This round goes to Krugman

Nocturnal catch-up with blogs in my IPAD led me to this post by Greg Mankiw. As David Demery mentions, it was a non-committal statement by Greg Mankiw. I checked out the Council of Foreign Relations (CFR) post and the comments on the post. It is rather obvious that, on this occasion, the score is Krugman 1 – CFR and Mankiw 0.

Even a non-economist would know that one does not measure the success of a policy (non) intervention by the recovery from the trough but also the gap that still remains to catch up with the pre-recession peak. If a price dropped from 100 to 20 units and recovered to 40, it is a 100% gain from the trough but one is still off 60% from the peak.

In contrast, another widget drops from 100 to 60 units and recovers to 90 units, it is only a 50% recovery (compared to 100% in case A above) from the trough but it is now only 10% away from the previous peak.

It is hard to make the case that policies pursued in case A have worked better or superior to case B. Of course, it does not necessarily mean that the opposite is true either.  More importantly, the measurement technique used to make the case is spurious and that is what makes one doubly suspect of the so-called conservatives’ claims.

Of course, this blog is no fan of Krugman’s prescription to keep raising the dosage of a medicine that does not seem to work. That is why TGS has stopped following Krugman, let alone comment on his blogs or articles.

What worked in Iceland might not have worked in Latvia. It may well be the wrong medicine for the U.S. too. Iceland could easily devalue the koruna because the Icelandic koruna is not the global reserve currency.

Latvia might have been worse off had it pursed Icelandic approach or Iceland might have fared worse had it followed Latvia or done better. We simply do not know. No one size fits all in economics. Yet, ideologues on both sides have only measurement and one shirt for all wardrobes.

More importantly, it is good to revisit the cases 10-years hence. Economic policies work with long and variable lags. There is no need to pass instant judgments and the urge to do so must be resisted. Of course, what we are witnessing is a battle of ideologues – a waste of time. This is not a debate between policy pragmatists who want to see what works in which context and over what time horizon.

If bankers and Wall Street have not learnt anything from the crisis, neither have economists.

India is better off with Khemka than without

Ashok Khemka reminds us of the noble purpose of education and public service. Also reminds us to be rather humble about what we do, in the so-called public space. This is about imparting meaning or generating meaning to one’s own existence. All strength to him.

Notwithstanding Khemka, T. N. Ninan reminds us of the long struggle lies ahead:

a backlash from the political system — to restrict the scope of the Right to Information (RTI) law, redefine corruption more narrowly so as to give more protection to ministers and officials, and to find ways to tar the private sector with the same brush (all three of which, please note, the prime minister has proposed!).

Hope this is really the answer for India’s corruption especially RTI is joining the list of India’s endangered species.

Good friend Anirudha Dutta responds objectively to Dinesh Narayan’s self-righteous piece in Forbes India on Gujarat under Narendra Modi.

International matters:

Reuters has an exclusive story on the preferred (by Party elders, that is) leadership line-up in China.

Moody’s warns of the fragility of the German banking system. Unlike America’s, I think it remains unreformed, post-crisis. Not that American banking system has reformed itself. But, American banks individually might have done more to shore up their balance-sheets than European banks have.

Staying with Germany, it is interesting to see the Bloomberg story on the discounts being offered by car manufacturers in Germany. Numbers talk of a 20-year low in vehicle sales, etc. Good for the global climate.

From Germany to China: Bloomberg headlines the scepticism of Standard Chartered economists on China’s GDP number for the third quarter, produced within a fortnight of the end of the quarter. It met consensus expectations bang on at 7.4% (y/y). Asianomics’ Jim Walker had a hard-hitting piece on it for clients (disclosure: I write for Asianomics). Interestingly, Bloomberg piece does not omit to cite the remarks of Chinese Premier-to-be on their GDP growth numbers. I came across this paper on manipulation of economic data in dictatorships in the Social Sciences Research Network (SSRN).

In fairness, one must record here many question the statistical seasonal adjustments carried out by the Bureau of the Labour Statistics of the US Government too. More recently, the non-seasonally adjusted retail sales figures for September contracted whereas the seasonally adjusted figure changed that to a solid m/m growth.  Again, Jim Walker of Asianomics, who is more positive on the U.S. economy than he is on the rest of the world – voiced his own surprise at the surprise dip in the U.S. Initial Jobless Claims between two Presidential debates and its climb-back to more normal levels after the debate ended.

While the Washington Post article chose to highlight companies that have reported good earnings in the third quarter and thus suggest good health for the U.S. economy, the Reuters news-story chose to focus on companies missing top line growth estimates (that have been lowered enough so that companies beat them – the oldest trick in the book that still remains fashionable).

Spanish Central Bank is attaching a 1% probability to an outcome (6+% contraction in real GDP between 2012 and 2014) that is fast becoming the baseline scenario for many economists.

On the 35th anniversary of the 1987 Stock Market Crash, Floyd Norris writes a somewhat hurried piece on the (rising) perils of (increasing) dependence on computers to generate stock market trades.

Finally, Andrew Sheng’s co-authored piece in ‘Project Syndicate’ is a good response to the Nobel Committee decision on the winners of the Economics Nobel this year (and last). Incidentally, just finished reading his Foreword to Dr. Reddy’s book on the Global Crisis released in 2010. Very well-written and disarming. Those who have not followed Dr. Reddy’s thoughts on many matters concerning the financial sector and its linkages with the broader economy and his thoughts on Indian economy and the Indian financial sector should buy the book without delay.

How to lose friends and turn people away – the IE way

Well, the title of the post says it all. That seems to be the objective of this IE editorial that seeks to advice the Reserve Bank of India on monetary policy. It starts off alright with the plight of the SME sector on credit availability. That is a problem that has continued to exist over time, over many governments and over many interest rate cycles. The problems and the remedies lie elsewhere. Not just in interest rate setting. They do not have access to credit at any price. Period.

The second paragraph talks of the pricey credit even for large borrowers.

The third paragraph then dives into a question which does not have a simple answer. But, the edit is brave enough to hypothesize (conclude, rather) that the high domestic cost of funds has made many corporations go overseas to borrow from foreign creditors. High cost of domestic funds is one reason but even if India brings down the interest rate to 6%, cost of funds in zero interest rate countries would still be lower for good Indian corporate borrowers. That would always be tempting for them. Therefore, that is no reason for the RBI to lower interest rates in India. Those who opt for overseas loans should take into account their present and future repayment capacity in foreign currencies. After all, the exchange rate risk has hurt them. Suzlon is a case in point. Of course, the exchange rate is not the only factor at work here.

Then, the last two sentences are pretty much disastrous:

The gainers are, of course, the arrangers for foreign loans, mostly foreign banks. Is it a coincidence that many of them have urged the RBI to hold its rates? The mid-term policy review on October 30 would be a good time to take a call.

Most of the economists covering India for foreign banks sit in India. The loans are perhaps agreed upon and signed off somewhere in Europe or in North America. When they extend these loans to Indian corporations, they have to factor in a whole lot of risks. It is not a risk-free arbitrage business vs. interest rates in India.

Moreover, what does the edit wish to convey to its readers about the intellectual calibre at RBI? That they dance to the tune of economists from foreign banks? So, on October 30th, if the RBI were to leave interest rates on hold, is the IE hinting that it could be due to the influence of foreign banks and not because the Government of India has talked a lot but delivered little (so far) on fiscal consolidation and that inflation is still around 8% (wholesale) and 10% (retail)?

Reasonable people can disagree on whether the Reserve Bank of India should cut rates on October 30th. But, to peg the argument for an economic policy and, that too, a monetary policy decision, on dark, conspiracy theories is sub-standard journalism.

(p.s: It is on par with their edit published in September on the detox treatment that Shri. Anna Hazare chose to go through. There is no public interest involved in that. Yet, the IE wasted an editorial on Anna Hazare’s detox treatment).

The politics of crisis-recoveries

A former colleague of mine had sent the latest and short update by Reinhart and Rogoff to their work (a continuing one) on debt crises, recoveries, etc. Their update seems to be a reaction to the comments made by Romney advisors – Hubbard, Hassett, John Taylor – that the US has had rapid recoveries from crises in the past and that this time it has been sluggish and different. In other words, blame Obama. That, in my mind, is silly. See this Bloomberg article.

But, I am not convinced by the ‘rebuttal’ put out by R&R. One, I do not know if the unemployment rates are comparable across different time periods. I am not saying they are not. I would like to be doubly sure since BLS methodologies changed over time. What is currently put out as the U6 measure of un/under employment used to be the original unemployment rate. Perhaps, BLS does revise the entire time-series when they make methodological changes.

Second, the recovery per dollar of stimulus – fiscal and monetary – must be taken into consideration – when one compares this recovery to the past. This recovery has seen massive stimulus – unprecedented. For that, it has very little to show. Costs will be harvested by the next incumbent – Obama or Romney.

In other words,  both camps have not got it right, in my view.

What am I missing?

A slightly edited version of an email written by Yours Truly to friends who research Indian macro for a sell-side house:

Dear Gentlemen,

Surjit Bhalla castigates himself for having written off this government. Newspapers are breathless about a reform a day. Even the sceptics have become a lot more understanding of the UPA.

I am seeing a largely ‘smoke and mirrors’ exercise. An effective one, surely. So, I am curious to know if I am missing anything substantive here.

  • FDI in retail – very little near-term impact; long-term could go either way
  • FDI in aviation – is any one bothered now? too little too late
  • FDI in pension and insurance – Parliament in the way still
  • FDI in power exchange – no one bothered
  • Aadhaar and cash transfer for fertiliser subsidy – pilot study launched and might take two years to become national policy, if at all it does
  •  Bank bad loans to Discoms – explicit fiscalisation and restructuring; underlying causes of DISCOM problem loans remain unaddressed
  •  Diesel prices raised by the GoI and not by OMCs and excise duty reduced. Should have been done six months ago. Brent crude still at 115 dollars er barrel. Can go a lot higher. Lot more might have to be done. Most Congress governments increased LPG cylinders to 9 from 6.
  • MSP for wheat, etc., were raised in July.
So, what exactly has been addressed? Fiscal deficit? End to RBI monetisation? So, how would inflation drop?
There are 12 hour power cuts pretty much throughout Tamil Nadu, including in Coimbatore, an industrial town. I do not know the situation in other parts of India. How is stagflation being addressed, really?
Governance deficit: RTI requests on Rahul Gandhi’s travel not responded to. The entire Congress Party raises in defence of a private individual who is exempt from airport security checks. Kalmadi and Raja included in Parliamentary panels.
There is lot of talk, hand-waving and nothing substantive on the key deficits in the country: probity in public life; governance and fiscal deficit.
These headlines are substituting for substantive decisions. Many are ecstatic. The only good news in recent times has been that monsoon was not as much deficient as originally feared.
Am I missing something?

A seminar course in economic policy

National Council of Applied Economic Research (NCAER) has uploaded the videos and papers from various sessions at their Annual India Policy Forum, 2012. Most of them sound interesting. I have gone though the IPF 2012 lecture by Dr. Y. V. Reddy and the Q&A that followed it. Extremely stimulating and educative. Worth almost ten hours of classroom lectures on public policy-making in India, especially given the current global context.

You need a paper and pen and the willingness to pause, rewind and take notes.

His comments on the following need to be pondered over, a great deal:

(1) Why States need room for policy-making and the rationale that he offers are profoundly important.

(2) Subsidies vs. Incentives and tying both to outcomes cannot be faulted. The discussion in India has been overwhelmingly on subsidies. I,too,am guilty of that.

(3) Taxation of financial sector and/or transactions – well, I have always been a votary.

(4) Ending the high pre-emption of banking resources by the State (financial repression) – in fact, he makes the point that the sequencing of financial sector reforms – the opening of the financial sector for foreign capital should be the last.

I would say that the opening of the financial sector for more players – foreign or domestic – should come after the various existing dysfunctionalities are fixed. I mention them in my MINT column today.

(5) 8-9% growth is not possible unless policy decisions are made. It is not automatic. It has to be earned. It is this hubristic thinking that has got us into stagflation. Dr. Reddy cites I.G. Patel’s observations on this more than once. Worth pondering over.

(6) Finally, on the point of the zero current account deficit over the medium-term, I am able to see the logic rather clearly. In the final analysis, it is about the sustainable level of current account deficit and the sustainable level of growth that go with it. Realism about the latter (economic growth) that would also induce realism on the former (CA deficit).

Alternatively, problems in funding the CA deficit would bring about realism on the achievable and sustainable level of economic growth. 2012 has been a warning shot and I doubt if it has been heeded. The government has tried to make external debt financing more attractive. That is dangerous.

If there is something to ‘complain’ about his speech,

(a) The question of allocating responsibility on local and global factors for the slowdown was not discussed, although he mentions the issue upfront.

(b) This is related to (a) above. If he had done (a) above, perhaps he could or would have at least obliquely covered the factors that led to the deterioration in the fiscal situation in the last several years. The preemption of resources by the government and financial repression that followed from have contributed to the decline/stagnation in the savings rate, the investment rate and hence the economic growth rate.

The link to the speech and the Q&A session are here and here, respectively.

Poor advice

An example of muddled thinking and writing is this paragraph in an edit in ‘Financial Express’ newspaper that appeared on Saturday:

Though headline inflation numbers suggest RBI shouldn’t cut rates this time around, it’s not clear what it’s strategy is since progress on cutting the deficit is going to be weak—the government has made a start with a 30% cut in diesel under-recoveries and a cap on LPG subsidies, but lower economic growth means there will be large undershooting of the tax target. Other reforms steps have been initiated even if Parliament may not pass all of them. And the moves on GAAR, on retrospective taxation, on retail-FDI among others have excited investors—the National Investment Board is another such, but has to demonstrate its effectiveness. In which case, RBI can’t take refuge in the old argument that the government wasn’t doing its fair share of the heavy lifting.

What should the RBI do really? What does the writer think? Has the government done anything worthwhile on fiscal deficit or not?

The reason why this has come out like this is that the writers are struggling to make a case where none exists. The lack of conviction comes through in such shoddy logic.

The Economics ‘Nobel’ Prize

From the press release that accompanied by the announcement of the Nobel Prize in economics,

This year’s prize is awarded for an outstanding example of economic engineering.

My eyes glazed over on reading the full press release. I can easily place a bet on whether I would be able to go through any paper that demonstrated their work.

TGS was not very enthused by the award last year too. I wonder what the Nobel committee in Sweden is trying to prove when the GFC 2008 was a reminder to nudge the field back to its social science roots with an emphasis on solving the underlying human challenges with due regard to culture, context, history and institutions.

For a good critique of this year’s awards, check out this post.

Does India need more banks?

‘Business Standard’ carried a news-item on the FinMin pressing the RBI for the issue of new banking licenses, ASAP. For good measure, it invoked the name of Raghuram Rajan too. Find it here.

I wonder if there is any shift in the position of Raghuram Rajan. In April 2011, he is said to have opposed the issue of banking licenses to Indian corporations. Very sound. I would still hold on to it. Let me be clear. There is nothing in the BS news-item to suggest that RR has changed his stance. I am merely posing the question, for re-validation.

This has been the time-line on the issue of new banking licenses:

August 2010: RBI releases a discussion paper. Full discussion paper here.

Dec. 2010: RBI releases gist of comments on the discussion paper

Aug. 2011: RBI releases draft guidelines.

The underlying premise behind the consideration of the issue of new banking licenses was this statement by the then Finance Minister in his budget speech in 2010-11:

The Indian banking system has emerged unscathed from the crisis. We need to ensure that the banking system grows in size and sophistication to meet the needs of a modern economy. Besides, there is a need to extend the geographic coverage of banks and improve access to banking services. In this context, I am happy to inform the Honourable Members that the RBI is considering giving some additional banking licences to private sector players. Non Banking Financial Companies could also be considered, if they meet the RBI’s eligibility criteria.’ [Link]

The underlined emphasis of the first sentence is mine and that has been effectively demolished by the rising strains in Indian banks’ balance-sheets. Therefore, the whole exercise could now be abandoned? Instead, should the focus not be on strengthening governance, morality, banking and risk management practices in the Indian banking, corporate and political spaces?

Of course, the inclusion of ‘morality’ and ‘corporate’ and ‘political’ is deliberate and certainly, these are not within the realm of RBI (or even that of God, as  far as India is concerned). The key point is that, given the gaping holes and weaknesses exposed by the nexus of bank credit decisions and India’s cronyism, new banking licenses could well be put on hold. After all, even if depositors are protected, given India’s political and financial culture, new banks are a fiscal risk.  For instance, we do not know the ultimate beneficiary of bank loans to ‘Deccan Chronicle’. Effectively, Indian taxpayers have funded the ultimate beneficiary through the Indian banking system and ‘Deccan Chronicle’. India cannot afford to continue to do so.

If banks compete in the same space for business in corporate and in urban India, then banks will take excessive risk to offset margin compression. That is what happened in the US between 2003 and 2007. Banks will run up bad assets in the process and would need to be re-capitalised. That is another source of fiscal risk.

RBI Deputy Governor Subir Gokarn has opined that Indian banks will find it ‘challenging’ to raise capital to meet Basel III standards. His full speech is not yet uploaded on the RBI website. So, we do not know what prompted him to say so. Nonetheless,we agree with him. On a risk-adjusted basis, holding equity capital in Indian banks has to make sense for investors. Given political pressure and opacity of loan transactions, it is not clear if investing in Indian banks’ share capital makes sense on a risk-adjusted basis.

Assuming that this blog post by TGS does not throw the issue of the issue of new banking licenses into the deep freezer, the next important question is whether new bank licenses in India will address the issue of financial inclusion. Indian Micro Finance Institutions (MFI) cannot accept deposits. That is, they have no savings products. They have only debt to offer.  Mr. Mohammed Yunus argues against MFIs seeking private capital. Indian regulations have left them with little choice.Will reforms in that area help India’s financial inclusion goals or will issuing new banking licenses address financial inclusion? My question, doubtless, indicates my bias in favour of the former.

Prof. Vaidyanathan has written an excellent piece on the kind of economic reforms that India needs. In that piece, he has tried to piece together data on how credit flows in India and to whom. Unsurprisingly, much of the credit flows to the private incorporated sector which only has a relatively more modest share in India’s manufacturing and services output.

Of course, that may not be their fault. India’s laws place heavy boulders on the road of SMEs becoming big. No wonder the corporate sector share of GDP remains small. True reforms are about removing those boulders. I guess T. N. Ninan agrees with Prof. Vaidyanathan on this.

In his latest column , he wrote:

The short point is that the economy’s problems have not been caused by the lack of investment from abroad.

Tailpiece: When the Finance Minister talks about the focus on the poor being the reason for non-implementation of structural reforms, he is not making a circular argument as MINT Quickedit claims. He is making a non-argument. True economic reforms are pro-poor.