Approach paper released by the Financial Sector Legislative Reforms Commission

The Financial Sector
Legislative Reforms Commission (FSLRC) is rethinking the
legislative foundations of the Indian financial system. FSLRC was
setup by a
notification on 24 March 2011 and asked to submit its findings
on 24 March 2013. FSLRC constitutes the first time in Indian history
that a large-scale re-examination of multiple laws in a sector is
being undertaken.

FSLRC has released a
compact approach
paper showing preliminary findings about the strategy that will
be adopted. The release of this report is part of the consultative
mechanisms that have been followed within the Commission. The
Commission has invited feedback from experts and interested parties
on this document.

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What the computer revolution has done

That computing has become immensely more powerful in recent decades veers on the cliche. I recently got a few reminders of precisely how much distance we have moved.



Cory Doctorow tells us that the computation that goes into one google query is roughly the same as all the computing done for the entire Apollo program.



Jay Goldberg is astonished to discover pretty powerful no-name tablets now go for $45. One can see whole new world opening up with ubiquitous use and firm-deployment of tablets.



And most astonishing of all: the ipad (2012) matches the floating point performance of the Cray 2 supercomputer (1989). That's a gap of 23 short years. Also note the completely different slope seen on the right hand set of dots:

Source: Slideshow by Jack Dongarra and Piotr Luszczek, linked to by Michael Larabel.



This story has been going on for decades but it isn't finished yet. Just this year, my laptop got four cores, and I'm steadily shifting all my R programs to utilise parallel processing. For all X, it's interesting and useful to ask How would X change if computation, communications and storage got cheaper and better?. On this theme, you may like to read this post -- The new world of computers -- from earlier this year.



As an old timer, I always worry that we used to do Things That Mattered using the Cray 2 supercomputer, like forecast the weather or simulate nuclear explosions, whereas the bulk of the ipad's compute power is being deployed to watch cat videos on youtube. We have yet to re-imagine our world in terms of these new powers.

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Finance and law: Call for papers

National Seminar on Financial Law & Policy: An
Inter-disciplinary Approach (December 1, 2012) Organised by
National Institute of Public Finance and Policy, New Delhi in
collaboration with National Law University, Delhi

The National Institute of Public
Finance and Policy (NIPFP), New Delhi invites papers for a
national-level seminar titled "Financial Law & Policy: An
Inter-disciplinary Approach" to be held at the
National Law University, Delhi
(NLU Delhi) on December 1, 2012.

Background

The financial sector in India is currently governed by more than
sixty legislations along with a plethora of rules and
regulations. This has led to a lot of ambiguity in the legal framework
applicable for doing business in the country. The problem gets
compounded by the fact that many of these legislations were enacted
more than sixty years ago, with objectives and purposes that are
largely not in sync with the realities of the present day globalised
competitive world.

Realising the need to address these issues and for formulating a
legal framework geared up to facilitate growth of the financial sector
in the future, the Government of India set up the Financial Sector
Legislative Reforms Commission (FSLRC) on March 2011 under the
chairmanship of Justice (Retd.) B.N. Srikrishna. The mandate of FSLRC
involves overhauling these existing legislations and laying down a
policy and legislative landscape geared towards creating a more
coherent and dynamic financial environment. This exercise will also
involve identifying regulatory gaps and overlaps seen in the existing
system. In this regard FSLRC is focusing towards of rewriting and
harmonizing the existing financial sector laws in the country, to
bring them in tune with the requirements of a modern financial
system.

In an evolving financial world, FSLRC intends that the new
legislations will cater to the requirements of a large and fast
growing economy. This is indeed a unique challenge not only because it
is the first time in the history of independent India that such a
large scale organised legislative reform initiative is being
undertaken but also since the work involves absolute cutting edge
inter-disciplinary research involving law, economics and finance.

For fulfilling its mandate, FSLRC has entered into a Memorandum of
Understanding with NIPFP whereby NIPFP is engaged in providing
research and technical support services to FSLRC; managing the process
of conducting the core legal, public policy, economic research for the
various working groups established by FSLRC and drafting of the
relevant draft legislation.

However, this ambitious reform will be meaningful only if a culture
of inter-disciplinary thinking and research can be encouraged in
Indian academia. In this context the NIPFP is organising a national
level seminar on "Financial Law & Policy: An Inter-disciplinary
Approach" at NLU Delhi, on December 1, 2012.

Topics

To engage with a wider audience in a constructive debate over the
various issues of contemporary relevance raised in FSLRC's Terms of
Reference (available at http://finmin.nic.in/fslrc/fslrc_index.asp),
the broad issues from which the authors may choose are:

1. Appropriate means of oversight over financial regulators and
   their autonomy from the government;


2. Consumer protection as an aspect of financial regulations;


3. Role of the Central Bank in financial market regulation and
   supervision


4. Resolution of financial firms;


5. Principle-based or ruled-based legislation: what will work in India?


6. Unified regulator or sectoral regulator: which will work in Indi?


7. Financial Regulation and competition policy


8. Emergency powers in systemic risk situation


9. Legal process in financial regulation

Procedure

The author(s) has to submit the completed, original and unpublished
paper with the Seminar Co-ordination Committee by November 1, 2012
(23.59 hrs). The Seminar Co-ordination Committee will be responsible
for evaluation and selection of the top 5 papers. The authors of the 5
selected papers will be invited to NLU, Delhi to present their papers
before an elite panel composing of legal practioners and members of
FSLRC.

Word Limit: The paper must not exceed 5000 words (excluding
footnotes or endnotes).

Format: The paper must be in Times New Roman font, character
size 12 and with 1.5 spacing. Footnotes or endnotes must be in Times
New Roman font, character size 10 and with single spacing. No specific
style of footnotes/endnotes is required. However, the
footnotes/endnotes must be written in a uniform style and provide
necessary information.

Submission Procedure: The Paper must be mailed to
ankur.saxena@nipfp.org.in in soft copy (pdf format) by November 1,
2012 (23.59 hrs) along with:

• Duly filled-in attached registration form (soft copy)


• Presentation in .ppt/.pdf format that the author seeks to use in
  the course of the presentation (optional)

Please note that the subject of the mail should be 'Paper
submission'.

Eligibility: Papers may be contributed by any person (academicians,
researchers, practitioners, students etc.) interested in contemporary
financial regulations.

Co-authorship: Papers may be works of joint authorship.

Publication of selected papers: The 5 selected papers will
be published on the NIPFP website with appropriate disclaimer.

Composition of the Seminar Co-ordination Committee

The Co-ordination Committee Comprises of:

Chairman:

• Mr. Dhirendra Swarup, Member Convenor, FSLRC

Moderator:

• Prof. Ajay Shah, Professor, NIPFP

Evaluators:

• Mr. Rajshekhar Rao, Advocate, Supreme Court of India


• Mr. Somasekhar Sundaresan, Partner, J. Sagar Associates


• Mr. Risham Garg, Assistant Professor of Law, NLU Delhi

Contact Person:

Mr. Ankur N. Saxena, Legal Consultant, NIPFP, email id:
ankur.saxena@nipfp.org.in

Other Relevant Information

Crucial Dates

• The last date for submission of the completed paper: November 1,
  2012 (23.59 hrs)


• Intimation of shortlisted papers: November 15, 2012


• The date of seminar: 1 December, 2012

Expenses:

The authors of the selected papers will be provided boarding and
lodging facilities at NLU Delhi.

Venue: National Law University, Delhi Sector 14, Dwarka, New
Delhi- 110078

REGISTRATION FORM

National Seminar on Financial Law & Policy: An
Inter-disciplinary Approach

Name of the Author(s):

Designation:

Institute/Organisation:

Title of Proposal/Paper:

Contact Number:

Email :

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Interesting readings

Rajdeep
Sardesai on the problems of law and order in Bombay. Nothing
is more important in the priorities of the State than the police
and the courts.

In recent weeks, we're seeing fresh attention on the flaws of the
HR processes of
government. Shashi
Tharoor in the Indian Express on the IFS,
and Sundeep
Khanna in Mint.

Trampling on the individual in India:

- Sending cartoonist
Aseem Trivedi to jail is
ridiculous.

- Vijaita
Singh in the Indian Express about the government
interfering in grants to think tanks, followed
by an
editorial on this.

- As Robert Kaplan says, underdevelopment
is where the police are more dangerous than the
criminals. Here's a
story about the police in
Gurgaon.

- Meghan
Davidson Ladly writes in the New York Times about the
struggle for freedom that many women in Pakistan are facing. We
can't say we're finished with this. What fraction of India faces
this level of social backwardness?

N. Sundaresha Subramanian has
a great
first draft of history, telling the story of Sahara in
the Business Standard. This is a great vindication for
K. M. Abraham and C. B. Bhave, and a reminder of the importance of
the recruitment process in government. Also see great reportage on
Firstpost
: Sahara
will have to sell realty assets to pay off investors by
Raman
Kirpal; ROC:
The dog that did not bark when Sahara came in by
R. Jagannathan.

I recently blogged
about checks
and balances that will keep Indian capitalism safe. I guess I am
picking up ideas from the zeitgeist. On related themes,
see: The
old India is dead. Wake up, netas and business babus by
R. Jagannathan on
Firstpost; A
long way from 1984 by Pratap Bhanu Mehta in the Indian
Express and an
editorial Behind
the curve in the Business Standard.

Many people in India like to invest in gold and in real estate. I
would like to remind them that the analytical case for these is
weak. Here is
some new
evidence on gold, and here are
some older
arguments about real estate.

Sunil
S. in Pragati magazine about India's electricity grid problem.

Mobis Philipose in the Mint writes
about an
intruiging development: a `Intermediaries and Investor Welfare
Association (India)' has filed a petition in the Delhi High Court
alleging that algorithmic trading is bad. I wonder who is behind
this.

On the theme
of the
transformative impact of google maps,
see How
Google Builds Its Maps, and What It Means for the Future of
Everything by Alexis C. Madrigal.

Sebastian
Mallaby has a great response (originally in the Financial
Times) to the Apple-Samsung patent violation case. If you're
in the US, you need
to run,
not walk to buy cool Samsung equipment, or buy it when you
travel abroad.

The
Euro crisis is back from vacation by Adam Davidson, in
the New York Times magazine.

If
Xerox PARC invented the PC, Google invented the Internet
by Cade Metz in Wired magazine.

Why
sex could be history by Kira Cochrane in the Guardian, about a new book
by Aarathi Prasad.

Some of the biology that we learned in high school
is
getting overturned.

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Did the Indian GDP just jump up by a basis point?

Google made two important announcements:

• The database underlying google maps is now of the quality required to support turn-by-turn navigation. Every smart phone or tablet that can use google maps just became a GPS device that is capable of giving you turn-by-turn navigation including giving you instructions in audio.


• In six cities, they now have realtime traffic data available as an overlay on google maps. You can look at the map and it will show you what segments of what roads are congested.

This will, I assume, enable cool things within applications like Google Now to work: it knows your calendar, it analyses traffic conditions, and tells you at the right time "Now it's time for you to leave". Similarly, we can now use Google Places ("search for a coffee shop close to where I am right now"). It shows you the list of what's available, you touch one of them, and it's now ready to give you turn-by-turn directions to go there.

Industry sources say there are roughly 26 million smart phones out there that are able to use google maps. In other words, we have just had 26 million satnav devices added to the Indian capital stock. And, we've added realtime traffic data for the subset of these that are in 6 cities. Millions of people have just had a jump in productivity.



An interesting Fermi problem : Will this add one basis point to GDP? At first, I thought this was hard because it'd require making assumptions about how much time each satnav saves for the person, that person's output per minute, and so on. But a reverse calculation is illuminating: 1 basis point of GDP is Rs.1000 crore or Rs.10 billion. Divide by 26 million smart phones and you get : a flow of increased output of Rs.384 per satnav per year. In other words, if each satnav device adds Rs.384 of output to the owner's life per year, then Google's turn-by-turn navigation added 1 bps to GDP. And I'm not even counting the impact of realtime traffic data. This number (Rs.384 per satnav per year on average) seems plausible to me.



You may like to see this material on map databases in India.

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Indian capitalism is not doomed

India's problem of crony capitalism

The rise of modern capitalism in India in the 1990s was at first
viewed in optimistic terms. A new breed of companies were born, who
seemed to exhibit a new kind of competence, international
competitiveness and high ethical standards. We could start putting our
old mistrust of corrupt business houses behind us.

These hopes were substantially dashed by the fresh emergence of
crony capitalism. Doing business in many areas in India involves an
extensive interface with the government. In these areas, the
weaknesses of the State generated an opportunity for crooks. At first,
the financial system sent massive resources into dubious companies,
with an attitude of being blind to anything but profits. When these
companies controlled vast resources, and were shown the promise of
even bigger valuations to come, they embarked on systematically
undermining the State. Through this, we got a feedback loop: The
crooks came up where the State was weak, and their activities further
undermined the State.

In some cases, we saw rotten companies spring up in one part of the
economy where the State was weak, and once these companies were up and
running, they turned their attention to related fields and devoted
themselves to undermining State institutions in related
fields. Through this, the gangrene spread from one area to the
next.

In the the early 1990s, we could hope that India would smoothly
moving up to the ranks of middle income countries, powered by world
class local companies in addition to global companies building
operations here. These hopes have substantially receded. The heart of
the Indian story is now about the feedback loop between rotten
companies and the State. If we manage to bootstrap ourselves out of
this, we have a bright future. But will be be able to bootstrap
ourselves out of this? Many countries got mired in this
`middle
income trap': we shouldn't assume that our destiny is rosy.

At first blush, stopping the rotten companies seems
infeasible. These are typically efficient and competent firms in a day
to day tactical sense. They are staffed with hard-driving amoral
people (typically incentivised very strongly using high-powered
incentives), who fully understand the weaknesses of the system and
attack it. Considerable resources are invested into subverting
politicians, bureaucrats, judges and the media. The Indian system is
rotten and ripe for attack. It's like computer criminals attacking
Microsoft Windows. Resistance is futile. Indian capitalism is
doomed.

There is, however, an array of homeostatic forces in place which
are generating push back. Some crooked companies have faced
enforcement actions by arms of the State. In some cases, India has had
good
discussions in the public domain which has generated checks and
balances. In addition, while many people are devoid of ethics and
will support the latest nouveau riche entrepreneur who is
throwing cash around, a large number of people get revulsed by the
sight of this, and quietly and doggedly refuse to cooperate.

Enforcement in India does not work perfectly. The key point of this
blog post is that medium grade enforcement has far reaching
implications. The key insight is to look at the way the goals of
labour and capital (i.e. investors and employees) are reshaped by
medium grade enforcement.

The perspective of the investor

The enforcement push back against rotten firms is yielding
results. Many crooked companies have grossly underperformed the
index. Some have experienced enforcement actions and have experienced
jaw-dropping returns. Some have experienced dogged opposition from
pockets of high ethics in the system, which have effectively led to
systematic and sustained under-performance of the index over five- and
ten-year periods. The stock market has become wary about ethical
issues. As Shekhar Gupta
says in
the Indian Express yesterday:

If you draw a simple chart of the large companies that have lost the most value on the stock markets over the past three years, you'd notice that almost all of these were doing business on the same cusp of politics, finance and natural resources. To that extent, you have to admit that the market has been the first to sense the rot and has applied a stunning self-correction, severely punishing those responsible for it.

There was a time when investors used to be oblivious about ethical
standards of portfolio companies. The attitude of the investor in the
1990s used to be I don't want to know how you do business; I will
hold my nose since you stink; but as long as you will produce returns,
I will happily invest in you. This attitude has been thoroughly
broken. The investors who pursued such strategies have often been
devastated. Even if you have only 10% invested in a crooked company,
if you get -80% returns on it, this generates a -800 basis point
returns drag on your overall portfolio performance. As a consequence,
portfolio managers have started caring about the ethical standards of
portfolio companies.

Enforcement does not have to be 100% perfect for it to impact on
the decision making of investors. Even if there is only a 10% chance
of getting caught and thus getting -80% returns, that is a big risk
from the viewpoint of the investor. From the viewpoint of the
investor: Why take the risk? Why not make a thorough analysis of the
ethical standards of a company one element of the security selection
process?

The problem of freedom of speech

Journalism is printing
what someone else does
not want printed.
Everything else is public relations.

-- George Orwell.

India is supposed to be a liberal democracy, and a free press is
supposed to write vigorously about misdeeds ( href="http://www.mayin.org/ajayshah/MEDIA/1997/fraud.html">link). By
and large, this has not worked out as it was meant to be. On one hand,
it is quite easy for the bad guys to corrupt the media. Whether this
is done through gifts of shares to a media company, or through
advertising and sponsorship, it is fairly easy to obtain a supportive
media. In addition, defamation is a criminal offence in India: a
legacy of colonial law that we have not yet been bright enough to
undo. Putting these together, the bad guys have a nice combination of
carrot (throwing money at the media) and stick (litigation).

Analysts and financial intermediaries are supposed to make a living
out of spotting problems in firms. Here also, there is quite a bit of
corruption which impedes speaking freely. Few are willing to go
against the latest nouveau riche entrepreneur who is throwing
cash around, including his efforts
at buying
respectability. The mainstream strategy is to participate in the
gravy train, and look for ways to part the fool and his money.

This is a real shame: India should be much better than China in the
role of freedom of speech acting as a check against
corporations. However, the Indian media has largely caved in the
face of carrot and stick: it is largely doing public relations.

At the same time, there is strong demand among investors for skills
in identifying the crooks, given that this is an important investment
fundamental. The problems of the conventional media and financial
firms, which inhibit naming the crooks openly and in the public
domain, has created a business opportunity in this space. Supply has
come up to fill this demand; a new breed of companies has come up,
reflecting this need. Examples of firms with these capabilities
include Ambit
Capital, Veritas Investment
Research, Forensic Asia,
and Espirito Santo. Numerous investors are building in this analysis
into their portfolio process, and this is helping to channel capital
away from dubious companies.

Foreign firms seem to be more prominent in this field of research
and analysis from the viewpoint of ethical standards, because they are
relatively immune to the problems of intimidation through courts and
police in India, and because they are relatively cutoff from the
reciprocity that binds everyone in the world of business in India. See
href="http://articles.economictimes.indiatimes.com/2012-08-12/news/33154072_1_veritas-investment-research-indiabulls-analyst">Veritas'
report on Indiabulls has put in contrast the research by India-based
analysts in the Economic Times by Uday
Khandeparkar. But even they are href="http://www.dnaindia.com/money/report_veritas-takes-the-war-to-indiabulls_1726141">not
immune to the problems of the Indian legal system. Now we have a
new investment tool: sell shares of the companies that embark on such
litigation.

The weaknesses of freedom of speech in India have thus emphasised a
greater role for information processing and analysis away from Indian
shores. I am reminded of what is going on in China, where some of the
most important short sellers who are bringing out the misdeeds of
Chinese companies are located abroad: it's too dangerous to do the
same things within China. We in India are evolving towards a similar
structure of information processing.

The perspective of the employee

In the modern world, a vital determinant of the success of an
enterprise is the kind of people it is able to attract. Here also, at
first, there was a relatively amoral attitude on the part of most
young people: I don't want to know how you do business; I will hold
my nose since you stink; but as long as you offer me the highest wage,
I will join you. But over the years, it has been demonstrated that
this is a bad strategy:

• The sight of senior employees going into Tihar Jail has given out
  powerful messages to everyone in Indian companies that good people
  should not hang out with crooks.
  
  
• The second phenomenon is reputational damage. It makes business
  sense for an individual
  to engage
  in fair play. I have been in recruitment conversations where a
  person is being discussed but his name gets shot down as he has not
  been careful about the company that he keeps. Birds of a feather flock
  together. I recently heard a senior person say: ``I knew XXX was a
  rotten firm when a bunch of corrupt people from SEBI joined
  it''. Low ethical standards in people and in firms go together; a
  cloud of mistrust envelops them.
  
  
• Gradually, as regulators develop and refine the doctrine of `fit
  and proper' such people will increasingly suffer career damage. We
  aren't fully there in Indian finance yet, but it will increasingly be
  the case that a name is shot down for a CEO position because he was
  part of a team that was caught doing nasty things by SEBI or RBI.
  
  
• These factors are particularly important for the best and the
  brightest. If you are the best and the brightest, why would you suffer
  even epsilon risk of going to jail? Why would you run with crooks if
  this could hamper your rise to CEO? Why would you suffer reputational
  damage, and not be able to hold your head high at your class
  reunion?
  

These factors are inhibiting the flow of talent to dubious
companies. I know of several situations where a person was made an
offer, and chatted about this with his friends, and turned it down. It
was just too much of a risk to be seen in the wrong company.

Second rate people recruit third rate people. Once a firm is
contaminated with a series of low grade staff at senior levels, it
becomes increasingly hard to draw in top quality talent, which drags
down capabilities all across the board.

I believe this is one of the factors which has generated systematic
under-performance in the stock price of dubious companies. It isn't
just the case that they are in danger of enforcement actions. It is
also the case that on an every day basis, they find it harder to
operate well given that they generally fail to recruit as well as
their competitors.

How might Indian capitalism develop?

If the crooks had thundered ahead producing super-normal stock
market returns, and attracting the best talent, I would have been
truly gloomy. What is fascinating about the Indian story is that
things have worked out differently. Some dubious companies have
cratered with -80% returns over short periods. Others have generated
substantial under-performance when compared with the index over 5- and
10-year horizons. The best people are avoiding rotten
companies. Putting these together, the bad guys are finding it
difficult to obtain both capital and labour, which are seeking out
better firms.

Wall Street tells Main Street what to do. At a time when the
investors did not care about ethical standards of portfolio companies,
and only asked for earnings growth, this sent out powerful signals
into the economy (a) Favouring rotten firms and (b) Encouraging rotten
entrepreneurs to setup firms so as to harvest the opportunities
available by selling shares. We got a precipitous collapse of ethical
standards in India in the last decade in India, partly because that is
what a financial system that was oblivious to ethical standards was
encouraging. Some of the most rotten companies rose to the top. Now
that the investors and the employees are seeing things differently,
this is sending out signals into the economy (a) Favouring healthy
firms and (b) Encouraging healthy entrepreneurs to setup firms so as
to harvest the opportunities available by selling shares. We will also
see some chameleons turn a new leaf: You will see the oddest of
characters preaching purity.

Vishal Kampani pointed out a remarkable fact to me: Some of the
biggest successes of the last decade have been the old `Bombay Club'
companies. All too often, they have outperformed when compared with
the hard-driving unethical nouveau riche entrepreneur. What is
going on? I would conjecture that there is a survivorship bias. A
large number of different strands of corporate DNA compete. Over the
long run, the survivors are those where elements of policy and
strategy are of a certain kind. The old rich of the `Bombay Club' are
not paragons of virtue, but they have developed certain good practices
which are conducive to survival and stock market returns.

I am reminded of the mighty German Wehrmacht in the Second World
War. At the level of tactics and operations, it was second to none. In
the short run, it generated the most amazing achievements in
battle. After the campaigns from September 1939 till December 1941,
many contemporary observers thought that Germany was unstoppable. But
at the same time, Germany was making profound mistakes at the levels
of strategy and policy. No amount of operational art could overcome
those fundamental mistakes in strategy and policy.

In similar fashion, we tend to get very impressed by the
hard-driving take-no-prisoners nouveau riche entrepreneurs and
their hypercharged sidekicks. Their dynamism and willingness to play
dirty seems to be unstoppable, particularly given the weaknesses of
politicians, bureaucrats, judges and media in India. But it appears
that in India, these strengths in tactics and operations have often
been unable to overcome fundamental mistakes in strategy and
policy. Indian capitalism is not doomed.

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Has monetary policy in India helped or hurt?

Carlos Vegh and Guillermo Vuletin have an article Overcoming the fear of free falling: Monetary policy graduation in emerging markets, in `The role of Central Banks in financial stability: How has it changed?', Federal Reserve Bank of Chicago, 2012. They have drawn on this to write a column on voxEU titled Graduation from monetary policy procyclicality.



In an ideal world, monetary policy should stabilise business cycle conditions. When times are good, the central bank should raise rates, thus reining in a boom. When times are bad, the central bank should cut rates. As an example of how this might not arise, recall that on 16 Jan 1998, in what was arguably a pretty bad time for the Indian economy, RBI raised rates by 200 basis points. Economists have a delicate and damning phrase for monetary policy that fuels a boom and exacerbates a bust: it is termed "procyclical" monetary policy.



Vegh and Vuletin construct a measure of monetary policy procyclicality : the correlation between the cyclical component of the short-term interest rate and GDP. This is computed for a large number of countries for the 1960-1999 period. Here is the result:

The bars in black are advanced economies and the bars in yellow are developing countries. There is a striking pattern: All the countries with a negative correlations -- i.e. interest rates are raised in bad times -- are developing countries. This is a striking demonstration of the faulty monetary policy frameworks that are found in developing countries: Every country which suffers from procyclicality in this period is a developing country.



India fares pretty badly in this list: Starting from the bottom, we have Uruguay (Rank 1 from the bottom), Chile, Mexico, Venezuela, Gambia, and then India (Rank 6 from the bottom).



Things got better after 1999. Vegh and Vuletin repeat the analysis for 2000-2009 and find that India did much better. The correlation swung to a positive value. India moved up, to the middle of the distribution. You could find one developed country -- Japan -- which did worse than India in this period.



In my assessment, there are two elements to this story: (a) Is there room to manoeuvre for monetary policy and (b) Is the monetary policy process properly constructed? The first is largely a question about exchange rate flexibility. If the central bank pursues exchange rate goals, this uses up the instrument of monetary policy. The second is about how monetary policy is conducted.

The figure above shows how India's exchange rate regime evolved towards flexibility. The structural break dates (23 May 2003 and 23 March 2007) are computed using the methodology of Zeileis, Shah, Patnaik, 2010. For 4.74 years, we had INR/USD volatility of 2.31% per year. On 23 May 2003, the contradictions of this regime became unbearable, and the exchange rate regime changed: volatility jumped up to 3.93% per year: a rough doubling. On 23 March 2007, the contradictions of this regime became unbearable, and the exchange rate regime changed: volatility jumped up to 9.05% per year: another rough doubling.



From 23 March 2007 onwards, we have finished 5.43 years -- the longest single period out of the three shown here -- in this zone of high exchange rate flexibility. On the subject of the Indian exchange rate regime, you may like to read this post.



I believe these changes have substantially, though not completely, freed monetary policy of the burden of pursuing exchange rate goals. This is one half of the story of Indian monetary policy reform. The second half is that of setting up a sound monetary policy process. Now that you have a lever of setting the short rate in your hands, what would you like to do with it? The first stage is a relatively easy and nihilistic one: it requires getting out of trading in the currency market. By 23 March 2007, this was completed. The second stage is harder: it requires institution building. We have not yet begun on this phase.



This increase in exchange rate flexibility is consistent with the Vegh & Vuletin calculation which shows that the procyclicality of Indian monetary policy was reduced in the 2000-2009 period.

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