Wrong solution for a distant problem

I was happy to read Harsh Vora’s piece and it is good that he was thinking far ahead – 10 to 20 years down the line.

I just have the following comments:

The case for freer capital flows, however, does not follow from his argument. If global economies are in a far advanced state of demographic decline – which they are – how do freer l capital flows help overcome the low natural rate of interest problem induced by the aging of the population?

Second, in India’s case, it will still be a developing nation and potential GDP growth improvements will occur through many other channels. In advanced nations, their potential growth is already exhausted. It is between 0.0% and 2.0%. The demographic transition to old age compounds the situation. It is not so in India.

Third, even if the supposed benefit of freer capital flows is that it allows the country to circumvent the domestic interest rate ceiling imposed by aging population is true, it comes with other bigger costs. Monetary policy autonomy is gone, in the presence of capital flows. It is the famous impossible trinity. In fact, it is an impossible duality. The exchange rate regime does not matter at all.

It might amount to burning down the house to get read of the bed bug.

On the Edg(e)baston

Three days and one session – that is all it took to get a result in Edgbaston – the venue of the first of the five Test match series between England and India. It was gripping but as India entered the fourth day needing 84 runs with five wickets in hand, one had to admit the odds favoured England. Seldom these days have teams performed well overseas. Probably, that distinction belonged to the West Indies team of the Seventies and Eighties and the Australian team of that period too. After that, it is not just India who are supposedly tigers at home and lambs everywhere else. It applies to all teams.

I had watched South Africa in England last summer. I watched a day’s play each at the Oval and at Old Trafford. Hashim Amla, Faf du Plessis – they all disappointed. South African bowlers did not make English batsmen play as many balls as they should have. I was disappointed by their under-par performance.

India had a good outing in England in 2002 and in 2007, not to mention 1986. In 1990 and in 1996, India lost a test each. They were three-test series. In 2002, India drew the series. It was a four-test series in 2002. In 2007, India won the three-test series. India was humilated in the Test Series in 2011 and in 2014. A 0-4 whitewash in 2011 and India lost the final three tests badly in 2014, after having drawn the first and won the second.

Indian batsmen, based on my recollection, have not done that well, with the exception of Vengsarkar in the Eighties and Dravid from 1996 up to 2011. Sachin has a good average against England but he had two good series – 1996 and 2002. The rest – 1990, 2007 and 2011 were mediocre, especially the 2011 series. In that series, he managed two fifties in ten innings.

Ganguly had only twelve tests against England and he has a better average. Laxman had not done well against them, except perhaps in 2002. I am citing all these from memory. In other words, Indian top order batsmen have not fired consistently against England. That, to the best of my recollection, happened only in 2002.

So, the failure of Rahane, Rahul, Murali Vijay and Shikhar Dhawan in both the innings are par for the course although one is disappointed at Rahane’s shot selection. I thought he was made of better stuff. Rahul had a brutish delivery in the second innings but, in the first, the dismissal was of his own making.

It is the pressure, of course, that is built up by the good deliveries that make batsmen play loose shots at poor deliveries and get out to them.

That is the achievement of Virat Kohli in this test match – he did not let the good deliveries creat the platform for the poor deliveries to swallow him!

That said, I would hold his dismissal – against the run of play – on day 2 – as an important turning point in the match. Towards the end of the innings, he was on fire, toying with Ben Stokes and other bowlers. I thought he would earn India a 20-run lead or something closer to that. But, his tame dismissal against Rashid was a bit of a surprise. It came unexpectedly.

The second important turning point of the match was the quick half century+ by Curran. At 87 for 7, India will have fancied their chances of getting England out under 150, at most. The extra thirty runs made the difference in the end.

To succeed in England or to avoid embarrassing series defeats, a team needs at least two top order batsmen to score well and consistently and bat longer. If India does not manage that, a repeat of 2011 and 2014 might be in store. One hopes not.

In English conditions, this England team has a good attack – Anderson, Broad, Stokes and Curran. One has to admire Jimmy Anderson’s resilience, fitness and longevity in Test cricket.

Engrossing game of cricket, no doubt – not very pleasant to watch, if you are a batsman or inclined towards batsmen but gritty game. One that separates the greats from the also-rans. In that sense, Kohli succeeding in this test overcoming his own mental blocks and ego was a far more satisfying outcome for him and his fans than his centuries on other occasions.

Battling the mental demons and coming on top is always very satisfying. It elevates us and maks us better and stronger human beings.

When he talks, we cannot be silent

Dr. Manmohan Singh might have earned the distinction of being a ‘maun’ (silent) Prime Minister. But ,when he talks, it is difficult for others to remain silent.

I saw his remarks in ‘Business Standard’ on bank frauds, on ‘national losses’ and on ‘economic mismanagment’. It is hard to take criticism on economic mismanagement coming from him. Sorry, Sir. He presided over economic mismanagement for ten years.

Yes, like him, I am also choosing my words carefully. I deliberately said that he presided over it for ten years, not restricting myself to his second term. The consequences of whatever his government did in the first term showed up in the second term because, during his first term, the global economic boom helped hide weaknesses. Rising global economic tide lifted many leaky economic boats. India was one of them.

Quite what governments can do about bank frauds? It is the job of the bank managements to avoid or to detect them in time. The government could privatise the public sector banks. His government did not do that. If his government did that, he could not have announced a massive waiver of farm loans one year before the elections of 2009.  The NDA government too is not thinking about it. If it did, will his party support it?

He is regretting that the NDA government had not passed on the benefits of lower crude oil prices to Indian consumers. Quite correct. This government did not do it and should have done it. But, he should know why and he should be embarrassed about it.

This government chose to make good a hollow fiscal deficit target that his government had bequeathed. The fiscal deficit target of 4.9% that his government achieved in 2013-14 was a myth and its target of 4.1% was hence, massively overambitious.

Taking advantage of the dramatic drop in the price of crude oil, the NDA government chose to mobillise tax revenues to legitimise a bogus fiscal deficit target. It was a mistake. The NDA government should have made haste more slowly and should have taken the nation and the world into confidence about the economic mess, including the fiscal mess, it had inherited.

He is talking about massive losses to the country. Quite how does he measure lossses for the nation? Over what time frame? If anything, the 2008 global crisis and the fiscal deficit + current account deficit + double digit inflation record of his government had lowered India’s potential growth rate to a range of 6.0% to 6.5%. So, how exactly does he measure ‘losses’?

Perhaps, he has demonetisation in mind. But, just this week, the usually critical (of Modi, NDA, BJP and Hindu-Nationalists) FT wrote that both demonetisation and the introduction of GST would go down as Modi’s greatest economic legacy:

The numbers are so stark that some say it will go down as Mr Modi’s greatest economic legacy, while others are offering India as a model for other developing countries looking to tackle widespread tax evasion. (Source: https://goo.gl/ejqCg4)

The numbers that the journalist is referring to is the increase in the number of people filing tax return.

In short, the NDA government is guilty of many acts of omission on the economic policy front. Chief among them is its failure to understand the gravity of the economic situation it was inheriting from Dr. Singh’s government.

It is not guilty of many acts of commission. That honour belongs to the government he led for a decade.  However, one of the errors of commission of this government is the perpetuation and deepening of ‘tax terrrorism’ initiated by his government.

But, set against that could be its many structural reforms that might help future  governments and elevate the future growth rate of the country.

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.

Powell’s seminal debut

After easing substantially during 2017, financial conditions in the United States have reversed some of that easing. At this point, we do not see these developments as weighing heavily on the outlook for economic activity, the labor market, and inflation.

The FOMC will continue to strike a balance between avoiding an overheated economy and bringing PCE price inflation to 2 percent on a sustained basis. [Link]

Powell’s prepared remarks were rather brief but telling. He does not think that financial market volatility will have a big bearing on  economic activity.  We agree. One hopes that it is not just about current level of volatility but also reflects a structural attitude that assigns a lower weight to the goings-on in financial markets in terms of their impact on the real economy. Anna Cieslak and Annette-Vissing Jorgensen have documented this rather well. The Fed is more concerned about declines in financial asset prices than they ought to be. In reality, the impact is far lower than what Fed models assume.

His second statement is even more interesting. He is no longer talking about striking a balance between employment and inflation but between avoiding overheating and bringing inflation to 2% (from below). He is not going to be fixated on bringing inflation up to 2% from below. He will also keep an eye on overheating. Good for him!

Interesting times ahead.

Nearly three months ago, Gavyn Davies wrote a blog post for FT that Trump has the opportunity to shape the Federal Reserve Board this year in an unprecedented manner:

Including the promotion of Jerome Powell to Chair, six of the seven board members will have been nominated by the current administration when the process is completed next year. In addition, the President of the New York Fed will have been replaced by its own board. Such a root-and-branch upheaval in the Fed’s key personnel is unprecedented in its history.  [Link]

He predicted that the new Federal Reserve Board would likely display the following tendencies:

There may be more enthusiasm for expansionary fiscal policy, and greater belief in beneficial supply side effects from cuts in marginal tax rates;

There may be greater concern about possible instability from rising asset prices;

There may be greater willingness to reverse some of the regulatory restrictions in the Dodd Frank legislation;

There may be less emphasis on gradualism when it comes to raising interest rates;

There may be a greater eagerness to run down the balance sheet, especially in non-treasury assets;

There may be more emphasis on rules-based policy decisions, notably on the use of the Taylor Rule.

I like most of the above. In fact, I think Jerome Powell alluded to the second item in the above list when he spoke of balancing between overheating considerations and bringing inflation up to 2%.

I was surprised that many have not observed his comment about balancing between avoiding an overheating economy and bringing inflation to 2.0%. John Authers, here, notes that his message was not too different than that of Ms. Yellen but that he delivered the message in a business-like fashion. I disagree. The message too was different.

It is the first time in a long time that a Fed chair mentions overheating risks while trying to bring inflation back up to 2%!

In November 2017, Stephen King (formerly with HSBC) wrote a nice piece in FT suggesting that “central banks that focus on price stability alone may only be stoking the next financial bubble”.

We may have found a central banker who wants to put an end to that practice.

What is RBI’s role in PNB?

Someone who read my blog post called me and told me to consider the following:

If a fraud in any company occurs, it is the problem for the management, the Board and the owner, in that order.

In this instance, can the regulator change the owner? No. The Board? – No. The owner appoints them. Can the regulator order the CEO replaced? No! The owner does not need the regulator’s approval for public sector banks to appoint CEOs whereas private sector banks do need the regulator’s approval.

The regulator is responsible for financial stability and consumer protection.

Now, Tamal Bandyopadhyay in his piece for MINT says that RBI insists on reconciliation of Nostro accounts:

Finally, RBI is very particular in keeping a tab on all transactions in banks’ Nostro accounts and it always insists on timely reconciliation of such accounts. How could the rapid rise in transactions in PNB’s Nostro account escape the regulator’s eye?

I understand RBI sent a note to all banks in the first week of February, asking them to reconcile all Nostro accounts.

What if banks tell the RBI they have done so, without doing so? What can the regulator do, in such situations? Have the bank’s internal auditors and statutory auditors failed here?

From Tamal:

Concurrent auditors in bank branches are assigned the job of transaction verification. There could be delay, but I wonder how the concurrent auditors failed in tracing out the full chain. Ditto about the statutory auditors. They are supposed to check customer-wise transaction register, along with sanctions /approvals for authenticating the true state of the books of accounts and establish the amount of bank’s contingent liabilities on the date of book closure. Similarly, the internal auditors are expected to verify client files, outstanding transactions, approvals and transaction registers. Besides, RBI auditors conduct the annual financial review.

But, Tamal also added this:

Besides, RBI auditors conduct the annual financial review.

What is the depth and breadth of this review? So, is the regulator really free of lapses here?

A much scarier thought

On this Punjab National Bank scandal, it does seem simple enough to understand what happened. But, that is worrying. If it was reasonably simple, why did it go undetected? It is not unreasonable to assume that several could be on the take – cutting across banks, auditors, the regulator, governments, etc. We live in a cynical world.

But, that is low probability because it is risky to involve too many stakeholders. Someone could spill the beans, if not out of altruism and morality but out of pique, let us say, because the spoils were not shared ‘fairly’. Yes, there could be moral considerations in immorality!

A scarier thought – scarier than the possibility of multiple layers and cross-sections of involvement – is that simply no one bothered to notice or do their job. The mind-numbing possibility is one of pervasive and deeply ingrained indifference and sloppiness. In other words, no one cared or cares any more!

Hence, it was scary to read that someone actually mentioned this as the possible reason for the scandal remaining undetected:

The accounts given by current and former executives who spoke to Reuters suggest an answer as simple as it is alarming: no one was paying attention. [Link]

This does not augur well for the integrity and unity of the country at all because it could be pervasive – yes, not within the banking system alone. Why should other sectors be different?

[Postscript: If the bank issued LoU to foreign banks (or, foreign branches of Indian banks, I presume that they would credit PNB’s Nostro account held with them before PNB credits the account of the borrower with the money. If I am right, why did the audit of PNB’s Nostro Accounts not spot the ‘unusual’ transactions? Why did anyone not raise a flag? Are these stupid questions? Perhaps.]