How to make progress on payments: a talk

I did a talk How to make progress on payments at the Payment Inclusion Roundtable hosted by the MicroPension Lab of Invest India Micro Pensions:









This is part of the NIPFPMF channel at youtube.

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Who is in charge of fiscal policy and tax policy?

In any country, various arms of government like to indulge in taxation of their own choice, and in setting up little treasuries that they control. However, it is quite clear that there must be only one treasury, and only one authority that determines taxation, through only one Finance Act.



In the Economic Times today, I have an article that applies this idea into analysing a recent proposal by DOT to impose an 8% tax on wireline broadband providers.



You may find some of the associated materials useful:

1. Consultation paper issued by DOT on this in December 2012.


2. National Telecom Policy, 2012.


3. TRAI recommendations on broadband.

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Competence in policing

David Montgomery, Sari Horwitz and Marc Fisher have a great story in the Washington Post about how the police tracked down the murderers in Boston. Also see Spencer Ackerman in Wired magazine. On a similar theme, look back at the attack at Times Square in New York.



We in India fare dismally on this. Lacking competence in the police, we repeatedly engage in faulty tradeoffs in security, where police either infringe on the freedom of citizens or resort to brutality against innocent `suspects'. Every time the police quickly solve a case, I worry that they merely tortured some plausible sounding suspect.



Law and order is the most important and most basic public good. Dense urban congregations, which are the essence of modern creative capitalism, are only possible with very high levels of safety. The US is priority #1 for the bad guys, and has had two attacks in 12 years, both of which were followed by outstanding investigations. We in India suffer from thousands of attacks, most of which are never solved. This shows the low capabilities of our law enforcement crew.



We in India go wrong at three levels:

• Elections have degenerated into competitive subsidy programs; both politicians and voters have stopped focusing on performance of the government on public goods. Left-oriented intellectuals are complicit in this, with an emphasis on inequality and subsidies rather than on public goods. When voters are not focused on public goods, the accountability through elections does not generate feedback loops in favour of better public goods.


• In this environment, inadequate resources go into public goods, the most important of which is the criminal justice system.


• Within the criminal justice system, there is little accountability, and we are not seeing feedback loops through which the system is constantly reshaped (within existing budget constraints) towards better performance.

The recent wave of outrage on law and order should ideally help set a new course. See Law and order: Going from outrage to action. Mistreating women is not encoded in our culture or our DNA: it is endogenous to the incentives provided by the criminal justice system. The same Indians behave very differently towards women when placed in alternative criminal justice systems in other countries. If enough voters demand performance from politicians for better law and order, we will get a greater focus on it, in terms of:

• More top management time. E.g. how many hours per year does the PM work on law and order in Delhi versus how many hours does he spend on NREGA?


• More money. E.g. how much money do we put into law and order in Delhi versus how much money do we put into NREGA? 


• More and better people. E.g. how do we get the best and brightest civil servants out of relatively unproductive tasks (subsidies) and into the things that matter (public goods)? How do we increase the staff strength of government in public goods, while cutting the size of government on subsidies? How do we make careers in police, courts and jails more attractive, and careers in education, health and welfare programs less interesting?


• More analysis. How do we get more research papers on the criminal justice system, and fewer research papers on development economics?

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Sugar: Letting the invisible hand work

by Apoorva Gupta.



The recent announcement that dismantled the levy and monthly release mechanisms, in the sugar industry, will make the industry more efficient and competitive. But much remains to be done. This is a good time to look at the government interventions in this industry, the implications of recent decisions, and the way forward.

Major government controls

With an aim of offering farmers, firms, and consumers a fair deal, the government intervenes in production and distribution through various controls:

1. Minimum price for cane: Under the Sugarcane (Control) Order, 1966 (SCO), the Central government announces a `Fair and Remunerative Price' (FRP) to ensure a good return to farmers. The state governments announce a `State Advised Price'  (SAP) which has typically been higher than the FRP, thus making the FRP redundant. In 2010-11, the SAP was 47% higher than the FRP.
   
   


2. Cane Reservation Area: To guarantee continuous and sufficient supply of cane to all mills, the area from which a mill can procure cane is reserved. It is also obligatory for the farmer to sell all  produce to the mill in that area. The state has the power to reserve this area under the SCO.
   
   


3. Minimum Distance Criterion: The Central government, under the SCO, has set a requirement of a 15 km. minimum distance between two mills to ensure supply of cane to all. States are authorised to increase this limit with prior approval from the Center. Punjab, Haryana and Maharashtra have a minimum distance requirement of 25 km.
   
   


4. Levy Obligation: Under the Levy Sugar Supply (Control) Order, 1979, till recently, mills had to sell 10% of their produce to the government at a price lower than the market price, and this sugar was distributed through the public distribution system.
   
   


5. Monthly release mechanism: The central government dictated the amount of sugar a mill could release each month in the open market, under the Essential Commodities Act, 1955 and the SCO. This allowed the government to control the prices of sugar in the market. In 2012, the release orders became quarterly.
   
   


6. Trade Policy: To ensure national food security and contain price volatility, the government has historically used quantitative restrictions on export and import, depending on domestic and foreign conditions.
   
   


7. Controls on by-products of sugar manufacture: Molasses is used to produce alcohol which is used in the production of potable alcohol, chemicals and blending with petrol. States impose restrictions on the movement of molasses, and artificially reduce the price for the benefit of liquor barons. The Center has not yet released a clear policy on pricing of ethanol for blending in petrol. The state also imposes restrictions on open access sale of power generated from bagasse.
   
   


8. Compulsory jute packaging : The central government has made it compulsory for mills to pack 40% of the sugar produce in jute bags.

These controls add up to a comprehensive central planning system that blankets the sugar industry.

No one gains!

Each of these controls has created distortions.



#1: The minimum support price aims to ensure a fair price for cane to farmers, but on the contrary, it is the leading cause of accumulation of cane arrears (Rs 5495.04 crore for 2011-12 sugar season). The SAP is often not commensurate with the market price of sugar, making it hard for the mills to pay the farmers in time. Farmers shift to cultivation of a different crop because of delayed payments and this leads to shortages of cane. With lower production of sugar and higher market prices, the mills are able to reduce cane arrears and this incentivises the farmer to shift back to cane cultivation and the cycle is repeated. The graph below shows these fluctuations.

The figure above shows cyclicality in total production, total cane arrears and the average PBDIT of a balanced panel of 50 sugar companies observed in the CMIE Prowess database. There is a direct relationship between the production of sugar and the cane arrears, and an inverse relationship between total production and firm profit. This cycle is characteristic of the present restricted industry industry.  The price and supply of sugar are extremely volatile, even though consumption has been growing at a steady pace. The mills are often working under capacity and many small ones are shut down in the lean season since production is not economically viable. Farmers are burdened with delayed payments, and consumer welfare is reduced due to volatile prices.



#2 and #3: The cane reservation area and minimum distance requirement have fostered creation of monopolies. The farmer is obliged to sell his produce to a mill irrespective of its past payment record and cannot search for the best price for his produce. This gives monopoly power and artificial protection to firms, and helps inefficient firms to persist in the market. Currently, there are approximately 500 mills, some of which operate only in times when the cane is in surplus, produce as little as 500 tonnes of sugar in a year, and have a very low ratio of recovery of sugar from cane. Moreover, these controls do not allow high productivity firms to expand and achieve economies of scale, invest in increasing the acreage and sucrose content of cane.



#4 and #5: The levy obligation imposed a direct cost on mills to the tune of Rs.3000 crore in 2011-12. In 2011-12, the levy sugar price was Rs. 1904 per quintal, while the price of non-levy sugar was Rs. 2749 per quintal, excluding excise. The mills passed on these losses to consumers in the form of higher prices, and to farmers by delaying payments. The monthly release mechanism led to high inventory accumulation costs and made it hard for mills to manage cash flows. These two controls also incentivised mills to hoard inventory, increasing the administrative and litigation costs of implementing these controls.



#6: The abrupt and unanticipated trade barriers in the form of duties and outright bans, has not achieved the desired reduction in price volatility. Besides the dead weight loss of restricting trade, the unstable policy regarding export and import has reduced the ability of mills to foster long term contracts abroad.



#7 and #8: Mills lose money by selling molasses to liquor barons at an artificially low price. The unclear policy on ethanol pricing for oil marketing companies leads to unfulfilled contracts between sugar mills and OMCs and increases losses for both industries, since blending ethanol reduces the price of petrol for OMCs, and mills do not get revenues from the sale of molasses. The restriction on open sale of power generated from bagasse imposes an environmental cost. Compulsory packing in jute bags adds Rs 0.40 per kg of sugar. These policies, which try to develop one industry at the cost of another, eventually increase the cost for consumers and farmers.

Rangarajan Committee recommendations

The Rangarajan Committee was appointed to study the issues related to regulation of the sugar industry in early 2012. They recommended phased decontrol of the industry.



The recommendations include immediate removal of the levy obligation and monthly release mechanism, and phasing out of cane reservation area, minimum distance criterion and trade barriers over the next couple of years. Concerning cane pricing, the committee recommends that cane price should be a combination of FRP and a share in value of sugar. On international trade, they suggest that the current policy should be replaced by moderate duties not exceeding 5-10 percent. The need to deregulate the movement, pricing and quantitative restrictions on by-products of sugar, and abolish mandatory packaging or sugar in jute bags is also emphasised.

Recent decisions on decontrol

The Cabinet Committee on Economic Affairs has recently approved the removal of levy obligation and the monthly release mechanism (#4 and #5), as suggested by the Rangarajan Committee. The markets welcomed this decision, with a cumulative abnormal return of the CMIE COSPI Sugar Industry Index of 9% over the 2 days after the announcement. The spot price of sugar also spiked after the announcement. The market was over-exuberant at the partial decontrol of the industry and some of these gains have been reversed.

The implications of this partial decontrol are:

1. Impact on finances: The removal of levy implies a direct increase in profit for mills of about Rs.3000 crore since they no longer have to sell 10% of the produce at significantly low prices. With the freedom to release stock, the mills will have choices about selling in India and abroad. The mills facing financial problems can liquidate their inventory when needed.
   
   


2. Reduction in cane arrears: Mills with large cane arrears will now be able to release stock to make pending payments. But as elections come closer, there is a possibility that the SAP is increased and cane arrears accumulate. This will hurt the financial health of the firms.
   
   


3. Volatility in prices: If mills release too much stock to reduce cane arrears or due to sheer inexperience with a free market, prices might plummet. The strategic moves of mills, rather than decisions of politicians and bureaucrats, will determine prices.
   
   


4. Greater trading: Since cane is crushed seasonally and the mills have full freedom to release sugar, the trading on futures market will matter more. The futures market will become much more important in shaping decisions of everyone involved in sugar.
   


5. Survival of the best: Until now the government regulated the amount of sugar released in the market, and the firms had no experience in thinking strategically. Reaching a Bayesian equilibrium will involve learning by doing, and creative destruction in the industry. Mills will require building up financial depth and skills in hedging using futures. Large firms, which have diversified into production of power and alcohol, will have an upper hand.
   
   


6. Stability in acreage and cyclicality: The ability to manage cash flows would increase the security of payment to farmers, incentivising them to continue with cane cultivation. The mills and farmers (in the area reserved for them) might enter into contracts where the supply of cane is guaranteed, in return for timely payments. This can considerably reduce the amplitude of the sugar cycle and lead to an improvement in cane acreage.
   
   


7. Impact on the growth of sector: With a better balance sheet, mills will be able to invest more. The global perception of the industry is going to change from highly regulated to partially decontrolled and this might give greater foreign investment. The freedom to release stock in domestic and foreign markets (provided export policy is not binding) will increase the international presence of mills.

Next steps

Of the list of eight controls, the government has removed two. Most of the pending controls come under the purview of the state governments and decontrol of this industry is now largely their task.



#1: Reforming the regulation of price is essential to reduce cyclicality in cane production, which is a leading cause of cane arrears and low profitability. The recommendation of the Rangarajan Committee on pricing of cane suggests that the farmer will be better off as he is protected from uncertainty in the market due to a guaranteed FRP, and also encourages him to invest in increasing the yield of cane for he has a share in the value.



#2 and #3: Abolishing the minimum distance requirement and the cane reservation area will lead to competitive bidding for cane and farmers would be able choose the best price on offer across an array of choices [analogy]. The increased competition to acquire cane might encourage mills to enter into long term contracts with farmers and offer them other benefits such as timely payments irrespective of the phase of the cycle, make them shareholders, and also assist in increasing cane yield. The inefficient firms are likely to perish with more competition in the market, leading to a more consolidated industry.



#6: Removal of trade barriers is likely to make trade more stable, foster global relationships between firms and make Indian firms internationally competitive. In the recent past, imports were duty free and export release orders were removed, suggesting that the government is slowly liberalising trade.



#7 and #8: Decontrolling movement, pricing and allocation of molasses can contribute significantly to the reduction of cyclicality in the sugar industry. In years of a bumper stock, cane can be used to produce molasses directly and can be distributed to all players at competitive prices. This will also make the sector more profitable. Co-generation from bagasse can become a reliable source of power. Removing restriction on sugar packaging will lead to a direct cut in costs of manufacturing.

Conclusion

The government needs to hasten the process of adopting the Rangarajan Committee recommendations. The job of the government is to focus on public goods, such as improved road and rail networks for the transportation of a heavy and perishable good like cane, improved irrigation facilities to reduce the dependence on monsoons and improved information dissemination for price discovery. Market forces will furnish higher efficiency and growth in the system by ensuring the survival of the best firms, fostering mutually beneficial contracts between the farmers and mills, and stabilising the price of sugar for the consumers.

Acknowledgements

This article has greatly benefited from suggestions from Dr. K. P. Krishnan, Dr. Ajit Ranade and Dr. G. S. C. Rao.

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FSLRC: The cast of 146

There is little experience in India with large complex projects of drafting law. The process adopted by FSLRC had many strengths. In the table below, I have pulled together the names of all 146 persons mentioned in the report. A diverse array of knowledge and perspective was brought into the project. In addition, the work took place over two years with a large dedicated workforce. In these respects, it represents an important contrast with the small closed groups, and small scale of resources, that have traditionally done drafting of law in India.

		Name		Designation and Organisation		Role in FSLRC
1		Shankar Acharya		Honorary Professor, Indian Council for Research on International Economic Relations		Special Invitee, FSLRC
2		Viral V Acharya		Professor of Economics, New York University Stern School of Business, USA		Honorary Adviser, FSLRC and External Reviewer, Technical Team
3		Late C Achuthan		Corporate Law Chambers India		Member, FSLRC
4		Rajiv Agarwal		Secretary (Consumer Affairs), Department of Consumer Affairs, Ministry of Consumer Affairs, Food and Public Distribution, Government of India		Special Invitee, FSLRC
5		Varsha Agrawal		Consultant, NIPFP		Member, Technical Team
6		K Aishwarya		Consultant, NIPFP		Member, Technical Team
7		Chirag Anand		Consultant, NIPFP		Member, Technical Team
8		Karan Anand		Consultant, NIPFP		Member, Technical Team
9		Kumar Anand		Consultant, NIPFP		Member, Technical Team
10		Bindu Ananth		President, IFMR Trust		External Reviewer, Technical Team
11		Uday P Apsingekar		Sr. PPS to Chairman, FSLRC		Member, FSLRC Administration Team
12		Molina Asthana		Principal Solicitor, Commercial, Property & Technology, Victorian Government Solicitor's Office, Melbourne, Australia		External Reviewer, Technical Team
13		Jahangir Aziz		Chief Economist, JP Morgan Chase & Co		Advisor and External Reviewer, Technical Team
14		Shobana B		Academic Associate, National Institute of Securities Markets		Member, Technical Team
15		Vikram Bahure		Consultant, NIPFP		Member, Technical Team
16		Tarun Bajaj		Former Joint Secretary (Insurance & Pension), Department of Financial Services, Ministry of Finance, Government of India		Member, Working Group on Insurance, Retirement Financing and Small Savings
17		Vimal Balasubramaniam		Consultant, NIPFP		Member, Technical Team
18		Dipak Banerjee		OSD, FSLRC		Member, FSLRC Administration Team
19		Sanjay Banerji		Professor of Finance, University of Nottingham Business School, UK		External Reviewer, Technical Team
20		Vishvesh Bhagat		Senior Vice President (Legal, Compliance & vigilance), National Institute of Securities Markets		Member, FSLRC Administration Team
21		Sudarshan Bhattacharjee		Consultant, NIPFP		Member, Technical Team
22		C B Bhave		Former Chairman, Securities and Exchange Board of India		Advisor and External Reviewer, Technical Team
23		M G Bhide		Former Chairman and Managing Director, Bank of India		Member, Working Group on Banking
24		Paul Binsted		Chairman, Financial Sector Advisory Council, Australia		Country Expert Consultation
25		Mark Boleat		City of London Roundtable, UK		Country Expert Consultation
26		Michele Bourque		President, Canada Deposit Insurance Corporation, Canada		Country Expert Consultation
27		Sarah Breeden		Prudential Regulatory Authority Transition Team, UK		Country Expert Consultation
28		Mike Callaghan		Executive Director, Treasury, Australia		Country Expert Consultation
29		Jeff Carmichael		Wallis Inquiry Member and Inaugural Chairman, Australian Prudential Regulation Authority, Australia		Country Expert Consultation
30		Sumathi Chandrashekaran		Consultant, NIPFP		Member, Technical Team
31		Ashok Chawla		Chairperson, Competition Commission of India		Special Invitee, FSLRC
32		Rajendra P Chitale		Managing Partner, M.P.Chitale & Co		Special Invitee, Working Group on Insurance, Retirement Financing and Small Savings
33		Russell Collins		Chairman, Financial Sector Practitioners' Panel, UK		Country Expert Consultation
34		Mary Condon		Vice-Chair, Ontario Securities Commission, Canada		Country Expert Consultation
35		Matt Crooke		Minister-Councillor, Australian High Commission, New Delhi		Country Expert Consultation
36		Devika Das		Consultant, NIPFP		Member, Technical Team
37		Pratik Datta		Consultant, NIPFP		Member, Technical Team
38		Akhil Dua		Consultant, NIPFP		Member, Technical Team
39		Alex Etra		Consultant, NIPFP		Member, Technical Team
40		Patty Evanoff		Senior Director, Office of the Superintendent of Financial Institutions, Canada		Country Expert Consultation
41		Stuart Fraser		City of London Roundtable, UK		Country Expert Consultation
42		Neeraj Gambhir		Head, Fixed Income Business for India, Nomura Holdings Inc		Member, Working Group on Securities
43		Meeta Ganguly		Consultant, NIPFP		Member, Technical Team
44		Charles Goodhart		Professor and Director of Financial Regulation Research Programme,London School of Economics, UK		Country Expert Consultation
45		R Gopalan		Secretary, Department of Economic Affairs, Ministry of Finance, Government of India		Special Invitee, FSLRC
46		Abhishek Gupta		Consultant, NIPFP		Member, Technical Team
47		Apoorva Gupta		Consultant, NIPFP		Member, Technical Team
48		Monika Halan		Editor, Mint Money		External Reviewer, Technical Team
49		Mark Hoban		Financial Secretary, The Treasury, UK		Country Expert Consultation
50		Lord Hoffman		Chairman, Financial Markets Law Committee, UK		Country Expert Consultation
51		Neena Jacob		Consultant, NIPFP		Member, Technical Team
52		Bhavna Jaisingh		Consultant, NIPFP		Member, Technical Team
53		Bimal Jalan		Former Governor, Reserve Bank of India		Special Invitee, FSLRC
54		Parikshit Kabra		Consultant, NIPFP		Member, Technical Team
55		Madhu Kannan		Former Managing Director and CEO, Bombay Stock Exchange Limited		Member, Working Group on Securities
56		Shreeya Kashyap		Consultant, NIPFP		Member, Technical Team
57		Vijay Kelkar		Chairman, Forum of Federations, Ottawa & India Development Foundation, New Delhi		Special Invitee, FSLRC
58		Vikramaditya Khanna		Professor, University of Michigan Law School, USA		External Reviewer, Technical Team
59		Sudhamoy Khasnobis		Founder, i-Care Life Pte. Ltd, Singapore		Expert and External Reviewer, Technical Team
60		Naina Lal Kidwai		Group General Manager and Country Head, HSBC India		Member, Working Group on Banking
61		James Knight		Debt Management Office, UK		Country Expert Consultation
62		Sunder Ram Korivi		Dean, School for Securities Education, National Institute of Securities Markets		Member, Technical Team
63		T Koshy		Executive Director, Advisory Services, Ernst & Young Private Limited		External Reviewer, Technical Team
64		K P Krishnan		Secretary, Economic Advisory Council to Prime Minister, Government of India		External Reviewer, Technical Team
65		Amol Kulkarni		Consultant, NIPFP		Member, Technical Team
66		Aishwarya Kumar		Consultant, NIPFP		Member, Technical Team
67		Shekhar Hari Kumar		Consultant, NIPFP		Member, Technical Team
68		Kanagasabapathy Kuppuswamy		Director, EPW Research Foundation		Member, Working Group on Debt Management Office
69		Bikku Kuruvila		Legal Consultant, New York, USA		Legal Consultant, Technical Team
70		John Laker		Chairman, Australian Prudential Regulation Authority, Australia		Country Expert Consultation
71		Rajiv Lall		Managing Director and Vice Chairman, Infrastructure Development Finance Company		Member, Working Group on Banking
72		Timothy Lane		Deputy Governor, Bank of Canada		Country Expert Consultation
73		Tiff Macklem		Senior Deputy Governor, Bank of Canada		Country Expert Consultation
74		Yezdi H Malegam		S.B. Billimoria & Company		Member, FSLRC and Member, Working Group on Banking
75		Aakriti Mathur		Consultant, NIPFP		Member, Technical Team
76		Kate McKee		Senior Advisor, CGAP		External Reviewer, Technical Team
77		Poonam Mehra		Assistant Professor, National Institute of Securities Markets		Member, Technical Team
78		Ursula Menke		Commissioner, Financial Consumer Agency of Canada		Country Expert Consultation
79		Ravi Menon		Managing Director, Monetary Authority of Singapore		Country Expert Consultation
80		Apoorva Ankur Mishra		Consultant, NIPFP		Member, Technical Team
81		Percy S Mistry		Director, J P Morgan Emerging Markets Investment Trust		Expert, FSLRC
82		Ambarish Mohanty		Consultant, NIPFP		Member, Technical Team
83		Nachiket Mor		Chair, Sugha Vazhvu Health Care Private Limited		External Reviewer, Technical Team
84		C K G Nair		Secretary, FSLRC		Secretary, FSLRC
85		N K Nampoothiry		Special Secretary, Department of Legal Affairs, Ministry of Law and Justice, Government of India		Expert, Technical Team
86		Ravi Narain		Managing Director & CEO, National Stock Exchange		Member, Working Group on Securities
87		S A Narayan		Managing Director, Kotak Securities Limited		Member, Working Group on Securities
88		Badri Narayanan		Advisor, Third Eye Capital Advisors LLP		External Reviewer, Technical Team
89		P J Nayak		Chairman, Morgan Stanley India Company Pvt. Ltd.		Member, FSLRC and Chairman, Working Group on Payments
90		Uttam Nayak		Country Manager, VISA		Member, Working Group on Payments
91		Lyndon Nelson		Director, Financial Services Authority, UK		Country Expert Consultation
92		Rob Nicholl		CEO, Debt Management Office, Australia		Country Expert Consultation
93		Justice Debi Prasad Pal		Member, FSLRC		Member, FSLRC
94		Radhika Pandey		Consultant, NIPFP		Member, Technical Team
95		Ritvik R Pandey		Director (Budget), Department of Economic Affairs, Ministry of Finance, Government of India		Expert , Technical Team
96		Deepak S Parekh		Non-executive Chairman, Housing Development Finance Corporation		Special Invitee, FSLRC
97		Bobby Parikh		Managing Partner, BMR & Associates		Consultant, FSLRC
98		Smriti Parsheera		Consultant, NIPFP		Member, Technical Team
99		Ila Patnaik		Professor, NIPFP		Co-lead, Technical Team
100		Avinash Persaud		Senior Fellow, Caribbean Policy Research Institute		Honorary Advisor, FSLRC
101		Bharat Poddar		Group Head, Boston Consulting Group, India		Member, Working Group on Payments
102		Anuradha Prasad		Chief Controller of Defence Accounts, Government of India		Member, Working Group on Insurance, Retirement Financing and Small Savings
103		Madhavi Pundit		Assistant Professor, NIPFP		Member, Technical Team
104		Aditya Puri		Managing Director, HDFC Bank Ltd		Member, Working Group on Banking
105		Suyash Rai		Consultant, NIPFP		Member, Technical Team
106		Raghuram G Rajan		Chief Economic Advisor, Department of Economic Affairs, Ministry of Finance, Government of India		Special Invitee, FSLRC
107		Tarun Ramadorai		Professor of Financial Economics, Said Business School & Oxford-Man Institute of Quantitative Finance, University of Oxford, UK		Honorary Advisor and External Reviewer, Technical Team
108		Kavitha Ranganathan		Programme Manager (Academic), National Institute of Securities Markets		Member, Technical Team
109		C Rangarajan		Chairman, Economic Advisory Council to the Prime Minister, Government of India		Special Invitee, FSLRC
110		C S Rao		Former Chairman, Insurance Regulatory and Development Authority		Senior Adviser, Working Group on Insurance, Retirement Financing and Small Savings
111		M Govinda Rao		Director, NIPFP		Member, FSLRC and Chairman, Working Group on Debt Management Office
112		Rajshekhar Rao		Advocate		Consultant, FSLRC
113		Sowmya Rao		Consultant, NIPFP		Member, Technical Team
114		O N Ravi		Corporate Development Officer, Clearing Corporation of India Limited		Honorary Advisor and External Reviewer, Technical Team
115		Barbara Ridpath		CEO Regulation, International Centre for Financial Regulation, UK		Country Expert Consultation
116		Shubho Roy		Consultant, NIPFP		Member, Technical Team
117		Jeremy Rudin		Assistant Deputy Minister, Department of Finance, Canada		Country Expert Consultation
118		K G Sahadevan		Professor of Economics, Indian Institute of Management, Lucknow		Member, Working Group on Securities
119		M S Sahoo		Former Member, Securities and Exchange Board of India		Legal Consultant, Technical Team
120		Renuka Sane		Research Economist, Indira Gandhi Institute of Development Research, Mumbai		External Reviewer, Technical Team
121		Subrata Sarkar		Professor, Indira Gandhi Institute of Development Research, Mumbai		External Reviewer, Technical Team
122		Ankur Narain Saxena		Consultant, NIPFP		Member, Technical Team
123		Sally Scutt		Deputy CEO, British Bankers' Association, UK		Country Expert Consultation
124		Ajay Shah		Professor, NIPFP		Co-lead, Technical Team
125		Sanjiv Shah		Executive Director, Goldman Sachs, India		Member, Technical Team
126		A P Singh		Joint Secretary, Unique Identification Authority of India, Planning Commission, Government of India		Member, Working Group on Payments
127		Darshika Singh		Consultant, NIPFP		Member, Technical Team
128		Neeraj Singh		Consultant, NIPFP		Member, Technical Team
129		A K Sinha		Deputy Secretary, FSLRC		Member, Administration Team
130		Abhishek Sinha		CEO, EKO India Financial Services Private Limited		Member, Working Group on Payments
131		Janmajeya Sinha		Chairman of Asia-Pacific Operations, Managing Director of Mumbai Operations and Senior Partner, Boston Consulting Group, Inc.		Member, Working Group on Banking
132		Justice B N Srikrishna		Chairman, FSLRC		Chairman, FSLRC
133		Glenn Stevens		Governor, Reserve Bank of Australia		Country Expert Consultation
134		Gregory Stevens		Prudential Regulatory Authority Transition Team, UK		Country Expert Consultation
135		Robert Stheeman		CEO, UK Debt Management Office		Country Expert Consultation
136		Somasekhar Sundaresan		J. Sagar Associates, Advocate & Solicitors		Consultant, FSLRC
137		Dhirendra Swarup		Member, FSLRC		Member Convenor, FSLRC, Chairman, Working Group on Insurance, Retirement Financing, and Small Savings and Member, Working Group on Debt Management Office
138		Lucie Tedesco		Deputy Commissioner, Financial Consumer Agency of Canada		Country Expert Consultation
139		Ranjit Tinaikar		Partner, McKinsey & Company, India		Member, Working Group on Payments
140		K J Udeshi		Chairperson, Banking, Codes & Standards Board of India		Member, FSLRC and Chairperson, Working Group on Banking
141		K N Vaidyanathan		Chief Risk Officer, Mahindra and Mahindra		Honorary Advisor and External Reviewer, Technical Team
142		Harsh Vardhan		Partner, Bain & Company		Member, Working Group on Banking
143		Jayanth R Varma		Professor (Finance and Accounting), Indian Institute of Management, Ahmedabad		Member, FSLRC and Chairman, Working Group on Securities
144		Kaushalya Venkataraman		Consultant, NIPFP		Member, Technical Team
145		Yesha Yadav		Assistant Professor of Law, Vanderbilt University Law School, USA		External Reviewer, Technical Team
146		Mark Zelmer		Assistant Superintendent, Office of the Superintendent of Financial Institutions, Canada		Country Expert Consultation

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Interesting readings

Ramchandra Guha in the Hindu on Narendra Modi.





Asif Ezdi writes in The News about how Indian culture is undermining Pakistan's `distinct way of life, values and language, which we have successfully preserved through the centuries in an alien and hostile environment'. The loony right in India thinks similarly about Valentine's day. It's interesting to see that Ezdi retired from the Foreign Service.







A lot of new material has come out about the draft Indian Financial Code; I have been updating my blog post on this.



Joseph Sternberg in the Wall Street Journal, on family businesses in India.



Manoj Nagpal in Mint on what NPS is doing wrong.



Bibek Debroy says that something big is brewing on the Delhi-Bombay Industrial Corridor with `NMIZ's.



The SEBI/IRDA conflict was a pivotal event in financial sector policy of recent years. Everyone interested in the field, and in the problems of consumer protection in India, should read Deepti Bhaskaran's interview with outgoing IRDA chairman Hari Narayan in Mint.



Big Cats in Our Backyards: Persistence of Large Carnivores in a Human Dominated Landscape in India by Athreya et al in PLOS One.





A great article by Husain Haqqani in Foreign Affairs about the US-Pakistan relationship.



Mira Sethi has a great piece in Caravan magazine about contemporary politics in Pakistan.





Joseph Sternberg in the Wall Street Journal on how industrial policy in China, on rare earths, has backfired.



Living with less. A lot less. by Graham Hill, in the New York Times, helps us go back to basics.



Francis, Hasan and Wu, 2013 find that professors are valuable in the board room.



For the first time, in 2013, the sum total of Windows installs will be smaller than the sum total of iOS installs.



Watching your body more effectively, by John Hewitt on ExtremeTech.

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Obtaining liquidity for illiquid stocks

The problem

While there are thousands of listed companies in India, for all practical purposes, stock market liquidity is the exclusive preserve of large companies. For small securities, the conventional continuous market presents daunting problems of liquidity. In conventional continuous trading, the price is made by the orders that come in from one second to the next. However, within a few seconds, there may not be many orders. The price may get swayed sharply by one large order.

An illiquid market suffers from two main problems: Investors suffer large transactions costs when entering and exiting, and there is a heightened danger of market abuse. Market abuse is the falsification of information about prices, spreads, turnover, etc. Innocent participants get sucked into making wrong decisions about investment when they see prices, spreads, turnover which are not the result of normal market forces, but are caused by a deceptive scheme. The possibility of market abuse, in turn, deters market participation and exacerbates illiquidity. This sets up a vicious cycle where fear causes illiquidity, illiquidity engenders market abuse, and the presence of market abuse causes fear. Detecting and blocking market abuse is the central function of infrastructure institutions and regulators.

While illiquidity is partly inherent to the listed firm, it is also influenced by the market design. There are mechanisms through which an improved market design can yield improved liquidity. As an example, when we moved from floor trading to continuous screen-based trading in India, liquidity improved.

The call auction

An alternative design -- the call auction -- helps address this problem. In a 30 minute call auction (say), orders that come in over a 30 minute period are pooled. The equilibrium price is worked out based on the supply and demand over this 30 minute period. This is likely to be a more robust price when compared with the price that is discovered moment to moment, under certain circumstances. 

In India, at present, the call auction is used in three settings:

1. The opening price is discovered using a call auction. This allows the market to absorb overnight news.


2. When trading halts owing to a circuit breaker (i.e. a large price movement), the news is absorbed into the market using a call auction when trading recommences. Example.


3. At first listing (or after re-listing), the price discovery in the first 60 minutes is done using a call auction.

In general, trading through call auctions is not exciting to securities firms since turnover is more limited. However, call auctions are good for investors (zero impact cost), issuers (lowered liquidity premium) and the economy at large (reduced market abuse).

SEBI announcement on new market mechanism for illiquid stocks

On 14 February, SEBI announced that for illiquid stocks, the market design shall constitute a series of one-hour blocks in the day which are call auctions. The SEBI circular gives a precise definition of what constitutes an illiquid stock. This is a fairly big initiative: it will affect 263 stocks on NSE and 2050 stocks on BSE. The new market mechanism will be in place from Monday the 8th of April onwards.

If this works well, it will have four effects:

1. From the viewpoint of investors, the ability to enter and exit a stock with zero impact cost should yield a reduced liquidity premium. The valuation of stocks that trade through the call auction should be better when compared with the valuation of stocks that trade in the continuous market, where the round-trip transactions cost (i.e. two payments of impact cost, at entry and exit) can be a substantial expense.


2. When an episode of market abuse comes together, there are extreme fluctuations of prices or turnover. This should take place to a reduced extent; the problems of market abuse are smaller for illiquid stocks under the call auction.


3. For unsophisticated investors, the call auction is more attractive as there is a reduced possibility of market abuse. Firms in this mechanism should be able to achieve a more diversified investor base. This would also yield an improved valuation.


4. The price in the call auction, revealed each hour, should be a better estimator of true value when compared with the price seen under continuous trading. There should be fewer departures from market efficiency, such as mean reversion. This will reflect a combination of two effects: avoiding the temporary price pressure associated with illiquidity, and avoiding market abuse.

Reflections on the regulatory process at SEBI

Now that the draft Indian Financial Code is in front of us, we see regulation-making in new light. This gives us a fresh perspective upon what SEBI has done. Why does SEBI use a `Circular' as a legal instrument? The only two legal instruments that SEBI should use are Regulations and Orders. It is nice to see that this circular was discussed at an Advisory Council (the existing SEBI SMAC). However, the SEBI document does not do enough in terms of analysis. What is the problem that this regulation seeks to solve? How will this intervention solve this problem? What are the costs and benefits? Where was the notice-and-comment period?



S.59 of the draft Code requires that three years after the issue of regulations, a review should take place. It requires measuring the costs and benefits. The clarity of articulating objectives (e.g. points 1..4 above) becomes the natural frame through which this review would be done. The extent to which these four outcomes are achieved constitutes a mapping of the benefits.



When we think of how one specific regulation (e.g. period call auction trading for illiquid securities) would work out under the Code, we see that the superior regulation-making process embedded in the Code would  push regulators towards more thought, and thus improve the quality of regulation-making.

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