross over the gulf between where the counterpart is right now and his desired end point. Such a move alone makes sense and contributes to the success of a negotiation than trying to jostle the other side from where he is to where you want him to be. No matter whether you are a kid or a seasoned negotiator from Grasim or any other corporate, to succeed in a negotiation, knowing what the other party wants to have from the deal, though not easy, is a must. And if you want to have more of something, you must be prepared to sacrifice more elsewhere.

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Self-regulation, the obvious panacea

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SEVENTY SEVEN

Self-regulation, the obvious panacea


Exogenous rules are only complied with while endogenous rules are simply lived.

s our world capricious, arbitrary, unpredictable, irrepressibly mad? No, not necessarily, but it is certainly a complex one. Its complexity is all due to its connectedness. It is this connectedness that makes prediction so difficult. Greater the connectedness, wider the spread of cause-and-effect relationship over both space and time and lesser is its predictability. This gets further complicated since people endowed with multiple, different, competing, or simply vague objectives are intrinsically part of all these events. But, if you pose the question of unpredictability to stock market pundits, they will simply chuckle at you and of course they have a reason too. They posit that financial transparency, which means timely, meaningful and reliable disclosure about a companys financial performance, enables investors to make informed investment decisions. To put it differently, the availability of reliable information about the performance of a company makes prediction of its market price feasible.

November 2002.

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Stock market pundits have yet another theory to gloat about the Theory of market efficiency which, in the words of Fama, means a market where there are a large number of rational profit maximizers actively competing, with each trying to predict future market values of individual securities, and where important current information is almost freely available to all participants. This definition has two critical components: Onea large number of rational profit maximizers and twoavailability of important current information almost freely to all participants. It is the availability of important current information to every participant that enables evaluation of a stocks intrinsic value, where intrinsic value is defined as the present value of all the cash flows shareholders expect to receive, with the expectation of these cash flows being formed on the basis of all the available information, and thereby predict its market price. This hypothesis begs a very critical and pertinent question: What is the level and quality of information needed for such prediction and against which, what is available to the ordinary investor today? To be honest, the answer is very obvious, particularly in the light of what has happened at Enron and the mind-numbing frauds and scandals that are of late pouring out of the western corporate world. The studies carried out by Prof. Leuz, Prof. Dhananjay Nanda and Prof. Peter Wysocki of Wharton Business school, Fuqua School of Business and Sloan School of Management respectively, reveal that many more firms outside the US suffer from accounting irregularities and minority shareholders are reported to be always at the receiving end in many of these countries. Earnings management and number manipulation are reported to be common in European countries like Austria, Italy, Germany, and South-East Asian countries like South Korea and Taiwan. All this means, existence of asymmetry of information in more than one way. First whatever information being made available to the public

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is what the owner or CEO of a company felt right to communicate with the rest of the world and, secondly, whatever is being made available need not necessarily be always true, as was witnessed in the recent past. Worse yet, the question is not so much Why asymmetry of information?, it is more like why the hell all those concerned didnt do something to correct it? If that is what is happening, is it not the duty of the directors and auditors to muster courage and confidence to ask for explanations or express dissent? The directors or auditors cannot simply delegate the clarity of disclosure to the management down the line and wash of their hands. It is that simple, yet it appears to have been forgotten quite often. It is also not uncommon for many to lament at a nave question: How to figure out what is going on inside an executives head? The answer is simple: No way. No regulation on earth can hack the mind of the owner of a company and read it, nor can it regulate a CEOs thinking. It is perhaps an eternal chasm that no one shareholder exactly knows what a company is up to better than its owners and examples are plentyno one, for that matter even its biggest shareholder, the Government of India, knew what Tatas intended to do with the cash reserves of VSNL till they announced their plans for investing it in Tata Tele Services. And so only the job of the Board of Directors and Auditors assumes greater significance. They must raise their hands and demand an explanation for things they did not understand. They should exhibit courage to go beneath the rules and unearth the truth to ensure transparency. So, what is needed now is not regulation to punish the erring CEOs, but to determine how to get more transparencya transparency that is true but not overloading an investor with more data. This becomes feasible, if only the corporate sector feels responsible and accountable. Companies should cultivate the habit of disclosing right

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information. They should regulate themselves, for no amount of outside regulation is capable of honing ones ethical practices. In this context, CEOs, being privy to inside information, have a pivotal role in accomplishing honest disclosure. True, sometimes, their wants and desires to succeed and produce the best price for their companys issue or profit margin get in the way of their ethical standing. Secondly, they are likely to be challenged by the question Why the hell should I be an honest disclosurer, while I am not sure of what others are up to? Despite such temptations, they must not get carried away by their own take-homes, instead exhibit selfregulation and abide by the need for fair transparency, lest What else in the long run can maintain thehomoeostasis of the market a market that is a pretty open system where a tinkering here is likely to pop up as a problem elsewhere? Of course, so long as the investors, as in India, remain passive and are content with whatever is doled out to them by the managements, the question of Market-punishment may not arise at all, and the managements will jolly well carry on with their present soppy governance.

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Silence of lambs

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SEVENTY EIGHT

Silence of lambs
Ownership doesnt matter; it is only those who care for and assert their rights that get paid.

t is often said that money is at the centre of problems. And throughout the recorded history of mankind, many were confounded with its insufficiency. Its perpetual insufficiency is vying for the mind-share of everyoneright from ministers to mutual fund managers, CEOs of corporates to ordinary citizens on the road, presidents of nations to destitutes in the sub-Saharan jungles. Its pursuit has driven many crazy. Even love didnt make that many fools of men. There are scant signs that wisdom evolving out of the enlightened governance of even the twenty-first century will help counter this. In fact, it has transformed into an infectious greed of giant proportions, as never before witnessed in the civilized history. This slide is best illustrated by the corporate scandals that are being reported from the US in which shareholders are reported to have lost trillions of dollars, while the corporate bosses have walked away with huge cash payments and stock options. Every one, right from the Board of Directors, CEOs, auditing firms to shareholders, has contributed his mite to this increasing rot in the corporate world.
October 2002.

352

REFLECTIONS ON FREE MARKET

For many, inclusion of shareholders in the list of the accused for the present sorry state of affairs in the corporate world of the US may sound unfair, but that cant be helped. Anyway, putting this aside for a while, let us take a deeper look at the otherwise expected role of the shareholders in protecting their own investment interests. No one can deny that investors are capable of influencing managers to create value for the firms shareholders. If not individuals, certainly, institutional shareholders are fully armed to ensure managerial discipline by significantly influencing corporate management, for today they control over half of the stock in the US market. It doesnt mean they have to take a confrontational posture. A behind-the-scene cooperative approach could have been launched by them to resolve issues that are in direct conflict with the interests of managers and shareholders, such as executive compensation, stock options, expansion or diversification of business. They should have taken the managements that are stonewalling shareholders interests to task. Another thing that these investors could have done to counter the corporate dishonesty was to act as whistle blowers. They could have drawn the attention of the regulators to the suspected corporate malpractices. Instead, during the whole of the last decade, American shareholders being entranced by their surging wealth, spent time and energy in deifying companies and their chief executives. In chorus, they have been singing the praises of the CEOs for the kind of growth they could record and market valuation they could offer. Amazingly, they remained content with the kind of market valuations they could enjoyall in the greed for making quick money. Swayed by irrational exuberance, they willingly ignored their own long-term interests vis--vis short-term gains. The sway was so strong that even the burst of the dotcoms or of the stock market bubble could not shake the investors out of their

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quiescence. They were so overwhelmed by their greed and the apparent scope to make money in the market that they never bothered about the kind of compensations being demanded by the executives from time to time nor did they have time to foresee the impact of stock options etc., on the ultimate behaviour of the executives or their propensity to manipulate these provisions for their personal aggrandizement. Today, however, having lost trillions of dollars, the investors have suddenly become vociferous in decrying the role of CEOs, board of directors, auditors, regulators etc. Such an outcry can at best only, help better the future. Nevertheless, it has changed the very mood of investors. All of them have become remorseful and to that extent everyone in the market has become wise. This newly-dawned wisdom prompts us to recall what Adam Smith once said: It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. Smith was very categorical in saying that the individual intends only his own gain. Ironically, the present episode stands as proof to Smiths proclamation. In the instant case, the corporate executives could articulate their own gains by seeking all kinds of remunerations and pursuing them to the hilt without being mindful of the means of their execution, while the poor shareholders who, by abdicating their responsibilities towards their own interests, lost all their wealth. The obvious revelation is that it is not just the corporate managers who need to be honest about their performance, even investors need to be more dispassionate in taking a view about what they have been told by the corporate bosses. As Americas Securities and Exchange Commission had advised, they need to view the pro-forma earnings reports of companies with appropriate and healthy scepticism as they are generated for a variety of purposes.

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REFLECTIONS ON FREE MARKET

True, in good times, these ambitious projections could be achieved. But in an economic downturn, these out-of-reach targets can lure some managers to fudge the figures and get away with it, unless shareholders are watchful of such misdeeds. At least, the institutional investors must be active in picking up such cues from the whistle blowers, hailing particularly from inside the companies and pursue them to their logical end. For example, it is reported that at Enron, some staff did express their concern about the accounting practices being adopted by it much before it spiralled into bankruptcy. It is just not enough to merely pick up the signals from such whistle blowers; they must also encourage and protect such employees interests as companies are reportedly treating them as alien-class, though regrettably. Now moving back to the alleged contribution of shareholders to the present corporate sham, it becomes obvious that unless shareholders pursue their own interests rationally and dynamically, nothing can counterbalance the corporate managers pursuit of their own interests. Doesnt it mean that it is not silence but the activism of shareholders which matters in ensuring personal as well as public good?

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Individual interests vs. public good

355

SEVENTY NINE

Individual interests vs. public good


Personalized interests that confine to natural boundaries can alone result in public good.

ong ago Adam Smith said: Every individual endeavours to employ his capital so that its produce may be of the greatest value. He generally neither intends to promote the public interest, nor knows how much he is promoting it. He intends only his own security, only his own gain. And he is in this led by an invisible hand to promote an end, which was no part of his intention. By pursuing his own interest he frequently promotes that of the society more effectually than he really intends to promote it. True, companies work towards creating shareholder value by identifying and undertaking investments that generate returns far greater than the firms cost of raising money and in so doing they do a favour to the societythe favour of facilitating allocation of capital to the best of the projects. Similarly, an individuals investment in a project, though for personal gain, produces the maximum public good that caters to the felt needs of the individuals. This is perhaps what Adam Smith meant by the invisible hand at work in the capital market.
September 2002.

356

REFLECTIONS ON FREE MARKET

But the current string of scandals pouring out of Americas most high-flying corporatesEnron, Xerox, Tyco, Global Crossing and most recently, WorldComare challenging this belief, for investors portfolios have shrunk in value while the CEOs pockets have puffed up. Worse, the much-talked-about USGAP and the regulatory institutions the so called beckon lights of capitalismhave all been found wanting while corporate bosses were busy cooking the books, shading the truth and breaking the laws. Furthermore, even the outside directors and auditors have failed to detect the growing corporate malfeasance. Responsible CEOs have continued to collect huge bonus packages while the value of their companies dramatically declined, resulting in a move towards filing for bankruptcy. Indeed, most of the Americans and their media today are squarely blaming the executive pay and granting of stock options as the root cause of all the bad that has happened. In certain quarters, there is a strong argument that it is the huge amount of stock options dished out to executives that encouraged the bosses to behave despicably. Since the venerated corporate bosses were exposed as fraudulent hucksters, the whole world has been gunning for their heads. Even President George Bush has lamented that faith in the integrity of American business leaders was being undermined by executives breaching trust and abusing power. The American agony over the corporate happenings is well captured in the statement of the Presidentthe business pages of American newspapers should not read like a scandal sheet. These misdeeds have only swelled up public anger and in the process, much abuse is being heaped upon the business executives who as a class are being condemned as untrustworthy and venal. The anguish generated by these outpourings from the citizens over the business executives is indeed making the likes of Intel Chief feel class alien.

Individual interests vs. public good

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Set against this long list of American corporate failings, one is ill at ease in appreciating Adam Smiths invisible hand and its supposed role in promoting public good. That apart, the present focused pursuit of personal interests by the corporate executives of Enron, etc., ended up eroding the value of real stake-holders. Amidst this mess, Where is the prophesied public good? remained a moot question. Hang on, for there are reasons for optimism. There is another side to the history of American corporate world that is equally interesting. The corporate landscape of the USA is equally swamped by philanthropic deeds of the corporate barons who poured their individual fortunes made out of their personal investments into great universities, art galleries and medical schools. As recently as last year, Gordon Moore of Intel is reported to have donated US$5.8 bn to their family foundation and another US$300 mn to California Institute of Technology. It is an acclaimed fact that the richer the Americans become, the higher the amounts they contribute to charities. And Americans have, of course, amply rewarded the corporate executives by simply deifying them till yesterday. The American business system, besides being highly creative, has virtues as well as vices. And there is nothing surprising if the Americans had alternately deified and demonized the corporate bosses. That aside, what now matters most is, What has this history of philanthropy exhibited by the business barons got to say about the ongoing ruckus over corporate malfeasance? This conflicting exhibition of virtues and vices perhaps reveals that pursuit of personal interests purely driven by infectious greed is less likely to do any public good. The invisible hand becomes visible if only the individuals or corporates pursue their interests with honesty of purpose and integrity of approach. Any deviation from the commonly expected rational, cool-headed and law-abiding behaviour

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REFLECTIONS ON FREE MARKET

is more prone to belittle Adam Smiths proclamation. In the ultimate analysis, who knows, if it wont do any good even to the pursuer of chicanery for he is likely to be haunted by the law-enforcing agencies compelling him to cough-up the ill-gotten money. Even jail-terms cannot be ruled out as is currently being contemplated by the political bosses. Such a reaction from the society for reversing these alarming trends when there is still time, hopefully will put the system back on rails enabling it to contribute its expected mite to the public good. And who knows if this mechanism is a part of the whole that constitutes Adam Smiths invisible hand working silently towards public good. If that is true, it is time for the eminent public-spirited businessmen of integrity to come forward and take the lead in devising measures to combat this metastasising malignancy. Else, there is every danger of political bosses, in their anxiety to prove their commitment to sanitize the system, enacting stifling legislation that may ultimately prove to be more harmful than the disease itself. Whether such a movement would restore the role of the corporates in contributing to the public good as contemplated by the great philosopher and economist, Adam Smith, way back in 1776 or not is for the corporate world and its leaders to decide.

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Anandame jeevita makarandam

359

EIGHTY

Anandame jeevita makarandam


Beauty is truth, truth beauty, that is all Ye know on earth, and all ye need to know. Thats all what one needs to know even to be in ananda.

ne summer evening, a song anandame jeevita makarandam (bliss is the nectar of life) wafted along from a distance. It was like notes of bells, sounds of musical instruments, the ordinary noise of wind or rain on window panels all in gay abandon. Walking along with it was like an unquenched thirst suddenly getting miraculously fulfilled. As the time ticked, the fading song posed a question: where to find ananda and how to possess it? Search for ananda has been eternally haunting man. This eternal search could have prompted Erich Fromm to say: man is the only animal for whom his own life is a problem which he has to solve. And the greatest hurdle that is coming in the way of finding a solution is the very thinking process that we apply and the set of values that we have evolved to guide our reasoning. Is it our over-emphasis on finding a single solution exclusive of all others that is defeating our very purpose of pursuit of happiness and ananda?

May 2006.

360

REFLECTIONS ON FREE MARKET

As the world is increasingly moving towards industrialization, the Western protagonists of capitalism perceived economic progress as the lynchpin of happiness. Its their belief that economic progress builds a fairer and better ordered society. It is supposed to facilitate a sensible and decent living. But it has not turned out to be so nor would it in the future. The capitalism-driven search for excellence and efficiency in every walk of life has only divided the society into haves and have-nots. They have positioned pursuit of efficiency and economic growth on a high pedestal that has resulted in pricing every work either very highly or simply at zero. Is it not what echoes from what Thoreau once said: the silent poor who built the pyramids to be the tombs of the Pharaohs were fed on garlic, and it may also be that they were not decently buried themselves? Does it mean that this difference between the haves and have-nots is the only constant to remain eternally unchanged amidst Epicures eternal change? This singular pursuit for economic excellence to the exclusion of all else which was the hallmark of laissez-faire capitalism could have made John Maynard Keynes to lament: There must be no mercy or protection for those who embark their capital or their labour in the wrong direction. It is a method of bringing the most successful profitmakers to the top by a ruthless struggle for survival, which selects the most efficient. It does not count the cost of struggle, but looks only to the benefits of the final result which are assumed to be lasting and permanent, once it has been attained. The object of life being to crop the leaves off the branches up to the greatest possible height, the likeliest way of achieving this end is to leave the giraffes with the longest necks to starve out those whose necks are shorter. Aside from these economic thoughts, there are wide-eyed poets who had something else to romanticize on happiness. There is John Oldham, Englands favorite satirist of 17th century, who wrote: Musics the cordial of a troubled breast,/The softest remedy that grief

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361

can find/The gentle spell that charms our care to rest/And calms the raffled passions of the mind. I feel physically refreshed and strengthened by it, said Coleridge about music. Even Goethe said that music made him unfold like the fingers of a threatening fist which straighten, amicable. A. E. Housman had a different poem (that captures the mood of industrial revolution well): And malt does more than Milton can/To justify Gods ways to man/Ale, man, ales the stuff to drink/For fellows whom it hurts to think. There is that saint-composer from South India, Thyagaraja, for whom the economics of happiness is centered on his commune with his God through his kritis Marugelara Oh! Raghavawhy concealment, Oh! God, and such other 500 and odd compositions. A noted Telugu poet of 20th century, Sri Sri, poured-out his longing for a poeticrelationship in his exquisite lyricism: love you for what you are/and say here I am to pop tear-filled eyes for thee/that alone is wealth/that alone is swarg. So, we had economists on one side who said economic progress leads to happiness and, on the other side, we had poets for whom right from music to tear-filled eyes to relationships, to malt, is the source of happiness. These conflicts relating to happiness made people to aver: there is more to human happiness than can be encompassed in terms of economic measures alone. This could not however last longer, for with the advancement in the tools for economic studies, a new breed of economists engaged themselves in examining the empirical determinants of happiness. Intriguingly, today, there is a copious literature on economics of happiness. David G Blanchflower of Dartmouth College, Hanover and Andrew J Oswald of Warwick University have taken it to further (bizarre?) heights by attempting to estimate econometric happiness, factoring sexual activity as an independent variable. Here, they conceptualized happiness relying on the definition given by Veenhoven: the degree to which an individual judges the overall

362

REFLECTIONS ON FREE MARKET

quality of his or her life as favorable, while ignoring the psychologists understanding of happiness in terms of context-free happiness well-being from life as a whole, and context-specific happiness well-being associated with a single area of life. Their conceptualization of happiness indeed has the support of literature which reveals that self-reported happiness is a mere reflection of four factors: circumstances, aspirations, comparisons with others, and a persons baseline happiness or disposition outlook. Interestingly, much of the literature suggests (redicules?) that one should think of people as getting utility from a comparison of themselves with others. They took off from this platform to construct an econometric happiness equation with sexual activity as independent variable to find out the links between money, sex, and happiness. The study revealed a positive association between frequency of sexual activity and happiness. Indeed, it was statistically well-determined, monotonic and large. That is the ever-mounting conflict between happiness and its attainment! Let us for a while look at it from an ancient Indian perspective: Nanda in Sanskrit means that which can reduce in quantity. Ananda means that which cannot reduce in quantity. Simply put, ananda means bliss! Ananda is not joy, for it comes without a reason. It just is or is not, while joy is something that we feel through senses and hence we need to have an external object such as sex in the case of econometric happiness or music or relationship as in the case of poets. When one feels joy without these external objects/sensory inputs, it becomes bliss. Ananda simply comes from within and thus is independent unlike the happiness in the econometric equation of David and Andrew. It otherwise means that the very living becomes a bliss when it is not attached to externalities. It is by stopping to seek that one finds bliss, and, if that is accepted and cultivated, every other economic good becomes irrelevant for being happy for being in bliss.

Anandame jeevita makarandam

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This raises a new question: How is it that some retain that intrinsic capacity to be happy, to be in bliss; while others lament its absence? The answer perhaps lies in the axiom: a man is nothing but his mind; if that be out of order, alls amiss and if that be well, the rest is at ease. Mind can be in order when there is coherence in our thought process. Our knowledge of happiness and ananda, as Paul Thagard observed elsewhere, is not like a house that sits on a foundation of solid stones, but is more like a raft that floats on the sea while all the pieces of the raft fit together and support one another. A belief cannot be justified merely because it is indubitable, but because it coheres well with other beliefs and support one another. As Rawls said, we must adjust our whole set of beliefs, practices, and principles until we reach a coherent state called reflective equilibrium. Now the question is how to achieve it? We all know that from music to rainbow, beautiful objects produce pleasure and happiness which means beauty has a large emotional component. But as many philosophers observed, it also has a large component of coherence. Beauty is the unity or coherence of the imaginary object; ugliness its lack of unity, its incoherence, said R.G. Collingwood. The human mind, by configuring such coherence amongst its various beliefs, values, and expectations can generate beautiful experiences, which means happiness, which means ananda. For that matter, the very knowledge of it, as an ancient Indian seer said, is ananda. No wonder, in that configuration, you hum those undying lines, all in gay abandon Andame anandam/anandame jeevitha makarandam* (Beauty is bliss and bliss is the elixir of life).

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* from a lyric of Samudrala (1958).

Index
A
A E Housman, 361 Acceptable Level of Inflation, 123 Accountability, 18, 112, 115, 119, 156, 265, 339, 340 Accumulation of Profit, 170 Acquisition, 39, 50, 73, 109, 141, 143-145, 186, 211, 212, 214, 325, 344 Adam Smith, 71, 98, 103, 353, 355, 357, 358 Adaptability, 40 Administration-Driven, 211, 212 Affluence, 14, 16 Affluent Class, 4 Air Sahara, 143 Aircraft Utilization, 144 Alan Greenspan, 30, 64, 281 Algurai Shastri, 332, 333 Alien-class, 354 Allocative Efficiency, 249 Alpharma SAS of France, 325 Alyssa Ayres, 304 American Economy, 30, 31, 34, 64 Amos Tversky, 178, 194 Ananda, 359, 362, 363 Anavrishti, 266, 370 Anchor Currency, 255 Anchoring, 195, 196 Andrew J Oswald, 361 Angry Apes, 316, 317 Anil Ambani, 336, 339, 341-343 Announcement-Effect, 121 Anti-Dumping, 88 Apsara, 314 Arcelor, 139-142 Art of Negotiation, 344 Asian Markets, 138 Asian Surpluses, 24 Asset Price Bubble, 32, 286 Asymmetry of Information, 348, 349 Atmospherics, 17, 18, 115, 258, 308, 310 Atomic Energy Commission, 313, 315 Aviation Industry, 143 Azim Premji, 10

B
Bad Cholesterol, 261 Bad Equilibrium, 249 Badla, 153 Balance of Payments Problem, 253, 254 Balanced Nutrition, 11 Bankruptcy, 72, 104, 127, 331, 354, 356

366 Barclays Capital, 4 Barrier-Free Trading, 56 Basel Committee, 222 Basel II Accord, 224 Base-Period, 77 Bayesian, 32 Ben S Bernake, 21 Berlin Wall, 79, 95

REFLECTIONS ON FREE MARKET

C
C Rangarajan, 331 Cadbury Committee, 340 California Institute of Technology, 357 Calvin and Hobbes Cartoon, 137 Cannibalize Competing Brands, 212 Capability Builder, 327 Capital Account Convertibility, 36, 209, 247, 248, 250, 272, 278 Capital Adequacy, 52, 214, 221-224, 250 Capital Flight, 249, 294 Capital Flows, 114, 192, 208, 248, 269 Capital Formation, 85, 152, 242, 249 Capital Gain, 151-154, 156 Capital Guzzler, 43, 81 Capital Market, 52, 92, 94, 118, 133, 146, 165, 168, 171, 182, 223, 247-249, 258, 265, 271, 284, 331, 337, 355 Capital Risk, 238 Capitalism, 6, 14, 16, 118, 356, 359, 360 Carnegie Endowment for International Peace, 313 Carolyn Merchant, 189 Carry Trade, 23, 24

Best-fit, 125, 345 Bhabha Atomic Research Centre, 301 Bilateralism, 88 Bill Watterson, 137 Bimal Jalan, 276 Biocon, 158 Biotechnology, 60, 158, 329 Bi-Polar, 4 Birla Ambani Report, 28 Black Monday, 160, 163 Bond Market, 34, 38 Bond Yields, 34, 75, 286 BPO, 5, 9, 26, 306, 307, 309, 310 Breaching Trust, 356 Bretton Woods System, 283 Brookings Institution, 312 Budget Deficit, 84-86, 253 Bureaucratic Interventions, 5 Buruntlant Commission, 191 Business Cycle Conditions, 169 Business Opportunity, 155 Business Prospects, 157 Business-Driven, 212, 215

Index

367 Commodity Derivative Instruments, 47 Commodity Prices, 44-47, 76 Common Investors, 147 Communism, 7, 14 Community Vocational Training Centers, 57 Compatibility, 61, 322 Competitive Edge, 42, 79 Complementary Role, 40, 80 Compulsive Buying, 203, 204 Condoleezza Rice, 312 Confucius, 339 Congress Party, 331, 332 Consumer Price Index, 120-123 Consumerism, 66, 74, 109, 110, 201, 203, 205, 241, 243 Context-free Happiness, 361 Contract Farming, 60-62 Contract Research, 327 Contrarian Fund, 164, 166, 167 Contrarian Investment, 149, 167 Contrarian View, 166, 167 Conventional Wisdom, 16, 285 Convergence, 25, 96, 161, 188, 292, 327, 339 Convergence in Communication and Computation, 25 Cooking the Books, 356 Cornell, 178 Corporate Governance, 119, 155, 182, 222, 223, 322, 336, 337, 340-343

Central Planning, 95 Centre for Asia Pacific Aviation, 144 Centre for Strategic and International Studies in Washington, 304 Ceylon National Congress, 68 Change Managers, 138 Chhandogya Upanishad, 323, 343 Chief Executive, 117, 218, 321, 352 Child Labor, 188 Chiquita, 97 CIRUS Reactor, 301, 314 Civic Strife, 67 Civilian Nuclear Power Industry, 303 Clarity of Purpose, 182 Class Alien, 356 Classical Economic Theory, 14 Clause 49, 321-323 Clinical Research Trails, 327 CMIE, 26, 294 CNOOC Ltd, 141 Coal-based Energy, 302 Cognitive Skill, 11 Colas, 332 Cold-War, 95 Coleridge, 361 Collaboration, 41, 42, 60, 101, 312, 327-329 Collection-base, 78 Commercial Potential, 303

368 Correction, 137, 180, 251, 260 Cost Effective, 326, 327, 329 Cost of Sterilization, 287 Cost Push, 75-77, 242 Country of Contrasts, 4 CP Pharmaceuticals, 325 Crawling Pegs, 209 Credible, 128, 169, 287, 313 Cross-Border Acquisitions, 141

REFLECTIONS ON FREE MARKET

Servicing Capacity, 44 to-the-GDP Ratio, 36 Default Risk, 157, 236 Deficit Financing, 254, 259 Deflation, 3, 21-24, 34, 132, 240, 242 Delivery Application Services, 306 Demand-Pull, 75, 242 Deng Xiaoping, 331 Depreciate, 37, 273 Deregulations, 167 Derivative Market, 152 Derivative Securities, 154 Derivatives, 44, 47, 48, 154, 183, 186 Derivatives Trading, 47, 48, 154, 183, 186 Destabilization of Economy, 272 Dhirubhai Ambani, 336 Discretionary Monetary Policy, 254, 255 Discriminatory Approach, 97 Disinvestment, 72, 116, 119 Diversification, 38, 162, 240 DMFs, 325 Doctrinaire Politics, 14 Domestic Assets, 24, 254 Borrowings, 84 Mutual Funds, 51, 171, 172, 206 Prices, 261 Support, 59

Cross-Border Portfolio Flows, 153 Crowding, 257 CRR (Cash Reserve Ratio), 122, 129-132, 277 Cultural Transition, 308 Currency Board, 209, 210, 252-256 Currency-Traders, 284 Current Account Deficit, 69, 262, 263 Custom Chemical Syntheses, 327 Cutting-edge Technology, 302 Cyclical Expansion, 237 Cyclical Inflows, 147

D
D R Mehta, 157 Daniel Kahnemal, 177 David Bweinberger, 183 David G Blanchflower, 361 David Hume, 259 Debt Financing, 37 Market, 38, 154, 157, 250 Payment, 38

Index

369 Economics of Happiness, 361 Economies of Scale, 212, 213 Education Zones, 9 Efficient Management, 118, 265 Elementary Education, 11 Embedded Risks, 156, 229 Emerging Economies, 30, 141, 266 Employable Graduates, 6, 8 Endowment Effect, 177 Enron, 127, 348, 354, 356, 357 Environment, 6, 104-106, 188, 190-192, 222, 239, 249, 302, 329, 339, 340 Epigraphist, 15 Equity Investments, 159 Erich Fromm, 217, 359 Ernst & Young, 325 Escape from Freedom, 217 Evergreening, 227, 228 Exchange Economy, 259 Exchange Rate Risk, 263, 280 Excluded Voices, 6 Exit of Foreign Investors, 37 Exoteric Knowledge, 16 Expansion, 8, 38, 114, 162, 164, 190, 191, 228, 229, 237, 240, 241, 259, 260, 352 Expected Utility Theory, 194 Export Subsidies, 59 Export-Driven, 70 Exporting Countries, 64 External Commercial Borrowings, 91, 227

Dotcom Era, 155 DP World, 141 Dr. Anil Kakodkar, 315 Dr. Y. V. Reddy, 122

E
Earnings Management, 348 Earnings Risk, 58 East-Asian Crisis, 277 Easy Monetary Policy, 21 Ecological Stability, 105 Ecology, 188 Econometric Happiness, 361, 362 Economic Contraction, 163 Exposure, 281 Freedom, 13 Fundamentals, 36, 136, 137, 147, 149, 208, 269, 283, 284, 289, 298 Inequality, 15, 106 Models, 32, 194 Patriotism, 142 Planning, 67 Reforms, 25, 71, 74, 202, 333 Risk Exposure, 268 Risk, 110, 263, 268, 281 Stability, 14, 15, 105, 106, 339 Theory, 14, 40, 106 Variable, 123, 281, 297 Economically Rational Owner, 268

370 External Debt, 36 External Payment Crisis, 37 Externalities, 362 Exuberance, 166, 291, 294, 352

REFLECTIONS ON FREE MARKET

Flat Yield Curve, 231-235 Flattening Yield Curve, 234, 235 Flexibility-Price Monetary Model, 283 Flexible Exchange Rate, 278 Float, 51, 100, 209, 210, 239, 265, 274, 277, 284, 363 Foreign Direct Investment, 55, 79, 95, 96, 272, 331 Exchange Reserves, 36, 37, 75, 83, 87, 92, 164, 207, 250, 257, 258, 261-266, 272, 273, 275, 276, 278, 286, 288, 289 Institutional Investors, 38, 168, 172, 175, 206, 331 Forex Reserves, 36, 92-94, 148, 247, 257, 259, 260, 262, 286, 290, 293, 294 France, 84, 139-141, 325 FRBM, 18 Free Float, 153, 168, 209, 210 Flowing Dollars, 138 Floating Stock, 153, 168 Market, 6, 16, 126, 159, 162, 172, 297 Trade, 105, 250 Trade Agreement, 87-90, 250 Functional Currency, 263, 280

F
Falling Unemployment, 33 Farming Community, 19, 59, 152 Fast Breeder Test Reactor, 301 Fast Reactors, 302 Feeder Funds, 274 Fiat Money System, 21 FICCI, 112, 115 FII Inflows, 93, 165, 169, 207, 251 Financial Crises, 32 Intermediation, 40 Reporting Council, 340 Risks, 157 Synergy, 213 Transparency, 347 Fiscal Constraints, 18 Crisis, 84, 85, 99, 100 Deficit, 18, 24, 27, 35-38, 83-86, 99, 109, 110, 113, 114, 119, 130, 223, 251, 257, 271, 294, 297 Discipline, 18, 255, 261 Material Cut off Treaty, 312 Material, 304, 312 Fixed Exchange Rate, 278 Flat Pitch, 231, 234, 235

Index

371 Governance, 3, 78, 105, 112, 113, 115, 119, 131, 155, 157, 182, 222, 223, 290, 299, 321-324, 336-343, 350, 351 Governance Risks, 322 Government Procurement Agreement, 59 Government Securities, 37, 75, 101, 154, 224, 232, 234, 236, 269 Government-owned Banks, 154 Grasim, 344, 346 Green Field Airports, 143 Greg Mankiw, 34 Ground Crew, 144 Growth Path, 34, 331 Guy Dolle, 140 Guzzler of Capital, 79

Future-initiatives-centric, 335 Futures Contract, 186

G
Gail, 72 Gas-cooled Fast Reactor, 302 Generic Players, 327 Geoffrey Garrett, 249 George Loewenstein, 178 George Perkovich, 313, 315 George Stiglitz, 96 GIC, 162, 172 Gilt Securities, 254 Glasnost, 95 Global Capital, 38, 249, 284 Interest Rates, 137, 169 Pharma Report 2004, 325 Trends, 56, 153 Globalization, 5, 7, 8, 10, 25, 28, 33, 58, 95-98, 103, 105, 135, 139, 142, 167, 208, 226, 251, 292, 340 Globalization-Free, 25 Globalized Economy, 8, 10, 13, 25, 42, 66, 82, 211, 236, 263, 268, 270, 281 Globalized India, 168, 169, 171 Goethe, 361 Goh Chok Tong, 330 Gold Rushes, 126 Good Equilibrium, 249 Gordon Moore, 357

H
Hamel, Doz & Prahalad, 327 Hamlet, 337 Hangars, 144 Happiness, 138, 359-363 Health Risk, 58 Hedge Funds, 161, 162, 165, 169, 174 Hedging, 127, 183-187, 273 Herd Mentality, 165 High Net-Worth Individuals, 171 High Price-earnings Ratio, 148 High-cost Processing Centers, 141 Hindu Growth Rate, 332

372 Homi Bhabha, 314 Homoeostasis, 350 Hubris, 136 Human Advance, 14 Capital, 5, 12, 108, 111 Dignity, 188, 308, 309 Progress, 15 Rights, 191, 340

REFLECTIONS ON FREE MARKET

International Atomic Energy Agency (IAEA), 311, 312 Energy Agency, 64 Herald Tribune, 142 Linear Collidor, 302 Statesman, 330 Thermonuclear Experimental Reactor, 302 Trade, 25, 64, 87, 88, 262 Inter-University Accelerator Centre, 303 Intrinsic Value, 158, 196, 348 Inversion of the Yield, 233 Inverted, 232-235 Investment-Shy, 226 Investor Community, 73, 156 Investors Heart, 145 Invisible Hand, 355, 357, 358 Inward-looking, 70 IPOs, 155, 156, 158, 162 Irish Digest, 151 Irrational, 136, 193, 194, 196, 197, 204, 229, 352 Irrational Behaviour, 194, 197 Irrational Exuberance, 352 Irrationality, 193, 194

I
IBM, 332 Ideologies, 14 Illiteracy, 4 Ill-Liquidity, 234 Import Substitution, 67, 68, 70 Imported Inflation, 76 Inclusive Brand of Capitalism, 6 Incredible Inflow, 169 Independent Directors, 322, 323 Index-Stocks, 149 Indian Air Travel Industry, 144 Indian Banking System, 29, 170, 213, 221 Indian Oil Corporation, 72 Indiana University, 304 Indira Rajaraman, 18 Infectious Greed, 351, 357 Insurance Penetration, 41 Insurance Regulatory and Development Authority, 39, 41, 81 Internal Debt, 36

J
Jacques Chirac, 140 Jaduguda, 315 Jagdish Bhagwati, 87, 248 James K Sebenius, 344

Index

373 Learning Society, 188 Least Uncertainty, 161 Lee Hsien Loong, 330 Lenders of the Last Resort, 254 Less Endowed, 11, 12, 62, 201 Less Monetized, 259 Leveraging on Diversity, 10 LIC, 41, 99-102, 162, 172 Licence Raj, 5 Liquidity, 21, 22, 37, 76, 92, 121, 122, 127, 130, 131, 135, 147, 148, 153, 168, 170, 228, 231, 233, 234, 237, 238, 258, 274, 275, 286, 287, 290, 293 Liquidity Crisis, 228, 258 Liquidity-Overhang, 92, 274 London Stock Exchange, 340 London Tube, 317 Long-Only-Market, 234 Long-term Capital Gains, 151-153 Capital Gains Tax, 152, 153 Interests, 153, 352 Investor, 153, 154, 163 Loss-making, 145 Low Price-earnings Ratios, 149 Low-density, 261 Low-priced Quality Goods, 141 LTCM, 31 Ludwig von Mises, 119 Luxembourg, 139-142

James Meade, 89 Japanese Forex Reserves, 148 Japanese Yen, 206, 207, 268 Jean-Claude Juneker, 140 Jet Airways, 143 Jnana, 343 John Maynard Keynes, 252, 360 John Oldham, 360 John Stuart Mill, 288

K
Kahneman, 178, 194, 196 Kant, 318 Karl Schiller, 255 Karma, 323, 324 Kautilya, 108, 339 Keynesian, 13, 103, 105, 114 Keynesian Theories, 105 Kings Cross, 316 Klein Lawrence, 8 Knetsch, 178 Korean Won, 268 Kuznets Curve, 106

L
L&T, 344 Labor Market Risk, 58 Lady Macbeth, 338 Lakshmi Mittal, 139 Lawrence Summers, 250, 251 Lazy Banking, 236 Leadership, 17, 26, 68, 77, 98, 111, 112, 115, 117, 118, 181, 214, 229, 278, 333

374

REFLECTIONS ON FREE MARKET

M
M V Ramana, 313 Macbeth, 338 Machiavelli, 333 Macroeconomic Fundamentals, 36, 147, 149, 208, 269, 283, 284 Macroeconomic Interdependencies, 25 Macro-Economic Management, 94 Macroeconomic Phenomenon, 148 Madrid, 317 Mahatma Gandhi, 112 Malls, 202, 309 Malt, 361 Managed Floats, 209 Management Efficiency, 118, 265 Mandatory Rating, 156, 159 Manmohan Singh, 301 Mark to the Market, 207 Market Access, 59 Capitalization, 135, 152, 160, 162, 164 Economy, 6, 96, 104, 106, 163, 216, 322, 331 Makers, 295, 296, 298 Mechanics, 33, 171 Neutral, 48 Perception, 158

Plus Return, 149 Prices, 47, 52, 62, 161, 173, 181 Sentiment, 149 Stabilization Bonds, 286 Stabilization Scheme, 269 Turnover, 165 Economy, 163 Punishment, 350 Stabilizers, 163 Massachusetts Institute of Technology, 315 Maturity Pattern, 36 Maturity Risk, 238 Maurice Greenberg, 322 Max India, 39, 43 Maximizing-Inflation, 132 McKinsey Global Institute, 25 Mental Hygiene, 11 Mergers and Acquisitions, 211, 212 Michael Eisner, 322 Micro-Manage, 17 Micro-Management, 94, 225 Midcap Companies, 38 Milton Friedman, 16, 31, 259 Mind-share, 351 Minor Risks, 32 Missile Technology Control Regime, 312 Missing Variable, 30, 32, 33 Mittal Steel, 139-141

Index

375

Modernization, 143 Modest Man, 330 Molten Salt Reactor, 302 Momentum Players, 165 Monetarists, 259 Monetary Basis Money Circulation, 254 Fronts, 251 Policy, 21, 23, 77, 78, 104, 120-122, 130-132, 209, 232, 251, 254, 255 Powers, 255 Sovereignty, 255 Stimulus, 31 Monetization, 261 Money Supply, 75, 128, 259, 261, 264, 276, 288 Month-end Scramble, 207 Monthly Turnover, 165 Morarji Desai, 332 Moratorium, 217, 218, 312 Morris Jastrow, 318 Mortgage-Backed Security Bonds, 52 MSBs, 264, 287, 288 Muhurat Trading, 146-148 Mujid Kazimi, 315 Mukesh Ambani, 335, 341 Multi-location Operations, 141 Mutual Funds, 51, 171, 172, 206, 291, 294

N
Nalgonda, 315 Namaskar, 307 Naresh Goyal, 143 Nascom, 309 Nasscom McKinsey Study 2005, 9, 26 Nations Payment System, 217 National Hedge, 282, 285 Employee Registry, 309 Interest, 7, 9, 305 Savings, 85, 110, 114 Uranium, 301, 302, 314, 315 Near Money, 217, 289 Negative Returns, 148 Nehruvian Economics, 331 Neoclassical, 113, 178, 179, 249 Neo-Liberal, 96 New York, 15, 35, 81, 169 New-Found Confidence, 226 Nippon Steel of Japan, 139 Niranjan Hiranandani, 50 Nirarthakam, 176, 177, 179 Nominal Interest Rate, 21, 124 Non Convulsive, 343 Delivery-based Trading, 153 Event, 17 Executive Director, 323

376

REFLECTIONS ON FREE MARKET

Institutional Segment, 153 Listed Conglomerate, 145 Plan Expenditure, 110 Polluting, 302 Proliferation, 312 Regressionary, 152 Resident Indians, 40, 169 Systemic Risks, 156 Normal Yield Curve, 232, 233 North-East, 315 NPAs, 117, 170, 226-230, 238 Nuclear Autonomy, 312 Fuel Cycle, 314 Quarantine, 304 Suppliers Group Guidelines, 312 Supply Group, 302 Technology, 302, 312 Triumph, 312 Number Manipulation, 348

Operating Efficiencies, 280, 281 Operating Synergy, 213 Opportunistic Behaviour, 83 Opportunity Loss, 184 Opportunity Share, 211 Option Contract, 186 Organization of Petroleum, 64 Organizational Learning, 211 Origin of Goods, 89 Orthodox Purists, 19 Othello, 338 Outflows, 38, 147, 208, 251 Outsourcing Politics, 158 Overand Under-Reactions Theory, 195 Over-Hyped Sectors/Stocks, 149 Overseas Corporate Bodies, 173

P
Pareto Efficiencies, 94 Parking Lots, 144 Parkville Holding, 39 Participatory Notes, 169, 173 Pass-through, 123 Pass-through Policy, 123 Paternalistic Authority, 16 Paul Volcker, 30 PCS, 158 Pension Funds, 40, 163, 165 Perestroika, 95 Peter Drucker, 214 Pharaohs, 360

O
OECD, 114, 250 O-Factor, 182 Off-Setting Swap, 297 Oil India Limited, 72 One-Time Assessment, 157 ONGC, 72, 118, 162 Opacity-Index, 182 Open Capital Markets, 271 Open Market Committee, 65

Index

377 Private Participation, 27, 143, 215, 305 Product Risk, 236 Production Problem, 61, 188 Prof. Peter Wysocki, 348 Profit Booking, 146, 165 Profitable Investment Avenues, 148 Profit-Maximization, 190 Progressive Politics, 13 Project Approach, 18 Promissory Notes, 165 Prospect Theory, 178, 179, 194, 195 Protectionist Economy, 90 Prototype Fast Breeder Reactor, 301 Provision Risk, 238 Prudent Investment, 41 Prudent Princes, 333 Prudential Protections, 38 PSU Banks, 181 Psychic Gratification, 202 Psychological Effects, 177, 178 PTAs, 87-89 Public Amenities, 14 Pull-Factor, 249 Purchasing Power Parity, 283

Philanthropic Efficiency, 324 Philosophic Calm, 324 PHWRs, 315 Planned-Economy, 163 Planning Commission, 257 PLR, 93, 238 Plutonium, 314, 315 Political Culture, 163 Liberalism, 13, 14 Overtones, 142 Power, 190, 339 Pollution, 188 Poor Growth Rate, 148 Portfolio Risk, 238, 292 Positive Inflation, 21 Postal Network, 101 Post-MFA Scenario, 55, 56 Poverty, 4, 14, 20, 53, 108, 111, 260, 261 Power Transmission, 258 Powerful Partnerships, 214 President Bush, 301 Pressurized Heavy Water Reactors, 315 Price Rigging, 218 Price Stability, 30, 31, 66, 104, 255 Price-Inelastic, 280 Primary Commodities, 44 Primary Market, 52 Principal-Agent Conflicts, 118, 265

Q
Quality of Reporting, 157 Quantitative Easing, 22, 23

378

REFLECTIONS ON FREE MARKET

R
R G Collingwood, 363 R&D, 57, 326 Rahul Bajaj, 10 Ratan Tata, 8, 10, 305 Rating Agencies, 157 Ratings, 37, 155-158, 169, 250, 322 Ratio of Debt-to-the-GDP, 85 Rational, 55, 106, 108, 117, 121, 136, 137, 144, 162, 171, 178, 193-197, 204, 213, 224, 229, 271, 272, 279, 297, 320, 348, 352, 354, 357 Rationality, 171, 193-195 Real Estate Equity Trust, 51 Investment Trusts, 50, 51 Mortgage Trust, 51 Syndicates, 50 Real Resources, 230, 259 Real-Time Gross Settlement, 239 Recession, 31, 32, 77, 105, 126, 128, 233, 235, 237, 249, 293 Re-Employable, 11, 57 Reflective Equilibrium, 363 Reform Trajectory, 208 Regret Theory, 195 Regulators, 52, 91, 119, 130, 131, 138, 157, 165,-167, 171, 173, 174, 180, 182, 185, 218, 220, 296, 298, 322, 323, 352, 353

Relegere, 317 Reliance, 20, 61, 95, 120, 305, 314, 335-338, 341 Reliance Capital, 36, 341 Energy, 336, 341 Infocomm, 341 Infrastructure, 341 Religare, 317 Religio, 67, 317-320 Repo Rate, 66, 233, 234, 287 Repositories of National Wealth, 217, 224 Representativeness-Heuristic, 196 Reservation Policies, 9, 10 Reserve Bank of India (RBI), 5, 18, 52, 66, 76, 83, 93, 122, 123, 129-132, 135, 167, 186, 204207, 209, 215-218, 221-225, 227, 228, 234, 235, 236, 238, 240, 241, 247, 251, 263, 264, 266, 267, 269, 271, 274, 276, 286-289, 293-298, 336, 337, 347 Resilience, 229, 236, 239 Resurgent India Bonds, 277 Retail Investors, 137, 165, 166, 171, 179, 183, 337 Returns on Capital, 145 Revenue Deficits, 18 Revenue/GDP, 114 Reverse Discrimination, 9, 11

Index

379 Self-centred Tendency, 346 Self-reliance, 95, 305, 314 Self-serving, 153 Sell-outs, 206 Sense of Conviction, 147, 149 Sensex, 76, 121, 1 3 5 - 1 3 7 , 146-149, 160, 164, 168, 172, 177, 179, 206 Services Business, 10 Shakespearean Drama, 336 Shareholder-Activism, 192 Silent Killer, 269 Siphoning of Funds, 118 Sir John Hicks, 252 Sir John Kotelawala, 69 Skewed, 4, 234, 346 SLR, 130, 131 Social Fabric, 11, 317 Social Inclusiveness, 12 Social Science, 16 Socialistic Program, 332 Socially Responsible Investing (SRI), 188, 191, 192 Solvency Margins, 42 Sordid Governance, 343 South-East Asian Countries, 249, 348 Sovereign Ratings, 37, 250 Special Purpose Vehicle, 261, 265 Spectrum Analyzers, 51, 52 Speculation-Driven Trading, 153 Speculators, 153, 165, 166, 296

Reverse Speculative Attack, 288 Richered Thaler, 194 Rising Inflation, 76, 137, 138, 243 Risk Analysis, 51, 184 and Return, 34, 137 Based Capital, 221 Perception, 157 Premiums, 238 Robert Blackwill, 302 Frost, 240 J Einhorn, 304 Shiller, 195 Roger Noll, 309 Rule Setter, 327 Rupee-Foreign Currency Swaps, 295

S
S.W.R.D. Bandaranaike, 69 SAARC, 250 Safety-Nets, 13 Sarbanes-Oxley Act of 2002, 322 Sarvahit, 324 Sarvopakari, 324, 343 Scale of Economies, 55, 212 Scientific Talent, 302 SDR, 126, 165, 212 Sebastian Edwards, 249 Secondary Debt Market, 154 Seismic Changes, 25

380 Spooking, 137 Sraddha, 323, 324, 343

REFLECTIONS ON FREE MARKET

Sweet Pill, 142 Symphony of Words, 15 Synergy Theory, 213 System of Affiliation, 27

Stabilizing, 40, 47, 80, 100, 264 Stagnation, 22, 32, 286 Stanford Center for International Development, 309 Start-ups, 162 State-Owned Enterprises, 117 Statesman, 301, 330, 331, 334 Steep Yield Curve, 232, 233 Stock in Trade, 136 Stock-Broking, 151 Stonewalling, 352 Store of Value, 127 Strange Familiars, 310 Strategic Clarity, 211 Strategic Counterweight to China, 312 Strategic Resilience, 239 Strobe Tall Bott, 312 Sub-Investment Grade, 38 Sub-PLR, 238 Sub-Saharan Jungles, 351 Subvention, 19 Sumit Ganguly, 304 Superficial Water-cooled Reactor, 302 Super-Rich, 4 Supply Chain Network, 328 Sustained Shareholder Value, 145 Swami Vivekananda, 323

T
Targeted Investments, 152 Tata Tele Services, 349 Tatas, 349 Tax Compliance, 154 Technology Upgradation Fund, 55 Theoretical Optimum, 209 Theoretical Threat, 37 Theory of Market Efficiency, 348 Thomas Friedman, 38 Thoreau, 360 Thorstein Veblen, 16 Three-stage Nuclear Power Program, 314 Tons of Patience, 147 Trade Agreements, 87-90, 250 Creation, 89, 90 Deficit, 33, 137, 208, 263, 264 Diversion, 89 Trampoline Architecture, 11 Trampolines, 11, 57 Transaction Tax, 15, 152-154 Transcendence, 318

Index

381

Transition of Power, 162 Transparency, 59, 106, 119, 222, 265, 297, 339-341, 347, 349, 350 Transparent, 51, 75, 77, 78, 106, 118, 221, 250, 313, 340 Tribal Gods of Both Left and Right, 15 Tricks, 151, 318 Tunnelling, 118 Turnover Tax, 151-154

V
Valuation, 52, 92, 137, 157, 158, 164, 166, 177, 322, 331, 348, 352 Value Outcome, 345 Value-creating Institutions, 340 Varishta Pension Bima Yojana, 99, 101 Vidya, 323, 324, 343 Virtuous Circle of Jobs, 5 Viryavattaram Bhavati, 323 Vision, 16, 84, 139, 147, 148, 150, 191, 212, 214, 314, 346 Volatility, 45, 52, 93, 135, 138, 148, 153, 169, 185, 208, 248, 251, 274, 292, 298, 337 VSNL, 349 Vulnerable Liabilities, 251, 294

U
Uncertainty, 40, 44, 47, 48, 61, 78, 106, 161, 163, 185, 217, 219, 284 Uncovered Interest Parity, 283 Under-Investment, 237 Under-Nourishment, 4 Unidentified Factor, 32 University of Maryland, 178 University of Pennsylvania, 304 Unocal Corp, 141 Unsolicited, 157, 204, 205 Urban Land Ceiling and Regulation Act, 50 US Federal Reserve, 65 US Housing Bubble, 24 US Trade and Fiscal Deficits, 24 USFDA, 325 USGAP, 326

W
Warren Buffett, 183 Warwick University, 361 Wealth Distribution, 4 Wealth Generation, 146 Welfare State, 13 Werner De Bondt, 194 Wharton Business School, 348 Whistle Blowers, 352, 354 Wholesale Price Index, 77, 120 William Jennings, 125 Wockhardt, 325

382

REFLECTIONS ON FREE MARKET

World Bank, 5, 27, 99, 100, 105, 110, 259, 261, 339, 340 World Bank Index, 5 World Interest Rate, 148, 284 World Trade Agreement, 59 World Trade Organization, 88, 325 WorldCom, 356 World-Machine, 189

Y
Yield Curve, 23, 231-235, 251, 287, 295, 297

Z
Zero Value, 296 Zia Mian, 313 Zydus Cadila, 325

X
Xenophobic Reaction, 141