Recent RBI moves in financial reform

I have an article in Financial Express today where I try to interpret recent RBI announcements in financial reforms.

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Looking back at Indira Gandhi

Writing in Indian Express, Pratap Bhanu Mehta looks back at Indira Gandhi. He offers five lessons for today's Congress:

1. Leaders are more effective when they work through institutions rather than attempting to subvert them.


2. Sound economic policies are not a matter of simply projecting good intentions; they require a concerted understanding of the causal conditions that make for successful intervention.


3. Being personally secular is neither here nor there. The important thing is to fish in the treacherous waters of communal identification, from wherever it comes.


4. As the Punjab crisis demonstrated, when the state does not act impartially and in time, it sows the seeds of greater violence in the future.


5. Democracy is not just about the practice of popular authorisation. It is about a whole gamut of constitutional values that have to be zealously guarded.

India had a bad period from 1962 to 1977, of which the worst part was the Emergency. This period preceded Pakistan's worst years (Zia ul Haq's period, 1978-1988). Kamal A. Munir has an article in Financial Express about Pakistan where we see the sustained impact of those years.



India seems to have come out better from the dark period, partly because that period ended a long time ago and there has been more time for healing. In addition, in Pakistan's case, the Afghan wars and islamisation which began in Zia ul Haq's period have not yet ended. In some sense, Pakistan is not yet into the post-authoritarian post-conflict period of reconstruction of institutions, which began in India in 1977.

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Regulation vs. micro-management

Writing in Business Standard, Somasekhar Sundaresan reminds us that SEBI has greater powers than US SEC. I'm curious: Does the US SEC have the power (if it should so decide) to control what time trading should start and stop at all exchanges?

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How evil is insider trading?

I have long been a skeptic about State action against insider trading, which is believed to be widely prevalent in India. Writing in the Wall Street Journal yesterday, Donald J. Boudreaux has a nice scheme which can replace the existing policy framework.

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New thinking on financial stability

I have an article in Financial Express today, where I discuss RBI's take on financial stability, which sums up to the rejection of all recent thinking in India on monetary and financial reform, in the light of recent thinking on this subject at the US Fed and the ECB.

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Movement on corporate bonds

Shilpy Sinha and Swapnil Mayekar have a story in Business Standard offering some optimism about the corporate bond market. They point out that in the six months from April to September 2009, corporate bond turnover was Rs.1.6 trillion, when compared with Rs.0.5 trillion in the same period of the previous year.



SEBI has decided to force many market participants to do netting by novation at a clearing corporation when trading on the corporate bond market. From 1 December 2009 onwards, there will be two possibilities for a trading mechanism:

1. OTC trade, reported on one of the three trade-reporting systems, run by BSE, NSE and FIMMDA, or


2. Order book trade, run by BSE or NSE.

But regardless of how trading takes place, counterparty risk will be eliminated, and netting efficiency obtained, through the clearing corporations. This will be a big win compared with the awful settlement mechanism that's used today. It should reduce transaction costs on this market.



The deeper problems of corporate bonds remain:

1. The lack of a liquid GOI yield curve along with interest rate derivatives, so as to be able to layoff interest rate risk when holding a corporate bond portfolio,


2. The low values for loss-given-default, given the lack of a bankruptcy code and


3. The ban on credit derivatives.

The workaround for #2 is: to stick to trading in short dated bonds from issuers where the failure probability is very low. A workaround for #3 is: to utilise information about credit risk embedded in the stock price.



The right way to think about the corporate bond market is in the context of the Bond-Currency-Derivatives Nexus, which emphasises the interlinkages between the government bond market, interest rate derivatives, corporate bonds, credit derivatives, the currency spot and currency derivatives. All these markets have to achieve liquidity with active arbitrage. The key ingredient for getting there is unifying the regulation and supervision at SEBI. This should address the bulk of the problems of corporate bonds -- other than the problem of loss-given-default.

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Interesting readings

• David Oakley reports on Brazil having made it to investment grade. This is their payoff to the immense progress that took place in the last decade in terms of fiscal, financial and monetary institution building. In many respects, India's starting conditions today are similar to where Brazil was before these reforms.
• Robert Shiller, in Financial Times defends financial innovation, and Robert Cryan, in New York Times worries that Canadian banks missed opportunities in this crisis.
• Chiraga Chakrabarty, in DNA, on the need for INR/EUR futures. Once INR/USD and INR/EUR futures are trading, futures on USD/EUR will close the currency triplet and ensure efficient pricing of all three.
• Raghuram Rajan in Financial Times on the neat idea of requiring banks to hold debt capital that will convert into equity when two triggers are met.
• Read about Larry Summers and the US economic policy process in New Yorker magazine.
• Anil Padmanabhan has an important column in Mint on the mess that is shaping up on the Goods and Services Tax.
• James Lamont describes the world's third largest producer of Gherkins: a firm named Global Green, out of Bangalore.
• On TV, Vivek Law takes on the mess found in fund management products sold by Indian insurance companies.
• Nell Minow in Financial Times with new thinking about corporate governance.
• Ila Patnaik on RBI's next moves. Also see The good news, analysed better and This is no time for a rate hike.
• Vimal B in Financial Express on the internationalisation of the Chinese yuan.
• Jayanth Varma is scathing about the SEC's efforts at being motherly towards fat fingers.
• India's New Capital Restrictions: What Are They, Why Were They Created, and Have They Been Effective? by Bryan J. Balin of The Johns Hopkins University School of Advanced International Studies (SAIS).
• Alan Blinder thinks that we should all be long India.
• Shubhashis Gangopadhyay pleads for the removal of capital controls against venture capital and private equity.
• Counterfactual history, by Ramachandra Guha: Episode 1: What if Subhas Chandra Bose had returned home sometime after WW-II ended?.
• How Sam Yin Chueh changed the world.
• We have serious problems with freedom of press in India.

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