11th Conference of the Macro/Finance Group

All the materials are up on the website.

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Implications of bringing commodity futures into the Ministry of Finance

Essentially everywhere in the world, we see unification of trading in all kinds of products -- spot or derivatives, equities or currencies or fixed income or commodities etc., OTC or exchange. It makes too much sense to reap economies of scale and economies of scope, both in the private sector and in the work of regulation and supervision. The arrangement in India, where the Forward Contracts Regulation Act (1952) envisages the Forward Markets Commission that is a part of the Department of Consumer Affairs, is a silly one.



Everything we have learned about how to run the equity market is valuable for commodity futures:

• The regulatory governance process at SEBI including authority to issue regulations, enforcement process, appeals at SAT, etc.


• Governance problems of Infrastructure Institutions with three-way separation between shareholders, managers and trading members.


• Netting by novation at the clearing corporation.


• Not having `badla' trading.

It is likely that the Ministry of Finance would not give an exemption to any exchange from regulation. A lot of what we saw in this field in the last decade would not have arisen if commodity futures had been placed with SEBI and MoF. But then, we have had dubious finance ministers and one should not be too confident. The price of sound governance is eternal vigilance.

Merging FMC into SEBI began as controversial ideas:

• One markets regulator or three? in the Business Standard, 1997.


• An interview in the Financial Express, 1998.


• Rethink financial intermediation in the Business Standard, 1998.

Then it turned into a government committee process:

• On 14 May 2003, a committee was setup headed by Wajahat Habibullah, who was secretary of the Department of Consumer Affairs. Key persons who shaped this work were S. Narayan, who was Secretary at the Department of Economic Affairs, and Ashok Lahiri, who was Chief Economic Advisor.


• Percy Mistry's committee said: Redraft the legal foundations for organised financial trading, so as to unify all organised financial trading under SEBI regulation. This would include currencies, equities, sovereign and corporate bonds, and commodity derivatives.


• Raghuram Rajan's report said: all organized financial trading, spanning currencies, fixed income, equities, commodity futures, exotics (such as weather and decision markets), and spanning all trading venues and forms of trading should come under a single regulator, the SEBI.


• The draft Indian Financial Code has a general and sector neutral treatment of financial regulation where all organised financial trading is the work of the Unified Financial Authority.

In 2003 and 2004, we were well on our way on getting this done. However, once the UPA government came to power in May 2004, and Sharad Pawar became the minister in charge of Consumer Affairs, it became infeasible to shrink his turf. By that time, substantial commercial interests had developed which wanted to preserve the existing arrangement, with regulatory capture of FMC.



More generally, one of the most harmful instincts of bureaucrats and citizens in India is the notion that the boundaries of government agencies are somehow sacred. There is much resistance to changing the role and function of a government agency. But every employee of government exists to serve the people of India, and we need to continually change the block diagram of government so as to best cater to the fast changing requirements of the economy.



Now we have a crisis on our hands, and policy makers have resurrected the project. While there is a news item, the details are not yet visible. The first step would be a small change in the allocation of business rules, through which the subject of commodity futures trading would shift from the Department of Consumer Affairs to the Ministry of Finance. The big step would be to repeal the FC(R)A and modify securities law appropriately; until this is done, the gains would be limited. The draft Indian Financial Code is a natural source of ideas on how this drafting should be done.



In the short term, the FMC would become a part of the Ministry of Finance. Important decisions at FMC would go up to the Ministry of Finance and ultimately the Minister of Finance for approval. The knowledge on organised financial trading at the Ministry of Finance will give us improved decisions under the existing law. We may expect considerable porting of regulations and public administration practice from SEBI into FMC.



This seems to be a season for old policy projects working out. First the Pensions Act, and now this. Nothing like adversity to make India deliver.

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Interesting readings

An
editorial in the Business Standard on getting away from
gerontocracy.

An
editorial in the Indian Express on the next steps on
pensions and the next steps on legislation.

Anil
Padmanabhan in Mint about the people in India who would
like for India to remain focused on poverty. I would add one more
interest group in this: Development economics.

The
burqa joins the league of cape and cowl by Mahvesh
Murad.

N.
Sundaresha Subramanian in the Business Standard reports
on the parties of India which have the biggest criminal
footprint.

One of the first sensible things in the field of higher education
policy in
India: Building
the Links Between Funding and Quality in Higher Education:
India's Challenge by Lindsay Daugherty, Trey Miller, Rafiq
Dossani, Megan Clifford, Rand
Corporation. Also
see.

Trampling on the individual in India: Here's something for us in India to envy:
the response of the Polish Prime
Minister to proposals to censor the Internet: We shall not block
access to legal content regardless of whether or not it appeases us
aesthetically or ethically.

And here is another: a story
of a
dentist who tried to interfere with the online freedom of speech
of customers.

Compare and contrast with what our Supreme
Court just
said to mouthshut.

Ila
Patnaik: What
Raghuram Rajan needs to do
and Gearing
up for the slow withdrawal of QE.

Mihir
Sharma in the Business Standard on the consequences of
exchange rate depreciation.

The
trouble with our banks by Shankar Sharma and Devina Mehra in
the Business Standard.

Editorial
in the Indian Express.

Trouble
for treaties by N. Sundaresha Subramanian in the Business
Standard, about the kind of firms who showed up in the
Private Treaties portfolio.

Anusha
Soni in the Business Standard about capacity
constraints in the government that are hindering the field of infrastructure.

When
rent-seekers and startups collide by Steve Blank: A useful
set of insights into the field of payments in India.

Noah Smith on the Economics Ph.D.: href="http://noahpinionblog.blogspot.jp/2013/05/if-you-get-phd-get-economics-phd.html">why
and href="http://qz.com/116081/the-complete-guide-to-getting-into-an-economics-phd-program/">how. Also
see: href="http://ajayshahblog.blogspot.in/2012/12/the-problems-of-economics-profession.html">a
set of concerns, and href="http://ajayshahblog.blogspot.in/2011/05/books-that-should-be-read-before.html">the
beautiful books.

Those who fail to remember our past will be forced to relive
it. See this
post. I wrote
something a
while ago which draws on a similar idea.

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Raghuram Rajan's day 1 statement

Everyone should read it.

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Implications of the Pensions Act

In 1998, the Ministry of Social Justice and Empowerment setup `Project OASIS', led by Surendra Dave, to engage in deep thinking about pension reforms. The report, which was submitted on 11 January 2000, envisaged an individual account defined-contribution system with central recordkeeping, and recruitment of fund managers by an auction which asked for the lowest fees+expenses.



This was a futuristic vision at the time, as a lot of the surrounding infrastructure had not fallen into place. In socialist India, it was quite novel to propose that households would build their own assets to take care of themselves in old age. However, the idea rapidly got widespread acceptance. More and more people started looking at the maladies around them and said that if only we had the NPS, these problems would not arise.



NPS was ahead of its time in being mistrustful of mutual funds and insurance companies. The great scandals of mutual funds and ULIPs lay in the future. Issues of consumer protection were not widely understood in 1998. But the key calls made in the NPS have proved to be the right ones: of delivering a solution that is good for the lifetime financial planning of households while giving financial firms wafer-thin margins. Apart from index funds, the NPS is essentially the only piece of Indian finance that is accessible to the average household that I trust. Thinking on consumer protection has progressed enormously in the following years, first at IFMR and then in FSLRC. Yet, the NPS designed in 2000 fares well in satisfying the consumer protection principles of the draft Indian Financial Code of 2013.



In December 2002, NPS was adopted by the NDA government as the mandatory pension system for all new recruits after 1 January 2004. All this was re-opened by the UPA government when it took charge in May 2004, and they chose to stay on course.



From May 2004 to September 2013, we were unable to make progress on the proper legal foundations. But the NPS was built and executed through a network of contracts and rules, planned out by one of India's best lawyers (P. Chidambaram), which is legally sound. All civil servants recruited after 1/1/2004 have been placed into the NPS, and by now this is shaping up to be substantial numbers. NPS has also started gradually going into the unorganised sector, with the assistance of co-contribution.



The wheels grind slow, but they grind true. I wish all this had happened faster, but it is good that it happened. The key implication of this decision by Parliament is that the NPS cannot be shut down by a future administration. To find out more, I suggest :

• Concepts of the NPS and their rationale: Indian pension reform: A sustainable and scalable approach by Ajay Shah, Chapter 7 in `Managing globalisation: Lessons from China and India', edited by David A. Kelly, Ramkishen S. Rajan and Gillian H. L. Goh, World Scientific, 2006.


• A story of how the NPS came about: India's pension reforms: A case study in complex institutional change by Surendra Dave, page 149--170 in `Documenting reforms: Case studies from India', edited by S. Narayan, Macmillan India, 2006.


• A recent look at developments in implementing the civil service pension: Civil service and Military Pensions in India by Renuka Sane and Ajay Shah. Chapter 4 in `Reforming Pensions for Civil and Military Servants', edited by Noriyuki Takayama, Maruzen Publishing, 2011.

This story is interesting not just from the immensely important problem of ageing, but also as a case study in how we achieve far-reaching change in India. I disagree with the pessimists who limit their ambitions to minor tinkering changes. We in India must constantly question the foundations; almost everything about the Indian State is broken and needs to be redone from scratch.

There has been a sea change in thinking about financial law in India thanks to the work of the Financial Sector Legislative Reforms Commission.  In 2001 and 2002 we did not know how to draft law. The PFRDA Act reflects the old ways of drafting law and will not look good to modern eyes.

Looking into the future, the story now runs on five tracks:

1. Making the civil servants NPS work properly as originally envisaged. At present it does not.


2. NPS has forked into two systems: one for the unorganised sector and another for civil servants. These need to be merged into one single system with full portability.


3. Achieving large-scale participation and sustained contribution for the unorganised sector -- while not sacrificing the heart of the NPS which is wafer thin charges. All too often, we get an urge to do to the NPS what was done to mutual funds and insurance companies.


4. Using this institutional capacity to solve the problems of EPFO.


5. We will need to adapt the PFRDA Act and the draft Indian Financial Code so as to achieve the following framework: (a) NPS would become a pension system run at the instance of the government, (b) It would be regulated by the machinery of the Indian Financial Code, (c) PFRDA would get merged into the proposed Unified Financial Authority (UFA). It is more important to be correct than to be consistent.

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A season for bad ideas

One feature of each period of turbulence is that we get an upsurge of out of the box thinking. While it is always good to think out of the box, these innovative ideas must also make sense. If I were a teacher of economics, I would use these in class as demos of how not to do economics:

• Coordinated intervention by emerging markets. Andy Mukherjee nails this one.


• Devesh Kapur and Arvind Subramanian want an import tariff -- that they term a `third best measure' -- to do things that exchange rate depreciation does better.


• Veerappa Moily says we should close down petrol pumps at night so as to reduce consumption of petrol.


• Swaminathan S. Anklesaria Aiyar thinks there is a second Asian Financial Crisis in store. But Asia has substantially moved away from exchange rate rigidity. He says depreciation is recessionary. No, depreciations are expansionary. He implies that depreciation is a problem in India today as corporations have large unhedged foreign currency borrowing. The existing evidence does not support this.


• Jamal Mecklai on temple gold. It is satire.

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Finding the middle road between Gotham City and Jurassic Park

In the Independence Day special issue of Forbes magazine, I have an article titled Rightsizing the State. At a recent show organised by Dun & Bradstreet, I joked that the puzzle in India is that of finding the middle road, between Gotham City on one hand (a murky world of corruption and criminality) and Jurassic Park on the other (with socialist dinosaurs destroying the economy). Pessimists about India might say that if the goons won't get you, the dinosaurs will.

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