Tuesday, 30 July 2013

Back to the Basics: What is CAD and why does it matter?

By now we have all read or heard from one source or the other that India is suffering a huge Current Account Deficit (CAD). This post is for those who are wondering what this is and why does it make a difference.

A lesson in Economics

Let us forget the individual companies and corporate houses for a minute and view India as a single entity. When we purchase things from another country we have to pay them in return. Similarly, when other countries buy things from us, they pay us. A simple understanding of budgeting tells us that if we do not sell as much, if not more, than the amount we buy, we are sooner or later going to run out of money. This is what we call a current account deficit. Effectively we, as a nation, are borrowing from other countries to fund our consumption. One way to sustain such a situation is to offset the Current Account Deficit with a Capital Account Surplus.

Capital account is the measure of money that enters and leaves our country in terms of investments. There are three main forms that this can take:

  1. Foreign Direct Investment (FDI): When foreign investors pick up a large stake in an Indian company or set-up their own operations in India. This is usually a longer term investment as compared to FII (below). For example, when Etihad will buy a stake in Jetairways, they will be paying Indian shareholders with capital from their country.
  2. Foreign Institutional Investment (FII): When foreign institutional investors trade in the Indian stock exchange they bring capital from their economy into our market.
  3. External Commercial Borrowing (ECB): When Indian companies borrow from foreign entities which are able to provide capital at a lower rate of interest.
If the cumulative of such investments into the country is greater than such investments out of the country we achieve a capital account surplus. Thus while overall we are running a deficit on our current account (i.e. money is leaving the economy) we are able to sustain it because of the capital account surplus (i.e. money is entering the economy).


Why we are a mess

India has historically managed to run a CAD of around 2% of GDP without stress as the capital inflow was easily able to offset it. However, with the rising uncertainty for investors in India, capital inflow is no longer as reliable as it once was. To add to this, there is threat of capital flocking back to the US where the interest rates might be on the rise soon. The situation is further worsened as our CAD has risen from 2.7% (2011) to 4.8% (2013) of GDP making us ever more reliant on the capital inflow.

So what happens if due to macroeconomic instability, capital inflow decreases and we reach a stage where the capital account surplus cannot offset the current account deficit?

International transactions happen in the US Dollars (USD). Hence, if overall more money were to leave the economy than enter it, the demand for the USD viz a viz Indian Rupee (INR) would be greater, causing the dollar to gain value relative to INR (i.e. INR would depreciate). What does this lead to? Say a year back a good produced in India was priced at $1 in the international market and Rs 50 in the domestic one. At that exchange rate the producer was effectively receiving Rs 50 for his product and he would be indifferent between selling it on the domestic market and the foreign market. However, a year later with the new rates, the foreign consumer is now able to pay Rs 60 to the producer with no extra cost to him. The producer will thus divert his goods to the foreign market till the scarcity in the domestic market raises its price to Rs 60 at which point he will once again be indifferent.

The example above has been simplified considerably to get the basic point across: Devaluation of our currency will cause further inflation. Inflation which is already in its double digits (CPI) and is the worst enemy of the poor which the Government swears to protect.

To make things worse the government has dug us another pit fall due to lack of timely reforms. Of the $502 billion worth of imports in the financial year 2013, $170 billion was spent on oil. Oil which the government provides at a bench-marked price no matter what the price they buy it at. Thus as the currency depreciates faster than the rate at which the government is increasing the price of oil (and related products) the government is in fact forced to provide more subsidy than it previously did. Hence not only is the rise in prices causing inflation but is also increasing the government's fiscal deficit which reached 4.8 at the end of FY 2013 - another threat to our macroeconomic stability.

And so the cycle continues.

Monday, 22 July 2013

Vote for No One

In the run down to the 2014 general elections there is a huge outcry imploring the people to exercise their right to vote. I, myself, have been part of this persuading movement. But the more I attempt to decide who to vote for the more uncertain I get. More than an economic bankruptcy, India is suffering a leadership one.

Your vote demonstrates who you think deserves to lead this country. It is a tool to demonstrate your confidence in a Party (in all practical terms an individual) to govern us for five years. But what if you do not think any of them are up for the task? What if you are so completely indifferent between candidates that voting becomes a matter of a lucky draw?

The way I see it, come 2014 I have the following options: Congress, BJP, AAP and the 3rd Front. The way I see it, none of them deserve my vote.

A recently trending article by Pratap Bhanu Mehta, illustrates what Congress has done to our country in their back-to-back reign for 10 years. A better job cannot be done by any and I urge you to read the article yourself. It explains how under Congress' rule almost every sector of the economy has been destroyed and is being destroyed further in their final attempt to consolidate certain vote banks using populous policy. The economy is in a bad shape, worse than we realise, while Congress seems to be on a suicide mission with laws such as the Food Security Act. It is almost like they realize they will lose and are setting up the economy to collapse post the 2014 elections.

No, Congress definitely does not deserve our vote. Not only because of their pathetic performance and their scandal filled reign but also because the kind of precedent we as a nation want to set: Do we allow terrible performance to be rewarded by once again giving them power? If so, how will we ever hold our leaders accountable? Our leaders, who already think of us as idiots, will have more reasons to mistreat us. No, Congress back in power would be a national shame.

So if not Congress, then BJP? That does seem to be the popular track as of now. Modi has proved himself as an able administrator. True, there are plenty of reports, with good grounds, that say he is more hype than action. But still, he has done good for Gujarat. With our current economy, Modi maybe our best option. But now I ask you to pause, breath, and picture this:

You are at work and are suddenly informed that riots are imminent and you should probably head home to your family. In the age of fewer mobile phones you find it difficult to get in touch and rush home to make sure your family is safe. You reach home to find general panic among your neighbors. No one seems to know what may happen and no one seems to know what to do. Suddenly some one shoots the idea that the neighboring Gulbarg Society which houses a Congress MP would be a safe bet. People pounce on this first rational suggestion and rush towards what they believe will be a safe retreat.

You are now with 30 other families in the MPs house when you see a mob appearing at gate of your society. The hooligans are armed with swords and guns. They are screaming slogans of an alien religion and lusting for the blood of you and your family. You reassure your children by telling them there is a 20 feet wall around the colony which will keep them safe. But when you hear the gas cylinders blowing up you begin to avoid their eyes. The helpless feeling of not being able to assure the people who rely on you is shattering your spirit. Watching the MP, with all his power, making calls after calls begging for help and being repeatedly turned down is washing away that little confidence you had left.

As a last resort your leader is trying to offer a bribe. No one believes it will work, but you have run out of options. You watch the MP reluctantly open the door and throw the money just to rush back in. But just before he could, arms grab him from behind and you watch him, in horror, being cut into pieces and burnt alive right in front of you. You know the same fate now awaits you and your family and there is absolutely nothing you can do...

The above narration was based on the in-depth research conducted by Tehelka on this topic. Their reports also comprehensively prove Modi's involvement (or lack of) in this episode (here and here to list a few). Such atrocities happened under the rule of this man. This man refused to help such people. Help he could have given with a mere phone call. Does such a man deserve the top job of this country? What is the precedent we are setting here? I shudder to think.

Chankya is credited with the quote: "If the king is pious, the subjects become so; but if the king is vicious, the subjects become the same. If he be indifferent to both (virtue and vice), then they too bear the same character. In short, as is the king so are his subjects." How can we, with a clean conscious, vote ourselves into this direction?

So no to Congress and no to BJP. We seem to be running out of options. Aam Aadmi Party (AAP) is not really feasible either as they are still a nascent party and do not have the experience. They have also periodically made a few statements that suggests they may not understand the economy very well. The 3rd Front on the other hand have all the experience in doing all the wrong things. With potential leaders like Banerjee, Mayawati or the Yadavs, this would be India's nightmare come true. Fortunately, it seems highly unlikely.

So who is left? No one. I am a young Indian very eager to exercise his right to vote. I had to wait 5 years after turning 18 to do so. If given the option I would have gone through the entire registration + voting process just to show how I think none of them deserve my vote. Alas, that is not an option. I am truly stuck between a rock and a hard place.

Correction: A friend has just brought to my attention Rule 49-O of the Conduct of Election Rules (1961) which provides you the ability to abstain (using form 17 A) and have the presiding officer make a note of this decision. I apologize for my ignorance. I guess I will be voting this elections after all!

PS - If you do agree with me, I urge you all to exercise this option even if it makes life a little difficult for you and the election commission.

Friday, 19 July 2013

Back to the Basics: The Game of Elections

The election is a game for the politicians. It is a competition for them which they have to win. But lets not get mistaken, it is a game for us too: We have to use our one vote to ensure the best possible outcome according to our perspective. This responsibility does not end at choosing who you want the winner to be and voting for him, but requires you to generate a ranking of the candidates in order of preference and calculate who your vote should go to backwards.

Those familiar with economics will recognize my attempt at explaining the basics of Game Theory. But to understand the need for this we must first understand how elections take place in India and what are the implications.

I am sure all of us are aware of the absolute basics: The country is divided into 543 constituencies which are suppose to be roughly equal in terms of their population. Each of these constituencies elects a representative. This representative need not even achieve a simple majority (i.e. 50%); as long as he has more votes than any other single candidate he will be given the seat in the Parliament. For example, if there are 3 people running from a constituency and the vote share is divided in the ratio 25%, 35% and 40%, the candidate with 40% will be declared the winner. This is called First-past-the-post voting (FPTP).

What does such a mechanism imply? It can result in skewed representation. For example in the 2012 UP state elections SP (Samajwadi Party) received 29.3% of vote share and were allocated 226 seats in the assembly out of 403, where as BSP (Bahujan Samay Party), who received 25.9% of the vote share were allocated only 80 seats. This happened because the SP won several seats against the BSP over a very small margin. Thus while BSP received considerable votes overall, they were thwarted in individual battles and thus annihilated in the war in the world of FPTP.

This may seem like an unfair mechanism, specially when compared to the proportional representation method. But that is a debate for another blog post. What I would like to discuss is what the voter should do.

Let us imagine that the people who voted for BJP would rather have BSP if their only other option was SP. Their strategy should be obvious: Instead of voting for BJP, who anyway did not have a chance of coming to power, they should have voted for their next best choice which was BSP. If we assume that in each constituencies the vote share was identical to the state level data, then with the transfer of BJPs 15% to BSP, the party would be propelled to number one status with almost 41% of the vote share. Thus the BJP supporters might not get their first choice, but at least they would not be stuck with their 3rd or 4th one.

This example is obviously simplified using several assumptions, but the principle remains the same. At the central election level this effect can be observed with Modi being portrayed as the PM candidate for BJP. While Congress' abysmal performance has lost them support, voters who fear Modi more will fall back to Congress which is the only credible force to stop BJP. The same applies to people who fear another five-year reign of Congress: Recognizing this possibility they will leave their regional parties and flock to Modi (also discussed in Back to the Basics: Polarising Mr Modi).

The FPTP system often has the effect of bringing the war down to two parties. Understanding the system is important or your vote may actually count for nothing.

Friday, 5 April 2013

Review: 'Rape Law'

Do you have a disgruntled (former) girlfriend or parents of a high school sweetheart who did not approve of your physical relationship? Well then - you are screwed. On the 3rd of April, the President approved the Criminal (Amendment) Law Bill which does as much harm, if not more, as it does good.

In an earlier blog post (found here), I argued that creating new laws is not the solution to India's 'rape problem' but rather we should persevere to ensure better enforceability. The post described the threat of generating socially undesirable incentives when we write excessive laws without fully understanding the subject. In any case, as long as the problem is enforceability, no amount of new legislation can make a difference. I feared then that our leaders will once again escape accountability by making a show of activity, using a new piece of legislation, instead of actually doing the hard work of improving the law enforcement.

I cannot say that the bill is complete nonsense, although I am very tempted to do so. It does introduce some worthy amendments (which are discussed below) however, judging by the size of the movement and the pressure it created on the government, the result is disappointing and even a little worrisome. To me it seems like once again the government has been able to out manoeuvre the public. Through this bill they have introduced features that provide some protection and greater ease for the victim to report the crime. However, the law also generates wrong incentives, blatantly discourages pre-marital sex and furthers the sexist thinking that many blame for the problem to begin with.

Positives

  1. Amendments in the Code of Criminal Procedure (1973): These seem to be sensible improvements. While the first change listed below will help with better enforcement, the others will reduce the 'cost' of registering a complaint for the victim.
    1. If the police refuses to register the complaint, as is often reported in the newspapers, they will be liable for up to one year in prison and/or a fine.
    2. As far as possible, the victim, if female, will have the option of giving her statement to a police woman.
    3. If the victim is mentally or physically disabled due to the incident, the police must go to the location of their convenience to register the statement.
    4. If the victim is below the age of 18 she does not need to confront the accused.
  2. Introduction of 'stalking': They have now introduced 'stalking' in the Indian Penal Code which will allow the person to register a legitimate complaint if followed by another person and feels like their safety is being threatened.
  3. Person's past not a factor: The victim's past actions, sexual experiences and character shall not be considered relevant in the debate about whether or not consent was given.

Negatives

  1. Marital Rape is fine: This is the most shocking aspect for me. Among the many explanations for the increasing number of sexual assaults in India was one which claimed that men cannot view women as their equals, and rape is used to demonstrate their power. People were demanding a change in mentality, but that is obviously a slow process. What makes it harder yet are poorly thought out amendments like these which just reinforce the out-of-date belief. This amendment has failed to change - in fact it has further reinforced - the idea that the husband owns his wife: Marital rape is yet again explicitly made an exception to the rape law.
  2. Guilty unless proven innocent: In standard criminal proceedings each person is considered innocent until evidence demonstrates their guilt at which point the obligation to prove their innocence shifts to the accused. However, this amendment seeks to change this fundamental principle: Now, if a girl accuses you of rape you will have to demonstrate how you did not do it. If, for whatever reason, you are unable to give evidence, and it comes down to your word against hers, you will be convicted and branded a rapist. If your former girl friend decides she wants make you pay for dumping her, she can claim you raped her the last time you were together and since you were alone, there is no way to disprove her.
  3. Age of consent: The age of consent for an unmarried woman remains at 18 years. In developed countries if a minor (less than 18 years of age) is involved in a sexual experience with an adult, it is considered statutory rape. However, if two minors are involved it is not considered rape. In India that will not be the case. If your high school sweetheart's parents discover, and are not happy about, your physical relationship - they can just as easily accuse of you rape even if your girlfriend testifies it to be consensual.
  4. Increase in severity of sentence: My earlier blog post (referred above) discusses this point in detail. Increasing the punishment for a crime just decreases the marginal cost of going a step further to murder or something as gruesome. For a full read visit - Don't let them off this easily.
This amendment has been a great disappointment. Just like during the Lokpal movement, the government has yet again managed to escape without actually giving much to the public's demand. This case is not a total loss, but there was so much more to achieve that the little difference that it did make seems insignificant.

Thursday, 28 March 2013

Financial Sector Legislative Reforms Commission (FSLRC)

Need for a revamp of the financial sector laws in India

Just like fashion, laws tend to go out of date with time. However unlike your wardrobe, changing legislations is a painstaking process. Not only do you have to recognise the modifications required, it has to also go through intense scrutiny before it is tabled at the Parliament where stakeholders and interested parties lobby creating a great struggle to pass the simplest change. Thus more often than not, the Government ends up making small add-ons or modifications to the existing laws which, they hope, will be easier to pass, i.e a quick fix.

This would not be as big a problem if our legislations were principle based; defining the basic expectations of the rights and duties that the legislation is generating. However due to the detailed nature of our legislations each additional add-on/modification has implications on several other parts, which often creates a mess. The idea is similar to a football team with a distinct game-play. Each player plays an important role in the teams overall strategy. Suppose an integral player retires and instead of rethinking their game-play or finding a player that will suit their style, the manager fills the gap by buying a player without much thought. If this process is repeated a few times the entire nature of the team will change and it will stop functioning properly. Players which complemented each other might be replaced by players with conflicting styles. Just like the football team, our legislations too face a similar doom.

There are over 60 Acts and several rules/regulations in the financial sector with some of the laws dating back decades. This is especially inconvenient due the the major changes in the financial sector landscape through the reforms over the years. With each passing round of amendments these laws have become increasingly complex and ambiguous.

What is FSLRC?

The Financial Sector Legislative Reforms Commission was set-up in 2011 by the Government under the Chairmanship of the former Chief Justice of India, Justice Srikrishna. Recognising the problem explained above, the Government set the objective of this commission to harmonising and simplifying the complex and often ambiguous laws of the financial sector in India. For the last nine months I have worked as a member of the Research team that fed into the Commission.

What to expect?

After two years of deliberation and research, the Commission has made its submission to the Ministry of Finance. Volume I of the submission is a detailed report which explains the concepts and argues the case of each of the recommendations made by the Commission. Volume II is a draft Code which entails the actual legislation. This is distinct from previous commissions and committees in this regard as for the first time the law was drafted by the Commission itself.

Another Commission - Another Report - Another waste of time

Some people I have met seem to have the resigned to the attitude that these Commissions, and all the hard work put in them, is a waste of time as our 'corrupt leaders' will not do anything with the research. The track record for India supports their attitude, however as I see it, you have to try and try till you succeed.

What gives me more confidence that this report stands a better chance of implementation is the economic climate of the country. With growth at its all time low and credit rating agencies threatening to categorise the Indian bond as 'junk' (BB) the leaders of the country have a lot to answer for. Furthermore, this law will effect only the financial sector which are big corporates and institutions; not the people who make up the vote banks. Even the corporates which look at the long term and doing a clean business should welcome the reforms unlike the ones which are cozy with the existing regulators. The major obstacle, however, will be the existing regulatory agencies themselves. With the wide spread changes in their jurisdiction, powers and structure, the regulator will probably resist the changes vigorously.

Why should you care?

Policy, politics and finance are all topics that many find too boring or just not important enough to care about it. I am not preaching that an in-depth understanding of the subject is necessary, but finance plays a huge role in each of our lives. It does not matter if you do not have a finance based job, in the end you will need finance to run your own budget. You use 'finance' when you purchase an insurance; when you use EMI for the payment of your cars; when you start saving for your pension etc. Furthermore, it is the financial sector that has the biggest impact on the economy and its growth, thus touching all our lives and livelihood. These laws may dictate the future rules of finance and thus it is important that we give it the attention it deserves.

Thursday, 31 January 2013

Understanding Direct Cash Transfers

In their recent burst of policy reforms, Congress introduced the concept of Direct Cash (or Benefits) Transfer. The idea is simple: Instead of subsidising goods/services for the people and taking the responsibility for it's distribution, the Government will now use the Unique Identification, or the Aadhaar program, to directly transfer monetary sums to each person's bank account. These accounts would be created for each beneficiary who will have access to it via a local vendor.

Upon unveiling this reform, Congress instantly came under heavy firing for both the policy and their motives behind it:

  1. Buying votes: Congress has been accused of using this reform to transfer large sums of money to the electorate and in effect buying the votes of the less well-off. This criticism is particularly supported by the timing of the reform and the rush with which Congress is attempting to implement it.
  2. Speed of implementation: India has had a long history of distribution of such subsidised goods and services via the government. The ration card is universally recognised in India and the people feel comfortable with that in their possession. Changing such a long tradition within a span of 2 years is going to be incredible difficult. Not only do they have to design the entire process for flawless delievery of money, but also educate the public about it. If either of these goes wrong, several million people will suffer.
  3. Lag in increasing benefits: Among other concerns is that the prices of the goods/services will increase based on the market forces which can happen rapidly. Where as the decision on the amount of money being transferred will be done by the Government process which can be slow and tedious. The people fear that there will be time spans when the money being transferred will not be enough for the market prices. To be fair this is one of the reasons for the government to move to direct cash transfers so that they are not committed to subsidise the goods no matter what the price, however this leaves the beneficiary with the potential burden.
  4. Will add to the deficit: There is also a fear that Congress might introduce this policy and continue the Government delievery mechanisms thus doubling the burden on the national exchequer.

The concerns and criticisms above are all valid and yet one cannot argue against the policy itself. If we were to assume that the Government does execute the policy properly, then the benefits are several:

  1. Targeted subsidy: Instead of providing the good/service at a particular price to everyone, the money can now be transferred to targeted socio-economic groups based on the needs. Using the UID mechanism the government will now be able to make sure that there are no replications and recognise the people most in need of the benefits. This will save resources and thus allow greater benefits for the people in need.
  2. Flexibility in consumption: So far, individuals entitled to benefits were given a quota for each good/service. For example x number of gas cylinders per year. Thus to utilise their benefits, the consumer had to buy that number of cylinders even if they did not need it. With direct cash transfers, the subsidy that the government provided for the those x cylinders will now be available to the consumer who may choose to utilise the money based on their individual needs.
  3. Reduction in leakages: With direct transfers, the elaborate delievery mechanism run by the government can now be avoided. This will reduce the power of the babus sitting in the government offices and thus reduce the scope for corruption and bribes. Opportunities for the same bureaucrats to seize the goods and sell them on a black market will also be removed allowing the benefits to actually reach the intended targets.
  4. Erosion of Government monopoly: With the money now in the hand of the people they are no longer forced to deal with the government delievery mechanism and can purchase their good/services from a 3rd party private vendor. This will allow multiple benefits: The consumer will benefit with better quality goods, the businesses will benefit with the increase in market size and the efficiency in these markets will improve due to competition between private parties.

However, there was a big 'if' in my argument. These benefits will only be realised if the execution is done well. The speed with which Congress is trying to execute the policy is my biggest concern. Changing such a long standing status quo should be done with more care. It gives me hope however, that since they are banking on this policy to win them the next election, they will ensure that the public does not suffer. But will this mean smooth execution or running parallel systems of subsidies and direct cash transfers? We will have to wait and see.

Friday, 18 January 2013

Foreign Homosexual Couples Barred from Renting Surrogates

Surrogate mother is someone who rents out her womb to carry and give birth to someone else's child. These are used by people who, for whatever reason, cannot (or choose not) bear the child themselves. The idea is not foreign; our ancient Hindu scriptures demonstrates how the idea was conceived eons ago. For example, Balarama (reincarnation of the Snake God, brother of Lord Krishna) miraculously moves from the womb of Devaki to Rohini to avoid being killed by his cruel uncle.

Recently, the Union Home Ministry has issued stringent guidelines regarding visas issued to foreigners seeking to 'rent a womb' in India. Most of the recommendations seem sensible although cumbersome. However, there is another clause that bars homosexual couples from this service.

India has for long discriminated against homosexuality. Up till 2009 it was illegal for two members of the sex to have sexual intercourse under Section 377 of the Indian Penal Code. It was only after the Delhi High Court struck it down citing a direct violation of the fundamental rights provided by the Indian constitution that homosexuality was properly recognised. Now a branch of the Government has gone to create another hinderance for people with this sexual orientation. These are new regulations and the fact that our leaders are still thinking along these lines is, while not surprising, irritating.

India moves ahead, our leaders pull us back.