A Blunt Regulatory Knife

Written on August 5th, 2012 by Deepak Shenoy Imagine criminals that have sophisticated guns, satellite radios, bombs, strong armour, GPS trackers and fancy cars. And imagine someone has been given the task of "policing" them from a bullock cart, with only bows, arrows, and a sign that says "Stop, or I'll say stop again". In the civilized world, it would be entirely unnecessary to kill the regulator. As long as you have the technology, you just have to get away in your car when a bullock cart chases you, and let your armour take the brunt of any bow or arrow that's fired. This is how our regulatory system is. Bernie Madoff was "discovered" at about the same time that Satyam founder Ramalinga Raju admitted he fudged accounted. Mr. Madoff is now cooling his heels in jail, where he will be for the rest of his life. Ramalinga Raju's only relation with heels is that he's probably getting a pedicure - he is out on bail and the cops haven't even been able to cobble together a case. That story isn't the only one. The 2G scandal involving A. Raja hasn't seen a conviction. The Adarsh housing scam is still "under investigation". The Commonwealth Games scam, the Tatra scam, and even the Fodder scam of 1996 (which has only recently seen charges framed!) It is no wonder that fraudsters operate with impunity. We just do not convict white collar criminals in India. It's not just plain outrage. In many cases the penalty does not even meet the scale of the crime. Recently, the Insurance Regulator, IRDA, passed an order against HDFC Life Insurance, asking it to pay a fine of Rs. 35 lakh. The crime? That it paid certain linked corporate agents, like HDFC Bank and HDFC Securities, excess money in the name of "marketing expenses". They were paid Rs. 428 cr. and 133 cr. respectively, which was more than 2.5 times the money actually spent. Think about it. You spend Rs. 200 cr. You get reimbursed with Rs. 428 cr. And you pay a Rs. 0.35 cr. fine. You'll take that deal every day of the week. And it's not IRDA's fault it seems they can't fine more than Rs. 5 lakh per "instance", and there were just seven instances. SEBI, the securities regulator, had provided a "consent order" against Anil Ambani and his aides in 2011, allowing them to pay Rs. 50 crore and banning them from the securities market for about a year. It has turned out that in an enquiry, a UK Tribunal found that a certain Sachin Karpe had created a front for Ambani's RCOM, using a Swiss bank account and a Mauritius entity to trade RCOM shares. The profit?

Potentially, Rs. 600 cr. A fine of Rs. 50 cr. with a meaningless ban, to earn (and keep) a profit of Rs. 600 cr? That is one sweet deal (and SEBI doesn't even have the limits that IRDA does) But it's not always the regulator's weakness. A regulatory order can be appealed at multiple levels, which in India just means a very long delay. Case in point: a brilliant order by SEBI against the Sahara group essentially cancelling a debt offering of over 20,000 cr. has been upheld by SAT and then has been stayed by the Supreme Court, and could take a long time to run through. While the appeal process is a principle of justice, it would indeed be a shame if the system is being subverted only to buy time. Recently the Competition Commission of India fined certain cement companies over 6,000 cr. about half their profits of the last two years for forming a cartel and hiking up prices artificially. It had earlier fined DLF over 600 cr. for abusing its market dominance in Gurgaon. Both these awards have gone on appeal, with a tribunal asking CCI to justify the fine amount in the DLF case. A proper method to calculate fines, with an additional amount for punitive damages to discourage other wrongdoers in the future will solidify the case for CCI. When regulators overreach, there may be further trouble and a need to counterbalance them. And it causes damage when a regulator is a participant as well. The Reserve Bank of India is a bank regulator it is the lender of last resort and the authority all banks must report to. Yet, it is also a player in the foreign exchange market. It is also the merchant banker to the government for selling GOI bonds. These introduce unnecessary complications; these functions should be moved out into independently managed institutions, even if the initial manpower comes from the RBI. Regulators need to be able to disgorge all profits and then charge further fines. If a bank mis-sold a policy to you, the bank should not only reimburse the policy amount, but also pay a fine, part of which goes to you. If a promoter earns illegal profits through insider trading, the full profit should be paid as a penalty with a further fine, including 18% interest for the time they enjoyed the money. Appeals should be dealt with swiftly, in all channels including the Supreme Court. Regulators needs strength and teeth. If we are outraged that doctors can get away with murder or that the ICAI has not still taken action against the Chartered Accountants at Satyam, we need to force our government to give the regulators more power, and provide the public accountability through mandatory reporting and RTI based disclosures. After all, you can't take a knife to a gunfight.

Definition of 'Sovereign Bond' A debt security issued by a national government within a given country and denominated in a foreign currency. The foreign currency used will most likely be a hard currency, and may represent significantly more risk to the bondholder. Investopedia explains 'Sovereign Bond' The government of a country with an unstable economy will tend to denominate its bonds in the currency of a country with a stable economy. Because of default risk, sovereign bonds tend to be offered at a discount. Brady bonds, which are issued by governments in developing countries, are a popular example of sovereign debt securities.

Quasi-Sovereign Bonds to Quasi-Close the Deficit

August 13th, 2013 by Deepak Shenoy The idea is to use quasi sovereign bonds , which means the debt is not being taken on government books, but if these companies were to default, the government will implicitly guarantee them. Any drop in the dollar-rupee equation or the interest paid out on these quasisovereign bonds will have to be paid by these companies. However it is unclear what they will do with the money that will yield the kind of return these bonds will have to give to be attractive. However, I would, rather than trying to borrow this money from abroad, simply have RBI lend them the money and replace the dollars with government securities. Why? Because it really *is* government debt and the return from long term infrastructure financing is actually gained by the government (you may not pay for the road, but trucks and hotels and shops and real estate near the road will pay taxes) Second, because the dollars on the RBI balance sheet finance the US, not India, and we could easily just use them instead. I know its considered a sin to have dollar reserves depleted, but I ask you to stop and think for a moment about why we even need dollar reserves if we have a longer term goal to convert our trade to rupees instead, or to make the rupee fully convertible, these reserves are useless at this magnitude. We can easily cut them to half and be all right, especially if we could mark half of our gold and oil trade in rupees. Third, think of $11 billion as a tiny tiny part of what the RBI holds over $270 billion. Think of it in terms of trading volumes on the forex markets which is probably $5bn in just markets in India, and there are non-deliverable forward markets outside the country. The $11 billion helps, but its a tiny amount, even if it is the maximum these steps can yield. We are a large nation now, and thinking like 1992 will make us look really stupid, especially if we understand that we are, in reality, way too big for a rescue by the IMF or any such body. It is much better to simply forget the rupee, and instead, focus on things like infrastructure, labour reform and reducing government size. The step I recommend above (RBI selling dollars to buy government securities which are given for infrastructure only) is key to that thinking. The rupee-dollar rate does not, and should not, matter, even if it impacts us in the short run. What we want, if were thinking of our children, is a more competitive economy.

Why Chidu's quasi-sovereign bond issue is a stupid idea

Aug 01, 2013, 01.20 PM IST R Jagannathan

Vinaasha kale vipareeta buddhi, goes a Sanskrit saying. It means, when one's downfall or destruction is at hand, one acts in a deluded state of mind. Those who prefer Latin, could try this: Quem deus vult perdere, dementat prius. Whom the gods would destroy, they first make them mad.

The actions of the UPA cabinet over the last few months confirm the applicability of these statements to it. Which is why there is feverish activity to prove both that poverty has fallen, but that you still require a food security bill for two-thirds of the population. Which is why just one man talking governance in Gujarat makes a whole pack of Congress ministers jump in to attack him.

Final proof comes from yesterday's press conference of P Chidambaram, who completed one year as finance minister. Despite the outward calm and confidence, the pronouncements of the sanest minister in the cabinet have started betraying a sense of panic and delusion.

A case in point is the issue of whether the country should issue a sovereign bond abroad to shore up foreign exchange reserves. In the alternative, given the Reserve Bank of Indias (RBIs) opposition to the idea, the finance minister said, we could consider a quasi-sovereign bond issue (or issues) by state entities such as banks or cash-rich public sector companies. "All options are on the table".

It is only a few months since the country abandoned the idea of floating a sovereign wealth fund (to invest abroad). Now it wants to float sovereign fund (to borrow from abroad). Swinging from one extreme to another, how delusionary can the government get?

If Chidambaram really wants to help the rupee find its feet, the sovereign/quasisovereign bond issue should be off the table for now. It's a stupid idea. It can only damage us as it sends two wrong signals at the wrong time: one, that the government has been spooked on the external front; and two, that it does indeed have a limit for the rupee's depreciation.

Gone is the old assertion that the government does not have any value of the rupee in mind. It is only concerned about volatility. By musing aloud about sovereign bond issues, et al, Chidambaram has just made the rupee even more volatile-especially after saying that the short-term liquidity curbs announced by the RBI to shore up the rupee will go once the currency stabilises. There is now concern in the markets about that the government will do to mess around with the rupee.

The truth is the government is deliberately reading the message in the rupee's fall wrongly because it threatens to expose the accumulated economic follies of the UPA under Sonia Gandhi just before the election.

What is the rupee really telling us when it hits Rs 60-61 to the dollar regularly? Many things, and four in particular.

First, inflation has eroded the real value of the currency. And so it should be priced lower against the dollar. Consumer inflation is nearly 10 percent, and may rise further.

Second, the country has accumulated too much dollar debt (USD 400 billion). So it should start deleveraging and cutting exposures to external creditors.

Third, exports are uncompetitive. So the rupee needs to be cheaper to give our exporters an edge.

Fourth, the country is over-consuming compared to its productive capacity. This means primarily the government, whose fiscal deficit this year has reached 48 percent of the annual target in the very first quarter. We have swallowed six months of the planned fiscal deficit for the whole year in three months.

Any school economics textbook will give you answers to these problems: reduce external debt little by little, remove bottlenecks to exports, allow the exchange rate to reduce imports naturally, keep interest rates high to improve the supply of savings in the domestic market and discourage overleveraging, and start cutting flab in government, especially on unproductive subsidies.

The government is doing the exact opposite. It is talking of sovereign/quasisovereign bonds and making plans to increase external debt. It is trying to raise the

rupees value by artificially constricting liquidity without formally raising interest rates; its import compression measures may end up reducing exports since it is difficult to separate imports that go into export production from imports that are merely for consumption; it is trying to say that rates must be cut, when the opposite is the need of the hour; and it is planning to spend even more on subsidies (for fuel, fertiliser, and food, and now even exports) in the coming months.

So how is the rupee going to benefit? If a 25 percent reduction in the rupee is not going to help exports, will an additional 1 percent interest subsidy on export credit (from 2 to 3 percent) help?

Granted. There is a short-term financing problem, where the country needs more dollar inflows to cover this year's anticipated current account deficit (CAD) in the range of USD 80-100 billion.

Granted. In the short term, as long as the external crisis persists, there will have to be some kind of import compression. If this means stamping out gold and luxury goods imports, so be it.

Granted. Exporters need a boost for the same reasons. So incentives for higher exports sound like par for the course.

But are these solutions? Is floating a sovereign bond issue abroad-or getting public sector companies to do so-a solution when foreign exchange reserves are at USD 251 billion (excluding gold)? Is raising more foreign debt at a time when dollar rates are set to rise even wise? The 10-year US Treasury bond has a yield of 2.65 percent right now. Add hedging costs, and the real borrowing costs will be closer to 9-10 percent for any quasi-sovereign borrower. Why does the government want to borrow at 10 percent abroad when it can get the same money at 8-8.5 percent at home? What is the point in giving foreigners a higher return when you want to deny the same to Indian savers?

And does the idea of using the State Bank or Coal India to raise dollars make sense for them? The SBI does not need dollars at such high cost for its business. It will borrow only if the government bankrolls the cost. Thats more subsidies. Coal India or ONGC do not need dollars at such costs when they are sitting on cash piles. Why sacrifice profitable companies at the altar of political expediency? Are taxpayer assets like SBI and Coal India or ONGC expendable in the Congress party's reelection quest?

Quite clearly, Chidambaram is practicing bad economics in the name of good politics. Actually, bad politics is screwing up the good economics he had in mind when he returned to the finance ministry.

Here are four simple things Chidambaram can do to revive sentiment.

One, announce that the food bill will apply only to the 22 percent of Indians below the current poverty line. More people will be covered, if needed, when the fiscal situation improves. They are anyway covered by the current public distribution system.

Two, oil prices-at least diesel-should be raised to break-even levels in one go rather than over several months or years. This will cut the fiscal deficit instantly-at the cost of short-term growth. But the message it will send the markets and investors is very, very positive. Capital inflows will automatically follow. Chidambaram will actually have more money to spend on infrastructure, which will revive growth in 2014-15.

Three, he should announce that all projects stuck for environment reasons will be automatically cleared as long as they involve compensatory afforestation, investment in green technology, etc. After a year, these norms can be made more transparent and even more stringent, but now is not to time to hold up anything for green reasons. The same goes for iron ore exports.

Four, the land bill should focus on adequate rehabilitation and compensation, not fixing the multiple payable over market prices for land purchases. The land bill has the potential to kill of growth for at least the next three years.

Sovereign bonds, quasi-sovereign bonds, food security, export subsidies and import compression are short-term economic or electoral placebos that will make the disease worse. They make sense only if the idea is to win the election, but write off the economy for the next three years.

The writer is editor-in-chief, digital and publishing, Network18 Group