Vimal's blog

Interesting paper in light of the FDI and multi-brand retail trade drama in India

noreply@blogger.com (Vimal Balasubramaniam) — Thu, 29 Dec 2011 12:54:00 +0000

The quiet revolution in India's food supply chains:

Date:	2011
By:	Reardon, Thomas Minten, Bart
URL:	http://d.repec.org/n?u=RePEc:fpr:ifprid:1115&r=ifn
	There has been a rapid transformation of food supply chains in India over the past two decades. Modern retail sales are growing at 49 percent per year and quickly penetrating urban food markets and even rural markets. The food-processing sector is growing quickly while also concentrating and undergoing a rapid increase in the capital-output ratio, with little increase in employment. A modern segment is emerging in the wholesale sector, with the penetration of modern logistics firms and specialized modern wholesalers.
Keywords:	wholesale markets, Supply chains, Farmers, Supermarkets, Food processing, logistics, cold chain, Food markets,

Some interesting papers relevant for Indian economic policy

noreply@blogger.com (Vimal Balasubramaniam) — Thu, 29 Dec 2011 12:32:00 +0000

Impact of fiscal policy shocks on the Indian economy

Date:	2010-12
By:	Yadav, Swati Upadhyaya, V Sharma, Seema
URL:	http://d.repec.org/n?u=RePEc:pra:mprapa:34071&r=ifn
	Impact of Fiscal Policy Shocks on the Indian Economy Swati Yadav , V.Upadhyay , Seema Sharma Abstract In this paper, we analyse the impact of fiscal shocks on the Indian economy using structural vector autoregression (SVAR) methodology. The study uses quarterly data for the period 1997Q1 to 2009Q2. Two different identification schemes have been used to assess the effects of shocks to government spending and tax revenues on output. The recursive scheme is based on the Cholesky decomposition and the second identification scheme Blanchard & Perrotti (1999) technique of using information on tax system to identify the SVAR model. We find that the impulse responses obtained from both identification schemes behave in a similar fashion but the value of multipliers differs. Also the shock to tax variable has a bigger impact on GDP than the government spending shock. In the extended four variable VAR model the effects of fiscal shocks on private consumption has been assessed using the recursive identification scheme. Findings indicate that the tax variable has larger impact on private consumption as compared to the government spending variable. In the short run the impact of expansionary fiscal shocks follow Keynesian tradition but the long run response is mixed.
Keywords:	SVAR; Fiscal shocks; Multipliers
JEL:	E12

Roaring Food Prices in India

Date:	2011-10-09
By:	Mukherjee, Soumyatanu
URL:	http://d.repec.org/n?u=RePEc:pra:mprapa:34009&r=ifn
	In this paper, we try to analyze the possible reasons behind food price hike. The motivation of doing this project is to see the probable reasons, which impact “common people” of India to the utmost extent. We concentrate mainly on the supply side, distribution aspects and the demand side. Checking these aspects we try to see their sensitivity in food prices.
Keywords:	Wholesale Price Index; Food grain prices; Public investment; Grain orientation; Public Distribution System; Wholesale and retail prices; Per capita net availability of food grains; Durbin-Watson ‘d’ test; augmented Dicky-Fullar(ADF)test; NREGA
JEL:	C32

An Economic policy and legal analysis of the Micro Finance Institutions (Development & Regulation) Bill, 2011

Date:	2011-10
By:	Shubho Roy (Indira Gandhi Institute of Development Research) Renuka Sane (Indira Gandhi Institute of Development Research) Susan Thomas (Indira Gandhi Institute of Development Research)
URL:	http://d.repec.org/n?u=RePEc:ind:igiwpp:2011-025&r=ifn
	In response to the Second Micro Finance Crisis in Andhra Pradesh, which took place in October 2010, the Ministry of Finance has pro- posed a new Micro Finance Institutions (Development & Regulation) Bill. This paper undertakes a detailed analysis of the draft Bill in terms of both economic policy and law. This analysis reveals many weak links, including: a lack of clarity on the objectives of the Bill; an insufficient focus on protection of the rights of the micro-borrower; lack of clarity about the definition of thrift; the loss of accountability that comes with multiple regulatory agencies; concerns about the rule of law; and constitutional issues about powers of the Centre versus the State Government.
Keywords:	microfinance, regulation, crisis resolution, consumer credit, consumer protection, regulatory objectives
JEL:	G20

Knowledge Flows and Capability Building in the Indian IT Sector: A Comparative Analysis of Cluster and Non-Cluster Locations

By:	Basant, Rakesh Chandra, Pankaj Upadhyayula Rajesh
URL:	http://d.repec.org/n?u=RePEc:iim:iimawp:10677&r=ifn
	The role of industrial clusters in the industrialization of many emerging economies continues to dominate the debate among policy makers and researchers worldwide. While recent discussions on this debate have focused on knowledge spillovers among participants within clusters, knowledge flows between non local networks and the cluster actors have not been accorded due attention in the literature. Further, the literature does not compare the relative impact of knowledge flows among firms within clusters and firms outside clusters. In this study, we attempt a comparative analysis of the role of knowledge flows in capability formation among firms in the Indian Information Technology sector (IT sector) across cluster and non-cluster locations. The empirical results suggest that at the firm level, leveraging of capabilities to enhance performance and networks to build capabilities is not automatic; structural features of the firms’ location enable this transformation. Moreover, while capabilities affect performance of firms positively only in clusters, economies of scale and some strategies like quality certification used by firms impact performance of firms outside clusters. Interestingly, although economies of scale do not impact the performance of firms within clusters, they do, however affect the capability formation of firms within clusters only. Further, we found that local and national non-customer networks affect capability formation of firms within and outside clusters whereas international customer networks affect capability formation of firms within clusters only. These have implications for how firms can develop appropriate strategies to enhance their performance.
Keywords:	Industrial Clustering, Information Technology industry, Networks, Capabilities

Complementing Bagehot: Illiquidity and insolvency resolution

Date:	2011-10
By:	Eijffinger, Sylvester C W Nijskens, Rob
URL:	http://d.repec.org/n?u=RePEc:cpr:ceprdp:8603&r=ifn
	During the recent financial crisis, central banks have provided liquidity and governments have set up rescue programmes to restore confidence and stability, often against the LLR principle advocated by Bagehot. Using a model of a systemic bank suffering from liquidity shocks, we find that the unregulated bank keeps too much liquidity and monitors too little. A central bank can alleviate the liquidity problem, but induces moral hazard. Therefore, we introduce an additional authority that is able to bail out the bank either by injecting capital at a fixed return or by receiving an equity claim. This authority faces a trade-off: demanding a fixed premium increases investment but worsens moral hazard. Request for an equity claim by the fiscal authority reduces excessive risk taking at the expense of investment. This resembles the current situation on financial markets, in which banks take less risk but also provide less credit to the economy
Keywords:	Bailout; Bank Regulation; Capital; Lender of Last Resort; Liquidity
JEL:	E58

Spatial Determinants of Entrepreneurship in India

Date:	2011-10
By:	Ejaz Ghani William R. Kerr Stephen D. O'Connell
URL:	http://d.repec.org/n?u=RePEc:nbr:nberwo:17514&r=ifn
	We analyze the spatial determinants of entrepreneurship in India in the manufacturing and services sectors. Among general district traits, quality of physical infrastructure and workforce education are the strongest predictors of entry, with labor laws and household banking quality also playing important roles. Looking at the district-industry level, we find extensive evidence of agglomeration economies among manufacturing industries. In particular, supportive incumbent industrial structures for input and output markets are strongly linked to higher establishment entry rates. We also find substantial evidence for the Chinitz effect where small local incumbent suppliers encourage entry. The importance of agglomeration economies for entry hold when considering changes in India’s incumbent industry structures from 1989, determined before large-scale deregulation began, to 2005.
JEL:	L10

What does financial volatility tell us about macroeconomic fluctuations?

Date:	2010-10
By:	Chauvet, Marcelle Senyuz, Zeynep Yoldas, Emre
URL:	http://d.repec.org/n?u=RePEc:pra:mprapa:34104&r=ifn
	This paper provides an extensive analysis of the predictive ability of financial volatility measures for economic activity. We construct monthly measures of aggregated and industry-level stock volatility, and bond market volatility from daily returns. We model log financial volatility as composed of a long-run component that is common across all series, and a short-run component. If volatility has components, volatility proxies are characterized by large measurement error, which veils analysis of their fundamental information and relationship with the economy. We find that there are substantial gains from using the long term component of the volatility measures for linearly projecting future economic activity, as well as for forecasting business cycle turning points. When we allow for asymmetry in the long-run volatility component, we find that it provides early signals of upcoming recessions. In a real-time out-of-sample analysis of the last recession, we find that these signals are concomitant with the first signs of distress in the financial markets due to problems in the housing sector around mid-2007 and the implied chronology is consistent with the crisis timeline.
Keywords:	Realized Volatility; Business Cycles; Forecasting; Dynamic Factor Models; Markov Switching
JEL:	C32

Update on the Indian Economy - December 2009

noreply@blogger.com (Vimal Balasubramaniam) — Mon, 07 Dec 2009 16:38:00 +0000

From this month onwards, there will be updates on a monthly basis up on this blog tracking the Indian economy both from the macroeconomic point of view as well as covering exclusively inputs on the exchange rate. This is an attempt to weave in academic research and policy discussions with ground level responses and changes in the economy. This update will primarily use seasonally adjusted data from the NIPFP-DEA seasonal adjustment database.

Indian Economy: December 2009

GDP growth in Q2 2009 was robust at 10.60% prompting markets to factor in a possible wind down of the prevailing easy monetary policy stance. While external demand remains weak with exports clocking a negative 11.24% 3mma saar in Oct-09, and domestic private consumption on shaky grounds, government consumption has sustained growth in Q2 2009. Going forward, rising inflation, poor agricultural growth and high fiscal deficit pose challenges to the Indian Economy.

Domestic Demand remained steady, although weak, with the Index of Industrial Production (Capital goods) posting a fall from 32.51% 3mma growth in Aug to 10.29% in September.
Contrary to popular perception of rising inflation, the seasonally adjusted annualised rate of CPI inflation has fallen from 10.78% in Sep to 8.10% in Oct. Further, WPI inflation has also fallen from 5.68% in Sep to 4.50% in Oct. However, food price inflation has risen from 7.74% in Sep to 13.41% in Oct.
Exports remained weak with -6.53% in Oct compared with 8.15% annualised growth rate in Sep. Imports have improved from a negative annualised growth rate of -27.01% in Sep to -18.36% in Oct.
The RBI purchased gold from the IMF as a part of its diversification of reserve holdings. However, this will not cause any increase in base money as money from retiring US treasury bills has been utilised. Foreign Exchange Reserves stood at U$264.4 billion in Sep, with intervention data showing little action from the RBI to manage the rupee.
The estimated combined fiscal deficit (federal and state level) of 9% remains a cause of worry with yields on 10-year treasury bonds significantly rising upwards compared with the five and one year bonds towards the 7.5% yield mark. However, the government announced recently its intentions to disinvest from public sector undertakings and utilisation of funds from the proceeds towards social sector programmes. The Fiscal Responsibility and Budget Management Act targets are far from being met, and no action plan on this front has been announced by the Finance Ministry.
Capital inflows have resumed with over U$6 bn inflow into the economy in Sep. Concerns of exit from easy monetary policy has raised concerns of increased capital flows. However, there is little policy room for the RBI to intervene in the currency markets to prevent appreciation of the rupee. With modest exchange rate pass through, the RBI may be seen to prefer a stronger currency in the coming months.

India's exit strategy - 1/ Does RBI really need to exit? 2/ To float or not to float?

noreply@blogger.com (Vimal Balasubramaniam) — Sun, 06 Dec 2009 04:40:00 +0000

Subir Gokhran spoke to the media on graded exit strategy from easy monetary policy in India. Before getting into the process of exiting from monetary policy, what does the inflation scenario in India look like?

Using the NIPFP-DEA database on seasonally adjusted macro data-series, one can see that the inflation situation is not very grave. The seasonally adjusted three-month moving average of WPI inflation suggests that WPI inflation is already dropping towards the 5% level. Even, WPI for fruits and vegetables are weakening on a point-on-point basis towards 3%. WPI food inflation has weakened too from the peak of over 25% to about 10%, and remains in double-digits.
On the other hand, the real economy has stabilized according to the GDP numbers. The quarter on quarter three month moving average of seasonally adjusted GDP at factor cost is back to its initial growth track of 10% reflecting in part the resilience of the manufacturing sector despite a drop in consumer goods production, from a peak of 40% 3mma to about 10% 3mma. Going forward, the drop in overall IIP from over 30% growth rate to 5% is of concern as well.

Growth in Non-food credit, a proxy for domestic credit for productive purposes, has also weakened further from 18% in April 2009 to about 11% in October 2009. This is well below the pre-crisis levels of over 25% growth in point on point estimates, and suggests that a tightening might have to account for both a sluggish pace in growth of non-food credit as well as IIP.

So do we exit?

Inflationary expectations are certainly on the upside with the long term 10-year government bond yields steeper than the short-term yields. However, to view inflation without looking at how stable the recovery process is might land the Indian economy in danger. Tightening monetary policy may yield to higher capital inflows with counter productive results on growth. RBI's de facto peg to the US dollar might be under the line of fire too as the ammunition to mop up excess liquidity from domestic markets as a result of intervention may not be renewed by the Ministry of Finance.

The policymakers lost an opportunity for structural reforms in the agricultural sector while inflation was benign and it has begun to reflect itself in the form of a price spiral when growth is tamed and fiscal deficit has ballooned to record levels. Notwithstanding the lack of foresight during the benign period, RBI is in a quagmire: to contain prices might lead to a threat to the rupee as the RBI intends on keeping it stable and not containing prices will not be politically a feasible option. Although trends show a weakening inflation scenario, food inflation remains in double-digits.

Subir's statement that there needs to be a graded exit from easy monetary policy is a truism; how, when and with what tools of monetary policy (RBI has multiple targets and multiple tools) remains unanswered. The exit from easy monetary policy is quintessential in dealing with inflation, although a stable rupee to support exporters may not be a wise policy combination as the pass through from world prices into the domestic prices can only be contained with an appreciating rupee.

To float or not to float?

While there is no doubt that capital flows into the economy are still weak and nowhere close to pre-crisis levels, a rise in interest rate can lead to a vicious cycle of greater flows, attempt to mop liquidity from domestic markets, raise in interest rates and further increase in capital inflows. Because of little openness with capital outflows, the path for balancing the rupee remains in the hands of the RBI.

Why would the RBI be worried with an appreciating rupee? An appreciating rupee at the time of poor export growth (with negative non-oil exports growth rates), and poor imports (that show a declining trend after recovering from negative growth rates for 11 consecutive months) may impact the Balance of Payments drastically by widening the current account deficit. However, the macroeconomic balance at this juncture will tilt towards domestic considerations such as inflation and will not be held hostage to a small group of export lobbyists. Given this proposition, there is no question whether the RBI can decide to let the rupee be more flexible: It has no choice but to let the rupee move unless it decides to go the Brazil path by imposing capital controls. However, the sentiment as expressed by the Finance Minister Pranab Mukherjee and through the formation of the Working Group on Portfolio Flows under the leadership of UTI Chairman Mr. U.K.Sinha suggests that the government is no mood to exercise capital controls and further complicate a complex web of controls that prevail in India.

In short, the RBI will certainly begin exiting from easy monetary policy by using its reserve ratio as its first tool of monetary policy, and will by deduction have to allow the rupee to appreciate in the event of such appreciating pressures.

China's yuan up, can we catch up?

noreply@blogger.com (Vimal Balasubramaniam) — Wed, 21 Oct 2009 12:41:00 +0000

My first article in the FE.

Common currency unit back on mainstream debate

noreply@blogger.com (Vimal Balasubramaniam) — Mon, 19 Oct 2009 05:31:00 +0000

The Asian Currency unit was a much talked about affair and was probably the most important currency unit debate since the ECU idea. Today, Central American countries such as Honduras, Guatemala, Nicaragua, have reached an understanding to promote a common currency unit and also a regional passport in their effort to promote regional cooperation.

In this light, it would be interesting to see if a CCU is warranted in the South Asian region. While there is no economic reason to prevent such a unification, South Asia's numero-uno obstacle is its political instability. What are the pressing economic concerns that promote such a possibility?

The present monetary arrangement has the Indian rupee on the forefront with Bhutan and Nepal relying on the Indian monetary policy actions to shape their domestic monetary policy. This has helped their economies in multifarious ways. Notably, because Bhutan and Nepal has India as its major trading partner, the business cycle synchrony allows for a regional peg to the INR. Further, currency trading does not happen on the BTN or NPR and they are convertible into INR freely. Business cycle in Bangladesh also co-move with the Indian business cycle. (While there is no substantive empirical research available on this front, preliminary evidence with quarterly y/y GDP suggests the same). The Srilankan monetary arrangement was heavily dependent on domestic political considerations and now that the war with LTTE has come to an end, a lot of internal cleaning up of macroeconomic policy framework is essential. Under this circumstance, a peg to the Indian rupee and arrangements to prevent debt monetisation will allow for macroeconomic stability for the economy. With Pakistan, potential for trade is enormous and the underlying economic conditions are very much similar to the Indian environment. The RBI was its central bank until SBP was formed and with a cordial political environment, a monetary unit can provide economic stability. With this the case, the RBI (may be an RBSA (south asia)) is no more a national entity, but a regional one such as the ECB. Profit transfer from operating a central bank could be shared on a mutually agreeable basis and the basic operational framework of the central bank could be similar to that of the ECB.

On the microeconomic benefits, the single most important benefit of a CCU is that of reduction in transaction costs. The mini monetary arrangement with Bhutan and de facto with Nepal has shown that with increased trade integration such an arrangement can reduce transaction costs through reducing production and distribution costs. Of course the basic requirement for such an arrangement to function is a fully operational SAFTA (South Asian Free Trade Agreement) which has similar duty and tax structures across the board. Externally, none of these economies are oil producing and in that sense have similar external threat to price stability.

A case for a RBSA is imminent, with the economics behind it being favourable. Like the stumbling block for the European countries, politics of it all will need to be sorted out and foremost of this issue is a resolution to the Kashmir issue. The present cordiality between Pakistan and China may also be an important obstacle in this formation.

Indian economy needs a core inflation measure

noreply@blogger.com (Vimal Balasubramaniam) — Wed, 30 Sep 2009 04:25:00 +0000

There are talks of the RBI hiking rates in the last quarter of 2009-2010. Even its own monetary policy statement sounded alert on rising inflation rates. Is inflation rising? I wouldn't be surprised if the RBI is actually alerting itself and the rest of the world on headline inflation and not core inflation. Former Governor Y.V Reddy also stated in 2006 that the RBI has added credibility and guided inflation expectations by adopting an explanatory approach to headline and underlying inflation in India. However, I see a lot of discretion and no rule to understand what these are.

Before heading off into what the monetary policy "prices" in, let us look at what core inflation is all about. In crude terms, core inflation is a measure of inflation which excludes volatile price movements. In other words, core inflation is the permanent rise in inflation not caused by any cyclical or temporary jump in prices. For instance the Fed uses the core Personal consumption expenditure index :

The chain-type price index for PCE draws extensively on data from the consumer price index but, while not entirely free of measurement problems, has several advantages relative to the CPI. The PCE chain-type index is constructed from a formula that reflects the changing composition of spending and thereby avoids some of the upward bias associated with the fixed-weight nature of the CPI. In addition, the weights are based on a more comprehensive measure of expenditures.

While discretion is needed in monetary policy, it may not be the best of tools in issues that can be clearly quantified and constructed. Core inflation is not rocket science to construct and anchoring monetary policy on inflation rules is not an undesirable goal.

In India, talks of core inflation have been lingering around for long. While it is true that the current measure of prices (both CPI and WPI) are not good representation of rate of change in domestic prices, it is important to understand that as the central bank, seasonally adjusted core inflation data may provide far more consistency to monetary policy than otherwise.

Is consistency in monetary policy desirable when prices are shooting up and down? Firstly, given the administered price mechanism in the country for oil and food, distortions in the market has already taken place. I call it distortion because there is no underlying economics to the price set for petrol (other than of course the balance sheet of oil companies) or for that matter on food. The Food Corporation of India could do much better in its distribution and storage processes and the cost of government intervention has been way too high. Neither has its intervention in food prices kept the food prices low. It might be important to differentiate commodities and services where prices are administered. Menu prices are inherently sticky in the short-run (The government does not and cannot change prices often). Secondly, an approach such as the Fed's would make much more sense as what the consumer pays for consumption is what needs to be tracked.

If the RBI has been concerned about price rise all along, they would have noticed the phenomenal rise in food prices long ago. These can be seen in the seasonally adjusted three month moving average graphs of various WPI components. In short, there is an impending need for a core inflation measure that captures adequately the underlying price changes in the economy.

In defense of financial innovation (From FT)

noreply@blogger.com (Vimal Balasubramaniam) — Mon, 28 Sep 2009 05:12:00 +0000

Financial innovation has been blamed for the current crisis. How far is that true? How much of it is just plain melo-drama of poorly equipped and sleeping regulatory authorities across the world? I liked this article by Robert Shiller in the Financial times who wrote:

In defence of financial innovation
By Robert Shiller
Published: September 27 2009 19:09 | Last updated: September 27 2009 19:09

Many appear to think that the increasing complexity of financial products is the source of the world financial crisis. In response to it, many argue that regulators should actively discourage complexity.
The June 2009 US Treasury white paper seemed to say this. The paper said that a new consumer financial protection agency be “authorised to define standards for ‘plain vanilla’ products that are simpler and have straightforward pricing,” and “require all providers and intermediaries to offer these products prominently, alongside whatever other lawful products they choose to offer”.
The July 2009, HM Treasury white paper “Reforming Financial Markets” similarly advocated “improving access to simple, transparent products so that there is always an easy-to-understand option for consumers who are not looking for potentially complex or sophisticated products.”
They do have a point. Unnecessary complexity can be a problem that regulators should worry about, if the complexity is used to obfuscate and deceive, or if people do not have good advice on how to use them properly. Complexity was indeed used that way in this crisis by some banks who created special purpose vehicles (to evade bank capital requirements) and by some originators of complex mortgage securities (to fool the ratings agencies and ultimate investors).
Modern behavioural economics shows that there are distinct limits to people’s ability to understand and deal with complex instruments. They are often inattentive to details and fail even to read or understand the implications of the contracts they sign. Recently, this failure led many homebuyers to take on mortgages that were unsuitable for them, which later contributed to massive defaults.
But any effort to deal with these problems has to recognise that increased complexity offers potential rewards as well as risks. New products must have an interface with consumers that is simple enough to make them comprehensible, so that they will want these products and use them correctly. But the products themselves do not have to be simple.
The advance of civilisation has brought immense new complexity to the devices we use every day. A century ago, homes were little more than roofs, walls and floors. Now they have a variety of complex electronic devices, including automatic on-off lighting, communications and data processing devices. People do not need to understand the complexity of these devices, which have been engineered to be simple to operate.
Financial markets have in some ways shared in this growth in complexity, with electronic databases and trading systems. But the actual financial products have not advanced as much. We are still mostly investing in plain vanilla products such as shares in corporations or ordinary nominal bonds, products that have not changed fundamentally in centuries.
Why have financial products remained mostly so simple? I believe the problem is trust. People are much more likely to buy some new electronic device such as a laptop than a sophisticated new financial product. People are more worried about hazards of financial products or the integrity of those who offer them.
The problem is that financial breakdowns come with low frequency. Since flaws in the financial system may appear decades apart, it is hard to figure out how some new financial device will behave. Moreover, because of the low frequency of crises, people who use financial instruments often have little or no personal experience with the crises and so trust is harder to establish.
When people invest for their children’s education or their retirement, they are concerned about risks that will not become visible for years. They may not be able to rebound from mistaken purchases of faulty financial devices and they may suffer if circumstances develop that create risks that could have been protected against.
Thus, to facilitate financial progress, we need regulators who ensure trust in sophisticated products. They must work towards clearing the way to widespread use of better products, concerning themselves with both safety and creative ideas. They must not simply be law enforcers against the shenanigans of cynical promoters, but also be open to making complex ideas work that have the potential to improve public welfare. Unfortunately, the crisis has sharply reduced trust in our financial system.
At this point in history, there has been over-reliance on housing as an investment. It is an appealing investment as it is simple to understand: we see the home we own every day. But in using housing as a big savings vehicle, people have built homes that are larger than needed and hard to maintain. This extra housing would be expected to have a negative return in the form of depreciation.
The popular reliance on housing as an investment, combined with the increased leverage with newer mortgage practices, contributed to the housing bubble that has now burst, resulting in historically unprecedented numbers of foreclosures. The fact that a bubble could grow this large and burst is a sure sign of imperfect financial institutions, not of overly complex institutions.
Unfortunately, people do not trust some good innovations that could protect them better. The innovations in mortgages in recent years (involving such things as option-adjustable rate mortgages) are not products of sophisticated financial theory. I have proposed the idea of “continuous workout mortgages”, motivated by basic principles of risk management. The privately issued mortgage would protect against exigencies such as recessions or drops in home prices. Had such mortgages been offered before this crisis, we would not have the rash of foreclosures. Yet, even after the crisis, regulators seem to be assuming a plain vanilla mortgage is just what we need for the future.
Another example of a potentially useful innovation is the target-date fund (also called life-cycle fund) that invests money for people’s retirement in a way that is specifically tailored for people their age. Such a fund plans for young people to take greater risks and for older people to invest more conservatively. Target-date funds, first introduced by Wells Fargo and BGI in the 1990s, are growing in importance, but few people commit the bulk of their portfolio to such funds, or make use of target-date funds that might make adjustments for their other investments. It appears that people do not fully trust that these funds are designed correctly, or would protect them from crises.
Another innovation that is underused is retirement annuities that include protections against potential risks. There are life annuities that protect people against outliving their wealth, inflation-indexed annuities that protect against inflation, impaired-life annuities that protect against having problems in old age that require they spend more money and generational annuities that exploit the possibilities of intergenerational risk sharing. But most people do not make use of any of these.
Ideally, all of these protections for retirement income should be rolled into a unified product. Such products are not generally available yet. Certainly, people might be mistrustful of committing their life savings to such a complex new product at first even if it were available. So, such products are not offered and people often do nothing to protect themselves against most of these risks.
Behind the creation of any such new retail products there needs to be an increasingly complex financial infrastructure so that professionals who try to create them can manage a full array of risks. We need liquid international markets for real estate price indices, owner-occupied and commercial, for aggregate macroeconomic risks such as gross domestic product and unemployment, for human longevity risks, as well as broader and more effective long-term markets for energy risks. These are markets for the risks that were not managed as the crisis unfolded, and they create a deeper array of possibilities for new retail financial products.
It is critical that we take the opportunity of the crisis to promote innovation-enhancing financial regulation and not let this be eclipsed by superficially popular issues. Despite the apparent improvement in the economy, the crisis is not over and so the public continues to support government-led interventions. Doing this means encouraging better dialogue between private-sector innovators and regulators. My experience with regulators suggests that they are intelligent and well-meaning but often bogged down in bureaucracy. Regulatory agencies need to be given a stronger mission of encouraging innovation. They must hire enough qualified staff to understand the complexity of the innovative process and talk to innovators with less of a disapprove-by-the-rules stance and more that of a contributor to a complex creative process.
The writer is professor of economics and finance at Yale University and chief economist at MacroMarkets LLC

India's telecom majors

noreply@blogger.com (Vimal Balasubramaniam) — Mon, 28 Sep 2009 03:31:00 +0000

The telecom majors in India have been indulging themselves in major deals in the recent past. The Bharti Airtel - MTN merger deal (a matter that is yet to be sorted out by the Ministry of Finance) has sent shock waves amongst the establishment in the North Block on the convertibility of the rupee. If not now, this devil will pop up yet again and this time the Ministry of Finance should resist and use its good offices with the Reserve Bank of India to prevent "piece-meal regulation" - something the RBI has been indulging in for way too long.

On a completely different note, the state run BSNL has made its intention of listing itself on the stock exchange. In what is seen as a major organizational shuffle, about 200,000 employees of BSNL are being shifted to a new organization the National Optic Fibre Authority who's job is to lay optic fibres across the country and lease it out to telecom service operators. This will reduce BSNL's wage bill by about 12,000 crores (1crore = 10 million).

This restructuring process is essential for a company that might book its first ever loss since its inception in 2000. Furthermore, before listing itself on the exchange, BSNL needs these reforms to improve its balance sheet before the IPO. However, the politics of disinvestment by the government and using the market to discover the price for disinvestment will be interesting to watch as they play out.

Interesting read...

noreply@blogger.com (Vimal Balasubramaniam) — Thu, 24 Sep 2009 12:01:00 +0000

Agnes Benassy-Quere and Olena Havrylchyk on the design on financial regulation...

Michael Pettis on the clash in savings (China and global imbalances). It seems clear that the author does not believe that the US has had a role to play in the global imbalances story (comes clearly in the article). There is nothing that prevents China from building large surpluses and pass the global imbalances around like a hot potato...

Peter Goodman takes a hard look at Greenspan's legacy. My take: It is quite easy to condemn ex-post the regulatory issues and Greenspan's lack of foresight. However much one calls derivatives the devil, it plays an important role of diversifying risk and that is essentially something that drove Greenspan's idea of the derivatives world. Not supporting Greenspan but I guess it is important to also see the good stuff derivatives bring on the table.

Otaviano Canuto on decoupling, reverse coupling and all that jazz... Interesting read indeed. Calls for some work on identifying demand, supply and monetary policy shocks and business cycles.

Return of the Glass-Steagall? (pasted from Calculated Risk)

noreply@blogger.com (Vimal Balasubramaniam) — Thu, 24 Sep 2009 05:39:00 +0000

Volcker on Financial Reform

from Calculated Risk by CalculatedRisk

Former Fed Chairman Paul Volcker testifies in front of the House Financial Services Committee at 9 AM ET on Thursday about financial reform.

For those interested, here is the webcast.

Here is his prepared statement. A few excerpts:

However well justified in terms of dealing with the extreme threats to the financial system in the midst of crisis, the emergency actions of the Federal Reserve, the Treasury, and ultimately the Congress to protect the viability of particular institutions – their bond holders and to some extent even their stockholders – have inevitably left an indelible mark on attitudes and behavior patterns of market participants.
• Will not the pattern of protection for the largest banks and their holding companies tend to encourage greater risk-taking, including active participation in volatile capital markets, especially when compensation practices so greatly reward short-term success?

• Are community or regional banks to be deemed “too small to save”, raising questions of competitive viability?

• Does not the extension of support to non-banks, and even to affiliates of commercial firms, undercut the banking/commerce divide, ultimately weakening the commercial banking system?

• Will not investors in money market mutual funds find reassurance in the fact that when push came to shove, the Treasury with an extreme interpretation of its authority, took action to preserve those funds ability to meet their declared commitment to pay their investors at par upon demand?
What all this amounts to is an unintended and unanticipated extension of the official “safety net”, an arrangement designed decades ago to protect the stability of the commercial banking system. The obvious danger is that with the passage of time, risk-taking will be encouraged and efforts at prudential restraint will be resisted. Ultimately, the possibility of further crises – even greater crises – will increase.

There is no easy answer, no one-size fits all contingencies. Experience, not only here but in every country with highly developed, inter-connected financial systems and institutions bears out one point. Governments are not willing to withhold financial and other support for failing institutions when there is a clear threat to the intertwined fabric of the financial system. What can be done is to put in place arrangements to minimize the extent of emergency intervention and to damp expectations of government “bailouts”.

Volcker goes on to disagree with the Treasury plan to name banks that are “systemically important” or "too big to fail".

Think of the practical difficulties of such designation. Can we really anticipate which institutions will be systemically significant amid the uncertainties in future crises and the complex inter-relationships of markets? Was Long Term Capital Management, a hedge fund, systemically significant in 1998? Was Bear Stearns, but not Lehman? How about General Electric’s huge financial affiliate, or the large affiliates of other substantial commercial firms? What about foreign institutions operating in the United States?

All hard questions. In practice the “border problem” seems intractable. In fair financial weather, the important institutions will feel competitively hobbled by stricter standards. In times of potential crisis, it would be the institution left out of the “too big to fail” club that will fear disadvantage.

Volcker argues for a more traditional approach that sounds like the return of Glass-Steagall.

NIPFP-DEA Conference

noreply@blogger.com (Vimal Balasubramaniam) — Mon, 21 Sep 2009 17:01:00 +0000

The fifth NIPFP-DEA conference took place last week and all the materials of that conference are now available at http://www.nipfp.org.in/nipfp-dea-program/meetings.html

My choice for reading up are:

     Technology adoption and production organisation in India, [paper]
     Sourafel Girma, Nottingham University Business School

Central bank preventing appreciation vs. preventing depreciation, [paper] [slideshow]
     Matthieu Stigler, Federal Department of Economic Affairs, Switzerland

What has happened with exchange rate regimes in Asia?, [paper]
     Ila Patnaik, NIPFP

For those who are interested in accessing more information on the exchange rate regimes and its methodology also refer to the R package titled "fxregime" and the paper Exchange Rate Regime Analysis Using Structural Change Methods by Achim Zeileis, Ajay Shah, Ila Patnaik. Research Report Series / Department of Statistics and Mathematics, Nr. 56, August 2007. Wirtschaftsuniversität Wien, Augasse 2-6, A-1090 Wien, Austria

My choice for reading...

noreply@blogger.com (Vimal Balasubramaniam) — Sat, 12 Sep 2009 03:20:00 +0000

A.Seshan on RBI in The Hindu. To mop-up or not to mop-up is a question that has been a bother to the RBI. See Ila Patnaik on why there is no reason to mop-up

Monica Halan on inflation indexed bonds in The Mint. It is time that the government got its act together and clean up the CPI and WPI measurement. Till this happens, I wonder if Monica's hypothetical retail RBI inflation protection bond (RRIPB) will ever be the reality.

An interview with T.T.Srinivasaraghavan where he says that we need an Indian model of financial services in The Hindu.

Paul Krugman on having math in economics, as a servant and not as our master.

Kenneth Rogoff's "From financial crisis to debt crisis?" in project-syndicate.

Tao Sun and Xiaojing Zhang on "Spillovers of the US crisis to mainland China and Hong Kong SAR: Evidence from the stock markets"

The Card Game...

noreply@blogger.com (Vimal Balasubramaniam) — Fri, 11 Sep 2009 11:54:00 +0000

Ron Lieber and Andrew Martin from the International Herald Tribune talk about how debit cards have become a source of credit worry for consumers in the US. (article) A very interesting issue brewing up in terms of regulation. There are proposals at the Fed Reserve to get banks to have prior permission from its customers for the overdraft option, and this proposal would only erase the line between debit and credit cards - requiring a change in the mindset of consumers.

China's investment into IMF bonds – a meagre diversification

noreply@blogger.com (Vimal Balasubramaniam) — Fri, 11 Sep 2009 06:17:00 +0000

The RMB 341.2 billion investment by the People's Bank of China (PBOC) in five-year International Monetary Fund (IMF) bonds has raised many questions on the reason behind such an investment. On the one hand, this has been seen as a strategic move to raise China's status in the IMF. On the other, this has also raised questions on whether the Chinese authorities are quietly promoting the use of the yuan abroad, especially in light of its currency swap deal with Argentina, and emergency lending agreements with the Bank of Korea, Bank Negara Malaysia and Bank Indonesia. These questions, especially the latter, are unfounded as what this investment really implies is a meagre diversification of its 2.1 trillion dollar reserves.

The agreement between the IMF and the PBOC suggests that SDR 15 billion out of SDR 32 billion has been invested under Series A notes, which allow for early payment on demand by the Chinese authorities under specific circumstances. The remaining investment are in Series B notes that do not have such a provision. Apart from the Chinese, Russia and Brazil have also expressed interest in investing into the IMF bonds.

What drove the Chinese to invest into the IMF bonds? In essence, concerns of excessive investment in dollar denominated assets has led to a small diversification in its portfolio. In 2008, the PBOC increased their holdings of US debt by 52%. Multiple reports suggest that the Chinese, seeking to reallocate resources, are moving out of the long-end of the curve. This investment is part of the many attempts to reduce the proportion of dollar denominated assets in its reserves.

The weights assigned to the US dollar, Euro, Japanese yen, and the Pound sterling in the SDR basket of four currencies are 44%, 34%, 11%, and 11% respectively. One of the main criterion to make it into the basket is whether the currency is freely usable in the global markets. Until this is the case, the current RMB 341.2 billion diversification becomes even more trivial. The use of SDR as a reserve currency is equivalent to holding reserves in the ratio of the four currencies currently in the basket. Even if the PBOC mimics the SDRs for all of its reserves, 44% of its reserves would still be in US dollar, 8% down from the previous year. The IMF, hence, is certainly not the decision-maker on what would be the global reserve currency nor can its unit of account, the SDR, replace the dollar as the reserve currency.

Internationalising the yuan would mean that the authorities must pave way for the yuan to be used by the market as a vehicle currency, quotation currency and as a currency in which investment into debt is possible. It would also mean that the yuan can be used as an intervention currency, anchor currency (for other economies) and as a reserve currency. These global functions of money, attributed to Peter Kenen, is possible only with full convertibility of the yuan. As a comparison, roughly 88% of daily trades in the currency market involves the US dollar. Further, the IMF data on currency composition of world reserves suggests that over 40% is held in US dollars in the first quarter of 2009. These are possible because of the liquidity in the US bond markets, complete convertibility of the dollar, and also to a significant extent, the low credit and default risk in investing into dollar denominated assets in the US. By doing what the PBOC has done, the Chinese have actually gone the otherway round and hence this move cannot be termed as a step towards internationalisation of its currency.

Being the first member country to invest in the first ever bond scheme from the IMF, China has only utilised the opportunity to diversify some of its reserves, which otherwise seemed difficult. The question of China gaining greater status within the IMF with $50 billion worth investment into the IMF, seems off track, yet again. Firstly, this investment is neither increasing its share capital in the IMF, nor increasing its voting share. Secondly, these investments need to be seen in the larger perspective of the G-20 commitment to support IMF's lending capacity. The European Union, for instance, has commited to contribute up to USD 175 billion out of which France has already contributed USD 15.8 billion and the United States has pledged support of USD 100 billion to the IMF. And lastly, this move by the PBOC cannot be placed within the ambit of political signals emanating from emerging economies for a greater role at international institutions for the lack of any significant agreement between the IMF and China to have received this sum of money.

Governor Zhang's call to oust the dollar from being the reserve currency earlier this year continues to be associated with the policy decisions at the PBOC and the Chinese government. At this juncture, the dollar seems the most obvious currency choice as an international currency, and with rapid global integration, ousting the dollar is only going to get more difficult nor is desirable. The roadmap for the renminbi or even the rupee to be an international currency is riddled with myriad obstacles, with convertibility of the currencies, and depth of bond markets being most complex issues of all.

Lost opportunity - Air India

noreply@blogger.com (Vimal Balasubramaniam) — Thu, 10 Sep 2009 08:24:00 +0000

In times of crisis, when there is an absolute cut in supply of air travel options (Jet Airways pilots strike), Air India has still not managed to rise up to the occasion. People who argue saying that government presence in service provisions such as air travel is important for a rainy day (such as now) do not realise that the government run airline company did not do what it was meant to, i.e., take more passengers.

HIGH FLIERS Peak time ticket rates from Delhi [ Images ] to Bangalore
Airline	Price earlier	Price now
Kingfisher	6,000	12,500
Go Air	3,000	4,500
Air India	6,000	6,000
SpiceJet	3,179	NA
IndiGo	3,179	NA
Amount in Rs NA: Tickets not available

Source:http://business.rediff.com/report/2009/sep/10/jet-cancels-198-flights-deadlock-continues.htm

Vijay Mallya's Kingfisher saw a 100 per cent load factor on Wednesday, after doubling its ticket price for business class travel. Go Air and all other low-cost airlines have also been running to its capacity. Without having raised the price, Air India has managed to see only a modest 14 per cent increase from 60 per cent passenger load on a normal day. Time for renaissance in the company?

Brad Setser's Blog on China's currency composition

noreply@blogger.com (Vimal Balasubramaniam) — Sat, 05 Sep 2009 08:28:00 +0000

This blog, although very old, explains why the "unallocated reserves" might be seeing the rise witnessed in the graphs on the previous post.

Some interesting facts about the Currency Composition of Reserves in the World

noreply@blogger.com (Vimal Balasubramaniam) — Sat, 05 Sep 2009 06:58:00 +0000

I was looking through the Currency Composition of Official Foreign Exchange Reserves database (COFER) of the IMF. What is interesting about this is that the percentage of reserves held as US dollar claims have dropped dramatically for emerging economies from over 50% in 2000 to less than 30% in 2008. However, advanced economies continued to hold reserves in US dollar assets and it has been in the range of 55% to 65% throughout the time period (1999 to 2009). The database divides total reserves by five major currencies, and "other currencies". There are also two other lines in the database. "Unallocated Reserves" and "Allocated Reserves". As the IMF website states:

The Unallocated Reserves line captures the difference between the total reserves data reported to IFS and to COFER, for each of the country groupings mentioned above. It consists of two components:

The total reserves of nonreporting countries, i.e., the countries within each grouping, which do not report currency composition data to COFER, and
any discrepancy between reporters’ data on total reserves as reported to COFER and to IFS.

The Allocated Reserves line equals the reporters’ data on total reserves as reported to COFER.

Very little estimation is used in producing the COFER tables. Estimation is undertaken only for data gaps of four quarters or less. There are about 33 advanced countries, 107 emerging market economies in the database. THE PITFALL OF THIS DATABASE IS THAT THE COUNTRIES PART OF EACH SEGMENT IS UNKNOWN. I looked around for quite sometime and couldn't find the composition of countries in the two divisions.

Interestingly, the drop in USD dollar reserves is not offset with an increase in the EUR / GBP / JPY or any currency. What has happened is that the unallocated reserves data spikes up.There is a lot to see from this trend provided there is an understanding on what the "Unallocated reserves" imply. It is too early to say that the US dollar is losing its purpose as an international reserve currency.

DRG Study on “Monetary Policy, Forex Markets and Feedback under Uncertainty ...

noreply@blogger.com (Vimal Balasubramaniam) — Fri, 04 Sep 2009 09:11:00 +0000

This study suggests that RBI intervention in the forex market impacts both volatility and the level of exchange rate. It also finds that interest rate differentials have weak effects on exchange rate levels and volatility but strong effects on FX market turnover.

"Signals about exchange rate changes, linked to random supply shocks, can generate surprise or enhance news, even while communicating clearly with the market. The markets will then help to bring them about, reducing the need for CB action. Transparency will reduce speculative positions and two-way movement of the nominal exchange rates will encourage hedging. Guidance to restrain nominal volatility within a ten percent band around a competitive exchange rate, but without committing to specific band edges, will maintain export competitiveness, helping the real sector."

Something that continues to puzzle me is this: Most studies look for how long the impact of forex intervention lasts. There is no word on that as yet. If intervention is just a slap in the face and works as signalling, what then does that signal imply to monetary policy when there is no specific monetary policy objective?

DRG Study on “Monetary Policy, Forex Markets and Feedback under Uncertainty in An Open Economy”

via PRESS RELEASES FROM RBI on 9/3/09

The Reserve Bank of India released a DRG Study entitled, "Monetary Policy, Forex Markets and Feedback under Uncertainty in An Open Economy". The Study is co-authored by Prof. Ashima Goyal, Indira Gandhi Institute of Development Research along with staff members from the Reserve Bank (Shri Ayyappan Nair, Assistant General Manager, Financial Markets Department and Dr. Amaresh Samantaraya, Assistant Adviser, Department of Banking Supervision).

The Study attempted to examine options for monetary policy arising from its intervention in Indian foreign exchange markets. Beginning with a brief survey of current microstructure of foreign exchange markets in India and its monetary policy institutions, the study brings out policy trilemmas in dealing with large cross border flows in a rapidly growing emerging market, where fundamentals are uncertain. Major findings of the study are as follows:

Intervention affects both the level of the exchange rate and its volatility – supporting intervention as an additional policy tool.
Among microstructure variables, merchant net demand or order flows affect the level of exchange rate, while dealer order flow and turnover variables affect volatility.
Although intervention increases turnover, anticipated intervention decreases it, suggesting it is optimal to reveal information about future intervention. Expectations of future exchange rates and intervention are stabilising and not perverse.
Estimated strategic market behaviour and model derivations both indicate intervention and signaling may be a more effective influence on exchange rates in the Indian context than interest rate changes.

Markets form expectations of intervention activity and respond strategically to it. The increase in dealer turnover with intervention may imply strategic intraday arbitrage, whereby dealers profit at the expense of merchants and the central bank.

[Note: Development Research Group (DRG) is constituted in the Reserve Bank's Department of Economic Analysis and Policy for undertaking effective policy-oriented research backed by strong analytical and empirical basis on subjects of current interests. The views expressed in these studies are those of the authors and do not reflect the views of the Reserve Bank.]

G. Raghuraj
Deputy General Manager

Press Release : 2009-2010/364

Asset prices in Monetary policy?

noreply@blogger.com (Vimal Balasubramaniam) — Fri, 04 Sep 2009 07:14:00 +0000

Shyam Patabi from PWC has revisited a contentious debate in most parts of the world - taking asset prices into account in monetary policy decisions in his article.While he raises valid and important questions about the CPI and WPI index construction issues, I wonder how and why monetary policy should take into account asset prices.

Before all this, I would think that it is imperative that the RBI monitors business cycles to synchronise monetary policy reaction with business cycle movements. Secondly, what troubles me the most in including asset prices into monetary policy in a place like India is reversion back to centralised planning policies. Who decides what is a bubble? There is no doubt that monetary policy responds to asset price bubbles in an asymmetric fashion, i.e., do nothing when the bubble gets built, and then react when the bubble bursts. But why should monetary policy be doing anything else? There are other imperatives for a healthy globalised economy that would do justice to addressing asset price bubbles: a/ macro-prudential regulation; b/ gradual opening up of complementary markets to hedge risks; c/ transaction monitoring and strong anti-competitiveness policy.

These are just initial reactions to his article. More on it sometime soon...

"No doubt, setting monetary policy in line with developments in financial markets is a challenging task. But it is one that economists should embrace, rather than shy away from — at least for the sake of preventing the next mega bubble." - Next post will think about ways to address bubbles...

GDP forecasts trimmed by major banks for India - misplaced concern?

noreply@blogger.com (Vimal Balasubramaniam) — Fri, 04 Sep 2009 06:57:00 +0000

The CSO realeased the Q1 data for FY2009-10 and the growth rate of GDP at factor cost was estimated to be 6.1% (y/y). A lot of concern regarding growth recovery has set into the markets because of poor monsoon (and not so much on global economic conditions). Claims that Agriculture is less than 1/4th of total GDP is misplaced as a lot of industries are agro-based; domestic demand also depends on agriculture. Inflationary concerns cannot be disregarded as the CPI (Industrial Workers) has already begun to rise. In many ways, fiscal concerns are pinned on agricultural output as well.

Fig 1: GDP measured on right scale

Since there is no seasonally adjusted data available for GDP breakdown on a quarterly basis, a look at the year on year estimates of agriculture growth and GDP growth suggests something unique.A simple perusal of this graph may lead us to understand how much agriculture affects GDP growth. I wouldn't call it misplaced concern despite the cushioning effect of the National Rural Employment Guarantee Programme and other such schemes of the Central Government.

Also, the NIPFP-DEA program has come up with seasonally adjusted quarterly GDP data. I would suggest that quarterly projections use this dataset (which will eventually put up seasonally adjusted sub-components of GDP too). For more information see www.mayin.org/cycle.in

Risky to take foot off AML pedal

noreply@blogger.com (Vimal Balasubramaniam) — Fri, 04 Sep 2009 06:07:00 +0000

A recent article on AML concerns throws up a lot of concerns with RBI as the banking regulator. Primarily, the desire to be a member of the FATF (Financial Action Task Force) has driven the Indian authorities to do a lot more through the recent amendments Prevention of Money Laundering Act. However, as this interview rightly points out, there are a lot of issues with implementation with Indian banks. Firstly, on the PML act, it is interesting to ntoe the definition of "Politically Exposed Persons" (PEPs) as they don't include Indians and only focus on foreigners. Besides which it has been so broadly defined. Secondly on implementation, it is shocking to learn that only 14% of the personnel handling AML in Public Sector Banks are AML certified. Other issues of technology driven transaction monitoring across all branches in India remain.

http://www.thehindubusinessline.com/2009/09/03/stories/2009090350230900.htm

Sarabjeet Singh is a worried man. As the partner leading the AML (anti-money-laundering) practice in BMR Advisors ( www.bmradvisors.com), he finds it disturbing that the pressure from the regulator is not felt as much by banks in India. If banks do not make the kind of investments required now, they will always be laggards in the global pecking order, he cautions, during the cours e of a recent email interview with Business Line.
Given the meltdown and its impact on businesses, bank managements globally cannot afford to take their foot off the AML pedal, Sarab notes. If Indian banks treat the topic as a secondary one, and starve it of the required emphasis and attention, they would perpetually be playing catch-up, he adds. “Also, this will seriously impact the ability of Indian banks to expand their offshore footprint.”
Excerpts from the interview:
First, on the seriousness of the problem.
With the increase in integration of India’s markets with global ones, Indian regulators and the banking institutions are under greater stress to rise to the threat of money laundering than ever before. Money laundering concerns have grown manifold in the mature economies as, apart from its known links with terrorist financing and narcotics smuggling, new avenues such as football clubs and other large revenue sporting events are also attracting investigation. Many global financial institutions have reported an increase in suspicious activity over the past year.
Don’t we have the rules in place?
India has enhanced the AML regulatory framework significantly. Recent additions to the PMLA (Prevention of Money Laundering Act, 2002) have brought more entities under its ambit. Expanding from banks, non-banking and even non-financial entities such as casinos have to comply with AML requirements. The RBI (Reserve Bank of India) has done its bit by notifying the rules that are fairly detailed and specific in their specifications. On the monitoring side, the FIU (Financial Intelligence Unit) has managed to get institutions to increase the filing of CTRs (Cash Transaction Reports) and STRs (Suspicious Transaction Reports).
What do you see as the issues demanding urgent attention?
Regulators in the western economies have placed enormous importance on AML laws, regulations and processes, particularly so post 9/11. There has been a significant amount of efforts that have been made by regulators, banks and institutions on setting up new AML systems post more stringent regulations being in place. These efforts in training, people and large technology platforms have been significant and run into hundreds of millions of dollars.
Clearly the objective has matured from a detective control system to a more preventative one. In India, the regulations have only now been put in place; and after the regulatory framework comes, the challenges are of its implementation and institutionalisation.
This requires massive investments in training and hiring additional skilled resources and building technology platforms/software for complex data monitoring. These key issues of skills and the need for better and more robust systems have been pointed out consistently by the AML professionals in the World-Check BMR India AML Survey, 2009.
Your suggestions on how our regulations can be improved.
India plans to be a full member of the Financial Action Task Force (FATF) and accordingly has updated its PML Act, 2002 this year, incorporating a number of FATF guidelines. However, there are key areas where the regulatory framework requires improvements. These include issues such as designated non-financial businesses to include dealers in real estate, precious stones, etc., and to criminalise money laundering as per the UN Convention Against Transnational Crime, 2000.
A step in the right direction has been also taken by including the definition of Politically Exposed Persons (PEPs). However, its broad definition makes it open for differential interpretation and hence issues such as duration of a person being considered as a PEP after remitting office and seniority of government officials needs to be addressed.
A key exception is that Indian PEPs have been kept out of the ambit of the definition and only foreign nationals are subject to this requirement.
Any significant findings from your study?
One important finding is that there is a need for more training and more relevant and advanced training, rather than just an outline of laws and key requirements. Industry experts have to be tapped for training people on not just practices but tools, as well, that are widely used in the global industry.

From the respondents that took the survey, there were three clear types of banks — public sector, private and foreign, with their own sets of issues.
Public sector banks identified transaction monitoring as a key improvement area and the need to invest in more robust AML technology. This tied in well to another marked difference in response on the manner of monitoring in public sector banks. PSBs identified staff vigilance as the primary form of transaction monitoring, as against private and foreign banks which relied more on robust AML technologies.
It points out to a significant issue, given that the majority of transactions in India are done in PSBs, on the need to have more vigilant systems to monitor transactions.
They need massive investments in training, personnel and technology to be in a position to even start being comparable to some of the private sector banks, or for that matter a generational jump is a must to come to the level of most foreign banks operating in India.
Another aspect pointed out was the background of people. For PSBs, personnel who are in the AML function of the banks, only 14 per cent had relevant AML certifications as compared to more than double that for foreign and private Indian banks. It clearly points out to the need for more training, exposure and specialisation in this function.

Back to 2007: Fear of appreciation in emerging economies

noreply@blogger.com (Vimal Balasubramaniam) — Sun, 30 Aug 2009 05:40:00 +0000

Andrea Kiguel and Eduardo Levy-Yeyati in this article argue that the fear of appreciation is back in emerging economies. While what they claim in this article is true to a large extent in the Indian case as well, what one doesn't understand is how much are the authorities willing to resist appreciation? Politically there is only a favourable climate to prevent appreciation and thus there is no reason to believe that the crisis will change the way emerging economies look at managing economies that are fast integrating with the rest of the world. However, there are a couple of statements that probably needs empirical evaluation:

Asian currencies are unlikely to lead the way insofar as the Chinese renminbi, against which many Asian currencies are implicitly anchored, remains stable.

It will be interesting to see which of the currencies are implicitly anchored on the CNY. If the article talks about the HKD, a paper by Dong He et. al from the HKMA might be an interesting read. Insofar as other currencies are concerned, I think the DXY index provides a better idea as the CNY is anyway pegged to the US dollar.

On the other hand, leaning against the wind policy of exchange rate management will not only harm the global rebalancing initiative (is there one underway?), but also continue to highlight the credibility of Central Banks of the respective economies regarding inflation and domestic monetary management. In specific, Brazil and Philippines, following an Inflation Target regime (on paper and to a large extent except for exchange rate intervention) will be under severe stress. In short, it might well be the case that short-term goals of export stabilisation will be given greater priority than learning from the current crisis.

Throwing ATMs open.

noreply@blogger.com (Vimal Balasubramaniam) — Sat, 29 Aug 2009 18:47:00 +0000

The Reserve Bank of India had thrown open ATMs owned by all banks for cash withdrawals since April, 2009. What one doesn't understand is the rationale behind why the RBI chose to single out and micro-manage this service provision provided by banks to its own customers. Here's why I say so:

For sometime now, I've tracked down the transaction cost of withdrawing money using my SBI ATM card. Least surprised, I have found that the unit cost of withdrawing Rs. 1000 has only been increasing and peaked during the weekend after the Bank strike on the 6th and 7th of August, 2009. This is a case in point that doesn't seek to address another problem with the nationalised banks: They don't stock up their ATMs with money! There are 8 ATMs near my workplace out of which only one is that of a private bank, ICICI. The rest are SBI (4), Canara Bank (2), and Indian Bank (1). The maximum it would cost me if I were to withdraw money in a user charge regime is a five minute walk +/- the Rs.20 which other banks charged me for using their ATM! Let us see why this is so:

All the blue balloons (but for one) in Qutub Institutional Area refer to ATMs

View NIPFP in a larger map

Controlling for extraneous factors (of not knowing hindi and being heckled to pay more for an auto ride), and for different times of the day (it was almost always around 8pm on Fridays), the following graph plots the cost of withdrawing a sum of Rs.1000. True, one could have withdrawn Rs.2000 instead and the marginal cost of withdrawal goes down. But wait a minute, aren't ATMs supposed to help you avoid carrying so much money around all the time other than of course reduce the burden of going to a bank and standing in long queues to write yourself a cheque?

Also, what one often does not understand is that there is no prior information that an ATM does not have money. Therefore, I have always managed to visit at least three ATMs before getting money. This estimate of course does not include the opportunity cost of time spent in looking for an ATM with money.

So now, what do we see? We see that the least I have spent in the past one month is Rs. 20 to withdraw money from an ATM that isn't a service provided by SBI as I withdrew from Indian Bank ATM. Why did I have to spend this amount of money? SBI has the largest network of ATMs in the country and in all probability, being the biggest operator when it comes to this service provision, there was no incentive for SBI to stock money in the ATMs given that everybody else is going to use the same.
The case in point is that the RBI, as a banking regulator and a monetary policy authority, shouldn't be interfering with what the banks know best and what the banks do better: serve customers. If one goes through the notification carefully, it says:

"3. International experience indicates that in countries such as UK, Germany and France, bank customers have access to all ATMs in the country, free of charge except when cash is withdrawn from white label ATMs or from ATMs managed by non-bank entities. There is also a move, internationally, to regulate the fee structure by the regulator from the public policy angle. The ideal situation is that a customer should be able to access any ATM installed in the country free of charge through an equitable cooperative initiative by banks.

4. In view of this, RBI had placed on its website an Approach paper and sought public comments. The comments received have been analysed. Based on the feed back a framework of service charges would be implemented by all banks as under:

Sr.No.
Service
Charges

(i) For use of own ATMs for any purpose Free (with immediate effect)

(2) For use of other bank ATMs for balance enquiries Free (with immediate effect)

(3) For use of other bank ATMs for cash withdrawals
No bank shall increase the charges prevailing as on December 23, 2007 (i.e. the date of release of Approach Paper on RBI website)

Banks which are charging more than Rs.20 per transaction shall reduce the charges to a maximum of Rs.20 per transaction by March 31, 2008

Free - with effect from April 1, 2009.

5. For the services at (1) and (2) above, the customer will not be levied any charge under any other head and the service will be totally free.

6. For the service number (3) the charge of Rs.20/- indicated will be all inclusive and no other charges will be levied to the customers under any other head irrespective of the amount of withdrawal.

7. The service charges for the following types of cash withdrawal transactions may be determined by the banks themselves:

(a) cash withdrawal with the use of credit cards

(b) cash withdrawal in an ATM located abroad.

Firstly, this was a move based on "international experience". Elsewhere in the world, withdrawing money from other ATMs may not be a problem because there are other norms issued by banks that regulate withdrawals. Eg: Customers cannot withdraw more than thrice (and in some cases twice) a day. Secondly, banks know money demand and velocity and based on that decide location, and facilities provided to customers. Thirdly, in most cases one would find an ATM of every bank within a mall or where there is large movement of population. Fourthly, ATM facility isn't a service provision on which banks compete abroad. They compete on different provisions and make money on other things.

In India, and more specifically using Delhi as a case in point, main market places at the most have two different banks with ATM facilities, and why would those two banks need to incur the cost of reloading these machines for a bank that has chosen not to provide that facility for its customers in the same market? Secondly, one has permanently altered the incentive structure for banks to open up new ATM centers. And last but not the least, the customer (me in this example) is having to incur more cost in withdrawing money than what I used to before.

The current RBI stance of restricting the number of transactions by a single customer using ATM centers provided by other banks is not going to help either. Simply put, the scale and number of people with ATM cards is large and the restriction fails to address basic issues with such notifications: altering incentives and future investment propositions by banks into ATM centers.

Sr.No.	Service	Charges
(i)	For use of own ATMs for any purpose	Free (with immediate effect)
(2)	For use of other bank ATMs for balance enquiries	Free (with immediate effect)
(3)	For use of other bank ATMs for cash withdrawals	No bank shall increase the charges prevailing as on December 23, 2007 (i.e. the date of release of Approach Paper on RBI website) Banks which are charging more than Rs.20 per transaction shall reduce the charges to a maximum of Rs.20 per transaction by March 31, 2008 Free - with effect from April 1, 2009.