The Son of Cash

Cash is King. Or, in the context of our government's benefits structure "cash is leaking". We have known about this for a while: I vividly recall having dissected the ills of India's subsidy framework as part of Economics curriculum in College in the 90s; and it was a well-worn fact then. Commentary focused on flaws in the mechanism and mushrooming of vested interests that were mooching off it. Indeed, the latter had gotten so well entrenched, and critical voices so muted, that the infirmities had became part of the accepted, expected ways of working of mai-baap sarkaar.

Little wonder then that, far from being shown the door, the framework has continued to prosper to this day. Sample this: the GoI spends an estimated INR 3.65 for every Rupee of benefit to reach its intended target. The resultant fiscal burden across the 3F's (subsidy categories: food, fuel and fertilizer) is clearly unsustainably high already. Yet, there is every indication from our government, reeling under the influence of NAC-chhaap Welfare State model, that the economic cost shall escalate further.

Before casting our eye to the future, it may be instructive to take a look at the design and delivery challenges that plague our mechanism today. First, the design is inherently faulty. For instance, food subsidies are run via PDS, pivoted around identiication of BPL (below-poverty-line) needy. This tagging has been a corruption magnet. Inability to pay bribes for BPL ration cards means large swathes of true beneficiaries remain denied benefits, while the subsidy bill for the government continues to grow.

Next, lets talk about delivery. Staying with the food example, there is little control over diversion of subsidised grain (meant for BPL households) to open market by ration shopowners wanting to make a quick buck off the price differential. Likewise, practices like adulteration, false BPL cards, or stockpiling lead to leakages. Upstream too, we have distribtion losses in acquistion, storage and transport due to substandard quality and potential for corruption. Finally, the government spends a packet in administrative expenses to keep this massive rig afloat.

Now, the mammaries of our welfare state are expected to grow (the GoI seems serious about the Food Security bill). This makes the case to entirely overhaul the benefit distribution process even more compelling. Simply put, the need of the hour is to replace the corrupt and convoluted PDS with direct cash transfers to the target population. Life changes dramatically at the consumption end, with a pronise to empower the needy; bid goodbye to the ration-wallah's corruption and coercive power; and incentivize quality supply. Likewise, the government's unproductive (administrative) subsidy burden gets a haircut from dismantled PDS, reduced sourcing & storage expenses and tech-enabled planning & monitoring.

One cannot, of course, expected it to be a walk in the park. The most critical element is target identification. UID is trying to solve this tagging problem multi-dimensionally (technolgy, process, controls, change management). Helmed by Nandan Nilekani since last year, one should expect a good outcome here. Next, the farmer lobby would need to be managed: anything that is seen as encroaching on MSP and government's grain offtake, is a political hot potato. It remains to be seen how much will UPA-2 has to tackle this. At another level, the availability of cash (and presumably an increased amount) in lump sum has been called out as a cultural problem. Fears are that menfolk would drink this 'windfall' away. Not only for this reason, but as broader social empowerment or financial inclusion move, the GoI would do well to contemplate transfers to the Lakshmi, the woman of the house instead. And so on.

Cash, in any event, is likely to see a return, if only in a new avatar. Even if not perfect (and we don't know all the questions yet, far to speak of all answers) it cannot be but an improvement from the mess we have today. Much of this will be played at the level of policy, even more in execution; we have seen UPA botch up both umpteen times. Yet, for the high stakes here, let us remain hopeful.

2B Or Nought 2B

A degree in Economics and early years trading commodities mean that the markets hold me in an enduring thrall. I mostly restrict my passion to delivery trades though; F&O action is rare. Equally, those that I talk equities with are folks that classify more as investors than traders. This means that margin speculation is around the fringes of my stockpicking existence.

I was, however, greatly intrigued with JP Morgan Chase's losses on account of derivatives trade last quarter. For one, the amount involved was an obscene $2B (frankly, my imagination runs short when faced with such astronomical sums, for reasons not entirely unrelated to my humble circumstances)! I hear too that many believe the actual hole to be at least twice that ungodly number (phew).

Of course, markets are replete with instances of mindnumbing losses. I was in College when Nick 'I'm Sorry' Leeson brought down Barings. He was neither the first, nor last, in a long line of operators whose avarice or ambition (but almost never ineptitude) delivered similar shocks. Indeed, the trail of destruction in their wake often had more than a fair share of the humble investor in addition to institution in question.

Naturally, it begets the question as to how organizations of considerable repute come to such massive grief. These are not easy to reconcile with the high quality of internal talent either (case in point: Jamie Dimon has been a star in an industry under intense public scrutiny of late). We ought to know of process or technology inadequacies that resulted in failure to detect and correct the situation.

In the current instance, for starters, let us rule out that Options as a financial product itself is an issue. Arguing this is like blaming steel for knife-wounds in ghetto crime. That out of the way, the picture is no less messy, with mismanaged hedges at JPMC's London Treasury at its core. The sequence went thus:

JPMC, like any commercial bank with funds in its charge, needs to optimize returns (invest in high quality, long term bonds) vs liquidity (via overnight money market, at near zero interest in a QE world). Too much liquidity lowers the spread between investment returns and what the bank pays depositors; too little risks it running out of cash. Bond investments need protection too, since prices vary inversely with interest rate. When rate moves up it is a double whammy for the bank: its investments erode in value, and it coughs up a larger 'share' of returns due to increased interest outflow. Naturally, banks hedge such exposure, including through Credit Default Swaps (bankruptcy-protection instruments).

By all accounts, JPMC's Treasury at London was running huge positions. This forced them to trade massively in a relatively small, illiquid CDS market as a hedge strategy. This created price skews that drew hedge funds (and others) seeking arbitrage opportunities. Continued aggression from 'London Whale', however, meant that the distortions grew larger (valuations changed an unheard-of 50% in three months). Pressure on CDS market players mounted: the game was too expensive and prolonged. They were angry, but could do little in an unregulated market with the Whale running amok.

If this was bad, it soon turned worse. Perhaps realizing limitations of the original CDS hedge strategy, Whale & Co devised new plans. Defying logic, they got into related but riskier instruments, with further exposure to volatility. Hedge funds started to sense the desperation and waited for the nut to crack.

Meanwhile, this had rung alarm bells within JPMC too. Reinforcements from the core i-banking unit were sent to London Treasury. It did not take them long to figure out how untenable and inherently risky JPMC's position was. They wanted out, presenting the perfect revenge opportunity to hedge funds and CDS market punters. To liquidate the trades, these players wanted their price. $2B, or more, is this pound of flesh.

Perhaps I am guilty of over-simplification (for more gory details, refer an excellent article on the Whale at Seeking Alpha). Regardless, the episode throws up a few conclusions. The most critical is the need to regulate such specialized (and illiquid) markets. Another lesson is the limitations in deploying narrowly defined, fixed technical strategies to mitigate risk.

In an 'Occupy Wall St' backdrop, it is worthwhile to note too that this was not a case of i-banking excesses that have fired up public imagination and invited lawmaker attention lately. In fact the scene of crime at Chase commercial bank Treasury in London is far removed from JP Morgan i-bank. Of course, the starring role for CDSs is a throwback to GFC, but that's about all (or an 'ought-to-regulate' lesson at max).

Unless you own JPMC stock, therefore, the pall of gloom and hyper-suspicion is somewhat ill-founded. A sigh of relief too, may not be out of line. Until, of course, the next quake strikes.

NCTC - Intel Inside

By all accounts, Shri P Chidambaram, our Home Minister, does not take kindly to fools. Nor, can stakes be higher than on Terror, with multiple strikes over the few years highlighting our extraordinarily vulnerable national security status. Yet, when GoI shared a "50 Most Wanted" dossier with Pakistan a few months ago, it was a disgrace (two on the list were in India). That very fortnight, CBI's pursuit of Kim Davy (Purulia arms drop notoriety) in Denmark ended with egg on the face owing to an "expired" extradition notice.

Those 'bureaucratic gaffes' were, of course, only the latest in long history of ignominy (Kargil, 26/11, David Headley, Red Corridor being but a few of its more sordid chapters). Questions were asked of Indian intelligence, or the lack of it. In response we were told to think beyond the CBI, NIA, IB and RAW, all under our venerable Home Minister's charge, to NATGRID, his pet project. NATGRID would allow 11 security agencies access to 21 linked databases covering financial, travel, immigration, asset ownership, telephone and internet usage information for individuals and entities in the country.

Arguments had been made against a NATGRID style response. There were concerns around diffusing focus away from building good ol' Hum-Int with a grandiose but potentially ineffective programme. For instance, it may not raise any alert for an American citizen with Caucasian looks, no cellphone or financial records in his name (save, perhaps, every itinerary with return via Pakistan; an obvious need to brief ISI-LeT) thereby missing Headley. Equally, the potential for assault on personal liberty and data privacy with Government's power to obtain sensitive information without warrant or consent, bred its own share of D Thomases.

Resolution to these, naturally, lay in a well-considered approach. Last week's order notifying the creation of NCTC, alas, displays none of this sure-footedness. In typical PC fashion, it managed to raise hackles all over instead. Opposition-ruled states are up in arms, for one, when Center-State cooperation would be ideal for seamless execution. Likewise, we have conflicts within GoI's own framework with RAW (external intel); NTRO (collection and analysis); and NIA (investigation and prosecution), all of whom have mandates broader than counterterrorism. Nesting the NCTC under the IB, a body sans parliamentary sanction or oversight, too reeks of shoddy legal formulation, if not downright empire-building on part of the Home Min.

PC apologists may point out that feedback has gone into the current notification vis-a-vis his original plan (IB centenary endowment lecture; Dec 2009). This had the NIA, NTRO, NCRB and NSG under the NCTC; as also the counter-terror work of RAW and CBI. Yet, even if watered-down, NCTC remains deeply flawed, most notably in its lack of separation of analytical and operative powers. Add lack of governaceto that, and we can put the US miliatry-industrial complex to shame in its reach. I hope sense prevails soon, with a better design that helps our counterterrorism effort acquire effective teeth. No terrorism-frontline State (for we are unmistakably one) worth its salt should settle for any less.

Bihar: A New State of Mind

I have been meaning to stay a lot more connected to my hometown. Despite intention though, physical visits have been few and far between. Thus, it was a direct call to action when the W alerted me to my expected housebound status for the next few weeks. I planned a trip in a jiffy, managing to cover Patna, Muzaffarpur and our ancestral village - all in the space of one weekend.

Hurried as it may be but the trip's mood was ponderous; and overall much upbeat. In fact I came away with my intent to travel Patna-wards markedly stronger. This reinforcement, admittedly, is partly on emotional counts. Yet, Bihar's almost unique socioeconomic theatre too contributes to my renewed resolve.

For the record, I have long believed my beloved native state (often including Jharkhand in the bargain) to be a microcosm of India at large. Indeed, its fertile Gangetic plains or mineral-rich badlands present, firsthand, a quintessential paradox: penury-amidst-plenty. Of late, in Bihar like in India, nature's bounty fought and lost a daily battle with the grime and toil of life in poverty. Equally (and perhaps inevitably), beyond the obvious despondency and squalor, a subterranean strife constantly tested the overt social detente, the undercurrents often erupting in murderous class wars.

Talk history and the microcosm argument is actually an understatement. Bihar's leadership - in thought or wordly terms - is sans parallel. Yet, some years ago, an otherwise discerning (non-Bihari) friend had scoffed at my assertion that Patna (Patliputra) was capital of 'India' longer than any city but Delhi. For Doubting Thomases such as he, try google the following to get a sense of what I say: the Buddha, Mahavir or Guru Govind Singh; Balmiki, Vishwamitra, Aryabhatt, Panini, Gargi, Maitreyi, Vatsyayan, Banabhatt or Chanakya; and certainly the Guptas, Mauryas, Ashoka or Sher Shah! (The list is by no means complete.)

I believe too that there was more to my aforementioned friend's mirth. The unfortunate but undeniable truth was that Bihar had simply lost the plot over the years. Always in news for the wrong reasons, it was tough to associate glory or excellence with the state. Appreciate too that through the 90s and this millenium's first few years, the Indian nation was burying its Nehruvian policy overhang in favour of globalization and free market. As sarkari sloth made way for private enterprise, the air was rich with the promise of prosperity, not hollow socialist shibboleths. In this period, the land of Nalanda and the Lichhavi republic was going the other way. As if under a sorcerer's spell, Bihar turned a family's fiefdom, discovering new heights of lawlessness, negative growth rates, and wanton polarization of an already fractious society.

At another level, with liberalization, cable TV came to town. Likely looking for comic appeal, the media lapped up Shri Laloo Prasad and his country bumpkin caricature. Bihar's strongman readily obliged, with bytes or antics more befitting a Bollywood comic than otherwise. Arguably, this was deliberate: playing-up his rustic roots for lowest common denominator appeal. Regardless, he made a virtue of the ludicrous. With a clear development-is-anathema stance (discordant with rest of India) and longevity in power, this perpetuated a rather sorry image of Biharis: buffoons who wouldn't know (or didn't deserve) any better.

For most of this peiod, I was still deeply rooted in Bihar, yet spent significant time outside the state. At its worst, I felt my compatriots had given up hope; that the pithy but patently unfair caricature had grown larger than life. Bihar had gone from being a state to become a state of mind.

I hoped too, that some day, regardless of the dispensation's colour, my home-state's fortunes would rest with a believer in progressive political agenda. Bihar would then feel the difference, reward the change, and break the defeatist psyche. On this trip, driving on a new rural road as alternate route to my village, I felt my idea's time had come (much better than merely talking of Nitish Kumar and Elections 2010; equally hope that having reaped benefits, the NDA regime will push for more in Round 2). Its zindagi mili hai dobara!

Cinema Cinema

I love cinema. At the risk of domestic bliss, I can add that we haven’t got much of it lately (IPTV is a godsend, but the W isn't exactly chuffed at the prospect of which I'm perfectly capable, namely a weekend watching two to four, maybe more)! It is not as if good cinema is my sole preserve in the household though. The difference lies solely in my preference for remote control (some may aver it’s the couch) driven variety versus the more social cinematic experience in a theater.

Interestingly, I grew up to almost no moviegoing, nor much interest in films. Through school, cinema was regulated like fresh air on a chilly winter night: you may be unable to shut it out entirely, but at least limit its intake. I reckon this was mostly in keeping with a general bias towards discipline in upbringing (to which I owe a number of my latter-day strengths). Economics may have played a part too (thrift is good); concern over my grades most certainly did. Thus, I averaged one to two films in the 'hall' (as we called them) a year over this period. These were thanks to a friend who consistently planned such as his birthday outing; and the occasional parental endorsement (Dweep Ka Rahasya was one such: I loved it).

Of course, the few I caught on TV (courtesy neighbours, till we acquired our own in '84) were not without a twist. Given that we did not stay out late, a chunk of these films were incomplete, missing 'climax'! I vividly remember the festive air in our middle-class community too, when Doordarshan decided to telecast movies on Thursday evenings, thus doubling frequency to a joyous twice weekly (the first such offering was Vachan, and I have good reason to forget all about it sans name). In short, the uninspired offerings and fragmented viewership did little to stoke my cinegoer buds (though an ill-understood Achanak or half-seen Ittefaq did plant seeds of love for crime-mystery-thriller genre that I have not shaken off ever since).

Later, the VCR came to town. It brought with it a rudimentary element of choice. Grainy picture quality (not that DD was any different) was small price to pay for the ability to watch what you wanted, and at the pace and time of your choosing. Naturally, video libraries, parlours etc mushroomed all over town. At home, the Pater made decisions of his own though (likely inspired by my scholastic record) and this contraption only entered the Jha household once the son had been packed off to College! Most of my movie-on-video, thus, was with friends. I emerged much enlightened from these soirees (I can sense your wicked smile, reader!) not the least of which was exposure to cinema beyond mainstream Hindi (a Khamosh or Prahar amidst The Godfather and The Medusa Touch). Not entirely unrelated, this included QSQT, a milestone in the sense I saw as well understood it (ah those vague, vicarious pleasures)!

Come College. My means stayed modest but the joys of freedom more than made up for it, strained by early stirrings of a sense of responsibility. Films played a part in this general process of self-discovery as always, occasionally as input, but often a companion in the journey. The plot stayed true at B-School too; save for a mild sharpening of the pen.

The intervening years have taught me how much I delight in having (almost one too) many balls in the air. As in life, so in the movies (or literature and friendships) and variety is an overarching theme. I can watch almost any movie once, and a few many times to this day. And thus, a remote control helps.

Asleep at the Wheel

One of the most telling descriptions of the bureaucracy in the 70s went thus: "if you can, don't move; if you must, move slowly; if pushed, move in circles; if cornered, appoint a committee!" One can say this most certainly of our economic policy. Despite years of evidence, governments in India hung on to an anachronistic Nehruvian model, mouthing hollow garibi-hatao type slogans, till being forced off our backs two decades ago. Few know this better than our venerable PM. As key apparatichik in the estwhile growth-sapping regime (something Congress propogandists wantonly gloss over) he wilfully fashioned policies that eventually had us staring down the barrel of a gun in 1991.

Should it, therefore, surprise us that, when the bottom falls off the Rupee, or GDP growth plummets to its lowest in almost a decade as it has today, the GoI is a deer caught in the headlights? Dr Singh would have us believe this is all thanks to the global economic slowdown or Eurozone woes (external locus of control; not leadership). Notably he calls out RBI's tight-fisted monetary stance even though structural problems need a fiscal and not monetary response. Indeed, the central bank has little elbow room in the face of oil price risks or current account gap (widest since 1980). I would argue, on the other hand, that the RBI is doing its damnedest to keep inflation in check.

In context, it is important to peel the onion (!) on our inflation problem. Food is a structural shortage story. Agricultural growth at 4-5% is simply inadequate to meet the demands of a burgeoning 1.2B population with real incomes rising 5%. Next, MNREGA pushes up rural wages (10% YOY in Jan 2010, accelerated to 14% now) to unprecedented levels as GoI continues to dole out money with low to no link to productive use. Then the government raises MSP adding further fuel to the fire. Consequent rise in rural wages soon translates to urban wage inflation (via construction and informal workers).

This cycle of food and wage inflation combining to increase input costs for goods has turned our inflation into a structural one. It can, of course, be tackled. The path lies through supply chain efficiency and productivity. These, however, need a strong policy response, not status-quoist bias that is happier with incremental versus exponential change. Likewise, the GoI cannot print its way out of the quagmire, continuing to push populist policies in the run up to elections in 2014. With fiscal deficit spiralling out of control, there is only so much the RBI can do. If he is half the economic genius he is touted to be, then Dr Manmohan Singh knows this. Point is will he act; bell the cat?

The Real State of Real Estate

I plead guilty to being less than laudatory of the Real Estate sector in recent posts. This comes partly from experience: investments where I was promised the Moon have yielded negative to negligible returns. Again, I understand the caveat emptor argument (my ventures being ill-advised, risk-reward equation etc). It could be sour grapes too: nerves made me sit out the boom years and now I am priced out. Yet, it remains true that many of us are wary of the sector and its general functioning in our country.

Logically, things ought not to be in a bind. The dictum of being in money when investing in mitti had been ancient wisdom. Further, India's long term housing shortage story had its takers a decade ago. Little wonder then that, as friendly interest rates and rising household incomes fed core demand, realty prices pushed north. Investors attracted by visible short-term price upswing (perhaps more than long run potential) and overseas liquidity added to the momentum. Landowners made fortunes selling ancestral holdings in New India’s cities (NCR, Hyderabad, Bangalore, Pune etc). 'Buy pre-launch sell pre-possession' became the go-to strategy while a few risk averse or financially constrained folks like I fretted on the boundary!

This is where it began to go crazy. Developers overleveraged themselves using all avenues under the sun to raise money domestically (banks, IPOs) or across borders (ECB, FDI, PE). In short order (unlike most parts of the world), this borrowing stopped funding construction. Instead we had a mad frenzy to build ‘land banks' driven by continuous new project launches, and realty valuations feeding off every cycle. End-users were relegated to the sidelines; investor mood swung into high speculation zone. Fly-by-night developers sprung up dime-a-dozen in urban India, more than a few clearly headed towards a debt trap.

Enter GFC 2008. Liquidity dried up and demand, speculative or otherwise, was hit. It was mayhem. Buyers, caught unware, were the worst off; New India was abuzz with protests against project delays or defaults. The response from even the most well-known realty names was not much to write home; dharnas and court cases became the order of the day. The government could finally not look the other way, virtually leaning on banks to go easy on real estate loans to stop the bleeding for getting worse.

Today, we have come off the crisis edge. Property prices almost regained their peaks last year (although 2011 appears flat). The fundamental issues in the sector, however, have not been fixed for good. Like much else in our beloved country, there is more than meets the eye:

• core demand stays strong, a good chunk unmet. It ought to rise over time for population and prosperity reasons (the good);
• scope for corruption is unabated, ranging from Money Matters borrower scam variety to land acquisition, clearances etc (the bad);
• cash preponderance makes it a money-laundering magnet. Shahid Balwa types shall fester, with vested interest from powerful neta-naukarshah-businessman nexus (the ugly)

Clearly, the only way out of this jalebi of a mess is reform. A solution benefits those looking for roti-kapda-makan; yet others desiring more upmarket addresses; and wannabe investors like I. Hope is at a premium mid-week, but I set some aside for this. And may be rethink those Noida Expressway SMSs again :)