Thursday, January 29, 2009

On floating exchange rates

Ten years of floating exchange rates in Brazil, by Henrique Meirelles, Governor of the Central Bank of Brazil, on 19 January 2009. A crisp 3-page story that's germane for India's thinking about the exchange rate regime.

Downturn for CEOs

I have an opinion piece in Financial Express today titled What's a CEO to do in this downturn?

First measurement about crime and police

To economists, the role of government is to deliver `public goods'. A public good is something that is non-rival and non-excludable. Something is non-rival when my consumption of it doesn't detract from your consumption of it. Non-excludability is the inability to exclude a person from benefiting from the public good.

Law and order is a public good. When a city is safe, everyone benefits: the safety that one person enjoys doesn't detract from the safety that another person enjoys. And, it isn't possible to exclude any one person from benefiting from this safety.

In recent decades, economists have pushed for greater government involvement in `human development' covering issues such as health and education. Most activities in this field are actually not public goods. The bulk of educational services and health services are private goods: I get healthier or smarter, I benefit, it is a private good. Hence, the economic logic of pushing the government into this field was always suspect [link].

In India, we have had this great government interest in human development while - at the same time - we've had a worsening of the police and judiciary. While law and order is a public good, the performance of the State in this field has been getting worse. While most of human development is not a public good, we've seen an increasing focus and resource outlay in those areas.

The terrorist attacks in Bombay brought forth an outpouring of interest in stopping terrorism. But it is not possible to do this through superficial changes; genuinely achieving safety requires fundamental change to the police and judiciary.

I find it useful to compare and contrast the judiciary against the election commission. If the election commission came to us and said that conducting a general election would take 20 years, there would be an uproar and the entire leadership of the election commission would be sacked. It has not been easy, but the election commission has figured out how to run a fairly clean general election within roughly two months. Compare and contrast this with the non-performance of the judiciary. Why are we willing to accept non-performance from the judiciary of a kind that we would never accept from the election commission? If anything, as Fareed Zakaria has emphasised, a healthy democracy is more about good courts than it is about good elections.

The challenge in India is that of reining in the State, getting it to perform on the police and judiciary, and shift the focus of the State away from the pleasures of recruiting teachers who do not teach.

One of the first pieces of work that I have seen on the police in India was done by the MIT `Poverty Action Lab', and is written up by Jacob P. Koshy in Mint [slideshow].

I was very impressed at the fact that the research involved conducting a `crime survey'. Once again, there are a zillion surveys in India on issues like poverty or health, but none on the critical business of police and judiciary. In my knowledge, this is the first survey evidence on the experience of citizens with crime and the police. In the US, such surveys are called `crime victimisation surveys'.

Here are some gems from this. There are four districts that they report (Dholpur, Kota, Chittorgarh, Jaipur) where one in ten households (or worse) reports direct experience with one crime. I'd be curious to know what comparable international values are. In districts like Udaipur, Nagaur and Barmer, this value is 5% or lower.

Only 21% of the victims reported the crime and got an FIR registered.

13% of the victims were completely satisfied and 14% of the victims were satisfied with what the police did. The remaining vast majority were unsatisfied at what the police did. This is a massive vote of no confidence in the police. A full 82% reported that no beat constable ever visits their village or neighbourhood.

The slideshow goes on into statistical measurement of a few innovations in how the police could be made to function better. As with the bulk of this `development policy through randomised evaluation' literature, I'm underwhelmed at the usefulness of such simplistic schemes for making government work better. I have worked in government, and I have worked on reforming government from outside government, and this is not the way fundamental change is achieved.

In short, I was very impressed at (a) the crime victimisation survey, which is a big step forward, and (b) the fact that more people are taking interest in the most important public good of all. All of us should be pushing the top leadership to put more time and focus and resources into true public goods (e.g. law and order) at the expense of areas which are not public goods (e.g. most of human development).

Wednesday, January 28, 2009

Remarkable development in higher education

From 1947 onwards, the Indian government pushed one strategy for higher education: that of universities run mostly like government departments, and entry barriers that hindered new ideas from coming about. By and large, this approach has consistently yielded failure.

One innovation which slipped through the cracks was the Indian School of Business. Today, ISB has scored rank 15 of the world's business schools (after getting to rank 20 last year). Also see the Financial Times rankings page.

This is a really remarkable achievement. There is no other global ranking where an Indian university has come out at rank 15. This is particularly an achievement when we consider that ISB only got started in 2001, and it normally takes many decades for a university to achieve a reputation. As an example, IIT Bombay got started in 1957 and eight years later (i.e. 1965) it had a lot less prominence when compared with today. This emphasises the importance of the business process innovations that distinguish ISB from the mainstream strategy of universities that are run mostly like government departments.

RBI's credit policy announcement

RBI's credit non-policy announcement elicited relatively little by way of commentary. See Saugata Bhattacharya in Financial Express, and the editorials in Financial Express and Indian Express.

Tuesday, January 27, 2009

Another market on the verge of takeoff

The NSE currency futures did turnover of $473 million today, and got to open interest of $289 million. Macro underlyings become the biggest derivatives, so this contract has been the 2nd biggest derivative at NSE (after Nifty) for a while now.

They still have small transaction sizes: with 17,163 trades, the average transaction size was Rs.1,348,767. This suggests that the market has grown on the strengths of the traditional equity market community; thus far the banks and corporate customers haven't come in. But with turnover of $473 million it's starting to sound like real money, and the peeling off of smaller corporations from the OTC market can commence. The position limit for an individual client is now $17 million.

Saturday, January 24, 2009

We learn from history that we learn nothing from history

Right after the pious G-20 proclamations on eschewing protectionism, we got a flurry of protectionism from G-20 countries. Now India has banned the import of Chinese toys. Those who fail to learn from history are doomed to relive it. An outburst of barriers to trade or capital flows could tip us from this great recession to a great depression.

Friday, January 23, 2009

Data on corruption in India

Did someone ask you for a bribe today? Do something new: Report it in an anonymous and safe fashion. Measurement and publicity about corruption will help reduce it.

This system is run by `Business Registry for International Bribery and Extortion' or BRIBEline.

What does this database show? They have a report and a press-release out on India. A report and press-release on China is also out.

The data shows that 30% of the demands for bribes in India are from the police while in China it is only 11%. There is a lot of interest in fighting terrorism today, but sadly, there is no short-cut to obtaining better law and order without fundamental surgery of the police and the judiciary. The beat constable who feasts on extortion, and is willing to be bribed by criminals, is a beat constable who will not be watchful for interesting information about impending attacks.

I feel the strangest thing about Slumdog Millionaire is the lack of outrage about the evil police that are shown in the film. In India, too often, the police have become criminals in uniform against whom the citizen has no recourse. We've grown numb, we accept this as a given. I think it's a real puzzle: Why is a participatory democracy unable to rein in the State, and ensure that public goods are delivered?

While on this subject, do read Lant Pritchett's `flailing state' paper.

Wednesday, January 14, 2009

SEBI case against NSDL overturned by SAT

Here's the order. This is a step forward for the rule of law in India. In the future, a government agency is less likely to go after an innocent, knowing that the appeals mechanism works. For the back story, see here.

Nice display of intra-day option data

When there are a large number of option strikes and maturities, the human mind suffers from immense information overload. Nice displays of information are crucial for a mere mortal to be able to take in this information and turn it into good decisions. As David Gelernter might have said, beauty is the only defence against complexity.

Today NSE has released a sweet and simple display summarising data for options at all strike prices for one underlying at one expiration date. Click on any of the strikes for another slice on this data. Or if you want a more interesting example, here's Satyamcomp. I feel this display will be extremely valuable to anyone trading the option market. Suggestion to NSE: Why not have this page update in realtime without my hitting Apple-R?

Right to Education Bill, 2008

Read Ila Patnaik on this proposed law. While on this subject, you might like to see my five-part classification scheme on education policy. I guess the education bureaucracy is keen to go from #3 (State production but do no harm to the private sector) to #4 (State production while trying to actively damage the private sector).

Wednesday, January 07, 2009

Oh no

I was hopeful that in the Satyam story, the management would be sacked by the shareholders. Instead, it's turned into a disaster. Here's the resignation letter. Do see: satyam, satyam, fraud.

Dimensions of pro-cyclicality

The fiscal stance of sub-national governments

M. Govinda Rao taught me something very interesting yesterday:

  • Suppose we had a country where there are strong fiscal rules which forbid deficits at the sub-national level. This is a nice thing to do from the viewpoint of debt stability - as anyone who has studied the fiscal excesses of Argentina's sub-national governments knows. But in this case, fiscal policy at the sub-national level is pro-cyclical. In a downturn, tax revenues are reduced (whether own revenues or transfers from above) and expenditures have to be crimped.
  • In good countries, there is strong accountability at sub-national governments. The Mayor of New York is a person who runs for election on the strength of his achievements in delivering public goods. In Bombay, the Mayor is often someone you have never heard of, with little interest in delivering public goods; the typical reader of this blog doesn't bother to vote in these elections.

As a consequence, when (and only when) there is accountability at the sub-national government level, an effective strategy for a fiscal stimulus consists of delivering money to sub-national governments. This combats the procyclicality of their budgetary balances. If they embark on building roads or urban transport systems, there is a better chance that the money will not be wasted. But all this is conditional on having a proper mechanism of local government, where the Mayor of Bombay lives and dies by the delivery of public goods in Bombay.

We can describe these perverse problems with the fiscal balance of sub-national governments in India today, but there's precious little which we can do about it in the short run. Do read M. Govinda Rao and Ed Glaeser on these issues.

Some other examples of pro-cyclicality

On a similar note, see Surjit Bhalla's complaints about RBI violating the Taylor Principle. (You might find my comment here on estimating Taylor rules to be of interest). Badly structured monetary policy exacerbates the business cycle instead of stabilising it. And even if monetary policy sometimes does the right things, the malfunctioning Bond-Currency-Derivatives Nexus implies that there is a feeble monetary policy transmission; changes in the policy rate mean rather little for the economy. Long-standing policy mistakes have given us a crippled set of markets for government bonds, corporate bonds, currencies and derivatives thereof. A bad monetary policy framework gives poor choices on the policy rate; a bad financial policy framework gives a feeble monetary policy transmission.

For another example, witness companies using the 19th century mechanism of `company deposits'. This is the price that we pay today for ignoring bond market development for the last 25 years. When there are such deficiencies in financing firms, bad times become worse. Weak institutional capabilities in finance induce pro-cyclicality.

Or, of course, witness the inability of a government that's running a fiscal deficit of above 10% to meaningfully expand the fiscal deficit in a downturn. The good years should have been used to run up fiscal surpluses, which would have created space to enlarge the deficit in a downturn. That space is largely absent in India today. We are paying for our sins of not reforming the fiscal system in the great business cycle expansion of 2002-2007.

Stabilising the business cycle through sound institutional capabilities for fiscal, financial and monetary policy

More generally, look back at all the dimensions of pro-cyclicality of fiscal, financial and monetary policy which are hitting India in reverse now. When times were good, all these things are popular, because they convert good times into 10% GDP growth. Nobody minds pro-cyclicality when the going is good. It's only when the going gets hard that we realise how damaging these things are. John Kennedy said that the time to fix the roof is when the sun is shining. A storm has enveloped our house, and fixing the roof is hard.

Good countries avoid this boom and bust cycle through institution building on fiscal, financial and monetary economics. The best outcome that we can ask for, from the pain of 2009, is that the political and economic leadership brings better economic thinking into the institutional foundations of economic policy.

When India was a $250 billion agricultural country that was closed to the world, thoughts of fiscal, financial and monetary institution building were far away. We built and operated rickety structures such as the RBI Act. At that time, there was no `business cycle' in the modern sense of the term: there was just a sequence of monsoon lotteries. But now, things have changed. Operating the levers of a globalised $1 trillion economy with such institutional foundations is reckless. (You might like to read this paper).

Monday, January 05, 2009

Recent monetary policy response to the slowdown

Read Jayanth Varma in Financial Express and Ila Patnaik in Indian Express, and the editorial in Business Standard on recent moves by RBI. I found it useful to compare and contrast where we stand against policy analysis at the outset, in October.

Thursday, January 01, 2009

Bye bye 2008

Interesting things in the papers today: