Raja Beta Banega Neta!

No, this is not a rant against dynastic politics. Only an ostrich, or your average Congressi blessed with archetypal thick skin, would have missed its disastrous limitations. The fact is that present-day India pretty much makes the case for the misfortunes that result when power is thrust into the hands of those whose credentials begin and end with parentage. Thankfully, although General Elections are a year away, the writing seems to be on the wall for sundry dynasts and their brazen sense of entitlement.

My pitch today is almost the opposite. For our polity to step up, more of our bright young things ought to be encouraged to don the political mantle. This, however, is a long walk from current reality. Quiz any Indian schoolgoing child about career ambitions, and it is difficult to transcend the familiar doctor-engineer-civil servant territory. Yes, an MBA has gained some coinage as a livelihood option in the last decade or so; and there will be the occasional interest in bijness (often running in the family); but you can bet the barn against finding anything more than the odd aspirant for public life.

Yet, at many levels, politics is at the top of the pyramid. Take a country like ours, and it is easy to argue that professionals of all ilks actually have to defer to the neta class more often than any other. Apart from an undeniable power to do good, it is not as if there is no economic upside either (and that is without perforce descending, UPA style, into my-kursi-is-my-ATM moral degeneracy). Despite this, politics as a career somehow continues to be considered lowly and fit only for 'the scoundrel'.

Of course, this is in stark contrast to democracies housed in the more developed nations of the West. Politics is right up there with medicine and law as career choices for the nation's bright minds. Sure, there are jokes on the neta as much as, say, on a banker, lawyer, movie star, or any other. However, there is no sustained scorn or uniform vilification of the kind we see locally. Thus, talent does enter, and often from the unlikeliest of quarters. In the US, for instance, from a Lincoln to an Obama, politics has accorded means for the proverbial outsider to rise to the very top by dint of merit (and some timing; but such is true in all walks of life). Must we be so very different?

The most commonly profferred hypothesis for this dichotomy seems to be the vintage of those democracies. Somehow, barriers to entry are lowered as the democratic model matures over time; and (eventually) the cesspool of politics becomes less murky. However, in this respect, our record of the last few years has been rather uninspiring. One does not have to look further than the principles that were IAC, to the compromise that is Kejriwal, in order to understand this gap.

To that extent, the AAP's apparent descent from the promise of breathtaking change may have ramifications beyond the obvious. Will similar future efforts be equally torn asunder by the fallibility of a few? Were they felled in trying to do too much too soon; and is that all we must guard against? Or must we be willing to tread the longer path by galvanising from within, centred around the two national parties? With the Congress seemingly intent on self-destruction, at least part of the answer is clear. The time is now.

Karnataka 2013: What Next?

It may not have made a monumental difference to the result, but I did not enjoy being forced to watch the recent state elections in Karnataka entirely from the sidelines. I had little choice though. Our move to India's IT capital was far too recent for us to have a vote, and I got a taste of what it feels like to be among the disenfranchised.

As it turned out, the contest was even more one-sided than expected. The incumbent BJP dispensation, battling misgovernance and corruption charges as much as a widely perceived disconnect with the electorate, was always facing an uphill task. Perhaps it could have weathered the storm better; a three-way split in its vote left it with no chance. A beleaguered Congress, stung nationally by a second summer of scandal (and an intervening winter of discontent), had some reason to cheer with a clear mandate in the state.

I don't know if many in the BJP were truly surprised by the result. Sure, India's principal opposition party would have been happier had it not been pipped to #2 by an HDK-led JD-S. Equally, they rightly worry about the ground ceded, not only to a resurgent Congress but even to the JD-S, in the usually more discerning urban vote. Yet, the saffron dream had gone sour in their fabled 'Gateway to the South' a lot earlier. Naturally, their spokespersons tried their feisty best to minimise airtime on Karnataka results, and focus debate in national media on the scam-battered Centre. (That a bumbling UPA-2 continues to provide grist to these windmills has more to it than meets the eye, perhaps; but that is another story.)

Does the Congress have enough to rejoice in its Vidhan Soudha victory? I would call it a mixed bag. Faced with a possible rout in Andhra and expected reverses in TN, the UPA is desperately looking at states to make up its losses. As things stand, it comes up woefully short. That, incidentally is the reason behind the unashamed wooing of a Nitish in Bihar despite a 'committed' Laloo ji who remains perpetually Barkis-is-willin'. One hears of a personal subtext too in Shri Chidambaram's new-found bonhomie with the Bihar CM; a fact that the Congress High Command may be unwilling to admit publicly. At any rate, gains in Karnataka help, but must be seen in the context of its relatively small 28-MP size in Lok Sabha arithmetic.

How does that leave the BJP (in itself a complicated call; it seems too much to prognosticate on the NDA overall) in the 2014 battle stakes? It is clear that they have their work cut out. For starters, this fixation with prime ministerial ambition is almost reminiscent of the erstwhile Janata Party — counting chickens long before the electoral eggs have hatched.

At one level, the BJP's predicament is understandable. It is difficult to see the party cross the 200 mark minus Narendra Modi at the helm (so the cadre believes). Truly, no figure polarises the debate in India today more than he. That so few folks in our polity tread the middle ground when it comes to NaMo must count as a significant (and hilariously unintended) achievement of post-2002 Congress strategy. Of course, a wide section of the media sympathetic either directly to it or to the 'secular' cause, has willingly played ball. The last word on this remains to be said though; I am sure this will occupy centre-stage over the next few months.

Coming back to Karnataka, it is do-or-die for the new regime to consolidate the vote ahead of LS elections next year. The fact is that 2014 remains a tough call. Can the UPA get its governance mechanism back together enough to perform an unlikely hat-trick? Will the BJP or the NDA get its house in order, politically and electorally, to be third time lucky? Or will an unfortunate nation be subject to a post-poll Third Front-led ragtag coalition as many pundits currently postulate? Let's keep watching.

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.