Interesting readings

India
needs a modern finance ministry equipped to meet macroeconomic
challenges by Shaji Vikraman in the Economic
Times. Editorials in
Mint,
Wall
Street Journal.

A
Reuters story about fat policemen in Pakistan makes me think
about similar questions in India. A dataset of the BMI of
policemen would be an interesting one.

T. N. Ninan
looks back at the dark days of 1975, and the lethality of bad laws
and bad
law-making. [Also
see my writing on this from 2007; but I'm not that optimistic today].

Manas
Chakravarty, in Mint, reminds us that State Domestic
Product (SDP) data is highly suspect. SDP sits alongside NSSO,
ASI, IIP, quarterly GDP,
etc. as pillars
of the Indian statistical system that inspire profound
mistrust. Another
bloomer. In the research community, we should be wary of
garbage-in-garbage-out projects which stand on these datasets.

Mobis
Philipose in Mint on clearing corporations.

The Survey of India needs
to learn
how maps are made in today's world. It must either match these
capabilities, or contract-out the production
of these
critical public goods to these firms.

The IGIDR Emerging Markets Finance
conference: 2011
program, 2012
call for papers.

Rohit
Viswanath in Mint on RBI reforms.

Paul
Geitner in the New York Times makes us think about the
Right to Vacation Act.

We in India are mostly finished with the business of RBI trading in
the currency market
(link). It
was still rather interesting to read Michael Bordo, Owen F. Humpage
and Anna J. Schwartz
(R.I.P.), writing
on voxEU about the experience of the US, Japan, China and
Switzerland on currency trading by the central bank, and the
impossible trinity.

In recent decades, one of the troubling features of the world has
been the retardation of innovation and competition that has been
caused by patents in the field of computer technology. One of the
tallest figures in law and economics, Richard Posner, has written a
devastating
ruling which may help precipitate a fresh look at the way patent
litigation will go. Deeper reform requires rewriting laws, but
judge-made law can help greatly in alleviating the pain. When will
we get judges of this quality in India?

Fairly frightening news is coming out of China. We are all long
China; if China should go bad, it will plunge the whole world into a
recession. href="http://www.the-tls.co.uk/tls/public/article1064549.ece">Rosemary
Righter in the Times Literary Supplement. href="http://www.nytimes.com/2012/06/23/business/global/chinese-data-said-to-be-manipulated-understating-its-slowdown.html?pagewanted=all">Keith
Bradsher says, in the New York Times, that there are fresh
concerns about a bizarre scale of manipulation of official statistics,
which makes you wonder if the communist party actually believes its
own press releases, and is actually flying blind. They are famed for
intra-party democracy and debate, but how can that happen without
accurate information? And, href="http://www.debtdeflation.com/blogs/2012/06/28/the-looting-of-china-by-the-kleptokapitalist-bourgeoisie-roaders/">Craig
Tindale describes the incredible levels of stress in that system,
which makes India's `functioning anarchy' seem almost idyllic in
comparison. Parts of this made me wonder. E.g. he says: the richest
70 members of the government have a net worth of $89.8 billion, an
average of over $1B each. This compares to $7.5 billion for the 660
for the US government, an average of $11M each.. How would we
fare, in comparison?

Read More

A tale of two economies and two currencies

by href="http://ajayshahblog.blogspot.in/2012/06/author-percy-mistry.html">Percy
S. Mistry, in the Financial Express.

A fortnight's visit to China in April, to understand better the progress it has
made with public and corporate governance, was startling in its revelations.
Having been to China years earlier, to advise the State Commission on Reform
of the Economic System (Ti-Gai-Wei) in 1988-1994, it was amazing to realise
in retrospect that, over the last two decades, much of the advice given then,
had actually been taken and applied.

That was in sharp contrast to experience in India. The advice provided
there -- e.g. through the Mistry Report and innumerable interactions with
MoF and RBI over the years - was applauded by the private financial system
for which it was intended (less so by public financial institutions which
need to be privatised). But such advice was taken and implemented by MoF
and RBI only grudgingly and at the margins of insignificance in terms of
impact.

What was most strikingly apparent during the visit was the resolution and
purposefulness with which China and its institutions are governed. That
applies to public institutions and agencies at various levels of central,
provincial and municipal governance, state-owned enterprises (SOEs), and
the rapidly growing number of private Chinese companies; whether
domestically owned or joint ventures with multinationals involving both
public and private partners. It was no surprise to confirm that China is
much better governed at central, state and municipal levels than India;
where public governance is deteriorating by the day. But, that Chinese
companies now seem better and more responsibly governed than their
Indian counterparts came as a rude shock!

The impression of corporate and public governance in China now being
well ahead of India (and a lot of what now mistakenly passes for the
'developed world' as well) emerges despite the occurrence of the Bo Xi
Lai/Gu Kai Lai affairs that were unfolding at the time. One almost got the
sense of careful orchestration and stage management of these 'affairs' by
two competing factions for influence within the ruling Politburo and its
supporting Standing Committee as the future leadership/management
team that takes over in October was being put in place.

To be sure the case is invariably made that such resolution and purpose
is usually (or can only be) exemplified by a totalitarian state like China,
rather than a democratic state like India. After all, China is unhindered
by the cumbersome processes of democracy. It has yet to provide many of
the personal and human freedoms/rights provided in much of the world and
in large emerging countries like India. Yet, despite the correctness of this
perception, one cannot help but feel that blaming the Opposition,
parliamentary process and democracy, as GoI invariably does routinely
(to explain its incompetence and loss of nerve for losing the plot on
macroeconomic management), stretches the excuse a bit too far.

One wondered after the China visit whether India is the world's largest
democracy as it always claims, or whether it is the world's largest abuse
of democracy. Abuse: because of the make-up and mind-set of its
parliamentarians and political class, and because of the characteristics of
the poor and destitute electorate that engenders, propagates and
perpetuates at each election such a dysfunctional polity with such
destructively counterproductive tendencies, habits and behaviors.

China still has to cross the Rubicon of political democratisation and
full extension of human rights taken for granted elsewhere. Until it does
so, the world is right to be sceptical (if not perturbed) about its
inexorable ascendancy into a position of global hegemonic power. But one
gets the sense (almost with certainty) that China -- in its own imitable
way and in its own time unhurried and unbowed by external pressures -- will
develop a 'democratic' or 'quasi-democratic' model that suits its purpose
and characteristics.

Learning hard lessons from Russia, where it is clear in retrospect that
economic and political liberalisation were carried out in the wrong
sequence and in the wrong manner, China will do so without destabilising
itself in the way that Russia did. The Chinese leadership has no desire
to repeat what happened in Russia - i.e. the emergence, after a period of
total confusion during the Yeltsin era, of a KGB-controlled/inspired
kleptocracy under Putin's leadership. That kleptocracy has now replaced
the econo-political apparatus (and power) of the former communist state.
Russia's situation has evolved in a manner that, if one thinks about
carefully, has some disturbing indirect parallels with 'liberalization'
in the Indian case.

The Indian public-private kleptocracy (a peculiarly Indian type of PPP)
that has emerged in India post-1991 reforms, has not involved the
membership of a repressive state intelligence apparatus, as in Russia.
India has never had an intelligence apparatus worthy of the name or of
any note. The only threat it poses (hopefully but not assuredly) is to
Pakistan. That too is an ineffectual, minuscule threat given how poorly
Indian intelligence (if that is not an oxymoron) is organised, funded and
conducted. But, the Indian kleptocracy that has emerged after 1991 has
certainly involved core relationships between established Indian political
dynasties and large corporate houses (especially newer ones) that
emerged after the Emergency.

Those corrosive relationships have become deep-rooted and taken hold in
various avatars at central and state levels. At each of these levels they
involve different business houses and different political dynasties; some
of which have become organised medium-scale businesses in their own
right, specialising in unique forms of rent extraction.

Taken together, they have resulted in Indian corruption becoming an
organised mega-industry post-1972, from the localised handloom cottage
industry that it was in the 1952-72 era. That mega-industry has its own
codes, institutions, intermediaries, processes and lexicon (peti
and khokha). It has resulted in a unique form of crony capitalism,
favouring those business houses in India that originated mahacorruption
and have since become its principal beneficiaries.

Indeed, such corruption has become embedded in the Indian economic
system. It is so essential to the 'functioning' of its post-1991
quasi-market, improperly liberalised economy -- where the grant of
licenses and inexplicable asymmetries in regulation play such a key
role in introducing anti-market distortions and subsequent market
failures -- that one now sees the visible damage being done to the
functioning of the economy as ham-handed attempts are made to root it
out.

One could make a good case that, in part, the slowing down of the
Indian economy, and the rapid decline in corporate investment following the
2G-scam, is the result not only of macro-economic mismanagement and poor
judgement by the FM/MoF, but also because corruption can no longer be
relied upon by corporate houses to get things done in the way they once
were. If the people (politicians, bureaucrats, regulators and police) a
corporate house 'buys' -- through corruption in the political and
bureaucratic systems, to retain its strategic and tactical advantages over
its competitors in its main markets - can no longer be relied upon to
deliver the goods, then what is the point of taking risks that simply
cannot be managed?

Corruption is not only an Indian phenomenon. It occurs in China;
possibly to a greater extent. Its totalitarian regime has not expunged it,
although it pretends to have. Petty corruption at lower levels of
officialdom is neither as pervasive nor as predatory as it is in India. But
at the upper reaches it certainly seems omnipresent. Indeed most Chinese
(in the public and private sectors) suspect that members of the Politburo
and Standing Committee are engaged in concealed corruption on a scale
that might make Indian corruption seem amateurish.

Corruption in China arises (and is fuelled) from pervasive state
ownership of large public manufacturing, exporting, service and transport
enterprises, of public construction companies that have benefitted from
massive public spending on infrastructure (of which 10-15% of all contracts
is allegedly accounted for by kick-backs), from public ownership of the
banking system, and over $3 trillion in reserves that are increasing by 10%
annually. On that amount of reserves, over $1-2 billion a day can easily be
salted away via accounting errors and omissions and through improperly
accounted-for effects of supposed daily exchange rate fluctuations or
mark-to-market losses on sovereign bond purchases.

Rumored public estimates of proceeds transferred abroad by the top
leadership in China invariably range from $100-150 billion over the last
five years. If one extrapolates from that figure the proceeds of corruption
at lower levels of governance (especially at municipal levels where the
granting of land leases is the major source of leakage), figures of around
$1 trillion over the last 5-10 years do not appear as outlandish as they
might.

Certainly the ostentatious wealth displayed by Chinese political and
business families abroad lends substance and credence to these estimates,
in the same way that the lavish life-styles and expenditures of expatriate
Russians in London give credence to its own kleptocratic state.

Yet, despite the functioning of both the Chinese and Indian economies
being profoundly affected by corruption (of different sorts) the growth and
resilience of the Chinese economy does not appear to have been as adversely
affected by it as has been the case in India. Instead, quite the reverse!
The Chinese economy is displaying extraordinary resilience in the face of
externally generated headwinds that are slowing down its dynamic export
machine. All the talk about hard and soft landings for the Chinese economy
seem moot after the April visit. China has managed to orchestrate a
reasonably soft landing with growth slowing to < 8% levels with China
switching gradually to a domestic-consumption led rather than export-led
growth strategy.

But it takes time for a super-tanker the size of China with its $6-7
trillion economy to change course and reverse gears. The single most
effective instrument to induce and accelerate such a change - i.e. opening
its capital account and floating its currency to result in more rapid
market-driven appreciation of the Chinese Yuan (CNY) or Renminbi - has
been eschewed as a policy tool to bring about more rapid switching.

Over the last two years the strength and resilience of the Chinese
economy, in the face of the worst global economic and financial crises the
world has experienced in nearly a century, have been remarkable, as
reflected in its continued build-up of reserves. These now amount to over
$3.2 trillion -- despite the impact of the post-Lehman financial crash of
2008 and the rapid deterioration in the economic circumstances of its two
largest export markets: i.e. the US and EU. This massive build-up of
surplus capital, which it seems unable to use for its own needs, has led
China to open its currency market through administrative measures.

The April visit suggested that China is deeply concerned about using
exchange rate adjustment as a policy tool, fearing that doing so would
destabilise its labour and wage markets. After all the key Chinese
imperative to ensure its success as an exporting power has been to manage
(manipulate?) its exchange and wage rates so as to import jobs from, and
export goods to, the rest of the world for as long as the rest of the world
permitted China to get away with it.

And, so far, the rest of the world has done that. In the process, China
has built up gargantuan reserves which are likely to grow at 10-20%
annually even if its trade account comes into balance. Such unprecedented,
large global reserves and the way in which they are managed -- perversely
reflecting the limitations and dysfunctionality of China's state-owned
financial system -- now pose an economic and political threat to the rest
of the world. A continued build up reserves at the same rate as before
would be intolerable.

Consequently, China has arrived at the stage where it has no option but
to liberalise its currency market and export capital a little more easily
in one way or another. It is choosing to do so through administrative
measures such as bilateral CNY swaps rather than via traditional open
market measures. These measures lead to a number of interesting interim
possibilities before full and traditional capital and currency market
liberalisation is undertaken.

Until this month, China had focused CNY swaps in local currencies
of major emerging market trading partners, and not with developed
market partners such as the US and EU. But, a couple of weeks ago,
China announced that it would do CNY:JPY swaps with Japan, a developed
and large trading partner. Partial capital account liberalisation is
also being attempted through gradual opening of the CNY (dim-sum)
bond-market in Hong Kong. That market has taken off faster than the
Chinese authorities seem comfortable with.

What are the implications of the latest Chinese measure to introduce
CNY:JPY swaps? They are not likely to be significant immediately
as few internationally traded contracts are denominated in either CNY or
JPY.The same arrangement for CNY:USD or CNY:EUR would have been more
globally significant and led to CNY internationalisation more quickly.

However, the question raises some interesting possibilities where
China-Japan, China-Asean and Japan-Asean trade is concerned. Triangulation
on trade and trade-related long term investment among these three large
trading blocs/players (more if one includes Korea and Taiwan) holds out
interesting possibilities for the growth of Asian markets in regional
currency trades and derivative hedges.

Also, Japanese multinationals are major investors in Chinese export
production, which is linked to their own export production for global
markets, in innumerable and intricate ways. If the CNY:JPY arrangements
stabilise the influence of currency fluctuations on such bilateral and
pass-through trade then the CNY will benefit and internationalise faster.

How rapidly the CNY becomes an international currency like the USD
depends initially on how the Asian/Asean markets perceive movements in the
CNY and JPY in the short, medium and long term. As a long-term hold, the
CNY seems more attractive than the JPY. The Japanese yen is intrinsically
a weak currency issued by a very heavily indebted country that is dying
slowly demographically, and is a waning global economic power in relative
terms. The opposite is the case for China and the CNY. But long-term
currency holds are for investors not traders. And China is denying the
world full market access to probably the most significant currency
numeraire for long-term investment over the next 30 years.

In the short and medium term, it is difficult to predict what will
happen to the value of the CNY relative to other currencies (especially
USD, EUR and JPY) because of administrative intervention. If currency
markets were left alone the CNY would appreciate significantly against all
three; despite the arguments being made that the CNY has found its real
effective equilibrium rate and does not need appreciation.

Anyone who believes that does not understand currency markets. Right
now the JPY is an international currency that seems to be overvalued,
taking Japan's underlying fundamentals and economic prospects into account.
Yet it is widely held in global central bank reserves though used to a more
limited extent than should be the case for Japan's trade contracts with its
various trading partners which, unfortunately, are still denominated more
in USD than in JPY.

The Chinese authorities could of course internationalise the CNY faster
and more efficiently by opening up their capital markets in a phased
fashion; making the CNY at first (up to 2016) a partially and then (2017
and beyond) a fully convertible currency. They are doing it instead in a
clumsy, administratively burdensome fashion in the belief that going that
route will result in more 'control' over the pace of internationalization.

A key concern is that this administrative approach (akin to the route
that Indian bureaucrats invariably prefer in the bizarre belief that their
control results in better outcomes, despite evidence to the contrary) will
lead to a series of significant anomalies. They will create distortions of
the kind that usually arise with administrative intervention and an
aversion to letting markets do what they do best -- i.e. price discovery.
Those anomalies and distortions could damage the world at a time when
the global economy is still quite fragile.

Yet the CNY is heading towards becoming a global currency, perhaps
second in importance to the USD over the next 20 years and even more
important than the USD thereafter. That process is as inexorable as it is
inevitable. Indeed that outcome has been delayed too long. For the world's
second largest economy, and its second largest trading economy, to continue
having a closed capital account, and a non-convertible currency with a
fiat-determined price, is an intolerable eccentricity that has damaged the
world and provides an unfair structural advantage to China. Oddly, China
has been permitted by the world trading community to play by its own rules
to its own advantage (and to the detriment of the rest of the world) for
too long by asserting the right to control the most significant price
affecting its trade with the rest of the world i.e. the price of its own
currency.

In an open economy global trading model, world trading patterns, and
consequently global investment patterns, as well as global production
location and market share, are all supposed to be determined/equilibrated
(i.e. with trade, current and capital account surpluses and deficits -- or
imbalances -- being sorted out) by markets and not by administrative
interventions; with market forces being left to adjust all prices, including
currency prices, that affect global trade.

When China respects the notion that market prices should determine the
prices of all inputs and outputs that make up the cost of its production,
but then asserts the right to control a key price (i.e. the price of its
currency), which in turn affects the price of imports from China by other
countries, it violates a fundamental precept of the open economy global
trading model. The sustained violation of that principle for two decades
has in large part been responsible for bringing the global economy to its
knees, while allowing China to accumulate extreme reserve surpluses
that now pose a fundamental political and economic threat to the rest of
the world.

In the post-Bretton Woods world, China is the most egregiously
anomalous case of a country (misusing the developing country argument)
becoming as significant as it is in the world economy without being obliged
to open its capital account and make its currency convertible. All the
other rising economies in the 1960s and 1970s (Germany, Japan and several
smaller European economies), 1980s and 1990s (Korea, Singapore, Taiwan,
some Asean and most Latin American economies) made their currencies
convertible and opened their capital accounts.

They did not suffer any of the kind of damage that China claims it
would suffer if it did the same. Essentially what China seems to be
asserting through its currency management policy is the divine, inalienable
right to import jobs from, and export manufactures to, the rest of the
world indefinitely by manipulating the price of its currency. That cannot
be permitted to continue given the devastating impact such a policy has
had on the rest of the world. The CNY must be internationalised sooner
rather than later in a market-oriented manner.

If that is so for the CNY then what is the future of the INR? As the
next largest emerging global economy after China shouldn't the INR follow a
similar trajectory? Until last year many astute commentators envisaged the
INR taking its own place in the world, following the CNY as an increasingly
significant trading currency. They thought at first that the INR would
become a littoral/regional (2015-2020) trading currency and later (2020
onwards) a globally significant trading and reserve currency.

But the dreadful mess that the UPA-2 coalition and central government
have made of the Indian economy over the last 24 months, and the shattering
of confidence in India on the part of both domestic and foreign investors,
has been an object lesson in confirming that India seems incapable of
coping with success for any length of time. India seems instead to be more
inured at coping with prolonged failure. It seems to know how to cope with
that better attitudinally.

Therefore the INR is unlikely to emulate the CNY as a global trading or
reserve currency for quite some time yet. Instead the INR is now seen as
a temporally if not structurally weak currency that can barely hold its own
value, leave alone become a serious trading or reserve currency in the
foreseeable future.

Contrary to assertions by the FM, PM, RBI and UPA-2 leaders, none of
the wounds that India is suffering from, and have inflicted on the INR,
have much to do with negative global influences or Europe. At most those
factors may have had only a marginal impact on growth and inward
investment. The damage done has been mostly self-inflicted.

The really devastating impact of MoF/FM misjudgement and malfeasance
has been on overall investment and in not relieving mounting supply-side
constraints sooner. The FM in particular has played a leading role in
convincing investors in India and around the world that India is no longer
worth investing in. That impression has been reinforced by aggressive but
injudicious posturing by the FM/MoF, goaded by their tax hawks, about the
'losses' India suffers from its DTAs with supposed tax-havens (such as
Mauritius) and its contradictory if not absurd positions on applying GAAR
retrospectively; and attracting the derision of the world at large.

Immense damage has been caused by this failure of judgement, obtuseness
and obstinacy in the vindictive vendetta that has been conducted against
Vodafone in particular, and foreign firms in general, on the capital gains
tax issue. No mention is made at all about the tax gains (direct and
indirect) as well as employment gains that have been derived from inward
FDI and about the losses that would be incurred if such FDI flows ceased -
as they now seem to be doing.

If GoI/MoF were so concerned about revenue losses to the exchequer,
from FDI that escapes capital gains taxation, the PM and FM would have
done better to look more closely at their neighbours in parliament and state
legislatures. They could apply more vigorously and impartially laws on
assets disproportionate to income. That approach would provide them with
a triple-whammy. It would deal holistically with the phenomena of black
money, corruption and tax evasion/avoidance, all at the same time. The
revenue raising possibilities from that source would make Vodafone look
trivial by comparison.

Had GoI/MoF done that they would have drawn more effective public
attention to the generation of black money which official India is
exerting every sinew to evade doing in the most clumsy fashion,
knowing that to take serious action on that issue would be to indict
virtually the entire political class in the country and bring in to
the black money net most corporate leaders as well.

The egregious and severely damaging misjudgements on the tax issue, and
the mismanagement of the Indian macro- economy since the change of
leadership of the Finance Ministry in 2009, have introduced the kind of
uncertainty into investment decisions that now make banana-republics and
places like Rwanda and Congo seem almost sagacious in comparison with
India.

How could this have happened? The answers seem obvious in
retrospect. The political and bureaucratic leadership of the
post-2009 Finance Ministry appears to have been childishly naive and
clueless about how finance or economics actually work. All of India,
and corporate sycophants dependent on the state-owned banking system
for liquidity and long-term loan largesse, have been worshipping a
false god -- as we seem to do relentlessly. Look at how we worship
supposed corporate titans with feet of clay. It would be funny if it
were not so tragic that one needs to screw up a country before one
becomes an eligible candidate for that country's Presidency!!

Compounding the problem of gross malfeasance in short-selling India as
an attractive long-term investment destination, GoI's top leadership
appears to have as little clue about what leadership or good governance is
all about. The other big beasts in the Cabinet (i.e. the Ministers of Home,
Defence and External Affairs) all seem to be in the wrong jobs that play to
their weaknesses rather than their strengths. As a consequence, GoI and
India have lost all credibility at home and abroad. The impression they
convey is of gross incompetence and surprising insouciance.

Being clueless seems widespread and endemic. It goes beyond
characterising what now seems to be a sorry excuse for a crippled
government that needs to be put out of its misery. At the top political
leadership level in the UPA, Madam Sonia and Master Rahul Gandhi
also appear to have no clue about anything, if the results of recent
state elections are to be judged dispassionately.

They and their sycophants in the leadership of the Congress Party
(simply a monarchy in drag) still believe in an India that should be
managed politically by hand-outs, subsidies and populist sops that break
the Union and state budgets. They do not yet believe in sustainable
long-term development generating growth of >8% for the next few decades
based on productive public and private investment of between 30-35% of GDP.
Nor do they believe in reducing poverty through productive and meaningful
private employment generation rather than on NREGA type income subsidies
and hand-outs. They would rather that, at election time, the poor voted for
them out of gratitude for hand-outs, than because employment was generated
by private companies investing in the economy that could not be visibly
attributed directly to them.

Their attitudes and supposed 'leadership' make proper macro-economic
management by anyone almost impossible. They still do not believe in
continuing with structural reforms that widen the distance between the
polity and the economy, thus limiting the amount of damage the former
can do to the latter through negligence, false ideologies about how the
poor can be helped, populism and plain economic ignorance.

They do not believe that significant reforms are needed, along with an
urgent programme of ambitious privatisation, beginning with Air India,
extending to state-owned companies in telecoms, transport, minerals,
natural resources, manufacturing, services (such as transport and tourism)
and most of all privatising the state-owned financial system. It is through
the SOBs that many of the weaknesses of the Indian economy are aggravated
and exacerbated. The SOBs are also the conduit for exercising the kind of
political influence that results in the kleptocratic quasi-market economy
that has emerged in India post-1991; through an inimical but pervasive
public-private partnership (PPP) between political dynasties and large
business houses.

Taken together, the top leaderships in MoF, GoI and UPA -- individually
and collectively -- are the PROBLEM, not the solution. Once that diagnosis
is accepted, a cure can be found. Until then one can but hope that the next
election brings more succour to India than is the case now.

What needs to be done urgently is to revive domestic and foreign
investment and growth in the Indian economy. Given the rapidly
deteriorating state of public finances, a widening current account deficit,
a collapsing Indian rupee, and the entrenchment of structural inflation,
which it will take prolonged tightness of monetary policy to control, GoI's
room for manoeuvre is limited. But there are options to be exercised. The
first is to revive confidence in government on the part of domestic and
foreign investors. For that to happen, the MoF's obsession with imaginary
tax losses has to be dropped in favour of more investor-friendly policies
that attract inward foreign investment in large amounts. If that happens,
it will spur domestic investment concomitantly.

A start can be made by putting the Insurance and Pensions Bills
immediately before parliament with GoI doing whatever it must with its
allies and opposition parties to get these passed. If the cap on FDI in
insurance were lifted from 26% to 49% in the next few months it would
result in a significant inflow of FDI. That would spill over through
linkages into private corporate capital investment as well as investment
in infrastructure. Both are needed urgently to relieve the supply-side
bottlenecks that have been built up in the economy over the years and
which are now responsible for structural inflation becoming
embedded.

Similarly, the counterproductive debates and hold-ups on limiting FDI
in retail (single and multi-brand) and on moving more urgently with
privatising Air-India need to be ended. No national interest is served
by imposing constraints and limits in any of these areas.

As far as Air India is concerned, it is now obvious to every Indian
that continued public investment in that hopeless airline is a waste
of public money. It benefits no one, least of all the poor, to run a
state-owned airline simply for the personal convenience of the
political class.

The same could be said for BSNL, MTNL, Coal India and all the SOBs. GoI
ought to commit itself to privatising all SOEs by no later than 2025 in a
phased manner. State governments need to follow suit rapidly in privatising
the plethora of inefficient state-level public enterprises they own as well.

Those steps might indicate to the world that GoI/MoF is serious about
undoing the immense damage it has done to India and its image as an
investment destination since 2009. Unless that is done, with an ambitious
far-reaching reform and privatisation agenda which convinces domestic
and global investors that GoI really does mean business, then the Indian
economy will continue to languish with prolonged sub-par performance.
If that happens fiscal performance will worsen, inflation will remain too
high, and growth will remain too low.

A financial crisis will ensue. The INR will continue to decline in
value internally through high inflation, and externally against other
currencies, putting at risk and perhaps even reversing all the
achievements of the 1991 reforms.

It would be a sad legacy for a beleaguered and exhausted PM to leave,
with the best of intentions but the worst of performance (and corruption)
records, as he exits a stage he has played a lead role on for nearly a
decade.

Read More

Author: Percy Mistry

• The talent pool in Macro and Finance, 25 August 2013.


• A tale of two economies and two currencies, 1 July 2012.


• Guide to the Eurozone crisis, 17 November 2011


• Mumbai as an international financial centre, 1 February 2010 


• Responding to the global crisis, 8 March 2009


• The image of India: Terrorised and tarnished, 24 December 2008


• Brown and TARP: Are they perpetuating the mess we're in?, 25 November 2008


• Does anyone have a post-recession exit strategy, 27 November 2008.
  
  


• `Ideas exchange' with Percy Mistry in IE & FE, 21 September 2008


• Global Turbulence: Its Unfolding Trajectory and the Likely Implications for India, 26 August 2008.


• Paying the price of ignorance, 17 May 2008


• Fouling up finance: Same old questions, same wrong answers, 31 March 2008


• Financial innovation and financial sector reform, 27 March 2008


• Pitfalls of the Indian middle path, 27 February 2008


• The Mumbai-IFC report: of Discourse, Garlands and Brickbats!, 9 August 2007


• Mumbai as an international financial centre, 2 April 2007

Read More

Highways: from good to great

In 2006, I had written a blog post titled Why are elephants attacking people? On a related note is the problem of roads and other barriers interfering with the natural migration paths of elephants in the wild. In India, we are in a great phase of building infrastructure, but alongside this is a new level of distortion imposed upon the animals.



Mark Thoma's blog just led me to fascinating pictures from Kenya about elephant-friendly underpasses. This will reduce destructive human-animal interactions, and improve gene flow.



In Canada recently, I saw some remarkable construction work on the big highways. They have huge overpasses which are then forested over, to permit the animals to cross from one side to another. Here is the Google satellite imagery:

The scale on the left suggests that the overpass is roughly 50m wide, which is quite a bit. It is wide enough for grizzly bears and elk to cross without necessarily having unpleasant encounters with each other. The photograph also shows trees growing on the overpass. Here is what it looks like while on the road:

I had never imagined something of this scale before, but there appears to be a flourishing effort worldwide of this nature. Also see Home on the range: A corridor for wildlife by Cornelia Dean in the New York Times from 23 May 2006.



I rode by train through Rajaji National Park recently, and the train went very slow and made noise constantly, in an attempt to avoid killing elephants. The initiatives at reducing collisions between trains and elephants in that region appear to be working. In 2012, I read a story by Nidhi Sharma in the Economic Times about NHAI building 13 underpasses for animals over a 9 kilometer stretch on NH-7 through Pench Tiger Reserve. This is an important dimension to the fresh focus on road safety that needs to be a part of the large scale building of new roads that is now taking place in India.

Read More

Why is solving India's inflation crisis important?

All of us are aware of India's inflation crisis. It is very
disappointing, how we lost our grip on stable 4-to-5 per cent
inflation which was prevailing earlier. From February 2006 onwards, in every single month, the
y-o-y CPI-IW inflation has exceeded the upper bound of 5 per cent.



All of us agree that there is something insiduous when 10%
inflation effectively steals 10% of the value of my wallet or fixed
income investments. In India, however, we often hear the argument
"Yes, this is bad, but if high inflation is the way to get to high GDP
growth, let's get on with it". It is, then, important to ask: Why
is low inflation valuable?

Nominal contracting is very important

Complex organisation of economic life involves myriad written and
unwritten contracts involving households and firms. The vast
majority of these contracts are written in nominal terms, i.e. in
rupee values that are not adjusted for inflation.



Every society needs to adjust all the time, in response to changes
in tastes and technology. When tastes or technology change, the
structure of production needs to change, which involves
renegotiation of (written or unwritten) contracts. These adjustments
are costly. Contracting is costly, and renegotiating contracts is
costly.



It is useful to think of a finite supply of adjustment as being
available in the country. We should devote that full power of
adjustment to the beneficial adjustments associated with changes in
tastes and technology. In a place like India, where GDP doubles
every decade, the requirement for adjustment is (in any case) large.



Inflation is an acid that corrodes all nominal contracts. Two
people may have agreed on a contract two years ago at Rs.100, but
that contract is thrown out of whack because of 10% inflation per
annum. That contract has to be renegotiated. Bigger values of
inflation corrode personal relationships also, given that there are
many financial ties within friends and family.



Contracting is costly. Almost everything that senior managers do
is to arrive at complex deals that create and sustain complex
structures of production. This work is continually torn down by high
inflation which makes the deals of last year break down today. Managers are able to build sophisticated edifices of contractual arrangements under low and stable inflation. These webs of contracting are harder to build and hold up when the acid rain of inflation is continually tearing these down.

Inflation messes up information processing

To continue on the theme of adjustment, the essence of a market
economy is adjustments to relative prices, reflecting changes in
tastes and technology. Firms learn about the viability of
alternative investments by watching relative prices
change. Inflation messes up this information processing. It
increases the `background noise' by making a large number of prices
change at once. This makes it harder to discern which price change
is fundamentally driven, and merits a response in terms of increased
or decreased production.



Building a sophisticated market economy is all about making
long-term plans. When a firm decides to build an airport or a highway,
this involves making NPVs over the next 20-40 years. This requires
having a fair idea about future inflation. If inflation will fluctuate
in the future, then firms will err on the side of caution when making
plans about the future, i.e. investment will be reduced. I will stress
that long-term investment, in projects such as infrastructure or heavy
industry, relies critically not just on a long-term bond market
(which, in turn, critically requires low and stable inflation) but
also on the calculations happening in a spreadsheet about the NPV of
the investment project, which involves projecting all revenues and all
expenses for the next 20-40 years (which also critically requires low
and stable inflation).

Impact upon pre-existing nominal savings

For a person at age 60 who expects to live to age 85 or 95, fixed
income investments are absolutely crucial in the financial planning
of these 25-35 years. These calculations can be destroyed by a short
bout of inflation.



A civilised society is one in which people can make plans for the
deep future, and trust in financial instruments. It is simply cruel on the elderly to inflate away their nominal assets. The possibility of
even one bout of high inflation over the coming 25-35 years forces
people to drop back to other mechanisms of protecting themselves in
old age. What is needed is not just inflation control right
now. What is needed is the environment of mature market economies,
where outbursts of inflation are fully ruled out for decades to
come.

Impact upon relationship with banks

In India, banks pay very low interest rates. While many interest
rates have been deregulated, the interest rates paid by banks are
held back by factors such as low competition and financial
repression (i.e. forced purchases of government bonds).



When households expect inflation will be 12%, they will see a 4%
interest rate paid by the bank as yielding -8%. This has many
consequences. On one hand, households and firms expend excessive
(wasteful) effort on minimising their holdings of low-yield cash. In
addition, households tend to shift away from fixed income
contracting with the formal financial system. Both these distortions
are caused by inflation, and exacerbated by flaws in the financial
system.



If the financial system were regulated sensibly, then with high
inflation we would immediately get higher nominal interest rates
since buyers of 90 day treasury bills would demand higher interest
rates to pay for inflation. This would reduce the damage caused by
high inflation. In India, we suffer from bigger negative effects
because of a faulty financial system.



These may seem to be small things but they actually are fairly
large effects. Towards an understanding of the costs of inflation
-- II, by Stan Fischer, 1981, argues that perfectly anticipated
10% inflation induces a cost of 0.3% of GDP on account of only one
factor : excessive efforts by households and firms to hold less
cash.

The rising prominence of gold

Gold is a barbarous relic; it is the investment strategy of choice
for uneducated people. It is also a vote of no confidence in fiat
money. Our failures in creating a capable central bank, which
delivers sound fiat money, are taking Indian households back to
their old ways. Many decades of progress in getting households to
engage with the modern financial system is being undone in this
inflation crisis.

A classic quotation

Lenin is said to have declared that the best way to destroy the
capitalist system was to debauch the currency. By a continuing process
of inflation, governments can confiscate, secretly and unobserved, an
important part of the wealth of their citizens. By this method they
not only confiscate, but they confiscate arbitrarily; and while the
process impoverishes many, it actually enriches some. The sight of
this arbitrary rearrangement of riches strikes not only at security,
but at confidence in the existing distribution of wealth. Those to
whom the system brings windfalls, beyond their deserts and even beyond
their expectations or desires, become `profiteers', who are the object
of the hatred of the bourgeoisie, whom the inflationism has
impoverished, not less than of the proletariat. As the inflation
proceeds and the value of the currency fluctuates wildly from month to
month, all permanent relations between debtors and creditors, which
form the ultimate foundation of capitalism, become so utterly
disordered as to be almost meaningless; and the process of
wealth-getting degenerates into a gamble and a lottery. 

Lenin was certainly right. There is no subtler, no surer means of
overturning the existing basis of society than to debauch the
currency. The process engages all the hidden forces of economic law on
the side of destruction, and it does it in a manner which not one man
in a million is able to diagnose.

From Chapter 6 of The Economic Consequences of the Peace, by
John Maynard Keynes. Source: Who
said ``Debauch the Currency'': Keynes or Lenin? by Michael
V. White and Kurt Schuler, Journal of Economic Perspectives,
Spring 2009.

But is there not a tradeoff between growth and inflation?

For a brief period, the empirical evidence in the US suggested that
there was a tradeoff between inflation and unemployment. Here's the
classic picture, for the 1960s in the US:

which shows a nice relationship where higher inflation has gone
with lower unemployment. This evidence has led many people,
particularly those concerned with the plight of the unemployed, to
advocate higher inflation.



A look at the same evidence for the US, over a longer time period, shows no such
tradeoff:

The idea that there is a tradeoff between inflation and
unemployment is thus an artifact found in the minds of people who
studied economics in the 1970s. This proposition was pretty much dead
by the late 1970s. One by one, as central banks moved to inflation targeting, aiming and delivering 2% inflation, unemployment went down, not up. Hawkish central banks are the central story about how the stagflation of the 1970s was broken.



In the empirical literature, it is quite clear that by the time we
get to double digit inflation, this has a discernable and negative
impact on growth. This generally means that at a 95 per cent level of
significance, you can reject the null of no effect, in conventional
datasets. The conceptual reasoning above gives no reason for believing
that there should be a threshold effect, that inflation above 10%
should hurt growth but below 10% things should be fine. It could well
be the case that when you get to smaller values for inflation
(e.g. 9%) this effect size is not detected with conventional datasets
at the 95 per cent level of significance.



It is interesting to look at the target inflation rate set in the numerous countries which have setup either de facto or de jure inflation targeting. The median value chosen has been: 2%. If people were convinced that inflation below 10% is not damaging to growth, inflation targets may have been higher. But instead, the typical inflation target in the world is 2%. This underlines the universal consensus in favour of targeting low inflation -- more like 2% and far below the 10% that we've got stuck with in India.



In the West, some people with a weak grip of economics, and strong sympathy for the unemployed, have argued that high inflation is a good thing because it helps reduce unemployment. In contrast, in India, economists have consistently found that the poor are adversely affected by inflation. There has not been a left-of-centre lobby that is soft on inflation, here.

Conclusion

There is no tradeoff between inflation and growth.



High inflation damages growth.



One element of India's growth crisis is India's inflation crisis.



It is important to think carefully about the accountability of the
central bank. RBI is not in charge of India's welfare. RBI is in
charge of India's fiat money. The one thing that RBI should be held
accountable for is delivering low and stable inflation, i.e. for
holding CPI-IW inflation within the 4 to 5 per cent range.



Low and stable inflation is an essential ingredient of the
foundations of high economic growth in India. RBI can lay that
platform. They can do no more. If they try to reach into other
objectives, they damage this core.

Read More

How to achieve safety in payments

The technological opportunity in payments

In the old days, the field of payments was inextricably
interlinked with banking. Money was only held in bank accounts; the
only way to move money around was through banks.



Advances in computer technology coupled with financial innovation
have changed all this. Banks are no longer the only game in town for
the business of holding money. An array of innovators are now in the
payments game. A few interesting examples are:

• Paypal is a pure-play Internet company, which rides on top of
  bank accounts, and gives users a payments solution.
  


• Western Union moves money from person to person across the
  globe without referencing a bank.
  


• M-pesa, in Kenya, does payments over mobile phones. Money is
  fed into a phone as with topping up a pre-paid card. Money is then
  transferred to another person using an SMS.
  

These developments have far reaching ramifications. We can now
think of payments as a distinct industry, one that is not joined at
the hip with banking. Banking is primarily a risk management business, of coping with callable deposits which have an assured rate of return, even though the assets are opaque and risky. In contrast, payments is primarily a computer technology business, closer to the working of a depository or an exchange.



As Merton Miller said, banking is a disaster-prone 19th century
industry. If a critical function like
payments can be increasingly decoupled from banking, it would make the
world safer.



There are two distinct problems in payments. The first is the systemically important payment system which is the core utility of the currency. In India, it is the RTGS. This is an entirely separate issue. The present discussion  is about the second component of the field of payments: the non-systemically important payments systems which are used by households and firms. This is an ordinary financial technology business.

The problem

When person X wishes to transfer Rs.100 to person Y, if the banking
channel is used, the steps are as follows:

1. Person X lends this money to the bank by putting it into a
   deposit account.
   


2. He instructs the bank to send this to person Y.
   


3. At the other end, it shows up as a demandable loan from person
   Y to the bank.
   

The balance sheet of the bank is inextricably tied into the
payments transaction. Through this, all the problems of banking flow
into the field of payments. Banks have opaque assets with 20x leverage or worse. It
seems odd to place a mission-critical function such as payments in the
hands of such entities. 




In the old world, it was not
possible to enjoy the benefits of payments without suffering the
credit risk of a bank. One solution that was mooted was for payments
to get done in central bank funds. You can do this for a few special situations like the securities
clearing corporation, but probably not for most other situations.



The same problem arises with a mobile phone company:

1. When you feed money, by topping up a pre-paid account,
   this goes into the balance sheet of the mobile phone company.
   


2. Now you have to hope that when the time comes for you to spend
   this money, the mobile phone company is still solvent.
   

Faced with this situation, conservative financial regulators have
proposed a few solutions:

1. Mobile phone companies cannot do payments; payments is the
   exclusive preserve of banks. (This is the state of affairs in
   India).
   


2. Mobile phone companies must become limited purpose banks.
   


3. Mobile phone companies must come under full banking regulation.
   

All these three solutions are unsatisfactory, because they are rooted in the old paradigm, where payments was inextricably intertwined with banking, and it was felt that this is the only way it could be. We need to look beyond this.

An alternative solution: Segregation of client funds

A remarkably clean solution has been invented in the field of asset
management: Segregation of client funds.



Consider a money manager such as an asset management company
(AMC). At a legal level, the AMC is a mere advisor. Client money never
goes onto the AMC balance sheet. Customer money sits completely
separate. If the AMC goes bust, this has zero implications for
clients. In the entire history of such arrangements, there has been
only one
episode (MF Global) where segregation of client funds did not
work, in protecting customer moneys. This is in contrast with the history of banking, where failures have been taking place across the centuries, across all countries, with a high frequency.



Under such an arrangement, client funds would always sit separately, segregated from the balance sheet of the payments provider.



Segregation of client funds requires a corresponding supervisory
capacity - and MF Global shows us that this supervision can possibly
fail. But it would involve a much lower failure rate when compared with the problems of banking.

Implication 1: Mobile phone company as payments provider

Suppose Vodafone is my mobile phone company. When I supply Rs.1000
into my mobile wallet, this would go sit separately in a customer
trust. This would not go into the balance sheet of Vodafone. If
Vodafone were to go bust, this money would be returned to
me. This solves the problem of the credit risk of the payments provider.



If we could do this, it would open up an array of payments innovations. The only
regulatory burden placed upon the provider would be: Never ever keep
customer money on your own balance sheet. We would then need some small resolution capability to kick in when the payments firm goes bust, to take money out of the customer trust and give it back to the customer.

Implication 2: This can be done with banks also

Bank accounts can be broken up into two kinds: illiquid and
liquid. (From a customer perspective, this is analogous to the Tier 1 and Tier 2 of the New Pension System; the former is illiquid and the latter is demandable). Illiquid accounts would be loans from customers to the bank
(as all bank deposits today are) and have greater restrictions against
convertibility. Liquid accounts would not belong to the bank. They
would be segregated client funds, used for payments activities.



This would derisk customers from the problems associated with bank
failure. It would greatly reduce the complexities of banking
regulation and supervision. It would put banks on a level playing
field when compared with other technological strategies in the field
of payments.



When banks do not capture the interest income on the liquid accounts, this will force a healthy unbundling of payments and banking. Banks who engage in the payments business would have to explicitly charge for payments services. This would help ensure a level playing field between bank and non-bank players in payments.

Implication 3: How to store segregated client funds

Payment vendors could place client funds into current accounts with
the central bank for riskless safekeeping. Or, they could place them
into NAV-based money market mutual funds, so as to earn some
return.



In this framework, there would be N money market mutual fund
accounts belonging to M entities. The payments system would be a
technologically diverse array of alternative competing mechanisms
through which money flows from account i to account j, which generates a fee income for the payments provider.

Conclusion

The idea of segregated client funds, which is very well established
in some areas of finance such as money management, brokerage, etc.,
can be usefully applied in the field of payments, to cut through the
gordian knot of banks and payments.

Read More

Trading in the rupee: Starting to look like serious numbers

by Vimal Balasubramaniam and Ajay Shah.



The rupee-dollar is the most important price of the Indian
economy. It is discovered on the currency market. What are the
contours of this market? Specifically:

1. How big is the daily trading in the rupee?
   


2. Where does the rupee stand, in global rankings of currencies?
   


3. Where does trading take place?
   


4. Where are we on the onshore versus offshore distinction?

How big is the daily trading in the rupee?

Trading in the rupee is composed of the following elements of the
market:

	Exchange-traded	OTC
Onshore	Options, futures	Spot, forwards, swaps, options
Offshore	Futures	Forwards, swaps, options

We attempt an estimate of turnover across all components, on 25 May
2012:^[1]

Location	Billion USD
OTC Spot (onshore)	19.82
OTC Forwards (onshore)	4.40
OTC Swaps (onshore)	11.34
Exchange Futures (onshore)	7.02
Exchange Options (onshore)	1.45
Exchange Futures (offshore)	1.17 [a]
OTC (offshore)	20.03 [b]
Total	65.23
Source:- RBI Weekly Statistical Supplement, NSE, USE, MCX-SX, DGCX, and BIS Survey (Tables D.1.1 and D.1.2)
[a] DGCX data as on June 6, 2012 for May 2012.
[b] This is the April 2010 BIS survey valuation of the offshore market, adjusted for the DGCX daily average value (estimated from overall value of futures contracts) for April 2010.

This is an under estimate for two reasons. Data for one important element
(offshore OTC) pertains to April 2010; the market must have grown
since then. Data from the BIS is likely to not capture activities of non-bank players.



Three interesting facts come out of this. First, that the overall
market for the rupee is roughly $70 billion a day. Second, that
roughly one-third of it is spot, and the rest is derivatives. Third,
that rougly one-third of it is offshore.



Growth in recent years has been tremendous. In May 2000, the
onshore market did only $2.7 billion a day. That is, we've got 24x
growth over 12 years.

Where does the rupee stand, in global rankings of currencies?

BIS surveys global banks and reveals interesting data about the currency market. However, it is likely that the BIS misses out on a great deal of non-bank activity. If a hedge fund sends an order to an exchange, this is likely to elude the measurement of the BIS.



According to the BIS, in April
2010, the daily average turnover for the INR against the USD was a
total of U$41.7 billion. ^[2] INR then ranked 15th
(spot), 10th (forwards) and 22nd (swaps) in a pool of 28 currencies
covered in this BIS survey. Summing up, the rupee stood at rank 16
in their group of 28 currencies. In the class of emerging markets,
the rupee ranked fourth, third and ninth in the spot, forwards and
swap markets respectively:

Ranking among EMs
Currency	Spot	Forwards	Swaps
Korean Won	1	1	3
Mexican Peso	2	6	1
Russian Ruble	3	12	5
Indian Rupee	4	3	9
South African Rand	5	9	4
Brazilan Real	6	4	14
Chinese Renminbi	7	2	8
Turkish Lira	8	8	6
Polish Zloty	9	7	2
Taiwan Dollar	10	5	11
Source:- BIS Survey, Tables D.1.1 and D.1.2

The BIS triennial survey included the INR since 1998. The
three-yearly snapshot of Rupee's position marks its rise over
time. Measuring only the spot market, the rupee ranked 13 (tied with
Hungary, Indonesia and Chile) in 1998 and moved to the third position
in 2010. In terms of change, the rupee has moved dramatically,
perhaps, with no other currency witnessing such rapid change.

Emerging market currencies rank: spot market
Economy	1998	2001	2004	2007	2010
Russia	2	1	1	1	1
Korea	6	2	3	2	2
India	13	10	6	3	3
Brazil	3	4	6	7	5
China	16	18	17	5	5
Chinese Taipei	6	6	4	4	6
Mexico	2	4	2	7	8
Turkey	18	17	17	18	8
Malaysia	16	17	17	13	10
South Africa	4	10	9	8	10
Source:- BIS Survey, Table D.19

The most surprising feature of these results is the extent to which
the rupee is a bigger market than the CNY, even though Chinese GDP and
internationalisation exceed that of India. It seems to suggest that you'd have to do bigger trades to obtain a 1% change in the INR/USD rate, when compared with the trade size required to obtain the same change with the CNY/USD rate. This helps us see why India has moved into greater exchange rate flexibility when compared with China: there was really no choice.

Where does trading take place?

For the first time, Table D.6 of the triennial survey provides
information about where currency trading takes place. A
surprisingly diverse set of locations light up:

Location of the currency market (% of turnover)
Location	BRL	CNY	INR	KRW	ZAR
India	--	--	50.02	0.00	0.04
Australia	0.51	0.44	0.31	0.50	1.20
Brazil	29.68	0.01	0.00	0.01	0.07
Canada	4.66	1.36	0.15	0.18	0.39
China	--	24.87	--	0.00	0.06
Hong Kong SAR	--	27.29	10.91	10.33	--
Japan	0.05	0.28	0.21	0.19	4.65
Korea	0.05	0.03	0.02	52.13	0.02
Singapore	1.07	19.01	16.12	21.01	1.18
United Kingdom	19.18	17.29	12.32	10.98	36.43
United States	37.53	7.72	9.26	3.95	8.36
Source:- BIS Survey, Table D.6

Where are we on the onshore versus offshore distinction?

As the table above suggests, roughly half of rupee trading takes
place in India. The issues which shape this onshore versus offshore
market share are likely to be similar
to those seen with Nifty. Recent events are likely to have driven
the share of the onshore market to below 50%.



The onshore OTC market consists of forex spot transactions,
forwards and swaps. The RBI publishes information on turnover in the
onshore spot and forward market and the forward and spot legs of the
swap transaction are captured in this data as well. An RBI report
on OTC derivatives in 2011 highlights that OTC derivative turnover was
3.53 trillion USD in FY2009-10. Out of this, forex swaps account for
over 60% of the total turnover in the same period. Here is the time series for the onshore OTC market:

Source: RBI, Weekly Statistical Supplement (1996 - 2012)

Exchange-trading of the rupee, in India, started in 2010. At a
point in time, turnover in exchange-traded currency futures did seem
to have overtaken
the OTC forward market. The USD-INR futures contract on MCX-SX, NSE,
and USE with a contract size of USD 1000 occupied the first three
ranks for volume in the world in 2010 and 2011. The USD-INR
options contract on the NSE ranked fourth while the EUR-INR futures on
the NSE also featured in the top 20 forex futures contracts in the
world. The collapse in the following graph, which shows exchange traded onshore turnover, is associated with the CCI
order:

Source: NSE, MCX-SX, and USE

Putting together the information from the onshore exchange-traded market
(options, and futures) and the onshore OTC market (spot, forward, swaps data
from the RBI), one gets a complete picture about the onshore INR
market:

Source: RBI, NSE, MCX-SX, and USE

The most recent BIS triennial survey (April 2010) had placed the
onshore market (USD-INR) at about U$20 billion. As the graph above shows, current values are
more like U$30 billion a day. The offshore market is likely to have
grown more, giving total INR turnover of well above U$70 billion a
day. This puts the Indian rupee today above the Korean Won as of
April 2010.

Conclusions

The Indian rupee has grown rapidly to becoming the sixteenth most
traded currency in the world. From less than 0.2% of the world forex
turnover in 1998, it has grown rapidly to constitute about 0.9% of the
world forex turnover in April 2010. It is one of the biggest emerging
market currencies with the Korean Won, Russian Ruble, Chinese Renminbi
and the Mexican Peso being its close competitors. The offshore market
today is as big as the onshore market, as is seen by other EMs. Today,
the rupee does roughly $70 billion a day, roughly where the biggest EM
currency (the KRW) was in 2010.



These developments have many ramifications:

1. The rise of a large currency market is consistent with India's
   rapid integration into the world economy of recent decades.
   
   


2. When a market does turnover of $70 billion a day, market
   manipulation is difficult. Manipulating the rupee is now as hard as manipulating Nifty: both are large globally traded products with highly liquid markets. This is the essence of India's
   evolution away from an INR/USD pegged exchange rate to a
   mostly-floating exchange rate: the monetary policy distortions
   required to support manipulation became too large.
   
   


3. As with Nifty,
   mistakes of domestic policy are giving a substantial shift in
   India-related finance to overseas locations. The two most
   important pillars of the Indian financial system are trading in
   the rupee and in the Nifty, and with both these, India is rapidly losing ground. If present policy mistakes continue, the role of the onshore market will continue to decline, for both the rupee and Nifty.


4. In the last 12 years, there was 24x growth. Suppose there is
   only 10x growth in the next 10 years. That would take us to $700
   billion a day, which would be quite something.
   
   


5. Looking into the future, if India is able to continue on the
   course of high GDP growth and integration into the world economy,
   the rupee will become a big currency by world standards. The big
   four currencies today are the USD, EUR, JPY, GBP. It is not
   inconceivable to think of CNY and INR joining that club. This could
   connect nicely with a
   role for India in global finance. But for all these good things
   to happen, we have to put our house in order.
   
   

Notes

[1] Forward market turnover is estimated as purchase + sale - cancellation.

[2] The BIS survey also does cross-border netting - something that we cannot adjust for from the RBI data. However, as Jayanth Varma points out, this may not be a very large number that the overall calculations dramatically change.

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Interesting readings

Anil
Padmanabhan in the Mint on Indo-Pakistan relations.



Jeff
Glekin on Reuters Breakingviews about who could succeed Pranab
Mukherjee as FM,
and Kaveree
Bamzai in the India Today about what could come next if
he
leaves. Who
will be the President? This time, it matters by Satarupa
Bhattacharjya of Reuters in Mint.



The
delicate technology of creating excellence by Pradip
Ghosh in
the Telegraph. Also
see.



Garima
Jain in Tehelka magazine about guns in Punjab. It's
remarkable how much our side of the Punjab is like, when compared
with the other side.



The Wanderer's Eye
is a remarkable blog being written out of India by Aniruddha H. D..







On the problem of the hollowing out of the Indian financial system,
read Shaji
Vikraman and Ram Sahgal in the Economic Times.



Ravi
Jagannathan on Firstpost, on the Sahara vs. SEBI case at the
Supreme Court.



Dhiraj
Nayyar in India Today on the woes of the Indian
oligarchs.



Sajjid
Chinoy in the Business Standard on what is going wrong
with investment.



A. K. Bhattacharya
in the Business Standard on how tax authorities in India have
gone astray.



Dinesh
Unnikrishnan in Mint about the unique problems of
public sector banks.





Sean
O'Hagan, writing the Guardian about Robert Capa and
Gerda Taro, reminds us that we're stuck in a pastel coloured
world.





Paul Krugman has a nice old article on comprehending comparative
advantage: Ricardo's
difficult idea. He ends with advice which could well be
applied to all economic policy debates in India: (i) Take ignorance
seriously; they actually do not know. (ii) Adopt the stance of
rebel. (iii) Don't take simple things for granted. (iv) Justify
modeling.



Jon
Lackman in Wired magazine, on what is uber-cool in Paris
today.

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