Europe - graphical status report

Excellent graphical picture of Eurozone in the Times. The GDP is estimated to contract sharply in all the peripheral economies, including Spain and Portugal.














Their respective banking sector assets are atleast double the size of each economy. And the ratio of bad loans have been mounting.



















Debt to GDP ratios have surged and are at unsustainable levels. Borrowing costs have accordingly risen steeply.

















Unemployment rate are very high and with economies contracting, there is limited prospects of the labour market improving any time soon.
















Greece, Ireland, Portugal, and Spain have so far received banking bailout funds.

Catalysing the growth of microinsurance in India

Microinsurance, which is the provision of insurance against specific perils to low income people, has the potential to follow mirco-credit and emerge as the next big business opportunity at the bottom of the pyramid in the financial sector. Microinsurance products which insure for healthcare and death, when combined with an investment opportunity, offer several attractions for low income people.

In India, since 2002 (with subsequent amendments) the Insurance Regulatory and Development Authority (IRDA) has mandated that all insurers provide a specific share of their policies in rural areas and social sectors. Insurers are required to provide 7% of new life insurance policies from rural areas from their first year and this quota rises to 20% over ten years. Currently there are 6 million such life insurance policies and 10 million in non-life insurance policies. The Indian microinsurance market is estimated at between 140-300 million policies. 

This policy mandate has played an important role in forcing insurance companies into rural areas and the low income people. This is all the more so given the meagre penetration of insurance products in India, the ample opportunities available for insurers from marketing their products to those in cities and at the upper half of the income ladder, and the high transaction costs associated with selling low value insurance to the poor in rural areas. But it has led to some innovative business models, where insurance providers have sought to leverage microcredit agencies and mobile phones to peddle their insurance products.

But such regulations also create distortions as insurers try to game the market to avoid meeting their obligations. Some insurers offer products which are not customized to add value to the poor and are merely to meet the regulatory requirements, while others stop selling it once they meet their quota. The major share of insurers have no incentive to innovate and see it as an issue of regulatory compliance.

In the circumstances, a more effective strategy to achieving the objective would be to allow tradeable permits in such policies. The IRDA should permit insurers to meet their quotas either directly or by buying permits from the other insurers who specialize in microinsurance or those with surplus policies. This will in turn catalyze a niche market with specialized microinsurance products and which has fewer market distortions and where insurers have greater incentive to innovate and expand their market shares.

Observations on the mid-quarterly monetary policy review

In its mid-quarterly monetary policy review, the Reserve Bank of India (RBI) has decided to stay the course by keeping rates unchanged. In the backdrop of the recent dismal fourth quarterly GDP figures, the government, businesses, and several influential voices have been arguing that the high interest rates are adversely affecting growth. They, therefore, strongly advocate rate cuts to boost economic growth.

However, there are also several factors militating against any rate cuts. Primarily, real rates are lower than at any time in recent years. Core inflation has fallen below 5% and is on a downward trend. Further, the depreciating rupee, by making exports attractive and imports costlier, too has added to the inflationary pressures. Most importantly, the headline WPI based inflation rose to 7.55% in May from 7.23% in April, on the back of rise in prices of manufactured products, fuel and power and non-food primary goods. In addition, retail inflation too has been rising, lending credence to the view that inflationary expectations are not fully anchored.

Clearly, the RBI is worried by the recent upward trends in inflation and has preferred to focus on inflation, even at the risk of growth being compromised. It believes that inflation is a bigger worry than economic growth. It also believes that monetary policy, especially baby step cuts, may be ineffectual in restoring growth and the onus for that should be with the government which has to rein in its fiscal profligacy and also take steps to ease supply bottlenecks in infrastructure and agriculture. 

But there is a danger in persisting with tight monetary policy. Econ 101 teaches us that inflation can be either cost-push or demand-pull. In the former, negative supply shocks and other supply constraining factors contribute to increase in prices. In such conditions, interest rates can play very limited role in lowering inflation. In the latter case, inflationary pressures arise due to aggregate supply failing to keep pace with aggregate demand. Here, raising interest rates can help restrain demand growth and thereby lower inflation. 

The RBI's tight monetary policy stance since early 2009 has been dictated by the belief that inflationary pressures were being caused by demand-pull factors arising from an overheating economy where supply-side bottlenecks had become prominent. This necessitated raising interest rates so as to lower economic growth rates to sustainable levels. This strategy has worked nicely in terms of moderating growth and even bringing down inflation from its double digit levels of 2010.

However, now with growth having fallen well below the potential output (and thereby having attentuated the demand-pull forces), the potential for tight monetary policy to reduce inflation may be limited. In fact, high interest rates may be having the effect of restraining investments and thereby perpetuating the supply constraints. In other words, inflationary pressures may be getting built up by way of the higher interest rates discouraging investments.

If inflationary pressures are indeed being stoked through this channel, as they could be, then the RBI risks falling behind the curve. The downside risk of this is the possibility of an economy getting trapped in a stagflationary environment with high inflation and declining growth rates. Political paralysis will only compound the problems. A recovery from such situation may not be easy.


Hindsight may be the only way in which we can satisfactorily resolve the argument about which of the two, inflation or growth, is a greater problem facing the Indian economy at this point in time.

In any case, having decided to go along with the inflationary-forces-are-still-at-large hypothesis, the best that the RBI can now do is to wait for the first quarter 2012-13 GDP figures. If they do not show marked improvement, the RBI would need to moderate its inflation fighting stance and embrace monetary loosening before it becomes too late to stop a free-fall or self fulfilling downward spiral.

Another interesting feature is the fundamental difference between the respective policy approaches adopted by the RBI and the US Federal Reserve when faced with weak economic conditions. For sure, inflationary environments in India and the US stand at the two extremes. But whereas the Fed has thrown every instrument in the monetary policy arsenal so as to prevent the economy slipping into a deflationary trap, the RBI has been more circumspect about growth and has preferred to focus on inflation, even at the risk of worsening stagflation.

Whatever, the final outcome, the RBI should be complimented for sticking to its inflation-fighting strategy, even in the face of such overwhelming calls for rate cuts from the markets and the government. It is also a clear signal to the markets about its relative autonomy and a boost to its institutional credibility. In some sense, when we look back in history, the global economic tumult of the past five years may well be recorded as the time when the RBI earned its central banking spurs as a genuinely independent and professional central bank.  

Auditors and policy populism

Official auditors in India appear to have been bitten by the discounted cash flow (DCF) analysis bug. Ever since the news of the Rs 1,76,000 Cr loss causing 2G spectrum scandal broke out, auditors have realized the populist appeal of such assessments. The temptation to scrutinize every resource allotment decision exclusively through the lens of expected future cash flows is irresistible.

This auditing formula is simple. Scarce and valuable revenue generating public resources have been allocated on preferential basis at concessional rates, allegedly in return for massive amounts of bribes. These resources, when subjected to standard DCF analysis, are estimated to have benefited the private allottees with massive revenues (and profits) running into several decades. The net present value (NPV) of these future cash flows is calculated at the current market price of the resource. The allotment price is deducted from the NPV and the difference is declared as revenues foregone and resultant loss caused to public exchequer.    

The latest in the series of such auditor discovered scams is the development rights of the New Delhi airport allotted on concessional terms. The Comptroller and Auditor-General (CAG) claims that Delhi International Airport Ltd (DIAL) could earn up to Rs1,636 tr ($29bn) over 60 years from using government land leased at an annual ground rent of just Rs 100, on top of a one-time payment of $ 324m.

Auditors who put such valuations at the center of their exercise risk simplifying very complex business problems. Even assuming such auditing reports (any audit is after all based on certain assumptions and formulas), it is surely irresponsible for responsible people analyzing these reports to take such assessment at face value to the near total exclusion of all other factors. If the mainstream debate on complex and multi-dimensional policy issues is driven by such DCF-based revenues foregone assessments, policy populism and decision paralysis become inevitable.     

In recent months, there have been three high-profile instances of policy populism in very important areas. First was the draft mining bill, second the land acquisition bill, and the last related to the revised 2G spectrum auction process.

Mineral exploration and extraction has been the subject of intense scrutiny due to both the corruption involved and its environmental and social costs. In the prevailing discretionary, first-come-first-serve basis mining block allotment regime, price discovery was always a problem. The lack of clear policy regime and uncertainty associated with environmental and other clearances made this a very risky activity for prospective developers. In addition, since most of these mines are in the remote forests and interior parts, such mining activity invariably affects the lifestyles and livelihoods of tribals and other indigenous people. The sensational CAG report which alleged a $210 bn scam in preferential mine allotments and widespread environmental and local opposition to mining activity in any area drove the government into formulating a new mining policy. 

Under the proposed Mines and Mineral Development and Regulation (MMDR) Bill, 2011, it would be mandatory for coal mining companies to share 26% of their profits with people displaced by mining activities. In case of non-coal mines, the new law will provide for payment of an amount equivalent to royalty paid to the state government to project-affected persons. Apart from this, it also obligates mining firms to pay a 10% cess to state governments and 2.5% to the Centre on the total royalty paid.

It was, as part of this populist drive, that the government announced the "no-go" areas policy in mid-2010, which barred mining in many major coal bearing areas on environmental grounds. The move blocked the development of 203 coal blocks with reserves of a 660 mt – enough to fire a power generation capacity of 130,000 MW. Though this has been done away with, the Environment Ministry is now working on demarcating "inviolate areas" where mining will be prohibited due to high forest cover.

A few high profile cases of forcible land acquisition by government to build public infrastructure assets or to benefit private parties, like with the Special Economic Zones or Singur or Nandigram, saw a series of often violent protests by land losers in many parts of the country.The fundamental political rallying point was that it was plain unfair for the government to use its eminent domain powers to dispossess rural poor from their primary livelihood source, land, in the name of development. There was a clamour to replace the century-old Land Acquisition Act 1894, which in any case had other stifling provisions.

In response the Union Government drafted a land acquisition bill that swerved to the other extreme. Its provisions include payment of compensation that is four times the highest registered sale price in the last three years in that area, mandatory consent of 80% of people in those cases of acquisition where the land is to be given to private parties, those made "landless" to get Rs 2000 per month for 20 years, emergency acquisition clause to be invoked only when security of the people is involved, and so on. The recommendations of the Parliamentary Standing Committee includes the payment of five times the market price of land acquired, returning 20 per cent developed land to the owner, job guarantee for next 20 years, and 70 per cent consent of land owners for any acquisition for commercial purposes.

The Land Acquisition, Rehabilitation and Resettlement Bill 2011 (LARR) is currently awaiting parliamentary nod before being promulgated into law. And even this fairly generous bill is being rubbished as being too little. Even a cursory reading would indicate that the draft bill goes much beyond the basic requirement of fairness in compensation and relief and rehabilitation package, and clarity in the definition of "public purpose".

In response to the Supreme Court's decision in February 2012 to cancel the 122 2G spectrum licenses, the government initiated the process to auction spectrum through competitive bids. The telecoms bureaucracy was then asked to fix the auction reserve price and other bid parameters. It was also decided that the spectrum would be technology-neutral, thereby allowing bidders to provide 2G, 3G, or even 4G services with the spectrum. Accordingly, the Telecom regulatory Authority of India (TRAI) recommended a reserve price of Rs 3,622 crore for 1 MHz pan-India spectrum, which is around 10 times higher than the price at which 2G licences were allocated in 2008.

Not to be outdone, while scrutinizing the TRAI proposal, the Department of Telecom (DoT) went one step further and hiked the reserve price by a further 17% to Rs 4,245 crore per unit. It also rejected the TRAI's proposal to allow telcos to stagger payments for spectrum over a 12-year period and the permission for telcos to mortgage spectrum to raise funds from financial institutions. The clarification by DoT officials on the rationale for the price fixation was revealing,

TRAI had determined the reserve price in the 1800 MHz band based on the 3G auction price of 2010. We feel that 3G auction price must be indexed for a period of two years to determine the present value of spectrum. During this period, State Bank of India's PLR rates have been between 11.75-14.75% and therefore the revised figure works out to Rs 4,245 crore for every unit of 2G spectrum in the 1800 MHz band.

Consider this. There is already enough evidence that the telecos over-paid during the 3G auctions and therefore a more efficient spectrum price should be lower. Instead, the DoT does a simple linear extrapolation of prices on the auction price, and that too based on the prevailing bank lending rates. Furthermore, influential sections within the government view such auctions as a convenient and costless way to raise resources to bridge fiscal gaps.

There are three concerns with such populism. One, when eye-popping figures like Rs 1,760 trillion or Rs 1,636 trillion are so casually bandied about, it does tend to focus attention on the sensational issue of bringing those responsible to light while glossing over the more important task of systemic changes that can sustainably prevent the recurrence of such scams. This is clearly evident in the aftermath of the 2G spectrum scandal when the focus was on implicating and punishing those accused. A great opportunity to put in place effective mechanisms to manage allotments of public resources has been missed.

Two, such highly simplistic assessment of loss caused to public exchequer based on DCF analysis of revenue flows, priced at prevailing market prices, immediately puts public servants on their guard. It completely divorces all other practical real world problems, challenges, and risks in such business decisions and encourages public officials to avoid pricing them into contracts. The result is still-born markets and contracts, and possibly even more corruption.

Three, they tend to mix often conflicting priorities. The primary objective of the mining and telecom bills ought to be the regulation of two critical sectors, so as to eliminate policy uncertainties and enable their efficient development. However, influential sections within the government tend to view them as excellent resource mobilization opportunities that can bridge the government's fiscal imbalances. Alternatively, they are also viewed as opportunities to expand the government's social programmes, like in case of the mining bill to the huge tribal belts of the country and generate funds for local development in such areas.  

It is obvious that such mechanistic, but procedurally safe, and financial returns maximizing, decision-making on such important policy issues is the inevitable result of the extreme vitiation of the political and bureaucratic environment in the aftermath of the spate of recent resource allocation scams. It cannot be denied that these revelations have provided the much needed wake-up call to begin cleansing public life off corrupt practices that had spiralled out of control.

However, its collateral damage has severely debilitated the policy making apparatus. It has induced a form of decision-paralysis and play-safe attitude among officials and even political representatives at all levels. The biggest casualty in the process is likely to be economic growth in general, and the development of these sectors in particular.

The EMU's spectacular forced risk convergence

Excellent graphic (from The Economic Crisis, via Frances Woolley, via Mark Thoma) about how fear and contagion has erupted across the Eurozone and how the EMU Project contributed to the artificial supression of sovereign risk in its members. I have blogged earlier about how over a four year-period, beginning 1995, the bond yields more than halved and converged around 4% across most of the eurozone economies.

As the pre-EMU Greek bond yields indicate, the low borrowing costs enjoyed by Greece for many years now had merely papered over serious structural inefficiencies. Now these unattended problems are resurfacing with some vengeance as risk gets re-priced at its original level.

New Age Manufacturing

FT has a series on the transformation taking place in global manufacturing sector. Reversing the trend of manufacturing gravitating to low-cost countries, developed countries have been embracing manufacturing in a big way. 

See also this report on how the Chinese have stormed the manufacturing sector over the past two decades.This NYT report examines the recent trend of many traditionally outsourced activities now returning back to the US.

Taxing out vehicle ownership?

I have blogged and written earlier about how Singapore uses Certificate of Entitlement (COE) quotas to restrict vehicle ownership growth by mandating that all new vehicle owners buy COE permits in auctions. The high COE permit auction rates are expected to act as a prohibitive tax on vehicle ownership.

As Bloomberg reports (via Steven Sanders), the COE tax has risen precipitously in recent years, 

At S$86,889 ($67,000) just for a permit, the total price of a Volkswagen Passat in Singapore is about the same as the median US metropolitan home. A 25 percent jump in residents in seven years, coupled with the world’s highest proportion of millionaire households, has fueled a 10-fold surge in license prices over three years...

A new 2012 Passat sedan made by Volkswagen AG (VOW), the world’s second-largest carmaker, costs about $152,000 in Singapore, including the license... The median price of a U.S. metropolitan area home is $158,100, National Association of Realtors data show.

So-called open-category permit, which can be used to buy any type of vehicle, reached S$92,010 in April, the highest since the end of 1994 when a record of S$110,500 was reached. At the latest auction May 23, the licenses went for S$86,889, compared with S$8,501 three years ago. The permits give the right to own a car for 10 years. The next auction is tomorrow. Besides having to bid for certificates at auctions that are held every two weeks, Singaporeans also pay registration fees and taxes that can amount to 150 percent of the market value of a vehicle

Now, if this were India, atleast two things would have happened to derail the COE permit system. One, the populist backlash surrounding the steep rise in COE prices would have been enough to force the government to abort the system. Two, the magnitude of the tax would have triggered off a rush to game the system. Either ways, such a stringent COE permit system would have struggled to survive in India.

In countries like India, a more effective strategy would be to use multiple instruments aimed at discouraging both vehicle ownership and usage, the cumulative cost of all of which would reduce private vehicles on our roads. Apart from others, they should include a less stringent COE type system. Most importantly, a very good public transit system is an essential requirement for the success of any such intervention.