Corruption: Obelix and the Magic Potion

There is much in R-Day celebrations to tug at the heartstrings. Its crowning moment is the parade: rich in nationalistic appeal, celebration of valour, and pride in the achievements of a republic but a few score years old, and a culture thousands of years young.

In addition to patriotic fervour, R-Day is also fitting occasion for solemn contemplation. In thus ruminating over the state of the nation, one can't help but rue what ails its fortunes. Today, the most prominent such malaise is corruption. The affliction is hardly new, but has become so endemic at the top, so brazen in its extent, that it is morale-sapping and threatens the very fabric of our motherland.

This is not scare-mongering. Take black money, which has a deeply symbiotic relationship with corruption. A few years ago, the Swiss Banking Association reported that banks in Switzerland had around $1.5 trillion in deposits from Indian nationals. Compare this illicit stash to the size of our formal economy, especially one that is strapped for investment to spur growth, and you wonder at the possibilities.

Of course corruption is hardly the preserve of those with access to the Confoederatio Helvetica (or the Bahamas, Caymans, BVI, or other similar global money-laundering havens). Enough exists around us, in the form of you friendly neighbourhood policeman, sarkari babu, driving licence agent, and so on. However, when the Central Govt gets as mired in it as UPA-2 has, then the nation starts to lose its moral compass. After all, what deterrence is to be expected when not a day goes by without headlines screaming obscene amounts and prominent names neck deep in graft. It appears that almost no part of Dilli sarkar is left untouched.

With the stench in Raisina Hill reaching unimaginable proportions, one looks for answers. The mind goes back to a UPA-2 corruption headline of a different kind. A year or so ago, then CEA Kaushik Basu, had offered a striking formulation (endorsed amongst others, interestingly, by INFY co-founder Narayana Murthy). Shri Basu advocated legalising bribe-giving so as to encourage reporting, thereby improving incidence capture.

As solutions go, perhaps we need something similarly drastic to shake us off our slumber. This idea though, however innovative, is a slippery slope. It can easily degenerate from honest reporting, to wilful entrapment (lessons from news channel 'sting operations' that have bred their own format of corruption). Stretch the point and one could start offering bribes by default. If caught, you claim immunity as a public-spirited citizen merely unearthing the corrupt. Rinse, repeat, till a pliable babu is found. Voilà.

My other bone with such legalisation is how it shifts the onus of catching the corrupt to whistleblowers, thereby diluting the ownership of the relevant authorities. Like it or not, it is the government's job to identify and nab the dishonest. Outsourcing it to sundry 'citizen journalists' of potentially dubious intent and zero oversight, sounds ominous to say the least.

Much as the heart would wish otherwise, here is no magical solution. Very little in the proclivities of the current government thus far suggest that a different, deep-rooted attempt to counter corruoption is imminent. It may take a regime change for the requisite political will to surface, and perhaps thats what one must pin hopes on, this 26 January.

Shape-shifting Monster

Being a toddler-parent means toys of assorted shapes and sizes are an inescapable part of existence. I have one of either gender, and would like to believe that neither is overly pampered. Yet, there are moments when I am at wit's end as to how so many trinkets make their way into the house — my childhood benchmarks clearly don't apply, outnumbered 1:16 or so. Equally, I cannot help but marvel at the ingenuity and imagination that power many of these. Colour-changing cars and shape-shifting beasts fall into this category.

It was such an object of fantasy that offered the perfect metaphor during a fevered discussion the other day. The conversation went somewhat like this: my friend, part of the domestic insurance industry, was trying to argue for more institutional indulgence — government, courts, banks etc — to support the fledgling sector. At some point in the evening, the conversation turned to ULIPs, one of my pet peeves, thereby prompting the monster reference. I don't know how the tête-à-tête ended (some Dalmore was involved!), but perhaps a few notes from it bear repetition.

In a nutshell, that India is under-insured is beyond doubt, but there is more to the picture. We ought to know that, second only to bank deposits, insurance is the most popular financial product in town. It has a legacy that goes back decades: LIC itself in its present avatar is over half a century old, National started in 1906, and there were companies in this business even in the 1800s. So the industry is no babe in the woods.

Cut to the present, and data shows 20% of household savings going into insurance — while all of equity inflows, including mutual funds, hover around a paltry 5%. Likewise, consider AUM: insurance is 10 times the size of equity MF, with ULIPs alone being more than double at last count. Insurance, therefore, can hardly claim not to have had enough of show-me-the-money.

This brings us back to the point on ULIPs. Just the last decade saw the industry peddle them aggressively to a gullible public, backed by disingenuous advertising and aggressive distributor incentives. The opaque nature of ULIP performance reporting and high exit costs were common knowledge — perhaps even deliberate. Certainly they did not speak to any genuine effort to serve the Great Unwashed.

The IRDA did — belatedly; and perhaps only spurred on by the SEBI turf war — attempt to rein in the monster. Fee structures and rudimentary visibility parameters were mandated. Yet, even after 2010, the messaging was around ‘new, improved’ plans accompanied by significant switching costs. Shape-shifting right there.

In truth, glancing beyond ULIPs at traditional plans too shows up the industry as pretty lazy. Despite lofty goals of serving under-insured India etc, these products (term cover is a particularly glaring need) are sold with terms mired in complicated legalese, unfriendly surrenders and claims, and overly high sales commissions. Once again, the IRDA has attempted a few fixes, but these are arguably half-hearted or too late.

Summarising, it is not difficult to posit that the insurance industry has itself to blame for much of its ills. If only the Indian investor was a tad more discerning (and not perplexingly averse to equity), the heat on insurers could, in fact, have been worse. For now though, the monster lives to see another day.

The Son of Cash

Cash is King. Or, in the context of our Government's benefits structure, "cash is leaking". This has long been understood: I vividly recall dissecting the ills of India's subsidy framework as part of the Economics curriculum in college in the 1990s; it was a well-worn fact even then. Commentary focused on flaws in the mechanism and the mushrooming of vested interests that were bleeding the system dry. Indeed, the latter had grown so well entrenched, and critical voices so muted, that the infirmities had become part of the accepted, expected ways of working of mai-baap sarkar.

Little wonder then that, far from being shown the door, the subsidy framework has continued to flourish to this day. Consider the math: the GOI spends an estimated ₹3.65 for every rupee of benefit to reach its intended recipient. The resultant fiscal burden across the 3Fs — food, fuel and fertilizer — is clearly already unsustainable. Yet, there is every indication that the Government, reeling under the influence of NAC-chhaap Welfare State model, will escalate these economic costs further.

Before turning our attention to the future, it may be instructive to examine the design and delivery challenges that plague our distribution architecture today. First, the design itself is inherently faulty. For instance, food subsidies are funneled through the PDS, pivoted on the identification of the Below-Poverty-Line population. This tagging has been a corruption magnet. An inability to pay bribes for BPL ration cards means large swathes of genuine beneficiaries remain denied benefits, even as the state's subsidy bill continues to burgeon.

Next, lets talk about the delivery architecture. Staying with the food example, there is little control over the diversion of subsidised grain meant for BPL households to the open market by avaricious ration shop owners profiting off the price differential. Likewise, practices like adulteration, ghost BPL cards, and deliberate stockpiling lead to rampant leakages. Upstream too, we have distribution losses in acquisition, storage, and transport due to inadequate infrastructure and systemic corruption. Finally, the state is drained by an ever-increasing administrative overhead merely to keep this unwieldy apparatus afloat.

Now, the mammaries of our welfare state are expected to grow further (the GOI seems serious about the Food Security Bill). This makes the case to overhaul the entire 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 promise to empower the needy, bid goodbye to the ration-wallah's corruption and coercive power, and incentivise quality supply. Likewise, the state's unproductive subsidy burden shrinks by dismantling the PDS and leveraging technology to plan, monitor and reduce sourcing and storage expenses.

One cannot, of course, expect 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 across technology, process, controls, and change management. Helmed by Nandan Nilekani since last year, one can expect a good outcome here. Next, the farmer lobby must be managed: anything seen as encroaching on the MSP and GOI's grain offtake is a political hot potato. It remains to be seen how much political will UPA-2 possesses to tackle this. At another level, the availability of cash in a lump sum has been flagged as a potential hazard. Fears are that menfolk would drink the 'windfall' away. Not for this reason alone, but as a broader social empowerment and financial inclusion measure, the GOI would do well to channel Lakshmi directly to the Lakshmi instead.

Cash, in any event, is likely to make a return, if only in a new avatar. Even if not perfect — and we do not yet know all the questions, let alone the answers — it cannot fail to be an improvement on the mess we have today. Much of this will play out at the level of policy, even more in execution; we have seen the UPA botch both on numerous occasions. Yet, given 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 with whom I talk equities classify more as investors than traders. This means margin speculation resides around the fringes of my stock-picking existence.

I was, however, greatly intrigued by JP Morgan Chase's massive derivative trading losses last quarter. For one, the initially reported figure was an obscene $2B (frankly, my imagination runs short when faced with such astronomical sums, for reasons not entirely unrelated to my humble circumstances)! Rumours abound, too, that the actual hole to be at least twice that ungodly number (phew).

Of course, financial markets are replete with instances of mind-numbing 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 market operators whose avarice or ambition — though rarely outright ineptitude — delivered similar rude shocks. Indeed, the trail of destruction in their wake invariably claimed more than a fair share of humble retail investors alongside the institutions themselves.

Naturally, it raises the question of how organizations of considerable repute come to such massive grief. These failures are difficult to reconcile with the high calibre of internal talent on display (for instance, Jamie Dimon himself has long been a star in an industry under intense public scrutiny). Equally, we ought to understand the process or technical inadequacies that led to a failure to detect and correct the exposure in time.

In the current instance, we can rule out derivatives themselves as the primary culprit. Targeting the financial instrument is like blaming steel for knife-wounds in street crime. That out of the way, the picture is no less turbid, with mismanaged hedges at JPMC's London Treasury at its core. The sequence unfolded as follows:

JPMC, like any commercial bank holding vast client deposits, must balance returns (by investing in long-term, high-quality bonds) against liquidity (through the overnight money market, yielding near zero in a QE regime). Excessive liquidity lowers the net interest margin; holding too little invites cash shortfalls. Moreover, bond portfolios need protection, since prices vary inversely with interest rates. When rates rise, the bank faces a double whammy: its bond portfolio suffers capital losses while funding costs escalate due to higher deposit payouts. Banks routinely hedge this exposure, including through Credit Default Swaps.

By all accounts, JPMC's Treasury in London was running huge positions. This forced them to trade aggressively in a relatively small, illiquid CDS market as a hedge strategy. This created price distortions that drew hedge funds and institutional traders seeking arbitrage opportunities. Continued pressure from the 'London Whale', however, meant that the pricing skews grew larger — spread valuations swung an unprecedented 50% in three months. Stresses on CDS market players mounted: the game was becoming relentlessly capital-intensive. They were squeezed, but could do little in an unregulated market with the Whale running amok.

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

Meanwhile, this had rung alarm bells within JPMC too. Reinforcements from the core i-banking unit were sent to the 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, was this pound of flesh.

Perhaps I am guilty of over-simplification (for more gory details, refer to an excellent article on the Whale at Seeking Alpha). Regardless, the episode yields several striking conclusions. The most critical is the imperative for oversight across bespoke, illiquid derivatives markets. Another lesson is the limitations of relying on rigid, narrowly defined quantitative models to mitigate risk.

In an 'Occupy Wall St' backdrop, it is worth noting 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 familiar echo of the GFC, but other than an 'ought-to-regulate', that is where the parallel ends.

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

NCTC - Intel Inside

By all accounts, Shri P Chidambaram, our Home Minister, does not take kindly to fools. Nor, can the stakes be higher than on terror, with multiple strikes over the last 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). In that very fortnight, CBI's pursuit of Kim Davy — of Purulia arms drop notoriety — in Denmark ended with egg on its face owing to an "expired" extradition notice.

Those 'bureaucratic gaffes' were, of course, only the latest in a long history of ignominy (Kargil, 26/11, David Headley, and the Red Corridor being but a few of its more sordid recent 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 new 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 and no cellphone or financial records in his name (save, perhaps, every itinerary with return via Pakistan — potentially indicative of an ISI-LeT nexus but equally high volume, Type I error risk) thereby missing a Headley entirely. Furthermore, the potential for an assault on personal liberty and data privacy with the Government's power to obtain sensitive information without warrant or consent, bred its own share of D Thomases.

Resolution to these concerns, naturally, lay in a fully thought-through 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 is vital for seamless execution. Likewise, we have conflicts within GOI's own framework with RAW (external intel), NTRO (collection & analysis), and NIA (investigation & prosecution) — all with mandates broader than counter-terrorism. Nesting 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-à-vis his original plan (the IB centenary endowment lecture, Dec 2009). That vision subsumed the NIA, NTRO, NCRB, and NSG under the NCTC, along with counter-terror operations of RAW and the CBI. Yet, even if watered-down, NCTC remains deeply flawed, most notably in its lack of separation between analytical and operative powers. Add lack of due governance to that, and we can put the famed US military-industrial complex to shame in its reach. I hope sense prevails soon, with a better design that helps our counter-terror 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 intentions 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 was, 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 near-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 has 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 détente, the undercurrents often erupting in murderous class wars.

Talk history, and the microcosm argument is actually an understatement. Bihar's leadership — in thought or worldly terms — is sans parallel. Yet, some years ago, an otherwise discerning (non-Bihari) friend had scoffed at my assertion that Patna (Patliputra) was the capital of 'India' longer than any city but Delhi. For Doubting Thomases such as he, try googling the following to get a sense of what I say: the Buddha, Mahavir, or Guru Gonind 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 exhaustive.)

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 the news for the wrong reasons, it was tough to associate glory or excellence with the state. Appreciate too that through the 90s and this millennium's first few years, the Indian nation was burying its Nehruvian policy overhang in favour of globalisation and the 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 Lichchhavi republic — which gave India its first coinage, trade arteries, and Arthashastra — was going the other way. As if under a sorcerer's spell, Bihar turned into a family's fiefdom, discovering new heights of lawlessness, negative growth rates, and wanton polarisation of an already fractious society.

At another level, with liberalisation, 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 the 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 period, 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 becoming 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 a 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 an alternative route to my village, I felt my idea's time had come (much better than merely talking of Nitish Kumar and Elections 2010; equally hoping that having reaped benefits, the NDA regime will push for more in Round 2). Its zindagi mili hai dobara!

Cinema Cinema

I love movies. At the risk of jeopardising domestic bliss, I can add that I haven’t seen enough lately. Lest I be misunderstood — IPTV is a godsend — but in a weekend I'm perfectly capable of watching two to four, maybe more — a prospect at which the W isn't exactly chuffed. Again, it is not as if good cinema is my sole preserve in the household. The difference lies entirely in my preference for remote control-driven (some may aver it’s the couch) variety versus the more social cinematic experience in a theatre.

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 — kept out if possible, or heavily rationed at least. I reckon this was mostly in keeping with a general bias towards discipline in our upbringing (to which I owe a number of my latter-day milestones). Economics may have played a part too (thrift is good); concern over my grades most likely did. Thus, I averaged less than two films a year in the 'hall' (as we called them) in this period. These too were mostly thanks to a friend who consistently planned one as his birthday outing; and the rare parentally endorsed gems (Dweep Ka Rahasya was one such — I loved it).

Of course, I caught a few on TV (courtesy neighbours, till we acquired our own in '84) but this too was not without a twist. Given that staying out late was not an option, several of these films were incomplete, missing the '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 believe I have good reason to forget all about it, save the name). In short, the uninspired offerings and fragmented viewership did little to stoke my cinegoer buds — though an ill-understood Achanak and half-seen Ittefaq did plant seeds of love for the crime-mystery-thriller genre that I have been unable to shake off since.

Later, the VCR came to town. It brought with it a rudimentary element of choice. Grainy picture quality (not that DD was much different) was a small price to pay for the ability to watch what you wanted, when you wanted, and how you wanted. Naturally, video libraries, parlours etc mushroomed all over town. At home, the Pater made decisions of his own though (likely inspired by my not-always-inspiring 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 hear 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 that I saw it and understood it (ah those vague, innocent, vicarious pleasures)!

Come college. My means stayed modest but the joys of freedom more than made up for it, strained only 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 as 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 movies — or literature and friendships — eclecticism reigns supreme. Yet, I can watch almost any film once, and a few many times, to this day. And hence, the sovereign power of the remote control.