Interesting readings

Since most of us in India can talk about little else other than
corruption, do read href="http://www.voxeu.org/index.php?q=node/5971">this article by
Nauro F. Campos and Ralitza Dimova on voxEU which is an interesting
meta-analysis about papers which analyse the impact of corruption on
growth. I have long heard about meta-analyses, but this one made me
sit up and notice.

Anand
Giridharadas in the New York Times on Arthur Bunder
Road in Bombay.

Roger Bate and Tom Woods, in The American, point to href="http://www.american.com/archive/2010/december/made-in-india-faked-in-china">a
new dimension in India's crisis of fake medicines.

I
I Sc will now use the IIT JEE as their entrance examination
for the new Bachelor in Science course. Given that the IIT JEE is
a well managed and difficult examination, it would make sense to
have more and more schools plugging into it in order to filter
their intake. But as you move away from the top .01% of the
distribution, the statistical precision of the score on a very
difficult exam as a measure of student capability tends to
decline. The managers of the IIT JEE will need to shift towards
adaptive
testing, where the questions are dynamically modified based on
student characteristics, in order to retain efficiency across the
distribution. Once this is done, the IIT JEE would be useful for
sifting through millions of students, and exert a beneficial
effect of all of them facing a more demanding high-stakes
examination.

href="http://financialexpress.com/news/column-great-job-mr-bhave/724748/0">Shobhana
Subramanian in the Financial Express on C. B. Bhave.

href="http://www.nytimes.com/2010/12/13/arts/design/13desert.html?_r=2&pagewanted=all">A
fascinating article by Nicolai Ourussoff in the New York
Times about the attempt to reinvent Saudi Arabia.

href="http://www.nybooks.com/blogs/nyrblog/2010/dec/25/fading-dream-europe/">Sadness
about Europe by Orhan Pamuk in the New York Review of
Books, and href="http://www.city-journal.org/2010/20_4_weimar-city.html">a
tragic perspective on Istanbul by Claire Berlinski in City
Journal.

href="http://spikejapan.wordpress.com/2010/11/28/amakusa-islands-of-dread/">A
dystopian future for the world: a story of ageing and depopulation
from Amakusa in Japan.

Liu Xiaobo's
beautiful acceptance
speech for the Nobel Prize for Peace. A lot of countries of the
world, including India, have much to do in order to achieve freedom.

href="http://www.asiasentinel.com/index.php?option=com_content&task=view&id=2869&Itemid=187">Philippines?

href="http://outsideonline.com/travel/travel-pf-201012-taliban-sidwcmdev_153115.html">Tourism
in Afghanistan by Damon Tabor.

href="http://www.ft.com/cms/s/0/d1248de4-11f4-11e0-92d0-00144feabdc0.html?ftcamp=rss#axzz19PnDeQ2O">Steven
Johnson in the Financial Times on the future of linking to
information sources on the web.

With 75% of world GDP in service, trade liberalisation in
agriculture or manufacturing is not that important. The really big
story is trade liberalisation in services, and there the picture is
quite bad. Read href="http://www.voxeu.org/index.php?q=node/5969">this article on
voxEU by Bernard Hoekman and Aaditya Matoo on how to obtain progress.

Understanding
the rise in currency turnover by Michael R. King and Dagfinn Rime on voxEU.

Anders Aslund, on Project Syndicate, on the
remarkable story of the global crisis as it played out in East
Europe. Also
see this
story in The Economist on the same subject, which is a
bit less optimistic. The recovery in East Europe matters for
recovery in Europe and elsewhere. It also illuminates our thinking
on some of the grand policy questions.

href="http://www.cis.org.au/publications/policy-magazine/article/2291-feature-public-opinion-divided-on-population-immigration-and-asylum">David
Alexander points out how Australia is the role model for the world.

href="http://www.project-syndicate.org/commentary/eichengreen25/English">Barry
Eichengreen, href="http://www.voxeu.org/index.php?q=node/5892">Daniel Gros and href="http://openlib.org/home/ila/MEDIA/2010/us_euro.html">Ila
Patnaik on the resolution of Europe's problems.

href="http://www.gq.com/news-politics/big-issues/201012/viral-me-silicon-valley-social-networking-devin-friedman?printable=true">Devin
Friedman in GQ on the strange world of social networking.

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Discussions on 'Mythbusting: Current account deficit edition'

Many interesting comments appeared on my previous blog post, href="http://ajayshahblog.blogspot.com/2010/12/mythbusting-current-account-deficit.html">Mythbusting:
Current account deficit edition, and I thought it made sense
to respond to all of them in this post.

Ambarish: I don't think there has been a sudden rise in rupee
trading outside India. It was always there; we weren't seeing it. As
Jayanth Varma has emphasised, we used to think the NDF market was in
Singapore. But the BIS data on rupee trading shows significant rupee
trading at many places worldwide, not just in Singapore. Overall, the
picture is roughly one with $20 billion of onshore trading a day and
another $20 billion of offshore trading, giving an overall market size
of $40 billion a day.

One can think of many good reasons for domestic and overseas
economic agents to do INR trading outside India. E.g. foreigners are,
presently, not permitted to trade on the onshore currency futures.
Given that gross flows across the Indian border, on the BOP, are now
at $1.3 trillion a year, it is not surprising that there is a lot of
rupee trading going on. Until big changes to the capital controls take
place, I believe there will be an increasing shift of INR trading away
from India.

Neeraj: I agree with you that capital controls can potentially
change the situation significantly. So one can think at two
levels. First, for a given set of capital controls, a central bank can
float as in not trading. That gives you a float, but yes, the price
that comes out of this is distorted because there are capital
controls. As an example, the government can have non-interference in
the domestic market for DRAM chips, but the domestic price can itself
be distorted through quantitative restrictions or customs duties on
DRAM chips. So even though the government is not manipulating the
domestic price by directly trading in the market (as it does with
foodgrain or currency) the observed price is a distorted one. Then
comes the second level where you have full convertibility. Once again,
here the central bank could choose to trade in the market or it could
choose to not trade in the market. Only when there are no capital
controls + no trading by the central bank do you get to the true
floating rate and the market's price.

Durga: Modulo the issue raised by Neeraj and touched upon above, I
think we're a fairly flexible rate today. If INR trading globally is
$40 billion, then RBI trading of anything less than $2 billion per day
would have a negligible impact on the price. RBI has to either hit the
market with very big trades (over $2 billion a day, i.e. over $40
billion a month, i.e. Chinese style currency manipulation) or RBI has
to sit back and accept the price. Small trades are pointless, and
actually make you wonder what the strategy there is.

That said, the rupee is still a small currency. India is a GDP of
only $1.25 trillion and there are a lot of restrictions on
cross-border commerce. So there is a long way to go before the INR
becomes a serious international currency. It does not, hence, surprise
me to see that the spreads on the INR are much worse than those seen
for the big international currencies.

However, what I talked about in the blog post -- that when a
central bank stops trading on the currency market, the CAD = capital
flows -- is not an equilibrium condition. It is an accounting
identity. It requires nothing about market microstructure on the
currency market, or about the capital controls, in order to hold. As
long as RBI trading on the currency market is zero, CAD will be
exactly equal to capital flows.

Finally, Anonymous, you ask: Is there a point where the CAD becomes
so big that it becomes dangerous? We should think in two parts.

First, in a place like the US, there has been a lot of concern that
the imbalance (= the very large CAD) is too big in the sense that
under reasonable assumptions, the US is not going to be able to
service all the capital coming into the country. After all, all the
equity / debt capital that comes into (say) India today inexorably
requires that at future dates, dividends and coupon payments and debt
repayment have to happen in dollars, which will require purchases of
foreign exchange by residents. In order to service the borrowing of
the US today, substantial exports growth will be required, which is
unlikely. Hence, when this borrowing of today is to be repaid in the
future, a huge dollar depreciation will have to take place.

As long as there is an environment of high growth in exports of
goods and services, there is no problem. If, hypothetically, you see a
country with a big CAD but you also have a WEAK pace of exports growth
then you know that at future dates, there will be pressure on the
currency which will give sharp depreciations. Odds are, the financial
system will see that and these fears will translate into a
depreciation right away! Conversely, if you see capital inflows going
into investments which will bolster growth of exports of goods and
services, then you feel comfortable that there is no problem.

I believe that's a fair description of the present Indian
situation. Over the last 15 years, the gross inflows on the current
account into India (which can be roughly interpreted as the total
revenues from exporting goods and services) grew by 8.1 times, from
$42 billion in 1994-95 to $343 billion in 2009-10. This was an average
annual growth rate of 15%. This is a huge pace of growth, and gives me
confidence that the CAD coming in today will be serviced tomorrow
without large currency depreciation. If, hypothetically, you disagree
with my optimism about future growth in exports of goods and services,
then you would think that this large CAD today increases the odds of
INR depreciation in the future, and you would go short the rupee.

For smaller emerging markets, there is a risk of sudden changes in
international financing conditions, which is rooted in the lack of
information in the hands of foreign investors about the country. Then
a large CAD could mean that if something goes wrong and a lot of
capital leaves the country, then it could yield a large currency
depreciation. I believe this is less and less an issue for the large
emerging markets like India, where problems of asymmetric information
and lack-of-attention in the global community are not a problem.

Read More

Mythbusting: Current account deficit edition

The question

In recent months, the current account deficit has risen. The latest data shows:

Sep 2009	-3.03
Dec 2009	-3.64
Mar 2010	-3.68
Jun 2010	-3.84

This has started making many people worried. Is such a `large' current account deficit a cause for concern?

The right answer

How long should a man's legs be? Long enough to touch the ground.

The old intuition

Under a fixed exchange rate, where the central bank holds the rate fixed by trading on the market:

• Net capital inflow is an autonomous variable
  
  


• All the capital that comes into the country is bought by the central bank (and vice versa), and this has consequences for sterilisation or monetary distortions.
  
  


• You can then ask yourself whether the amount of capital coming into the country is "too much" or "too little".

The new intuition

But all this changes under a floating exchange rate!

As the graph above shows, RBI's trading on the currency market has been at near-zero values in recent months: we have something that is essentially a floating exchange rate. The rupee is now a fairly big market, and small scale trading by RBI has zero impact on the price: i.e. what we're seeing is a true market price. Under a floating exchange rate:

• Net capital inflows = Current account deficit, as an accounting identity
  
  


• If there is a sudden increase in capital inflows, this yields a rupee appreciation, which tends to increase the current account deficit. Conversely, if there is a sudden capital outflow, this yields a rupee depreciation, which tends to decrease the current account deficit. Through this, there are constant equilibriating forces which bring the two together.

With a floating exchange rate, you curiously look at the current account deficit and wonder that if there is some sudden international crisis (e.g. Lehman's death) whether there would be a short-run dislocation. For the rest, there is no policy involvement in either the current account deficit or in net capital inflows, both of which are purely market phenomena.

A new angle

In the very short run (e.g. a day), changes in the exchange rate can have little impact upon imports or exports. So if $10 billion suddenly leaves the country in a day, when the rupee depreciates, there can't be a response from import or exports immediately. The only response that can come about immediately is: from capital flows.



When $10 billion leaves the country, the rupee depreciates, and some investors think that they will score some nice returns by buying short-dated rupee securities. They step in in the breach, thus yielding an equilibrium.



So I will conjecture: A country that has capital controls against short-dated debt flows will have more volatility on the currency market.

Also see

Viewing the current account deficit as a capital inflow by Matthew Higgins and Thomas Klitgaard, FRBNY, December 1998.

Previous editions of `Mythbusting'

Mythbusting: Reserves edition, 18 October 2008.

Read More

Talk on US financial regulatory reform, by Viral Acharya

Viral Acharya will do a talk Recent developments in financial
regulatory policy in the United States: Review and Critique at
NIPFP
(1st floor conference room) at 4:30 PM on Monday the 20th of
December. All are invited. The talk will be followed by snacks on
the lawns of NIPFP.

This will draw upon the work of many scholars at the NYU Stern
School of Business, which has given two
books: Restoring
financial stability: How to repair a failed system (Viral
V. Acharya, Matthew Richardson, 2009)
and Regulating
Wall Street: The Dodd-Frank Act and the new architecture of global
finance (Viral V. Acharya, Thomas F. Cooley, Matthew
P. Richardson, Ingo Walter, 2010).

Read More

Appropriate regulatory structure for development

A. D. Shroff Annual Public Lecture, by C. B. Bhave.

It is a great honour to be invited to deliver the A. D. Shroff
Annual Public Lecture. Mr. A. D. Shroff was an outstanding
financial thinker and a practioner who took great interest in
organisational and ideological issues. He was known to express his
views in a candid manner and without any fear of the consequences of
such expression. Regulators have a reputation of not speaking much
and if they do speak then not saying much. I will try to strike a
balance between Mr. Shroff's forthrightness and regulatory
reticence.

Costs and benefits of regulation

The world has gone through very troubled times in the last three
years. Unbridled growth and development in the financial markets is no
longer an accepted article of faith. Deregulation in developed markets
resulted in excessive leverage being built by large institutions, and
financial innovation being used more to hide risk than create real
value. This inevitably led to a crisis and the cost of repair is
being borne by the tax payer and the economies in general.

Those who are bearing the costs are, in a substantial measure, not
those who reaped the benefits of unchecked growth. In the event, there
is no support for development without regulation. For orderly
development, regulation is a sine qua non. Notwithstanding the
fact that regulation is a must for orderly development, we still need
to enquire and debate what constitutes an appropriate regulatory
structure. We need to debate issues around this especially in the
Indian context.

At the very basic level, regulation means restraint and restraint
is a hindrance. Thus any business subject to regulation does pay a
price whether the regulation is voluntary or imposed. The question is
not whether regulation will come in the way of development but whether
the price we pay by accepting regulation is worthwhile or not.

Three kinds of regulation

If we look at various sources of regulation one can roughly say
that there are three reasons why business entities agree to regulate
their behaviour even though it does make them pay a price for such
regulation or restraint:

• The first source of regulation arises from the fact that the
  commercial entity interacts with the outside world, suppliers,
  customers, financers, shareholders and so on. There are certain
  norms by which the entity decides to bind itself irrespective of
  whether there are formal rules and regulations or deterrent
  punishment for deviation from norms exists or not. No trader can
  repeatedly violate his contract even if oral, with either his
  customer or with his supplier. It will simply render his business
  impossible. One can call this self regulation at its most basic
  level with the source of discipline being the market place. The
  market place simply does not deal with you if your behaviour is
  substantially out of line with basic norms and we don't need the
  force of law here to enforce such norms.
  
  
• As a second source of demand for regulation one can look at
  situations where entities engaged in a particular business activity
  may decide to come together and conclude that certain norms of
  behaviour are not adequately discouraged if the entire thing is left
  to the individual entities. Yet, the group feels that such norms
  need to be in place for the overall development of their
  business. Since such voluntary groupings of entities do not enjoy
  the force of law they may decide that any behaviour against the
  agreed rules of behaviour will be punished by making the concerned
  entity lose the membership of that group. Trade Guilds, clubs, the
  early form of stock exchanges are examples of this. This form of
  regulation is commonly known as self regulation. This self
  regulation is not regulation of activities by the entity by itself
  but is the regulation of the entity by a common interest group of
  which that entity has agreed to be a member. For such a grouping to
  succeed, individual members must be able to see the benefits of
  membership. The price of being expelled from membership should be
  high enough to ensure behaviour as per the commonly agreed norms by
  the group itself. Our experience in India has not been entirely
  satisfactory in this area. Nevertheless, we need to continue our
  efforts at establishing credible self-regulation.
  
  
• That brings us to the third category of regulation which is
  regulation enforced by law. The argument in such cases appears to be
  that the activity of entities in a particular area of operation
  affects the lives of more than just the member entities. In other
  words the society has a stake in ensuring that the entities conduct
  their operation in a manner that is acceptable not just to those
  entities but to the society at large as well. The discontentment with
  financial meltdown is very aptly captured by the expression
  `privatisation of gains and nationalisation of losses'. This sentiment
  is also a reflection of the fact that there are stakeholders outside
  the universe of finance who suffer if finance is not regulated.
  

The interplay between self regulation and regulation by the
authority of law has been a subject of interesting discussion not only
in the area of capital markets but in other fields as well. Self
regulation is generally considered desirable since it is made by the
entities themselves and therefore,it is considered more business
friendly. Equally there are arguments that there are not sufficient
incentives in self regulation to put the interest of other
stakeholders before the interests of the participating entities. In
addition self regulation lacks the ability to enforce its rules beyond
depriving the member concerned the membership of the group. If a
significant group decides to violate norms the self regulatory
structure can become unsustainable and only the backing of law can
sustain such activity.

In different jurisdictions, efforts have been made to make the
deterrent actions of self regulatory organisations stronger by
granting such organisations `recognition'. However, difficulties arise
if more than one organisation wants to be recognised as a self
regulatory organisation for entities in the same area or business. In
other words if the entities split and form multiple organisations, all
of which seek recognition as self-regulatory organisations, the
situation is not amenable to an easy resolution. Notwithstanding the
various forms of self regulatory organisations and the different
degrees of strength and their deterrent actions, it is commonly
accepted around the world that self regulation alone is not sufficient
and an apex regulatory body is necessary.

The functions of the regulator

Regulation with the backing of legislation is administered either
by the Government itself or their autonomous statutory regulatory
organisations. While the model of Government being a regulator itself
has been tried in the past,the modern consensus is to have independent
and autonomous statutory regulatory bodies. In the wake of the
reforms undertaken by the Government in 1991, SEBI legislation was
passed by the Parliament in April 1992. SEBI has been created as an
independent statutory body.

What are regulators expected to do? Regulators set rules for
conduct of market entities, the manner of conducting business, and
even the tariff to be charged in certain cases. Regulators may also
lay down norms for entry as well as continuity of business for
entities. It is thus apparent that regulators can enjoy powers in the
area of rule making for entry / exit regulation, conduct regulation,
tariff regulation, and risk containment regulation.

Regulators not only set rules but are also required to keep an eye
on the compliance of these rules. They therefore, end up setting up
an elaborate mechanism for ensuring compliance. If despite this, the
rules are breached then the regulators are charged with the duty of
carrying out necessary investigation and enforcing these rules by
adjudication.

The question of autonomy of the regulator

The list of responsibilities is fairly onerous and since the
regulators combine in themselves the roles of rule making (legislative
role), administration of rules and investigation if breach of rules
occur (administrative function) and adjudication (judicial function),
it is necessary to pay careful attention to the governance issues of
regulators. It is an accepted principle that regulators need to be
autonomous in discharging the duties laid down by law. A regulator,
subordinate to or dependent on the executive wing of the Government
will not be in a position to do proper justice to its duties.

Autonomy is not only a matter of creating appropriate structures
and legal provisions but also a matter of perception. Regulatory
structures in India are in different stages of evolution and therefore
the thinking on autonomy and the perception of autonomy has not yet
fully crystallised.

The Reserve Bank of India as a regulator has been in existence for
more than 75 years and therefore, the relationship between the
executive branch of the Government and the RBI is far more evolved
compared to the relationship of regulators which are of more recent
origin. SEBI is in its 19th year and stands somewhere in the middle of
regulatory evolution: it is more evolved compared to the regulators
that have been set up in this century but has lesser history when
compared to the Central Bank.

The first Chairman of statutory SEBI, Mr. G. V. Ramakrishna, once
famously remarked in the early days that brokers of BSE should know
that the route from Dalal Street (BSE) to Mittal Court (the location
of the SEBI head office, then) is not via the North Block (Finance
Ministry, Delhi). The brokers at that time had not got used to the
idea of a regulatory body having been formed which would independently
set regulations. Capital market regulation was part of the Ministry of
Finance functions till the formation of SEBI. They therefore had a
tendency to run to the Government for every little problem.

The tension between the executive branch of the Government and the
regulatory bodies is not a phenomenon only during the early stages of
regulation nor is it peculiar to India alone. Both the regulators and
the executive need to nurture this relationship in a manner that
reinforces regulatory autonomy. It is not easy for the executive to
deal with this especially when the very powers that were exercised by
the executive are transferred to the regulator. It is imperative in
this context to make sure that there are adequate supportive
provisions in law and the rules to support the autonomous character of
the institutions.

To maintain the autonomous character of the institutions and its
independence from the executive one needs to start at the process of
the appointment and the terms of removal of the Members of the
regulatory apparatus. Interestingly, the framers of the Indian
Constitution saw the importance of this aspect in institutions such as
the Election Commission, the Higher Judiciary namely High Courts and
Supreme Courts and the Comptroller and Auditor General of India. The
Constitution makers were very careful in providing for the conditions
for removal of persons at the helm of these bodies even while
recognising that the appointments will be made by the executive. These
autonomous institutions have served India well. The prolonged tension
between the Election Commission and the other organs of the Government
is an example of how constitutional protection delivered a powerful
and autonomous Election Commission which admirably served the cause of
democracy.

The regulators do not enjoy protection in terms of the
conditions under which their services can be dispensed with by the
executive. In fact the regulators are at the other end of the spectrum
in terms of provisions for their removal. In SEBI, the Members and
the Chairman are appointed for a tenure of certain number of years or
until further orders whichever is earlier.

A tradition has been established that regulators are not removed
from their jobs as easily as the functionaries in the executive
itself. There is no known example of the executive having resorted to
the clause `until further orders whichever is earlier' to remove the
functionaries of the regulatory organisations. Whether it is
sufficient to rely on tradition or whether we need a better legal
mechanism with checks and balances needs to be debated, so that this
important aspect of governance is not ignored.

A vital component of autonomy is financial autonomy. In case of
SEBI and some other regulators such as IRDA this autonomy was built
into the legislation by way of providing that such authorities will
establish a separate fund into which the fees paid by the market
intermediaries will be credited. Such funds are to be used by the
authorities for discharging the functions entrusted to them by
law.

Currently there is a line of thought - as you must have all read in
the media - that the regulatory authorities should not be allowed to
have funds of their own but these funds should be merged with the
Consolidated Fund of India. If the Government finally accepts this
line of thinking, substantial damage will be done to the autonomy of
regulatory institutions. If the regulators have to depend on the
executive for release of funds the question of independent behaviour
by the regulators would be jeopardised. It is necessary to carefully
consider the pros and cons of taking away financial autonomy from
regulators.

The function of investigation in case of breach of rules is an area
that hinges in a vital manner on autonomy from the executive wing.
Regulators by the definition of their responsibility have
investigative wings. This function has come under increasing judicial
scrutiny and the movement of the last 15 to 20 years has been to free
the investigation function from the possibilities of influence by the
executive.

The CBI is a case in point. Under the direction of the Supreme
Court the supervision of this institution is with the Chief Vigilance
Commission which in itself is an independent statutory authority. I
would therefore, argue that regulatory autonomy vis a vis the
executive wing of the Government is not only necessary but is
essential.

The question of accountability

Any governance structure based on autonomy must also look into the
question of accountability. Since regulators have multiple roles, part
legislative, part administrative and part adjudicatory, the
accountability in the three areas is handled in different ways.
Regulators are creatures of law and the ultimate supervisory authority
of the Parliament to assess whether the regulators are discharging the
functions assigned to them is supreme.

The Comptroller and Auditor General of India is empowered under the
regulatory provisions to audit accounts of the regulators and submit
reports to the Parliament to help the legislative in its
assessment. In addition the regulators are required to prepare an
annual report on their activities and lay it on the table of both
Houses of Parliament.

The adjudicatory function of the regulators has been treated
differently and by its nature has to be a subject matter of
supervision by judicial bodies. A mechanism in the form of Securities
Appellate Tribunal headed by a retired High Court Judge and an appeal
provision to the Supreme Court of India forms an integral part of SEBI
legislation.

The rule making powers of SEBI are supervised by the
Parliament in order to ensure that the rule making is confined to the
powers granted by the Parliament to the regulators. If a regulator
exercises power beyond the permissible limit of legislation, the rules
can also be challenged in the courts of law.

In the rule making function the regulators do interact with the
executive branch of the Government. The executive wing of the
Government will have legitimate imputs into the rule making process
and a fine balance is required between the need for autonomy and the
need for harmonisation. This is achieved through the presence of
Government representatives in the Board of SEBI.

Conclusion

In conclusion, it is quite clear that attempts at unregulated
development not only in a particular sector but even in small
sub-sections of sectors have failed. The failure is mainly because
such development ultimately leads to crisis. The cost of resolving
such crisis is high and the burden of the cost is borne not just by
those who benefited from the development but a large portion is borne
by those who were not part of the recipients of the benefits. Clearly
the collateral damage is very high.

The question is, therefore, not so much as to whether development
and regulation are in conflict as the quality of regulation that will
enable us to find a balance between the needs of development and the
need to keep the risk-reward relationship appropriate. It is
necessary to carefully think and design proper regulatory structures,
ensure regulatory autonomy and make sure that there are checks and
balances in the system to address the concerns of accountability as
well.

Thank you.

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Emerging markets finance conference at IGIDR

link

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A puzzling data revision

Ordinarily, official statistics get revised because at first, provisional estimates are released, and when the full data filings come in, then improved estimates are put out.



In the case of RBI's data about RBI's trading on the currency market, such data revisions should ordinarily not arise.



But yesterday, data released by RBI modified the previous information that had been put out about RBI's trading on the currency market. Earlier, trading in June had been claimed to be 0. Now it shows purchase of $370 million and sale of $260 million. Earlier, trading in September had been claimed to be 0. Now it shows a purchase of $260 million. I wonder why this data revision took place.



The newest data - for October - shows a purchase of $450 million on the spot and $450 million on the forwards. At a time when rupee trading is estimated at above $40 billion a day (worldwide), it is hard to see how such a small scale of trading can generate a significant impact upon the price; so I wonder what is going on in terms of the rationale and the thought process.

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Interesting readings

One of the big impediments to India's integration into the world
economy is xenophobic visa rules. There is some progress in the
pipeline: visa
on arrival has been working from Jan 2010 onwards for visitors
from Finland, Japan, Luxembourg, New Zealand and Singapore. A nice
touch here is that India did not get stuck on issues of reciprocity;
this is unilateral liberalisation.

Watch
this talk by
Steve Coll.

Mature treatments of the Niira Radia wiretaps
: Sail
Tripathi in
the Mint, Pratap
Bhanu Mehta in the Indian Express.

Anil
Padmanabhan in Mint on the question of corruption, and
Sevanti
Ninan on the media response to the tapes.

In
search of America's liberty and India's dharma by
Gurcharan Das in the Times of India.

A
rumination by Vikram Doctor, on the need to shift focus in
Bombay from the West to the East.

Sam
Geall on the problems of Chinese science. Some of these
problems are found in India also.

With corruption scandals galore, what India needs most is competent
and clean government. SEBI continues to soldier on:
see the
recent order on bond issues by Sahara. Or if you don't have
appetite for the full text, here is
a precis
by V. Umakanth. Everyone interested in Indian finance should read
a few orders of Bhave's SEBI every year: they give you fresh
insights into how the interplay between law and regulation
works.

Tamal
Bandyopadhyay in Mint with his sense about the extent
of corruption in Indian banking.

How do foreign
capital flows behave around elections, on voxEU by Emmanuel
Frot and Javier Santiso.

Currency
warriors should consider India
by Sebastian Mallaby
in the Financial Times.

A. K. Bhattacharya
writes in the Business Standard about fresh thinking on
Indian Railways from an unexpected source.

Huang
Yiping on voxEU has a story from China which is similar to
what we often see in India: the use of microeconomic tools to go
after macroeconomic problems.

href="http://www.project-syndicate.org/commentary/jian5/English">In
the footsteps of Gandhi, Mandela and Havel, by Ma Jian, on
Project Syndicate. href="http://www.nybooks.com/articles/archives/2010/dec/09/unveiling-hidden-china/?pagination=false">Unveiling
hidden China by Christian Caryl in the New York Review of Books.

Good-bye
to Dubai by Joshua Hammer in the New York Review of Books.

Robert
Messenger looks back at Dien Bien Phu.

Richard
Boudreaux in the Wall Street Journal about Russia's
Parliament accepting Stalin's responsibility for the Katyn massacre.

href="http://www.project-syndicate.org/commentary/rogoff75/English">Kenneth
Rogoff on the Euro.

A tale from the frontiers of public administration. The Australian
government has announced a
competition to forecast the behaviour of traffic on Sydney's M4
freeway. This illustrates three themes. The first is that of better
living through science: the attempt at using statistical analysis to
shape public administration. The second is the unique value of public
domain databases. The third is the importance of harnessing
brainpower out there in innovative ways: through openness of data
and through the competition.

Trailhead
by E. O. Wilson. As I read it, I was astonished at the way in which
knowledge gleaned from hundreds of research papers has been
stitched into a compelling story.

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A club of 19

What binds this club of 19 countries: China, Russia, Kazakhstan, Colombia, Tunisia, Saudi Arabia, Pakistan, Serbia, Iraq, Iran, Vietnam, Afghanistan, Venezuela, the Philippines, Egypt, Sudan, Ukraine, Cuba and Morocco? Answer. Am I glad India is not in this club!

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Alternative stock market indexes

I
saw this
interesting article about the mind-share of Nifty as opposed to
the BSE Sensex. It is by Samie Modak and Muthukumar K. in
the Financial Express.

The NSE
data for June 2010 shows that Nifty futures have peaked at
Rs.0.36 trillion of notional turnover in a day (27 Jan 2010) and
Nifty options have peaked at Rs.0.89 trillion of notional turnover
in a day (24 June 2010). Nifty has shaped up as one of the big
contracts by world standards. It is interesting to go back and
read the
original paper. Those were interesting times. Looking back, it
seems obvious that Nifty would dominate the derivatives market,
but at the time, the outcome was far from clear.

This made me look at data on risk and reward of the alternative
indexes. I start from the first data for Nifty Junior, which takes
me back to 21 February 1997, thus giving data for 13.7 years.

	Mean	Volatility	Ratio
Nifty	12.99	26.37	0.4926
BSE Sensex	12.68	26.92	0.4711
Nifty Jr.	18.16	32.38	0.5608
CMIE Cospi	17.40	27.23	0.6391

Nifty and the BSE Sensex are a lot like each other.

The real surprise is Nifty Junior: Merely moving down from rank
1-50 to ranks 51-100 has given an enormous juice in the return and in
the reward-to-risk ratio. But the volatility of Nifty Junior is also
higher.

The CMIE Cospi index has roughly 2800 stocks today, and represents
the broad market. It includes the Nifty Junior stocks and a host of
other smaller stocks. But unfortunately, these numbers are not
comprabale with the other three in that it includes dividends while
the other three do not. With this combination of high diversification
(giving a low volatility), small-cap stocks (which helps returns) and
inclusion of dividends (which helps returns), it is not surprising
that it scores the best reward-to-risk ratio.

In my mind, most of the claims of out-performance by active
managers in India are purely about being invested in the non-Nifty
space. Nifty Junior ETFs are easily accessible and I get surprised
that more people aren't putting this into their investment
strategy.

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A more efficient piece of code

CMIE's firm databases use a fine-grained product code to identify
each product. Each firm is also allocated to a product code based on
its predominant activities. I like to reconstruct a coarse
classification out of this that suits my tastes. I do this using
this R function:

cmie.14.industries <- function(s) {
  values.8 <- c("Food","Textiles",
                 "Chemicals","NonMetalMin",
                "Metals","Machinery",
                 "TransportEq","MiscManuf",
                "Diversified","Serv.IT")
  names(values.8) <- c("01010101", "01010102",
                       "01010103", "01010104",
                       "01010105", "01010106",
                       "01010107", "01010108",
                       "01010109","01010408")
  values.6 <- c("Serv.Construction","Serv.Other",
                 "Mining","Electricity")
  names(values.6) <- c("010106","010104","010102",
                       "010103")

  if (is.na(s)) {return(NA)}

  leading8 <- substr(s, 1, 8)
  attempt <- values.8[leading8]
  if (!is.na(attempt)) {return(attempt)}

  leading6 <- substr(s, 1, 6)
  attempt <- values.6[leading6]
  if (!is.na(attempt)) {return(attempt)}

  leading4 <- substr(s, 1, 4)
  if (leading4 == "0102") {return("Serv.Finance")}

  return("MISTAKE")
}

This maps each firm into one of 14 coarse categories. Here are some
examples of this in action:

> cmie.14.industries("0102090000000000")
"Serv.Finance"
> cmie.14.industries("0101041502000000")
"Serv.Other" 
> cmie.14.industries("0101010601010000")
"Machinery"

So in short, the function cmie.14.industries() maps a
string like "0101010601010000" into a set of 14 broad industry names
such as "Machinery".

Faced with a file with roughly 48,000 firm-years, at first blush,
it seems that this function has to be run 48,000 times. For a given
firm, this classification could change over time, so it isn't just a
matter of doing this once for each firm. Here is one simple way to do
it:

badway <- function(task) {
  result <- rep("", length(task))
  for (i in 1:length(task)) {
    result[i] <- cmie.14.industries(task[i])
  }
  result
}

This is just a loop that runs over everything in the supplied
vector and calls cmie.14.industries() for each
element. The only concession to efficiency is that the empty vector
`result' is allocated ahead of time.

This proves to be quite slow. None of the standard R vectorisation
ideas offer much relief.

The key idea for obtaining a leap in performance was that while I
had to run through 48,000 firm-years, the industry codes actually
attain only a modest list of possibilities. This makes possible a
table lookup:

goodway <- function(task) {
  possibilities <- unique(task)
  values <- rep("", length(possibilities))
  for (i in 1:length(possibilities)) {
    values[i] <- cmie.14.industries(possibilities[i])
  }
  names(values) <- possibilities
  values[task]
}

For a problem of size 1000, this works out to be 13.5 times
faster:

> load("task.rda")
> length(task)
[1] 1000
> system.time(res1 <- badway(task))
   user  system elapsed 
  0.030   0.000   0.031 
> system.time(res2 <- goodway(task))
   user  system elapsed 
  0.002   0.000   0.002 

This is just a demo with a 1000-sized task. In my production
situation, the performance difference is even greater,
since badway() calls cmie.14.industries()
48,000 times while goodway() only calls it a few hundred
times.

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