Rebooting institutions

I came across this interesting and insightful (as usual) interview of Dr. Pratap Bhanu Mehta of the Centre for Policy Research in New Delhi carried by MINT Asia. This particular observation caught my attention and made me reflect on it:

You will have to reboot institutions and institutional practices, although you have to be careful about using the word institutions in the Indian context. Politicians are using the word institutions as a way of displacing responsibility.

Somebody has to take decisions for these institutions to be rebooted—someone has to say very clearly that we don’t do business this way any more. So, in that sense, there is a role for the political leadership.
I am glad that he added this clarification because institution building is so nebulous and abstract for many. A lot of people talk about respecting and building institutions but never choose to go further. Institutions are not self-created. Humans  – with all their faults – have to do the job. Politicians in office have a greater responsibility. It is a hallmark of leadership to build and nurture institutions that outlive themselves and their successors and that function with a degree of autonomy and competence so that when politicians (or, rulers) are confused and are looking for direction, the institution provides the anchor, the continuity and the wisdom. Good institutions, thus, play a big role in good governance and in maintaining and enhancing social stability.
Here is a (partial) list of the tasks involved in good institution building:
(1) For example, if the Parliament is to enact good laws that stand the test of time and fairness, then Parliamentarians must be law-makers and not law breakers. They must be qualified (and not just in their educational attainments) to pass laws that they expect citizens to comply with. So, they should not be criminals.
(2) They should respect their status as members of the Parliament and attend sessions. They should prepare for debates as students are expected to do, for their assignments.
(3) They should appoint competent people for regulatory authorities. Regulatory institutions should be insulated from political influence.  Decisions of regulatory institutions should not be tampered with, by politicians. Aggrieved parties should be encouraged to approach the proper appellate channels rather than expect the executive to overrule regulatory authorities.
(4) Government should set an example in complying with regulatory authorities’ directives
(5) Government should not make the tenure of regulatory authorities an instrument to coerce them to make arbitrary decisions.
(6) The government should not litigate citizens and the courts till the last drop.
(7) Government must set an example in honouring Supreme Court judgements. Laws should not backdated to overrule or annul the judgements of the highest court of the land.
(8) The government must consult the Leader of the Opposition on key decisions, legislation and appointments even if there is no formal need for it.
(9) Regulatory institutions and the judiciary must set an example in transparency of conduct, fairness of rulings and in accountability as they expect the regulated, to do so.
(10) Processes of appointments to judiciary, to technocratic institutions and to regulatory authorities should be insulated from political processes and the criteria for selection should be as transparent, objective and clear to the public.
(11) The government should not voice opinions on what the regulatory authorities should be doing nor should the government pre-judge their actions and decisions.  Those are coercive behaviour.
(12) The government and politicians must respect the constitutional checks and balances and allow such agencies to do their jobs while responding to their criticisms/observations in a dignified manner as per procedures laid down.
In sum, respecting institutions’ processes and decisions are important aspects of nurturing them.
Those who aspire for leadership positions should be questioned on their commitment to the above and they must subject themselves to scrutiny of their conduct in these aspects. It should be a rather important component of evaluation of their performance.
This must be an acid test of those who aspire for leadership position at all levels of government – Prime Minister, Chief Ministers, Mayors, Panchayat leaders, Chief justices, regulatory chiefs and heads of technocratic institutions (e.g, RBI), etc.

Farewell to Dr. Subbarao

Dr. Subbarao delivered the Nani Palkhivala Memorial Lecture yesterday and it was his last formal speech as the governor of the Reserve Bank of India. He clearly and correctly blames the government for India’s current economic problems/mess/crisis.

As this blogger has also mentioned several times, he correctly points out that the blame attached to RBI for tightening belatedly in 2010-11 is easier to do, in hindsight. The world looked as uncertain in 2010 as it did in 2009. Nonetheless, he was gracious to accept that charge. Further, even if was late and slow in tightening, he would not have anticipated that the government would be so derelict in its responsibilities. He clearly would not have known that it has taken it upon itself to sink India.

For those who blame ‘tight’ monetary policy for the growth slowdown, he has an effective riposte:

If the Reserve Bank’s repo rate was the only factor inhibiting growth, growth should have responded to our rate cuts of 125 bps between April 2012 and May 2013, CRR cut of 200 bps and open market operations (OMOs) of `1.5 trillion last year.

Yes, the only intellectually challenged/crippled would blame the RBI for India’s growth slowdown which is still unfolding.

He pays the obligatory tribute to the Prime Minister for having told him to keep his ear to the ground. Yes, Dr. Subbarao and his team did reach out to the public. The governor himself played a personal role in the education of the Indian public on the roles and responsibilities of the Reserve Bank of India. We have to acknowledge that here.

Of course, we also get a clue as to why the UPA did not govern but did everything else. The Prime Minister had outsourced every governance task to the RBI and not just monetary policy:

“… it is easy to forget that monetary policy is also about reducing hunger and malnutrition, putting children in school, creating jobs, building roads and bridges and increasing the productivity of our farms and firms. Keep your ear close to the ground.”

He had a good parting shot for India’s Finance Minister:

Gerard Schroeder, the former German Chancellor, once said, “I am often frustrated by the the Bundesbank. But thank God, it exists.” I do hope Finance Minister Chidambaram will one day say, “I am often frustrated by the Reserve Bank, so frustrated that I want to go for a walk, even if I have to walk alone. But thank God, the Reserve Bank exists.”

We should also applaud him for invoking Dharma in the last paragraph of his speech:

A nation prospers only if its public institutions are guided by dharma. The Reserve Bank of India tops the list of India’s public institutions that are guided by Dharma and Dharma alone.

I recall the words of French-born Indian and Indologist Mr. Michel Danino at my son’s Upanayanam ceremony in February this year at Madurai that Dharma was the unwritten constitution of India.

Farewell to Dr. Subbarao who had to go through a very tough tenure handling the fallout of a global crisis with an unfriendly, unresponsive, unhelpful, incompetent and venal government.

Overall, TGS assigns a letter grade of B+ to the Governor with a GPA of 3.6 to 3.8 out of 5.

May he enjoy a well deserved break from working for a mostly ungrateful government and may his retirement be full of good health and peace of mind.

What should India do and why?

Arvind Subramanian (Peterson Institute) and Devesh Kapur (Centre for the Advanced Study of India at the University of Pennsylvania) have written two of their proposed three part series on addressing India’s current problems. In this post, this blog (The Gold Standard – TGS) examines their diagnosis (mostly part 1) and proposals (part 2).

In the first installment of three-part series, they wrote the following:

Indian macroeconomic policy seems to be afflicted with exchange rate pessimism, the notion that depreciation cannot boost exports and reduce imports. High levels of intermediate inputs and foreign indebtedness may dampen and delay the positive impact of exchange rates. But all the experience around the world suggests that there will be positive effects. If it does not, that would amount to saying that prices change behaviour with the notable exception of the most important price, the exchange rate.

As academics, they should not have failed to note that changes in price affect demand, other things held constant. Global growth is one factor that is not constant and not in India’s control. Other countries’ competitiveness gains in the meantime (many currencies have depreciated too, along with the rupee) both through productivity and currency depreciation also determine how far India can take advantage of the weaker rupee.

The second point that they make could have also been more thoroughly thought through:

Another measure to finance the current account promoted by the financial community has been to defend the currency via tighter policy. The government and the Reserve Bank of India have – fitfully and half-heartedly, to be sure – accepted this advice. Not only does this action further stress private sector balance sheets, it also overlooks the fact that the currency depreciation will be less damaging than in the Asian crisis because of lower levels of external indebtedness.

They make the assumption that currency depreciation will be less damaging than in the Asian crisis because of lower levels of external indebtedness. The stock of external debt might be low in comparison to other countries in other times but the staggering increase in external debt in the last four + years, especially combined with weak corporate financials (top and bottom line) and strains on bank assets create a lethal combination for policymakers to take the risk of allowing the rupee to find its own level.

Further, ruling out monetary tightening, as they do in the second installment of their essay, and recommending an across-the-board import surcharge does two things: it raises prices all around (because some imports are inelastic – of course, they recommend exempting crude oil and coal from their import surcharge proposal) and the demand switching towards domestically produced goods (esp. when India’s supply side has been weak in the last several years) will also add fuel to inflationary pressures.

TGS agrees with the two authors when they rule out Prof. Kaushik Basu’s proposal for a fiscal stimulus to address the growth situation. At the present juncture, addressing economic growth directly through stimulus is the last thing that India should be doing.

However, much as the two professors promise to come up with a unique policy mix, their second instalment of the tri-part series does not exactly deliver that unique policy mix.

First, the text  could have avoided some simple confusion. Here is an example:

Macroeconomics 101 suggests that reducing the current account deficit requires two actions: switching demand away from, and encouraging production of, domestically produced goods; and reducing aggregate demand to essentially compress imports.

After the ‘from’, there should have been this: ‘foreign goods’.

Otherwise, the sentence leaves us one befuddled: switching demand away from domestically produced goods and encouraging production of domestically produced goods! That is a recipe for glut and further corporate distress!

TGS  agrees with their suggestion that there should be a overall reduction in aggregate demand. That, in simple terms, means lower economic growth near-term (4 to 6 quarters or slightly longer).

But, to achieve that, they recommend a short-term, time-bound import surcharge except on crude oil and coal import. I am not persuaded of this recommendation given its essentially backward looking nature and the potential for side-effects on inflation in a supply-constrained domestic economy.

Of course, TGS fully agrees with their final suggestion that some ‘important policy change’ needs to accompany their proposed import surcharge:

Given the government’s eagerness to go ahead with the food security Bill (and resulting increases in subsidy), it is important that the proposed import surcharge be coupled to at least one important policy change signalling resolve to reduce the deficit – be it fuel or fertiliser subsidies, whichever is politically least unpalatable. Simultaneously, the government must add ballast by expending its scarce political capital in pushing through the Constitutional Amendment Bill on the goods and services tax in the next session of Parliament.

The reason they opt for this is that they think that the political atmosphere does not permit two things: a monetary policy tightening and a fiscal spending compression.

That is precisely the problem. The Congress Party’s political compulsions and priorities over the last nine years have not only brought us the crisis but also are effective in preventing India from charting a way out of the crisis.

The speed with which we are able to reconcile to this reality is scary because this government can last another 7 months. That is too long a time in the current situation.

Final observation on their second installment. They note that there are two costs to the recent rupee depreciation that need to be addressed:

Of course, the recent rupee depreciation will have costs that will need to be addressed. Two costs need highlighting: additional inflation and the adverse effect on companies that have borrowed in foreign currency, and hence on the banking system.

But, the rest of the article does not deal with the second of the two costs they identify above – namely foreign currency borrowing and the banking system. May be, they will deal with it in the third installment.

Let us recap what needs to be done, in the view of TGS

(1) Draining liquidity and monetary tightening: RBI embarked on it in mid-July but, disappointingly, have backtracked on two occasions after that – at the monetary policy meeting of July 30 and then when they announced buying longer dated government securities. In the parlance of the two academics, this is about reducing overall demand. Growth has to be sacrificed for now, to restore it with vigour and sustainability later.

(2) Cash-flow management: government’s announcements on Indians’ outward remittances fall in this category.

(3) Fuel price reform: just remove the government totally from pricing of hydrocarbon fuels, especially in the retail price of diesel, petrol, kerosene and cooking gas. This has become very critical and urgent not only because of (what appears to be) an imminent attack on Syria but also what the Fed could do with its ‘forward guidance’ on interest rates if and when it reduces its monthly asset purchases. The price of crude oil could rule firm or even firmer in global markets. A weak and weakening rupee with higher crude oil price could be the final kiss of death for India. 

(4) Work on a war footing (policy and legal fronts) to resume coal and iron ore exports

(5) Send the land acquisition bill and the food security bill once more to Parliament select committees with external experts joining the select committees. After all, these laws are supposed to remain in perpetuity. Three-month delay won’t hurt. Recast them thoroughly to address genuine needs of the industry and the poor.

Even if (3) to (5) are pipe dreams in the current environment, the failure to credibly stick to (1) and, if necessary, add more muscle to it has been the biggest causal factor for the continued onslaught on the Indian rupee. 

In an interview to Business Standard, Ramesh Damani says that the market would bottom out within 48 hours if the government announces elections. Very astute observation and one that TGS has no difficulty in seconding.

However, since the dissolution of the Lok Sabha by the President requires the government’s recommendation and since that won’t be forthcoming, can the President cite the economic emergency and dissolve the Lok Sabha suo moto? Will this President do it as partial atonement for his role (as the Finance Minister) in India’s current sorry state?

Readying for stagflation

My column in MINT today (behind a subscription firewall) continues its recent critical scrutiny of the US economy. I find it wanting and not cracked up to be as economists tout. That is no surprise, of course. They could not anticipate the huge drop in sale of new homes in July despite mortgage applications dropping almost every week for the last thirteen months. In fact, previous data on sale of new homes underwent substantial downward revision for May and June too. Needless to add, I wrote this piece before the huge slide in durable goods orders and shipments reported on Monday night.

Quite how the sale of existing homes had a big spike in July is known only to the National Association of Realtors. The Chicago Fed National Activity Index (MA3) had a short-lived spike above the zero line late last and early this year and is now negative.

If recent research by the Federal Reserve Bank of San Francisco is any indication of likely Fed policy, then the Fed might go ahead with tapering in the next few months (whether they follow Professor Arvind Krishnamurthy’s advice and start with reduction in the purchase of US Treasuries is a matter of detail, for our purposes) but offset it with a substantially liberal forward guidance. That is what I anticipate and that is the scenario I write about in my MINT column.

Quite what it would do to Treasury yields is going to be rather interesting. I think it might be negative. In that sense, it indicates a revision in my thinking. I have always been anticipating one last rally in the Treasury before the Fed ‘goes all in’ on inflation. Now, I am beginning to wonder if that window for a rally is closed. I guess a lot depends on how ‘liberal’ the forward guidance is when the Fed begins to taper.

What a tangled web we weave when ……

A combination of weak dollar (potentially leading to higher price for crude oil and commodities) and higher Treasury yield would be very problematic for India and other emerging markets. Surely, this combination is recipe for stagflation even in the US, even as it had exported it first to emerging economies.

India reading links

Should not have taken this long for Shekhar Gupta to write this. Better late than never, though.

Swapan Dasgupta says the battle is not between Modi-led BJP and the Congress but between an outsider and the Establishment.

Sreenivasan Jain tries to present a two-sided case on the land dealings of Robert Vadra.

Chetan Bhagat on the polish that Modi needs.

M. J. Akbar highlights Modi’s observation that the only religion for an Indian politician is the Constitution of India.

Swaminathan Aiyar on the challenges that the Land Acquisition Bill would impose on industrialisation and change. To be read in conjunction with the piece by Shekhar Gupta in IE cited earlier.

T. N. Ninan tries to make light of the travails of the Indian rupee. Was the Indian rupee that overvalued before?

Prannoy Roy and Mihir Sharma

Two friends sent me the link to the interview conducted by Mr. Prannoy Roy on NDTV with Ruchir Sharma of Morgan Stanley and Dr. Arun Shourie. For people who do not follow these things on a daily basis, it might have been a useful one to watch.

I have the following observations to make on Mr. Roy’s remarks in that discussion:

(1) He countered Dr. Shourie who said that the Food Security Bill must be dropped. He said that it was meant for the ‘poorest of the poor’. Really? Two-thirds of India are the ‘poorest of the poor’? If he had said that not just the Food Security Bill, many corporate tax give-aways should also be examined afresh, then that would have been a better point to make.

(2) Despite enough slides and charts on display, Mr. Roy insisted on calling the India economic crisis a 50-50 mix of global and home-grown factors. That is simply not true. Not all emerging economies are hurting. Those who splurged (lived beyond their means) – either in the private sector or in the public sector or both – are hurting. The causal factors are 100% to 200% home-grown.

Read the piece by Mihir Sharma in today’s Business Standard. It is disinformation. It is not a crisis of all emerging markets. It is a crisis only for those emerging economies that lived beyond their means. Further, Indonesia and Brazil had massive real exchange rate appreciation in the last few years and hence their currency weakness is not the same as that of India. Check out my article in Pragati on the performance of Emerging market currencies since the global crisis began in July 2008 and since the recovery began in March 2009.

Mr. Sharma cites Krugman. We normally cite reputed academics for their knowledge and not for their ignorance. If Krugman did not have his facts on India, we should educate him and not cite him.

(3) Mr. Roy insisted on calling Dr. MMS, Dr. Ahluwalia and Mr. Chidambaram, the ‘dream-team’. Of the three, only Mr. Chidambaram dared to think boldly on his own in 1997. But, that is now very distant memory.

Dr. Singh implemented the blueprint, under the political cover of the then Prime Minister, Mr. Narasimha Rao, agreed to by Mr. Yashwant Sinha and Mr. Chandrasekhar with the IMF.

Confusion reigns

The title of the blog post is not just about RBI’s bizarre announcement three days ago (Tuesday, Aug. 20) that it had largely achieved the goals it set out for itself in mid-July when it raised interest rates by 200 basis points. This blogger applauded the move. Wanted RBI to stand firm. It diluted its stance a little when, in the monetary policy communication of July 30, it said that the rate move of mid-July was temporary. That was a confusing signal and second, it dilutes the efficacy of the rate move. Then, this week, it said that it would add liquidity by buying long-dated bonds. The rupee had not stabilised and more broadly, financial market conditions in India had not stabilised. So, it is unclear as to which objective of RBI had been achieved? The announcement of Aug. 20 was baffling, to say the least.

It gives one the impression that there is really no one in charge now or that multiple people are in charge of the RBI at the same time.

Even now, we find careless arguments being advanced about how the rupee should be allowed to find its level. In normal circumstances, yes. If your fundamentals are right, let asset prices find their own level. If fundamentals are bad, governments have two tasks. One is that asset prices should be stabilised lest they worsen the fundamentals beyond repair (the reverse feedback effect from asset prices to economy will happen) and the government should get to work fast and focused on fundamentals. India is in this category.

Arguments as to why the rupee should be stabilised were made by Yours Truly on several occasions in the last one month in this blog. You can find the most recent one here. Also, read this excellent primer by Sajjid Chinoy in Business Standard few days ago.

One, it is careless to argue that a falling rupee would boost exports. ‘Other things being equal’, it might. Other things are not equal. Global demand is weak:

  1. US recovery is shallow and superficial. Just check out the Chicago Fed National Activity Index and the weekly percentage change in new mortgage applications.
  2. Europe is just trying to get its head above water. How long can it stay above water is any one’s guess.
  3. Japan’s Fukushima reactor radioactive water leak – it appears to be a huge problem – is yet to sink into people’s consciousness. It could seriously erode the government’s authority and the PM’s credibility.
  4. HSBC’s Purchasing Manager Index for China prints an inexplicably strong headline number when its the components are weak. Go figure.
  5. Most other key emerging economies are in a crisis mode.

Lastly, Indian costs have gone up so much in recent years and productivity so low that we do not know the extent of rupee depreciation that is needed to make Indian exports competitive again on a sustainable basis.

So, a weak rupee is likely useless when demand elsewhere is anaemic. Second, a weak rupee raises domestic costs. A weak rupee has made crude oil costlier. The 50-paise per month hike in diesel price has been nullified by the weak rupe and firm trend in the global crude oil price. The under-recovery in the price of diesel is INR10.22 per litre as of August 16. Check out the website of the Indian Oil Corporation where it is updated regularly. The under-recovery is the same as what it was when the diesel price ‘normalisation’ started. We are back to square one. If rupee remains weak, the under-recovery would worsen further. Domestic price of diesel has to be raised one shot and freed. Fat chance it would happen.

Third, this point has been made ad infinitum: Indian corporations have borrowed 50 billion dollars in the last four years. The twice-a-year Financial Stability Report of the Reserve Bank of India gives all the information one needs on this. These loans are now anywhere between 10% to 50% costlier to repay because of rupee depreciation. If the rupee were to weaken further, it would make many Indian corporations default on their foreign loans. That would shut India off from foreign debt markets for a long time. It has both reputational and real consequences – serious ones.

So, the rupee had to be stabilised and measures include funding and reducing the current account (CA) deficit. What is the reality?

(1) The Reserve Bank of India has not done enough to stabilise the rupee beyond its rate hike in mid-July. Since then, it has diluted the measure. It has not allowed sufficient time for the rate hike to play out. RBI is being pulled in different directions.

(2) CA deficit must be funded. But, funding it now should not be at the expense of making too many concessions to foreign investors and lenders that would be long-term costly.

(3) Reducing current account deficit means reducing imports. We have seen how export revival is a harder task now. One way to reduce import growth is to slow the economy, near-term. That is what RBI’s rate hike of mid-July would have achieved. But, that measure is being diluted since the government does not seem to be willing to sacrifice growth further for several reasons – economic (tax revenues), political, etc.

(4) Another way to reduce the current account deficit is to reduce the fiscal deficit drastically – yes, not only the Food Security Bill but many ad-hoc tax concessions made to corporations can and should also be withdrawn now.

(5) Raising import duty on flat screen television set and reducing Indians’ foreign exchange outflows are a bean-counter’s response to the problem.

In sum, the rupee is not being stabilised with full commitment. Hence, financial conditions too would remain instable. The current account deficit is not being tackled the right way because the government is unwilling to pay the ‘growth’ bill for doing so.

What is the way out? It is possible that all the confusion has further undermined India’s business sentiment and confidence and that economic growth would be lower on its own. That would lower imports in any case. Hence, the government’s confusion, prevarication and vacillation appear to be working, in reducing economic growth! That is some strategy!

Investors’ misplaced faith in the economic recovery in the US and obsession with the Fed reducing asset purchases might ease, reducing pressure on emerging market currencies, including on the Indian rupee.

There can always be strokes of luck although the dice has not rolled in India’s favour since 2004.