Rupee on watchlist

I am grateful to MINT Edit for saving me the effort to write on the United States adding India to the watch list for its accumulation of foreign exchange reserves and for India’s bilateral trade surplus with the United States. One finds the American report here.

The report is all of 46 pages long and it is easy to read the portions pertaining to India. The data on India’a national savings rate is most likely wrong. India’s savings rate has stagnated, at best, and declined at worst. The change in the base year to 2011-12 in India and failure to provide a historical time series for the new base year renders comparisons impossible. Same goes for the comparison of growth rates over time. The report acknowledges that India has a rising current account deficit (chart on page 14) but it says elsewhere that India has managed to raise its national savings rate, post-2008 crisis. Untrue.

As per official Indian data, Gross Savings/GPD ratio had dropped to 30.0% in 2016-17 from 34.6% in 2011-12. This is as per the 2011-12 basis. As per the old basis, 2004-05,  the savings rate peaked at nearly 37% (36.8%, to be precise) in 2007-08. This is as per data from RBI Handbook of Statistics. In recent years, RBI has switched to report the savings rates as a percentage of Gross Domestic Income whereas the Government still provides the GDP ratio.

MINT Edit (ht Amol Agrawal of ‘Mostly Economics’) called the decision, ‘scandalous’. It is actually stupid. No one looks at bilateral trade balances to judge a currency’s under or overvaluation. India runs a overall trade deficit. In fact, the rate at which India’s trade and current acount deficits are running this financial year, it is possible that the current account deficit reaches 3.0% of GDP in 2018-19!

Of course, the US knows that no one looks at bilateral trade balances. It is yet another arm-twisting exercise except that when it came to China a much stronger case for twisting their arms existed and both Presidents Bush and Obama ducked the opportunity.

The question for India is whether letting USDINR depreciate is a good thing since the price of crude oil is rising. Will it make a difference to India’s struggling export performance? Or, will it suck in more imports? India is already on slippery ground with its external balances and this development does not help.

The Prime Minister should tell the MoF to take this up firmly with the US Treasury and get India off the watchlist. Pushing India to let Rupee appreciate for fear of ‘sanctions’ and seeing India facing a destabilising external balances situation is not in America’s interest. It goes against the geopolitical goals of the United States in the region. There is no co-ordination or consistency of logic in the American actions.


Finance Commission brouhaha – when the shoe is on the other foot

In these matters, I consider myself an outsider and dispassionate observer since these are intra-national matters. Nor do I come with any accumulated knowledge baggage about Finance Commissions, etc. All I did was to read the Terms of Reference (ToR) of the XV Finance Commission and that of the Fourteenth Finance Commission.

You can find the ToR for the Fifteenth Finance Commission (FC) here.  On the crucial issue of population, the ToR states the following:

5. The Commission shall use the population data of 2011 while making its recommendations.

On this aspect, the ToR of the Fourteenth Finance Commission had the following clause:

7. In making its recommendations on various matters, the Commission shall generally take the base of population figures as of 1971 in all cases where population is a factor for determination of devolution of taxes and duties and grants-in-aid; however, the Commission may also take into account the demographic changes that have taken place subsequent to 1971.

What the Southern States are protesting about?

Southern States are up in arms that this would mean a lower share of the central pool of taxes because they have done a good job of bringing their population growth under control since 1971. See here for the most recent data on Total Fertility Rate. The contrast between the Southern States and the laggards could not be more vivid. Tamil Nadu and Keral are among the top six States with the lowest fertility rate. Uttar Pradesh and Bihar are among the top four states with the maximum fertility rate. 

Uttar Pradesh has made tremenous progress, however, in bringing down its TFR from 4.46 in 2004 to 2.64 in 2017. Bihar relatively less so. Rajasthan and Madhya Pradesh too have made very good progress in bringing down the TFR from around 3.70-3.75 to 2.24-2.34.

R. Jagannathan at Swarajya had a very good piece on the controversy that has erupted on the ToR, particularly with respect to the use of 2011 population data as the basis for the Commission to make its recommendations. He says that sticking to 1971 would unfairly advantage the Southern States whereas using 2011 would not be bad for Tamil Nadu and Pondicherry since their decadal population growth between 2001 and 2011 actually picked up:

In contrast, the southern states show large divergences in their decadal population growth rates, with Kerala showing the largest absolute drop of 4.57 per cent (9.43 per cent to 4.86 per cent), Andhra Pradesh 3.49 per cent and Karnataka 1.84 per cent. But Tamil Nadu and Puducherry actually reported a rise in their decadal population growth rates, the former from 11.72 per cent to 15.6 per cent, and the latter from 20.62 per cent to 27.72 per cent. [Link]

What the Southern States (deliberately, perhaps) fail to acknowledge is an important component of the ToR of the Fifteenth Finance Commission which was not there in the Fourteenth Finance Commission. It is this:

4. The Commission may consider proposing measurable performance-based incentives for States, at the appropriate level of government, in following areas:

(i) Efforts made by the States in expansion and deepening of tax net under GST;

(ii) Efforts and Progress made in moving towards replacement rate of population growth;

(iii) Achievements in implementation of flagship schemes of Government of India, disaster resilient infrastructure, sustainable development goals, and quality of expenditure;

(iv) Progress made in increasing capital expenditure, eliminating losses of power sector, and improving the quality of such expenditure in generating future income streams;

(v) Progress made in increasing tax/non-tax revenues, promoting savings by adoption of Direct Benefit Transfers and Public Finance Management
System, promoting digital economy and removing layers between the government and the beneficiaries;

(vi) Progress made in promoting ease of doing business by effecting related policy and regulatory changes and promoting labour intensive growth;

(vii) Provision of grants in aid to local bodies for basic services, including quality human resources, and implementation of performance grant system in improving delivery of services;

(viii) Control or lack of it in incurring expenditure on populist measures; and

(ix) Progress made in sanitation, solid waste management and bringing in behavioural change to end open defecation.

If the Southern States think and claim that they are better governed, then they ought to do well on the above nine parameters (mostly, if not all) and hence, the Commission has a very big leeway in giving them incentives on the above to make up for any setback arising out of the population figures of 2011.

Clause (3) of the ToR of the Fifteenth Finance Commission and Clause (6) of the ToR of the Fourteenth Finance Commission are similar in principle and comparable. But, the considerations that the XIV FC was asked to keep in mind in that clause (6) were longer. This government has kept its clause (3) shorter.

Instead, it had come up with caluse (4) – see above – and that goes a long way in accommodating and recognising good governance.

The charge of politicisation of the Finance Commission

Some others have picked up issue with the fact that the ToR for the 15th Finance Commission includes the devolution sanctioned by the Fourteenth Finance Commission. The Fifteenth FC has been asked to study its impact.

The Union Government may have one political party in office now. When the Fifteenth Finance Commission submits its report, it may or may not be in office. So, it is hard to make the accusation that the Union government is politicising the institution.

ToR are meant to guide the Finance Commission’s deliberations and its analysis. It does not dictate the conclusions to be reached. The Commission can say that it finds nothing to change in the recommendations of the Fourteenth Finance Commission. To say that the Government is asking the Fifteenth to sit in judgement of the Fourteenth is a logical stretch and a consequence of some creative imagination.

The Fourteenth Finance Commission was asked to assess the impact of GST on the finances of the Union and State governments and the impact of the compensation mechanism to States in case of revenue loss. Can we argue that the Union Government then was asking the Fourteenth Finance Commisison to sit in judgement of the various Committees that had recommended the implementation of GST?

Good to see Souther CMs batting for efficiency 

Interestingly, Mr. Chandrababu Naidu told the HT Leadership Summit in Singapore on Friday the 13th April that his only point was that efficiency should not be penalised and non-performance rewarded.

Wow! a perfectly appropriate sentiment for a Chief Minister to have.

I am really happy to note that this aspect has now been recognised by the Southern Chief Ministers – the challenge is to strike the right balance between rewarding efficiency and performance even as one tries to bring the laggards up to speed.

But, they must now think of the so-called welfare policies that they had been following. There are multiple examples.

Think of loan waivers – whethere they are microfinance loans or farmer loans. What is the incentive for thoso who diligently repay? What is the incentive for the loan providers to keep providing those loans if the States write them off and do not compensate the lenders on time and in full and drag the compensation out? Second, why cannot States encourage the borrowers to honour their loan contract by giving them the money and ask them to repay. If they misuse the money, then they did not deserve it.

What about the permanent policy of reservations with the booster shot of diluted performance criteria for admissions to educational institutions – at all levels of learning. Why cannot the criteria be maintained or diluted just a little? Why cannot the ladder be withdrawn at some point in the higher education institutions if they had been given the leg up already at entry and slightly later levels? Also, for how long? It was meant to be for ten years after independence? Now, these policies are permanently in place.

What is the incentive for those who have performed well? Leave the State? Leave the country?

What about reservations in jobs in the government and even in promotions too? Doesn’t the same issue arise there too? Now, politicians are dropping threats every now and then that they would extend reservations to the private sector too.

In sum,  if the Southern States feel that they would be penalised unfairly for doing well on population management while laggards would be rewarded, they would do well to reflect on many segments of the population in their States must be feeling about some of their ‘welfare policies’ that achieve exactly the same thing – punish the achievers and pamper the laggards. Moral hazard is written all over India’s development policies – perhaps, as pervasively in Southern India as it is elsewhere, if not more.

Now that they know how the shoe pinches when it is on their foot, they would do well to rethink the impact of some of their ‘anti-development’ policies.

Let us be clear. India does need welfare policies as there are millions in the bottom of the pyramid for not much fault of theirs. As Warren Buffett put it, they just did not win the ovarian lottery. So, development policies are needed – they need good education, nutrition, sanitation and healthcare.

Government schools have to function, teachers have to teach, schools must have toilets and there should be running water. Streets should have functioning lights and not overflow with sewage. Drains must not clog and stagnate, pollute and contaminate drinking water. If the States do the above development tasks well, then many at the bottom of the pyaramid would compete rather well and rise up the material ladder.

The challenge for States is to do the development thing right and that too, without hurting, scaring or driving away the efficient and the well performing ones.

In that sense, the Union Government has achieved the impossible already. It has woken up the Southern State Chief Ministers to the quintessential challenge of economic and social development in India – one that they have either ducked or failed miserably, more precisely.

Interest rates and growth

This article by Rohan Chinchwadkar of IIM Tiruchi made me happy for more than one reason:

  • It is from a faculty member from one of the newer IIMs
  • It is well and simply written. It does not try to overdo its point
  • It sources a recent piece of international research
  • It shows a faculty member who is in touch with contemporary reserach. Good for students
  • It was well timed – on the eve of the RBI Monetary policy meeting
  • It presented a paper that had turned conventional wisdom on its head

Not much can be asked of an op.-ed.

Kudos to MINT for publishing it.

RBI dips into credibility balance

Quick off the blocks, Ms. Usha Thorat has written a good comment on the RBI monetary policy decision. Her last line was masterly.

As she points out in the first paragraph itself, RBI has increased the growth forecast, flagged fiscal policy risks and other inflation risks and yet, lowered the inflation forecast for the current financial year 2018-19. It is a tough one to explain away.

So, it is clear that they had set a goal for the policy meeting outcome today and worked backwards with the rationale. Of course, most human beings do that in most situations.

Frankly, there is so much uncertainty about both the growth and the inflation outcome right now for 2018-19 that one can pretty much justify any combination of projections.

Persnally, I would not set too much store by the recent uptick in some cyclical data. Hence, if I were in RBI, I would not have revised the growth projection higher.

Among the ‘forward looking’ surveys, the Consumer Confidence Survey must be a huge worry for the government. Together with inflation expectations, they present a double-whammy. Consumers are more pessimistic about their economic situation and expect inflation to be slightly higher as well! Would be a surprise if it is not reflected in the voting prefereences in the upcoming Assembly elections.

Consumer Confidence survey summary

Also, the Industrial Outlook survey (81st round) is not all that rosy. Check out Tables 15 and 16 on the availability of finance from banks and from foreign sources respectively.

Finally, one thought for the central bank’s credibility. The central bank sounded hawkish in February. Its Chief Economist keeps voting for rate increase. Suddenly, it turns soft on inflation forecast when all the logic (including faster GDP growth) points to the risk of a higher inflation rate.

But, financial markets do not call out the central bank for this ‘tangled web’ of projections. It takes them at face value and rallies! Mission accomplished! It does redound to the institution’s credibility that financial markets, instead of calling its bluff, lap up its projections and policy action.

What does it say about the financial markets, of course?  It continues to prove Eugene Fama wrong – day in and day out.

(Cheekily, I wonder if the decision,  the inflation projection, the growth projection and the dovish commentary are all a compensation for the Gandhi Nagar speech?)

Bangladesh shows the way and other links

Been a bit of a blogging hiatus due to too many visitors and grading commitments. Best way to get back is to identify articles recently read and ease back. In the meantime, thanks to the recommendation of Mr. TCA Srinivasa Raghavan, I finished reading the first of the trilogy of ‘House of Cards’ – the original.

Gulzar Natarajan drew my attention to the article in ‘The Economist’ which, in the process, rubbed India’s nose into the ground. Bangladesh had gotten a grip on diarrohea.

The ‘Wall Street Journal’ piece on Trump’s outburst against Amazon made for interesting reading. Different from the conventional response. Might be behind a paywall, though.

Manas Chakravarty has an interesting take on the philosophy behind the Modi Government’s policy initiatives. He calls it ‘creative destruction’.

A good article in ‘Business Word’ on the coincidental benefits that accrued to the venture owned by Chanda Kochchar’s husband after ICICI Bank extended a loan to Videocon. Videocon has defaulted. Investigations are on.

A good piece on how Cape Town is managing the water crisis because of three consecutive droughts. Is Bangalore ready?

Man Booker Prize changes the nationality of one of the nominees for the awards, since he hailed from Taiwan!

Jose Antonio Ocampo’s book, ‘Re-setting the international monetary (non) system’ is available for free download here (ht: Shri. Rakesh Mohan, former RBI Deputy Governor).

In the process, I came across this book. Gasp!

To be or not in the B-Index

It is difficult to keep up with Andy Mukherjee. At the rate at which he is writing, he might give Amol Agrawal of ‘Mostly Economics’ a complex with his prolificity of writing. In the last twenty-four hours alone, I have counted three Andy pieces – joining the Bond index, on the lone SELL rating on ICICI Bank and on Uber selling out to GRAB in SE Asia.

We shall focus on the column on China joining the Barclays-Bloomberg Bond index with India an onlooker. Andy thinks that India should be less fussy about foreigners holding its sovereign debt issued in Indian rupees. After all, the country runs a current account deficit and it can do with some foreign savings. Once you are in the index, index tracking funds will be invested, no matter what the fundamentals are. Of course, they can go underweight but they won’t sell and scoot fully. That is the sum and substance of his argument, if I understood them correctly.

I do not disagree with the logic. There is something to be said in its favour. Andy’s points are well made. But, on balance, I think India is not ready for it and I am not sure it will be ready in the very near future. India lacks the governance and discipline required for sustained macroeconomic stability. China can and will brazen it out. It is ‘Too big to fail’. India is not.

Whether most investors stay invested or not because of index tracking requirements, what matters to asset prices is the behaviour of the marginal investor.

Whether the debt held by foreigners is denominated in local currency or in foreign currency matters little in the end. If investors whose reference currency is not INR decide that they wish to get rid of INR risk, then the foreign exchange risk comes into play fully, regardless of the currency of denomination of the Indian debt.

India frequently gets into situations in which foreigners would want out. Despite its savings rate at a low 30%  (given its growth ambitions), India has not given up the ambition to become a high growth nation.  Governments feeling shaky politically – that may be a reality after 2019 elections – might want to go for high growth and do so via fiscal populism something that India did, not so long ago (2009 to 2011) and that is recipe for disaster for debt and for the currency because with a savings rate of 30% and low capital and labour productivity, high growth can come only via a ramp-up of aggregate demand and that would blow out the current account deficit.

The bond market – rational as they are with respect to emerging markets (only) – would administer tough love. Sometimes, it is too tough.

Bond markets are far more sanguine with respect to fiscal profligacy and debt accumulation by advanced nations. Indeed, over the last thirty five years, bond investors have rewarded advanced nations’ public debt accumulation with ever-lower interest rates. So much for market discipline!

Therefore, all told, if one is not sure of self-control and discipline and would likely binge, it is better not to look at the plate of delicious sweets.

So, India is better off not regretting missing out on the bond index membership.

The Indian banking purgatory – policy proposals – 3/3

I wrote part 2 on March 10. I have been wanting to excerpt Dr. Y.V. Reddy’s extarordinarily candid lecture on February 1st. It contained some definitive recommendations. I copy and paste them below.

In addition, he has spoken about the proximate and underlying causes of India’s bad debts problem in the banking system, etc. He is even questioning if the leitmotif for nationalisation of banks remains relevant nearly fifty years later. You should read the full speech if you are interested in Indian banking.

  1. The first step for improving our banking system is a commitment to reduce SLR and CRR to global levels as soon as possible. We cannot have a globally competitive economy with an over-burdened banking system.
  2. The current policy of ownership and governance in banking needs to be reviewed urgently to correct the outdated and distorted policies. This should be done before our banking system passes on to foreign owners, irrevocably.
  3. A high level internal enquiry within the RBI should be undertaken to fix the responsibility for excesses in NPAs in recent years and, more important, to suggest and adopt measures to improve the system as a whole.
  4. In view of the large amounts of public money involved, the government may put in public domain action taken on Fourteenth Finance Commission’s recommendation for improving the financial system with economical use of tax payer’s money.
  5. A White paper on the future of Public Sector banking may be placed before the Parliament at the earliest in view of their criticality for efficiency in financial sector as a whole, to be able to serve a globally competitive economy.
  6. In brief, the current approach of treating Banks as special and bank depositors as special must be continued, and an assurance to this effect may be extended by the Government.
  7. In view of global developments and emerging Indian economy, there is a case for RBI to internally review the current policy of annual transfer of surplus after determining the needs for addition to reserves and adopt a new policy after due consultation with Government.

The first two parts on Indian banking are here and here.