What should we do? Now that Mumbai carnage has ended.

I am writing this response to the lively discussion that is going on in our shoutbox about terrorism. My response to comments from cvrk and others...

What we see in most of the Middle East and North Africa, no doubt is terrorism, but of a civil war variety, barring what goes on in Palestine/Israel, which is pure civil war cum terrorism going hand in hand. The issue is not whether or not there is terrorism in those places. The issue on the table is: Is the rule of law prevailing there, to be dismissed as regressive?

When heinous crimes are committed, would it not be time to take a re-look at our humanitarian outlook of the rule of law? I think a time has come for the entire humanity to reconsider the definition of rule of law. Remember the fate meted out to William Wallace in the hands of the law of Longshanks? So heroically played out by Mel Gibson in Braveheart? Or remember Judge Dredd played by Sylvester Stallone? I wonder whether or not it is time we have such judges?

Tell the mother who has lost her son fighting terrorists that the present day rule of law forbids Longshanks laws. Plead with the wife who has lost her husband to let the captured terrorist serve a life term (which can effectively mean no more than 14 years) in jail and come out free; perhaps to commit more such attacks on release. Enjoin the mother of a Major Unnikrishnan or an Ameena Begum to be patient with the process of judicial system as the rule of law provides for a certain procedure to be followed before a terrorist can be sentenced. They do not know whether the rule of law sentences them at all and even if sentences, whether or not the sentences will be carried out ever! Remember Afzal Guru? Even after being convicted more than three years ago, he still is ensconsed safely in Tihar jail. Perhaps biding his time to come out one day and may be he will succeed the next time to bomb the very President of India who gave him clemency!!

It is this that I am riling against. Asking and getting the head of home minister, a chief minister or the government is not the solution. Not even bombing the country which supported such activities,as experience has shown that such bombing has only complicated the matter rather than finding a solution. An America could do it because it did so in addition to what it has done by way of strengthening the anti-terror infrastructure. It is time for the entire humanity to sit up and take notice that the kind of rule of law that we have in place is not simply delivering results. The political system that we have kept in place has miserably failed to protect the life of the common man. While the common man is felled by the terrorist bullets, why should there be VIPs, VVIPs and VVVIPs who are protected by NSG? Let such protection be there only for a few like the President, the PM, the Speaker and the Chief Justice of India. When the common man is vulnerable to the bullets of the terrorists, let the Home Minister of the country also be equally vulnerable to the same bullets. Is it not after all his duty to ensure that the country remains a safe place to dwell? As much as sons, daughters, wives and husbands appear replaceable / substitutable in the ethos of these VVIPs, let them also know that they are also equally replaceable. What if one home minister falls to a bullet? There will be somebody who will be ready and eager to occupy his gaddi.

Stages of economic development

This piece is written in response to a shout-box query on factor driven economy.

The earliest stage in economic development is recognized as a factor driven economy. In this the economic growth is recognized as primarily the result of mobilization of primary factors of production viz., land, primary commodities and unskilled labour. Contrast this with economies which are investment-driven. In the latter, economic growth is largely seen as the result of harnessing of global technologies to local production. This stage transforms itself into innovation-driven economy when there occurs an improvement in technologies that support economic growth. Largely this is how economic development / growth is explained.

Have more time or want more detail? Follow this piece. This is a ten page piece from the who's who of economics. Michael Porter, Jeffrey Sachs & John Mcarthur. Once in a while you should read such pieces. They will do you a lot of good and enhance the 'extensive' reading background that you get to possess over a long time.

Infrastructure creation and job creation; a debate

I try to answer below questions from two of our readers in the shout-box. Their questions are excerpted below for ready reference:

27 Nov 08, 15:19
Ashish: Pardon me Sir, but how does public expenditure in infrastructure will generate demand, apart from creating some job opportunities. What r the other constituents of demand generation, apart from jobs.

Mayank: He was discussing about the negative side effects of job creation in government sector and preferred government's financing private sector infrastructure creation for job creation.

My response:

It is more about creating jobs at the lowest level. The casual labourer, the low wage earner and small time employee. If about Rs. 50,000 crore is being spent on creating infrastructure, a substantial portion of it will go towards creation of such jobs directly. Then there is the indirect job creation because of the material being used, the operation of the infrastructure etc. This will lead to further creation of jobs and assets. That is how a virtuous cycle of creating demand can be commenced. More jobs means more money in the hands of large number of people. That means their spending for consumption. That will in turn create more demand for goods and services and in turn lead to further creation of jobs. Hope you can get the concept. The question is much more about creation of jobs; it is less about creating it in public sector or private sector. What we meant by 'government spending' was in the context of reports that the government is thinking of boosting invetment infrastructure by encouraging private investment i.e., largely through giving loans from the government coffers to business houses in the context of tightening liquidity conditions. Instead of that if the government spends directly on infrastructure creation, that will have a direct impact on job creation across various levels.

Whatever increases general consumption from the people is what leads to demand generation. This can include keeping more money in the hands of the people or lowering the prices of goods and services. Keeping more money in the hands of people can be achieved by, apart from employment generation, lowering taxes -- both direct and indirect and also by strengthening currency so that the same amount of currency can buy more goods and services. Lowering of prices can be achieved by deflation, lowering inflation, lowering indirect taxes and by strengthening currency.

Hope it clarified something for you.

Why is the India story intact?

Some fresh thoughts and points to ponder from Samir Arora, the CEO of Helios Capital Management, Singapore.

Till the other day we were listening to expert opinion which said the farm loan waiver was bad and the non-opening up of our banking and insurance sector to FDI was wanting and is not in consonance with the way the developments in the developed world are progressing. And then suddenly we find that our huge forex reserves are depleting at a rate which is worrisome. How should we read all this? It is an interesting and must read.

Some excerpts worth our attention:

A few months ago the government of India wrote off $16 billion of loans, made over the past decade or so, to more than 40 million farmers (at the rate of $400 per head) and was criticised by the whole world that economics was being sacrificed for the sake of politics. Now everyone (in most cases the employers of these "bearish on India" analysts) is asking for similar (and larger) and much more morally indefensible bailouts throughout the world.

Until a few weeks ago, investors were hoping that in pursuit of its reforms policy, the Indian government would accelerate the opening of its banking sector and insurance sector to foreign and private sector; and today all potential foreign partners are themselves seeking equity investments from their governments.

Last year India had less than $200 billion of foreign exchange (FX) reserves and I do not recall reading any reports that we had inadequate reserves which needed to be built up urgently. Now that FX reserves have fallen from $320 billion to $250 billion, economists are highlighting how we have had a record decline in FX reserves. It is a separate matter that more than half this fall can be explained by the strength of the US dollar which has reduced the dollar value of our reserves held in other currencies.

Indians (households) are the largest owners of gold in the world with their holdings estimated at more than 15,000 metric tonnes, currently valued at $400 billion plus. All the bearish doom and gloom analysts in the world have their price target for gold at $2,500 or higher. At $2,500 /ounce of gold, Indian households stand to make a paper profit of nearly $1 trillion (which is the same size as India's GDP). Contrast that with the total market capitalisation of the Indian market of $600 billion with Indian retail ownership of the market of around 20% and you can imagine why the average Indian may actually feel relatively much richer by the time the dooms day scenario comes along for the rest of the world.

Why is America to be blamed for the present financial crisis?

Some excerpts from a recently written piece by Nobel laureate, Joseph Stiglitz

We all know that the current global financial crisis has had its roots in the American mortgage market. That was just the beginning. There were quite a few other reasons / contributory factors that led to the present sorry state of affairs -- all because of America. If you are asked to list them out, can you do a better job than this one from Joseph Stiglitz?

America exported its toxic mortgages around the world, in the form of asset-backed securities. America exported its deregulatory free market philosophy, which even its high priest, Alan Greenspan, now admits was a mistake. America exported its culture of corporate irresponsibility – non-transparent stock options, which encourage the bad accounting that has played a role in this debacle, just as it did in the Enron and Worldcom scandals a few years ago. And, finally, America has exported its economic downturn.

In spite of all this the world still loves America! Why? Why does pumping money into America make sense? Even for the third world countries?

Remarkable as it may seem, America, for all its problems, is still seen as the safest place to put one’s money. No surprise, I suppose, because, despite everything, a US government guarantee has more credibility than a guarantee from a third-world country.

What's been wrong with the IMF policies?

Traditionally its recipes included fiscal and monetary contraction, which would only increase global inequities. While developed countries engage in stabilizing countercyclical policies, developing countries would be forced into destabilizing policies, driving away capital when they need it most.

Interest rates and reserve requirements

I was asked the following question yesterday in the Indian Current Affairs shout-box.

"When Federal bank of USA reduces interest rates, what rate exactly is that with context to RBI's? Is it in relation to CRR?"

The simple answer to the question is NO. The complicated answer is:

US Fed announces two different rates: the discount rate and the federal funds rate. The discount rate is the interest rate charged by the US Fed on the loans it gives to commercial banks. The federal funds rate is the interest rate at which banks lend to each other overnight. The US Fed only prescribes a target federal funds rate.

In contrast, the RBI announces only the bank rate. This is the same as the US Fed discount rate. There is no equivalent for the federal funds rate from the RBI. Instead, it announces its repo and reverse repo rates. Market rates (i.e., lendings and borrowings among the market participants) are determined based on these repo and reverse repo rates. Repo rate is the rate the RBI charges for the money lent by it to the banks. Reverse repo rate is the rate which it gives to the banks for lodging money with it. Both these types of transactions are backed by securities. In a repo transaction what happens is the banks lodge securities with the RBI in return for money. So, in effect what a repo transaction (a repo for the banks) does is infuse liquidity in the market. A reverse repo (for the banks) drains liquidity from the market.

Comparing rates with CRR is not correct. CRR and SLR are reserve requirements. That is, banks are mandated by the RBI to hold certain amount of money in the form of cash or invest a certain amount in prescribed securities. The US Fed has similar reserve requirements for banks operating there.

The US Fed has a single reserve requirement. It is at present 10% of the deposit liabilities of the banks. I am sure all of you know that RBI mandates two different reserve requirements: the CRR and the SLR. The former is the amount of funds that the banks have to keep with the RBI. The latter is the amount of money that the banks to keep invested in RBI approved securities to meet their liquidity requirements. We have covered about them in detail in this Disover-It post. However a repeat would be in order here:

Statutory Liquidity Ratio -- SLR, is the percentage of net demand and time liabilities of a bank that has to be maintained by a bank with the RBI. This can be in the form of cash, gold or approved securities. This percentage currently is at 25%. The Banking Regulation Act, 1949 actually prescribes a floor and ceiling for this percentage. The floor is at 25% and the ceiling is at 40%. That is, the RBI can't impound more than 40% of the net demand and time liabilities of banks nor can it prescribe a percentage which is below 25% for this purpose. It has to operate within this band. But recently the BR Act, 1949 was amended doing away with the floor. This gives RBI flexibility to prescribe a percentage of SLR which is lower than 25%. On the SLR funds, the RBI has to pay interest to the banks. It is currently at 6.5%.


Contrast this with CRR -- Cash Reserve Ratio, wherein the Bank has to maintain a certain percentage of its net time and demand liabilities in the form of cash with the RBI. CRR at present is 6. On the CRR funds, RBI will not pay any interest to the banks.
You can take the ‘net demand and time liabilities’ broadly to mean the deposits of the bank. Why this term is used is that many a time there will be situations in which the deposits figure will not be reflecting the actual deposits. It is the ‘net’ figure that is to be taken and not the ‘gross’ figure. Demand liabilities are those that have to be paid by the bank on ‘demand.’ And ‘time liabilities’ are those that have a time within which the bank has to pay these liabilities. Time deposits like bank FDs (Fixed Deposits) come under this ‘time liabilities’ category.

Note: This is one important link that gives a good explanation of repo and reverse repo rates.

Education as fundamental right

I am prompted to write this post because of a question in the shout-box on Indian Current Affairs. The question was to the following effect:

"When the Constitution of India already has the 86th amendment, guaranteeing right to education as a fundamental right, where is the necessity for the government to introduce yet another bill in the Parliament?"

It is a good question. To understand the answer, take a look at the 86th amendment first. What does Article 21A now read as? It says that the State shall provide free and compulsory education to all children in the age group of 6 to 14 years, in such manner as the State may, by law, determine. This highlighted portion is the key.

The Constitution amendment has just given an enabling provision. It is for the State to come out with an appropriate law that prescribes the method and manner in which this fundamental right is to be secured for the citizens.