Pakistan's ISI and Salafi groups

Quasim Nauman and Zeeshan Haider have a story on Reuters, where they quote Ahmed Shuja Pasha as saying:

We have never paid a penny or provided even a single bullet to the Haqqani network.

Would Jalalludin Haqqani have come to anything without the ISI? I was reminded of the phrase above, when I saw the following fragment from Peter Tomsen's fabulous book, The Wars of Afghanistan:

Pakistani Foreign Minister Assef Ali and ISI Director General Nasim Rana took Pakistan's message on noninterference in Afghanistan to Washington in February 1996, prior to a massive Taliban offensive from Pakistani soil planned for the summer. In a February 9 meeting with Acting Secretary of State Strobe Talbott at the State Department, Foreign Minister Assef ``categorically denied'' that Pakistan was giving military assistance to the Taliban. ... ISI Director General Rana asserted that ``not one bullet'' had been provided to the Taliban by Pakistan.

and:

During the 199s and down to the present, Pakistan's military and civilian leaders became highly skilled at denying Pakistan's covert empowerment of its unholy alliance partners inside Afghanistan and in Pakistan -- in other words, lying.

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Is there a case for supervision of alternative investment funds? A new working paper

by href="http://www.sbs.ox.ac.uk/research/people/Pages/TarunRamadorai.aspx">Tarun
Ramadorai.

The task of financial regulation can be broken up into consumer
protection (where we worry about small consumers being cheated by
financial firms), prudential regulation (where we worry about the
possibility of bankruptcy of one financial firm) and systemic risk
regulation (where we worry about the procyclicality of financial
regulation). Everything that we do in financial regulation must be
motivated by one of these three issues.

In the class of fund management mechanisms, there is one
interesting special case: the `alternative investment management
mechanisms' which include hedge funds, private equity funds, venture
capital, etc. The defining feature of these is that each customer
places a large sum of money under the control of the fund manager. A
typical value for the minimum ticket size is $1 million.

Once this is done, it is no longer possible to argue that the
investor is a small consumer who might be cheated by the fund
manager. A person who places atleast $1 million with a fund manager
has the capability and resources to protect his own interests. Hence,
the mainstream strategy utilised all over the world has been to leave
these fund managers completely unregulated.

Indeed, there has been a healthy competitive tension between these
investment vehicles (which are unregulated) versus mutual funds (which
are regulated). Large customers have the choice between going with
mutual funds, where the cost of regulation is suffered, or going to an
alternative investment mechanism where this cost is not suffered. If
these customers feel the gains from regulation are not justified, they
have the choice of walking away and not incurring the costs.

The world over, there are debates brewing about the need for hedge
funds to begin disclosing regular information on performance,
positions and counterparties to regulatory authorities. For example,
the SEC recently proposed a rule requiring U.S.-based hedge funds to
report such information to a new financial stability panel established
under the Dodd-Frank Act. Unsurprisingly, hedge funds argued against
this proposal, citing concerns that the government regulator
responsible for collecting the reports could not guarantee that their
contents would not eventually be made public.

In a recent paper, my coauthors Andrew J. Patton and Michael
Streatfield and I examine one element of the relationship between a
hedge fund and its customers: disclosure about returns. The paper is
titled href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1934543">The
reliability of voluntary disclosures: Evidence from hedge
funds.

Hedge funds are
notoriously protective of their proprietary trading models and
positions, and generally disclose only limited information, even to
their own investors. However they do voluntarily report their monthly
returns and assets under management to a wider audience through one or
more publicly available databases. These databases are widely used by
researchers, current and prospective investors, and the media.

Our paper examines the reliability of these voluntary disclosures
by hedge funds, by tracking snapshots of these hedge fund databases
captured at different points in time between 2007 and 2011. In each
vintage of these databases, hedge funds provide their entire
historical records (rather than just the new performance information
since the previous vintage). Using these data, we detect that older
performance records of hedge funds are revised as a matter of course.
Nearly 40% of the 18,000 or so hedge funds in our sample revise their
previous returns at least once over the vintages that we consider.

We then categorize hedge funds in real-time into revising and
non-revising funds, and find that on average revising funds
significantly underperform non-revising funds, and have a higher risk
of experiencing large negative returns. This suggests that mandatory,
audited disclosures by hedge funds, such as those proposed by the SEC
earlier this year, would be beneficial to investors and help to
prevent such negative outcomes.

SEBI has recently put out a href="http://www.sebi.gov.in/cms/sebi_data/attachdocs/1314072960975.pdf">request
for comments on a proposed strategy for regulation and
supervision of alternative investment vehicles. Our paper can help in
thinking about the issues faced in this field on the consumer
protection, and analysing the policy choices faced there. While there
is much merit to the mainstream strategy of leaving this industry
unregulated, our paper suggests that a small dose of supervision,
focusing on basic hygiene and motivated by consumer protection, may
help.

Read More

Two seminars at NIPFP

Seminars by Sanjay Banerji (today) and Tarun Ramadorai (Thursday).

Read More

What in the world is happening to the rupee?

The INR/USD rate is now nudging Rs.50 to the dollar. This is a big
move over a short period: a depreciation of 12.1 per cent over the 84
days from 1 July till 23 September.

What fluctuations of the INR/USD can we reasonably expect?

After the rupee became a float, so
far, it has had average volatility of roughly 9 per cent
annualised. Roughly speaking, this means that over a one year horizon,
the movement over a year would range between -18 per cent and +18
percent, with a 95 per cent probability. More extreme movements would
happen with a 5 per cent probability.

Over a period of 84 days, roughly speaking, we'd have expected this
95 per cent range to run from -8.6 per cent to +8.6 per cent. Compared
with that, a 12.1 per cent move is a bit unusual.

It's only a bit unusual because the historical volatility of the
INR/USD, in the period of the float, was rather low. The USD/EUR rate,
which is perhaps the world's most liquid market, has had an annualised
volatility from January 1999 onwards of 10.3 per cent. The INR/USD has
got to surely be more volatile than this, given the inferior liquidity
of the INR and given the greater macroeconomic volatility in
India. Hence, I think we should consider the 9 per cent vol, that was
seen in the early days of the float, as relatively unusual. The future
will most likely hold bigger values for this vol.

The implied volatility of the INR/USD href="http://nse-india.com/live_market/dynaContent/live_watch/fxTracker/optChainDataByExpDates.jsp">at
the NSE has reared up to values like 14 per cent annualised. That
sounds more sensible to me.

What about other currencies?

We tend to do wrong by focusing too much on the bilateral INR/USD
rate. In the recent days of distress, as fear has resurged, people
have taken money out of everything under the sun and put it into US
Treasury bills. This has given a strong dollar at the expense of
essentially every other currency. Here's the picture for the INR,
against the four major currencies of the world, from 1 July till 22
September:

	1 July	22 Sep.	Depreciation
			(per cent)
USD	44.585	48.821	9.50
EUR	64.804	66.103	2.00
JPY	0.553	0.636	15.01
GBP	71.720	75.481	5.24

The picture of the rupee is much more complex than that implied by
simply watching the bilateral rupee/dollar rate.

Can RBI block such a large depreciation?

Let's think through the steps which would follow if RBI tried to
sell dollars in trying to prop up the INR:

• Global trading in the INR stands at roughly $75
  billion a day. If you want to manipulate this market, you need a
  big stick. Small trades will do nothing. If preventing INR
  depreciation is the goal, RBI has to go into this with trades of $2
  to $5 billion a day, with the willingness to stick it out for the
  long run. With reserves of $281 billion, there is not much hope
  here. Specifically, if RBI sells $80 billion in reserves, the market
  will see that. They will know that further rupee defence is now
  going to be hard (since $200 billion of reserves is starting to look
  like a small hoard), and speculators across the world will start
  betting that RBI's defence of the rupee will fail.
  
  
• Reserve money is only $275 billion. For each $27.5 billion that
  RBI sells, reserve money drops by 10%. At a difficult time like
  this, a sharp and sudden monetary tightening will be an unpleasant
  side effect of defending the rupee. (This trading can be sterilised,
  but that has its own problems. I just want to emphasise that selling
  reserves is not easy and is not a free lunch).
  
  
• The rational speculator knows that the exchange rate will
  eventually find its level. When RBI prevents a large INR
  depreciation today, they are giving a free lunch to the speculator,
  who would take a bet that INR would depreciate in the
  future. Specifically, it would be efficient for domestic and foreign
  investors to dump assets in India, take money out at (say) Rs.45 to
  the dollar which is the artificial price, wait for the gradual
  depreciation to Rs.50 to the dollar, and come back into India to buy
  back the same assets. This trade generates 11% returns over a short
  period and is thus very attractive. In other words, a defence of the
  rupee would trigger off an asset price collapse in India.
  

Meddling in the affairs of the currency market is thus highly
ill-advised for a central bank.

Should RBI try to block INR depreciation, even if they could?

Let us play a thought experiment where RBI had $2810 billion,
i.e. 10x larger than what's with us today. In that case, RBI could
play in the currency market, selling $2 to $5 billion a day for a year
without serious distress. Is this a good idea?

I would argue that this is not a good idea. When times are bad, the
rupee should depreciate. This drives up the profit rates of all
Indian tradeables firms and thus bolsters the economy.

Under a floating rate, in good times, the INR appreciates (which
pulls back the exuberance of tradeables) and in bad times, the INR
depreciates (which fuels profits and thus the physical investment in
tradeables). This is arguably the only element of href="http://nipfp.blogspot.com/2010/03/stabilising-indian-business-cycle.html">stabilisation
in Indian macroeconomic policy.

RBI is playing this mostly right

From early 2007 onwards, the INR has been quite flexible. In
particular, after early 2009, RBI's trading on the market has tailed
off. There have been a few months with minor amounts of trading by
RBI. This trading has mystified me, since these small trades can do
nothing to influence the price. In practice, the INR has been a
float.

A floating exchange rate is exactly the right stance for difficult
times like this. In bad times, the best thing that can happen for
India is a big INR depreciation, thus bolstering the tradeables
sector.

Let's evaluate an alternative policy platform: To peg the INR in
normal times but to let go in difficult times. Is this feasible?
Yes. But this is very disruptive: if economic agents have been given
an implicit promise that the INR will not move, then the large move
(which will surely come) would cause pain. It is far better to stay
out of the market all the time, and create a trustworthy structure of
expectations in the minds of economic agents about what the future
holds.

We had a large depreciation in the crisis of 2008, and that served
India well. In similar fashion, we should welcome the INR depreciation
that is accompanying global gloom.

The only element of RBI policy where I have a major disagreement is
communication. RBI has never used the words floating exchange
rate. RBI needs to clearly communicate to the economy that the
rupee is now a market determined exchange rate, and RBI is no longer
in the business of trading in this market. There is greater clarity of
thought at RBI as compared with the quality of communciation; the
speech writing still suffers from twinges of 1960s economics.

What is the collateral damage of a large INR depreciation?

There are three things that go wrong alongside a big INR
depreciation:

1. Firms who have unhedged foreign currency borrowing get hurt,
   because they have to pay back more than anticipated. A person who
   borrowed Rs.100 (in unhedged USD) has to pay back Rs.110, owing to
   the 10 per cent INR depreciation. The stock market is doing a fine
   job of identifying these firms and beating down their stock prices.
   
   
   Of crucial importance is the fact that from early 2009 onwards, the
   INR had already moved to a float with a 9 per cent annualised
   vol. So CEOs and CFOs knew that the INR/USD rate was going to
   fluctuate. They were not lulled into complacence thinking that the
   exchange rate was going to be stable. By avoiding this moral hazard
   associated with pegged exchange rates, RBI's decision to float
   in early 2009 laid a good foundation for the structure of firm
   borrowing as of July 2011.
   
   
   When a country has a pegged exchange rate, you tend to see a big
   buildup of unhedged currency exposure on corporate balance
   sheets. When the big depreciation comes, the big businessmen then
   queue up to the central bank begging for defence of the
   LCY. Prevention is better than cure: It is far better to have high
   exchange rate volatility all along, so that firms do not undertake
   such risks, and the toxic political economy does not come into
   play.
   
   
2. With an INR depreciation, tradeables become costlier. On
   one hand, this bolsters the profitability of tradeables firms, and
   thus their investment plans. But at the same time, this feeds into
   inflation. In recent months, tradeables inflation has been sleeping
   while non-tradeables have contributed to the high CPI-IW
   inflation. We will now see a resurgence of tradeables
   inflation. This will exacerbate the inflation crisis. RBI will need
   to stay on the project of raising rates in order to combat this
   inflation.
   
   
3. The government's subsidy program with petroleum products and
   fertilisers gets costlier when the INR depreciates. So India's
   fiscal crisis gets a bit worse when the INR depreciates.
   
   

This logic is rooted in high levels of de facto capital
account openness. Sometimes, policy analysts think that you can have
your cake and eat it too, and try to dodge these arguments by
utilising capital controls. href="http://nipfp.blogspot.com/2011/04/did-indian-capital-controls-work-as.html">This
has not worked in India, and the levels of de facto
openness have only grown through the years.

In summary, what should RBI be doing?

RBI should be focused on using the short-term interest rate as a
tool to bring CPI-IW inflation under control, without distortions of
interest rate policy caused by trying to meddle in the currency
market. This should be accompanied by liberalisation of the
Bond-Currency-Derivatives Nexus so as to achieve an effective monetary
policy transmission. These are the two things that RBI needs to focus
on.

India shifted away from government interference in the currency
market, from 2007 onwards but particularly after 2009. This is one of
the biggest achievements in India's economic liberalisation. This is a
bigger issue in economic liberalisation than (say) decontrol of
petroleum product prices. The INR is now a market. Nifty and INR are
the two most important markets in the economy. It is time for all of
us to analyse the INR as we analyse Nifty: as the outcome of a market
process.

Is RBI back to trading the INR?

We don't know. The data only comes out at monthly resolution, with
a two month lag. But early signs that would show up would be unusual
jumps in the weekly data about reserves, reserve money, etc. Greater
transparency from their side would help greatly.

Read More

Seminar: "Contagion in international financial markets"

A seminar by Tarun Ramadorai, open to all.

Read More

Interesting readings

href="http://www.nytimes.com/2011/09/02/world/asia/02india.html?_r=1&hp=&pagewanted=all">A
nice story about UIDAI, by Lydia Polgreen, in the New York
Times.

A new insight into India's north-east states: href="http://chronicle.com/article/The-Battle-Over-Zomia/128845/">they
are part of a region provisionally named Zomia. An interesting
article in the Chronicle of Higher Education by Ruth
Hammond. The book.

On 21 April 1956, Jawaharlal Nehru did
the first
convocation address at IIT, Kharagpur. It's a good read, and
it's surprising how much of it makes sense in 2011. E.g.: in the
larger context of history, and looking at it in this way it seems to
me that at the present moment there is no more exciting place to
live in than India. Mind you, I use the word exciting. I did not use
the word comfortable or any other soothing word, because India is
going to be a hard place to live in. Let there be no mistake about
it; there is no room for soft living in India, not much room for
leisure, although leisure, occasional leisure is good. But there is
any amount of room in India for living the hard, exciting, creative
adventure of life. In case you have not yet seen the href="http://www.youtube.com/watch?v=D1R-jKKp3NA">Steve Jobs
commencement speech, it is worth watching.

href="http://www.livemint.com/2011/09/13223636/Lit-fests-bloom-as-interest-gr.html?h=B">How
civilised: Literature festivals in India, by Abhilasha Ojha in Mint.

A href="http://healthland.time.com/2011/08/30/the-math-gender-gap-nurture-can-trump-nature/">fascinating
story from rural India about the differences between boys and
girls on mathematics, by Maia Szalavitz in Time magazine.

href="http://blogs.wsj.com/indiarealtime/2011/09/12/whos-to-blame-for-indias-inflation/?mod=google_news_blog">Who's
to blame for India's inflation and href="http://online.wsj.com/article/SB10001424053111904836104576560780387580752.html">India's
Inflation Is a Lesson for Fast-Growing Economies by Alex
Frangos in the Wall Street Journal.

href="http://www.igidr.ac.in/faculty/susant/FSRR/papers.html">When
do stock futures dominate price discovery? by Nidhi Aggarwal
and Susan Thomas, IGIDR working paper, has some surprising results.

href="http://www.livemint.com/2011/09/04222153/Investments-in-Ethiopia-farmin.html">Anupama
Chandrasekaran and Vidya Padmanabhan, in Mint, on Indian
ventures into farming in Ethiopia.

href="http://www.business-standard.com/india/news/raghu-dayal-its-time-for-an-india-bangladesh-entente/447954/">Raghu
Dayal in the Business Standard on the huge opportunities in
better India-Bangladesh relations.

Mobis
Philipose in Mint, on recent developments in SEBI and
on currency derivatives trading.

href="http://www.livemint.com/2011/08/29002154/We-need-a-Hazare-in-the-financ.html?h=E">We
need a Hazare in the financial sector by Tamal Bandyopadhyay
in Mint. href="http://www.business-standard.com/india/news/abraham-ready-forformal-inquiry/447747/">N. Sundaresha
Subramanian in the Business Standard. href="http://www.indianexpress.com/news/exsebi-member-to-pm-id-leaked-family-at-grave-risk/838990/0">Ex-SEBI
member to PM: ID leaked, family at grave risk by
P. Vaidyanathan Iyer in the Indian Express. href="http://www.financialexpress.com/news/cvc-to-fin-min-probe-both-sides-complaints/838985/0">CVC
to Fin Min: Probe both sides' complaints by Ritu Sarin in
the Financial Express. And, href="http://indiatoday.intoday.in/story/ex-sebi-member-complains-against-pranab/1/149543.html?utm_source=twitterfeed&utm_medium=twitter">reportage
in India Today. href="http://www.livemint.com/2011/08/30235518/Spat-between-Abraham-Sebi-fi.html?h=A1">Spat
between Abraham, SEBI, finance ministry gets murkier by Appu
Esthose Suresh in Mint. href="http://www.livemint.com/2011/08/26233531/Supreme-Court-wants-petition-o.html?d=1">Supreme
Court wants petition on SEBI refiled by Nikhil Kanekal and
Appu Esthose Suresh in Mint. href="http://www.firstpost.com/politics/pranab-sebi-chief-accused-of-batting-for-sahara-ril-mcx-72881.html">A
first and then href="http://www.firstpost.com/business/pranab-ministrys-response-to-abraham-charges-off-the-mark-74416.html">a
second article on these issues, by R. Jagannathan, on
FirstPost. An href="http://www.business-standard.com/india/news/time-to-come-clean/447767/">editorial
in the Business Standard. href="http://www.financialexpress.com/news/column-whos-going-to-fix-sebis-credibility/840387/0">Subhomoy
Bhattacharjee in the Financial Express.

href="http://www.firstpost.com/business/your-post-office-wants-to-become-a-bank-lousy-idea-74523.html">R. Jagannathan
on post offices as banks (on firstpost). And, you might like this href="http://www.indiapost.gov.in/Pdf/IIEF-IndiaPostReport.pdf">related
document.

China's A. Q. Khan problem: an article by href="http://www.nytimes.com/2011/09/12/world/asia/12china.html?_r=1&ref=global-home&pagewanted=all">Michael
Wines in the New York Times.

href="http://www.nytimes.com/2011/09/04/magazine/syrias-sons-of-no-one.html?_r=3&hpw=&pagewanted=all">A
great story by Anthony Shadid in the New York Times about
being on the run in Syria.

A href="http://www.tnr.com/article/books-and-arts/magazine/94145/september-11-do-ideas-matter?passthru=NmU2ZDE4YTQxNGYwNGRjZGIxYWFjMzA1NTJkMWQ3MGQ">great
article by Paul Berman, in the New Republic, about
Islamism.

href="http://www.foreignpolicy.com/articles/2011/08/15/why_is_it_so_hard_to_find_a_suicide_bomber_these_days?page=full">Why
is it so hard to find a suicide bomber these days by Charles
Kurzman, in Foreign Policy.

Love and war, by Janine di Giovanni, in the
New York Times.

What's next for
the dollar? by Martin Feldstein.

href="http://dealbook.nytimes.com/2011/09/03/the-survivor-who-saw-the-future-for-cantor-fitzgerald/?hpw">Sussane
Craig has a great profile, in the New York Times, of how
Howard W. Lutnick brought Cantor Fitzgerald back to life after the
firm was savaged in the 9/11 attacks.

Read More

Paying for liquidity provision on exchanges

Market making versus the electronic limit order book

Exchanges in India all operate as electronic limit order book
markets. There are no `market makers'; there is just a publicly
visible limit order book. Anyone is free to supply liquidity, by
placing limit orders. The person who places market orders is the
consumer of liquidity: he pays market impact cost. [ href="http://www.mayin.org/ajayshah/MISC/lob-example.html">A guide to
the jargon].

Prior to the rise of the anonymous limit order book, there used to
be a great deal of effort on thinking about the market maker. Market
makers played a big role in many old markets. E.g. at the NYSE, the
`specialist' was obliged to provide liquidity. RBI established
`primary dealers' thinking that they would provide liquidity.

These market structures involved complicated problems of measuring
the liquidity provision by market makers, correctly compensating them,
avoiding monopoly power in the hands of the market market, and
enforcing against market manipulation by the market maker. The rise of
the open electronic order book cut through this Gordian knot.

For many years, there used to be a debate about whether the
anonymous open limit order book market (where anyone can provide
liquidity) is better or worse than a market maker market (where limit
orders can only be placed by one or more market makers). That debate
died down in the 1990s with the success of the electronic limit order
book.

Market making on the electronic limit order book

But even on a limit order book, does it make sense to pay one or
more market makers to provide liquidity? The public would be free to
place limit orders, but one or more market makers would be paid to
place limit orders.

The positive argument runs like this. In the life of every
contract, at first there is a lack of liquidity as various market
participants are reluctant to take the plunge and trade on an illiquid
contract. This leads to a chicken and egg problem. Illiquidity
inhibits participation, and the lack of participation is
illiquidity.

From a regulatory perspectives, exchanges might try to make
payments for liquidity provision (or outright turnover) by various
underhand means. If that is going to happen, then it is better to have
this come out into the open.

But there are also important problems that can come out by going
down this route. The resources that an exchange puts into portraying
tight spreads or high turnover could potentially be used to improve
services for customers. Market participants would make wrong decisions
about an investment decision when they see a product as looking liquid
on screen, whereas this liquidity is actually artificial: the screen
would be falsely portraying liquidity. When exchanges compete on
payments to market makers, this can degenerate into a slugfest where
the deepest pockets win.

The artificial liquidity pushed by mercenary market makers would
tend to lull the exchange into complacence. In the absence of market
making, the exchange would run harder to solve problems of market
mechanisms and contract design, and to get the word out about the
contract.

Recent developments in India

On 2 June 2011, SEBI chose to move ahead with the specification of
a ` href="http://www.sebi.gov.in/cms/sebi_data/attachdocs/1308552381802.pdf">Liquidity
Enhancement Scheme' (LES).

By these rules, LES is applicable for individual stocks where the trading volume on
the last 60 days is below 0.1 per cent of the market
capitalisation. (How would this be scaled to derivatives such as
currency futures, where market capitalisation cannot be defined?) I
think this makes sense. The LES would be used to kickstart liquidity
when it is abysmal. The moment a small amount of liquidity comes
about, the LES would step aside.

Based on these rules, href="http://www.nse-india.com/content/press/prs_gi_les.pdf">NSE
announced a program for market making on the derivatives products
recently launched at the exchange: on the S&P 500 and the Down
Jones Industrial Average (launched in partnership with the Chicago
Mercantile Exchange). These incentives are over and above the absence
of charges by the exchange. I was disappointed to see a payment
based on mere turnover. This would give the market maker an
incentive to do circular trading and thus show a lot of trades. But
turnover is not liquidity.

This program came into effect on 15 September. It may matter more
in the coming week, given that new contract series start trading from
tomorrow.

Will it matter? How will we know that it mattered?

Derivatives on the S&P 500 and the Dow Jones indexes have
gotten off to a surprisingly good start, even though there was no such
program. This has perhaps been helped by unusual levels of volatility
in the US after the launch of these contracts.

The early days of a contract can be a rollicking ride and even
after these time-series fall into place, it will not be easy to tell
whether LES was useful in the history of these contracts or not.

Similar thinking is taking place at BSE also: See href="http://www.livemint.com/2011/09/12223753/Will-BSE8217s-biggest-initi.html?h=D">Will
BSE's biggest initiative work? by Mobis Philipose in
Mint. The text there -- obligations such as providing
two-way continuous quotes within specified parameters for quote size
and spread -- sounds good, but here also there are payments per
crore of turnover. By and large, the payments being made at BSE look
much bigger than those at NSE.

In the case of BSE, if LES is able to lift BSE out of zero market
share in derivatives trading, even after the six month period has
expired, then it would be a clear proof that the LES helped. So this
experiment is unlike that of NSE where it will be hard to evaluate
whether or not the LES mattered.

Read More

The reversal of reforms on the New Pension System?

In December 2002, the NDA made a very big move in pension reforms. They decided that from 1/1/2004 onwards, all new staff recruited into the government would be switched out of the traditional defined-benefit pension and instead placed into a new individual-account defined contribution pension system. This was one of the major achievements of the economic reforms of that period. For a conceptual picture of the New Pension System (NPS), see this article, and for a story of that period, see this article.



An essential feature of the NPS was that it was a defined contribution system. India has a long history with getting into trouble with guaranteed returns. UTI's assured return schemes turned into a problem for the exchequer. EPS, run by EPFO, is bankrupt. When pension promises are made, they require peering into many decades into the future and arriving at estimates of longevity and asset returns. In the best of times, it is hard to make such estimates; honest mistakes are possible. In addition, when governance is weak, there are political pressures to make extravagant promises, which will look popular right now but generate staggering costs for the government in the future. As an example, rough calculations show that the implicit pension debt on account of the traditional civil servants pension in India (the one which was replaced by the NPS) stand at roughly 70% of GDP. This is a very big price to pay, for a tiny sliver of the workforce.



The NDA did the unpopular work of switching new recruits out of the defined benefit pensions. But the UPA did not follow through appropriately. At first, many years were lost in hoping that the CPI(M) would come on board the reform. After that, the legal engineering was put into place in order to get an NPS up and running without requiring the legislation. This process was slower than what one might have desired, but it has been making inexorable progress.



But now, a new existential threat seems to have come up : the Parliamentary Standing Committee on Finance seems to be saying that the fundamental idea of the NPS -- defined contributions -- should be scrapped. This would amount to a major reversal of India's economic reforms.



On this subject, see:

• Reportage in the Hindustan Times.


• How PFRDA Bill proposals change NPS structure, by Deepti Bhaskaran, in Mint.


• Editorial in Mint.

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