SensArticles

Economic Policies In Search for a Political Strategy for West Bengal

2011-09-16T06:02:00.000-07:00

The devolution of financial powers between the States and the Union governments in the Constitutional Federal structure probably does not unambiguously clarify the role of economic policy making at the State level. The US model and the EEC models are as much complex and could have been contrasted with Indian economic federalism for reforming the Indian system. This has not been done and the States have generally used political process to satisfy the State’s demand. West Bengal being the top industrialized State at the time of Indian Independence had to give up much of its legitimate demand for modernization and growth to accommodate the nice little slogans for balanced economic growth and backward region development. Therefore, West Bengal elites and intellectuals never used economics for policy making for the State. Nor did West Bengal have any view on what the State’s economy was, is or would look like in future. Selling dreams that would never be realized constituted economic policy making. For decades, West Bengal economy has been conceptualized primarily as a vehicle to demand, get or forget higher allocation of Government of India projects and expenditure in the state. The State Government published an economic survey every year with economic data and self-congratulatory composition: State Planning Boards and State Planning Department had been there without any perceptible impact on the State’s economic policy making and development.

2. West Bengal is only one among the several States in the Indian Union. In this Federal set up with constitotionally devised devolution of economic/ financial powers between the Central and State Governments, how far can a State pursue a set of economic policies that would effectively contribute to the economic growth, lower inflation/ higher protection against inflation, better employment, better income and wealth distribution and better quality of life for the State's citizens on a sustained basis? This has been discussed time to time in the past mainly from a political perspective but has not really been pursued consistently by Indian economists to yield a reasonable theories so far. When the economic reforms were introduced in the early 1990s, many political parties objected to liberalization, privatisation and globalization but did not have an alternative economic theory of their own (even the Congress which happened to be in Government and had to reluctantly being the economic reforms, did not have any consistent economic model or theory to justify the process of liberalisation). The Communist economist turne politician Finance Minister of West Bengal Dr. Asim Dasgupt proposed some alternative model that was probably unattractive to the economists and politicians including the communists and lost significance with the CPM government of West Bengal seeking collaboration of foreign capital from capitalist economies for the State's industrialisation. Many claim Chandra Babu Naidu of Andhra Pradesh did wonders for Andhra Pradesh and wonder about the economic successes of Gujarat under Narendra Modi. But the issue of economic policy formulation at the State level has benn neglected.

3. The issue had been rather one of getting more resources to the States from the Central pool. With the introduction of General Commodity and Service Tax is likely to intensify the conflict between the States and the Union Government. But how could the individual states pursue economic policies to meet specific goals of the States is not something that Indian economists have attempted. The European Common Marketm European Central Bank and Euro Curency is not yet successful and may be inconsistent with Indian federalism. But Indian economists have not generated any new theories or ideas to deal with the basic issue of economic policy making by individual State.

Economic Policy Paradigm of Government as Son of God
4. This was only natural because the State Government had envisaged a four-fold economic role:
(a) as a machinery to use whatever revenues happen to flow in to the exchequer and borrowings from the households’ savings pool for disbursing salaries (and pensions) to its ever increasing and scarcely performing staff and interest payment on ever increasing borrowings with sky as the limit,
(b) as a mechanism of acquisition of land with paltry or no compensation to the land owners and distributing them at low cost or free to others without land and needing land to do farming, set up factories and build residential buildings,
(c) as a catalyst for proliferating a micro-economic market structure of geographically and functionally distributed muscle-powered ‘license/ permit’ monopolies in the supply of building materials, education and medical services, in intermediation services for various sorts from allowing regularizing various unauthorized businesses like tea stalls, food stalls, vegetable and fish stalls, automobile repairing, construction of residential shanties and baths on footpaths, main roads, strips of lands meant for expansion of roads, as also in intermediation services for getting ration cards, birth certificates, hospital admissions, and
(d) as an unsolicited, unremunerated adviser to the Government of India on the inappropriateness and disastrous consequences of all the economic policies that it happens to pursue except nationalization, higher subsidies, higher corporate taxes, wage and pension increases for public sector employees, higher interest rates on provident funds, reservation of any type for most classes/ castes/ groups of people.

5. One economic policy option for West Bengal at present is to continue to same economic role of the State Government and therefore continue doing nothing more or new. Another variant of this status quo option is continue with the past while tinkering here and there with apparently pro-poor only measures like withdrawing State tax on LPG cylinders, increasing the number of people covered under Rs2/kg Rice distribution scheme, deferring the increase in taxi, auto, mini-bus and bus fares, crediting salaries of Government employees and teachers to their bank accounts on the first working day of each month. This kind of economic policy making would be simple and the consequences are well known. West Bengal economy will continue to grow so long as the Indian economy grows fast enough: if the economies of Bihar, Jharkhand & Oriya become fast developing West Bengal will have the benefit spill-over effects. Yes, the tax to GDP ratio will not improve from 4.5 % as ay present, debt burden will grow soon to such proportions to cause default and force emergency funding arrangements by the Government of India and the Reserve Bank of India. And, of course, West Bengal will witness a fall in her ranking in terms of economic growth rate, per capita income, percentage of population below the poverty line, state of education and health services. How does that future scenario matter to West Bengal now if such long-term objective or strategy or vision has not been of any interest among the elite and intellectuals advising the political rulers in the State? Status Quo economic policy by default is the most attractive option for West Bengal.

A Non-divine Government’s Economic Policy Framework
6. If, however, West Bengal happens to realizes that economic policy making is important, her elite / intellectual class and politicians must first get themselves convinced of the following:
(i) although the overall Indian economic policy remained the same for all States, many States have left West Bengal far behind in economic terms as well as in terms of quality of health and education services by just pursuing economic policies that were geared to certain economic strategy objectives of those States;
(ii) dreams, rhetoric by an all pervasive command and control State involvement at micro-economic level is doomed to failure as has happened in the past and the State role as a facilitator in economic development can only lead to serious economic policy making that has chances of succeeding;
(iii) economic policy making is neither easy nor anybody’s job and West Bengal has to deploy experienced expertise in applied macro-economics, public finance, industrial economics and micro-economics to formulate State-level economic policies designed to achieve certain long-term strategic economic goals: and
(iv) Generating a relevant and consistent set of economic policy options must be preceded by quickly evolving clarity on the long and medium term socio-economic goals and clearly articulated economic problems the State currently faces and their intensity. If the intensity of the problems is severe, the medium term goals may have to be moderated and instead of incremental changes in policy radical changes may have to be implemented.

7. For the purpose of the present discussion, we would assume that the medium term strategic economic goals of West Bengal would be something like this:
(a) To enable all citizens of West Bengal to increase their skills and productivity as well as gainfully deploy themselves in viable economic activities and create wealth for themselves so that they can progressively enjoy a better economic and social standard of living, beating the adverse impact due to inflation and slowdown in the Indian economy,
(b) To pursue such policies as would help maximize the flow and effective utilization of resources from the All-India public and private sector pool of investment and expertise into West Bengal,
(c) To get out of the habit of running State Revenue Budget deficits to a progressively rising Revenue Budget Surpluses to fund State-led development projects and thereby also contribute to (a) and (b) above,
(d) To quickly demolish the system of territorial and functional monopolies and rent-enjoying elements in the economic micro-structure and administrative machinery and bring in transparent, competitive forces at play, thereby reaping a few percentage point gain in State Domestic Product growth currently lost due to corruption, administrative delays, lower productivity, under-utilization of available productive capacity, stifling of innovations and large incidence of shirking, especially by people who are remunerated by the Government. This will in turn contribute to (a), (b) and (c) above.

8. We would now make a few illustration of the economic policy options consistent with the four medium term goals listed above in Para 5. Instead of using new nomenclature, we use the economists’ fashionable terminology and cliché.

Inclusive Growth and Exclusive Subsidies
9. Enhancing the economic power of all households would involve accelerating the rate of growth of State GDP per capita along with subsidies to the poorest (the tribal community in jungle mahal, the under-employed landless labor and the unemployed: (i) maximize utilization of the NREGA, (ii) allow and encourage farmers/ fishermen the access to demand from food/ vegetable/ fish malls in cities and urban areas, (iii) expedite the Central Government’s vegetable cluster centers coming up and (iv) do not apply exclusion principle to restrict farmers and fishermen from taking advantage food/ vegetable mall owned by foreign capital or domestic capital by using the blatant lie that these smalls affect income of small retailers small groceries/ vegetable or fish vendors just to protect the market power of politically supported small club of wholesalers. Finally, augment the production of rice and vegetables by increasing productivity per unit of land – the variety f seed that is about to cause a quantum jump in rice productivity is still eluding West Bengal.

10. Subsidies to the poor is fine, but equally important is to apply exclusion principle to tax households on their purchases beyond four LPG (liquefied petroleum gas) cylinders per year (this isn’t difficult to implement these days where LPG booking and delivery is computerized). Speeding up approvals to GAIL and such other agencies interested in supplying natural gas for cooking through network of pipelines to each kitchen at a costs lower than cost of LPG fuel. Yes, poor buying water is a non-inclusive growth: but exclusion from subsidized/ free water supply should apply to households in multi-stories buildings where a flat costs in excess of Rs. 30 lakhs or for washing cars and taxis. Water consumed can be recorded by meters and consumption beyond a monthly limit per household in such flats. Instead of not delaying the process of revising the fares of buses, taxis, mini-buses and auto-rickshaws to revise in response to change in petrol and diesel prices, agitate with the Government of India to raise the limit of standard deduction (zero tax) for income tax purposes linked to auto-fuel prices movements and hasten the pace of shifting to CNG (compressed natural gas) – using the new hydro-carbon policy of the Government of India.

Human Capital for Growth
11. Creating employment for the youth is fine but not for clerical-manual work in Government and municipalities. Fresh recruits by State Government/ municipality/ Zilla Parishad/ Panchyat service must necessarily have professional qualifications in citizen care administration and demonstrated proficiency in the use of MS Word and Excel. Make graduates turned out by Universities employable would be more productive than giving them state jobs or forcing new business units to recruit them locally through political goons. To rely on employment creation through private sector investments, bureaucratic/ administrative constraints on setting up of industrial units need to be removed, complete lists of land already acquired by Government lying idle in different locations need to in public domain as soon as possible and applications/ bids for lease on a transparent basis needs to be invited. Also, publish lists of land already leased to or acquired by private sector but not being used, giving the owners time limit beyond which such land would be taken over/ back for auction/ new leases (appropriate legislation may be necessary). Liberalize exit policy in respect of industrial establishments with less than 100 workmen so that such units can be down-sized / closed and assets become freely transferable. Department of labour need not wait till industrial disputes are brought up their notice: let the Government officers monitor labour relations in each unit on a continuous basis and be proactive enough to tackle brewing disputes before they become fully blown wars..

12. Encourage young entrepreneurs to run businesses like household plumbing, electrical and electronic repair services based on phone calls/ emails in cities, provided they have police verified service assistants with complete personal identification details. Make regulations on private medical doctor clinics to keep computerized record of all medical treatment service to each patient and issue computerized receipt for fees paid by the patients. For this purpose, require doctors’ private clinics to have a computer-trained patient services attendant and a professional nurse attendant. Have surprise visits and checks with roving squads. Make it mandatory for all pharmacy and drug stores to issue computer print-out receipts against all sales. All this will improve quality of medical service, professional employment and improve revenue collection.

Structural & Institutional Reforms

13. West Bengal needs all pervasive reforms in the market micro-structure to end economic crimes like levy collection by musclemen from business units/ shops, forced intermediation (dalal chakra) in hospital admissions, engagement of medical attendants by patients hospitalized, issue of ration cards, birth certificates, mutation certificates, registered property deeds, political party-sponsored locality-wise monopolies of building material supply and mobile vegetable vending on carts, levy collection by policemen from goods carrying trucks, etc. Inflicting of social costs by private auto-repairing shops, pavement hawkers, trucks awaiting on the road for custom and by shop-owners displaying ware on the pavement and roads must attract hefty financial penalties and cancellation of trade licenses: it is a pity that the roads broadened at public cost for smooth traffic flow are being occupied by stationery cars/ taxis/ trucks queuing for servicing, repair and painting, thereby narrowing the space available for pedestrians and movement of vehicles. Separate Road Clearing Force need to be put in place. This is all part of good economic governance that adds to efficiency gains and growth.

14. Merely repeating that West Bengal is the Gateway to Asian tiger economies is of no use. The State must negotiate with the Central Government to open up duty free trade with Bangladesh in cereals, coal, jute, tea, garments, vegetables, fish (not just hilsa), foot wear, drinking water bottles, etc. This would benefit the citizens of West Bengal more. Similar, State needs to take active interest in shaping trade agreements with Myanmar, Indonesia, Thailand and South Korea to maximize benefits to West Bengal.

Fiscal Prudence

15. A well thought out strategy to get out of the unsustainable debt trap and generating revenue budget surplus is the key to enhancing the State’s ability to pursue prudent economic policy. Immediate need is to target a slowdown in revenue expenditure together with higher revenue collection both by the State and all local self-governments. Only surplus revenue budgets can help the State government, municipalities, and panchayats to make necessary contribution to infrastructure projects and other development projects to get the benefit of attracting central matching grants and aid. State and municipalities have to improve their credit ratings to raise cheaper debts for funding credit worthy projects. Tax leakages are huge at present, partly because of the state-wide web of tax-evasion intermediary services collecting fees in black: this economic crime sector has to be totally crushed with the help of information technology, tracking cash transactions of such economic offence supporting intermediaries and day-to-day surveillance. Tax base needs to be broadened and subsidies need to be more targeted and direct. Industrial promotion may needs very little incentives if the industries do not have to bear costs of getting things cleared in Government and municipal offices. Government does not have a proper system of collection of annual land revenue (Khazna): the system needs immediate computerization, bills (separate for annual khazna installments and interest due on unpaid annual kahzna) may be sent to each household/ land owner and banks may be allowed to accept payments against these bills for direct credit to Government.

PPP Investment For Capacity Expansion

16. Now that the subsidized land acquisition support to private investment is being withdrawn/ minimized in the State and in the whole of India, PPP (public private partnerships) models to tap private sector investment would require fast track single window clearance mechanism and reduced politically convenient obligations on PPP projects immediately and more politically difficult relaxation on industrial exit laws after a while. The scope of the standard application of PPP model needs to widened to reduce the burden on the State exchequer: existing assets like Kolkata Zoo, other forest enclosures, Staid, vintage theater halls, swimming pools, libraries, river bank recreation enclosures and the like could attract private investment under PPP model for up-gradation, expansion and efficient, cost effective maintenance with flexibility in user charges for the rich on particular days of the week. Even in agriculture, PPP model with low equity and low interference from Government could help if contract farming and marketing of agricultural produce are also allowed.

Conclusion

17. Economic policy options appropriate for West Bengal at present and for the medium term future do not require arcane analysis. These options are well-known: what is required is the political will and administrative skills.

Corporate Governance & Social Responsibilty

2009-09-20T01:44:00.000-07:00

Corporate Social Responsibility & Corporate Governance
As An Organic Component of Business Activity
(Discussion Paper for SMT's Seminar on "Good governance and capacity
building for economic and social resurgence" in Kolkata)

By Dr. Basudeb Sen
(professional non-executive, independent director in companies)

Corporate Social Responsibility (CSR) and Corporate Governance (CG) have become the most fashionable subjects of discussion over the last two decades. Both these subjects have become important because of primarily one reason: the adverse impact of many companies/ corporations, businesses on the entire society or significant parts of the society. Although each and every business enterprise has not been found to produce adverse impact, the cases of large adverse impact have counted for the damaging image that all businesses have come to acquire. Businesses are mostly viewed as socially evil monster machines and the culprit responsible for societal damage is a group of evil persons called the management of businesses. That these evil people cause damage to the society is because they are very selfish operators motivated by maximizing profits for their businesses and for their own selves.

Are Businesses Socially Irresponsible?
2. Does this image of businesses a objective, realistic assessment? The correct answer is No. The image that is being painted of businesses is a false one. There are many instances of corporations, their rich owners and their rich managers making significant contributions to the society: just consider the innovations and inventions of Bill Gates or IBM or Kodak or Walt Disney. Who funds the many stadiums for games and universities for education? They are often rich businesses and their owners or managers and they include many banks which had to be bailed out by so-called tax-payers money or had to go bankrupt in many countries in the recent past. Consider the Bill Gates Foundation work across the world. The good, benevolent and charitable contribution of businesses and businessmen to the society are well known but regarded as a payment against their sin of becoming rich through exploiting others. On the other hand, their failures and competitive market practices are viewed as their anti-social, greedy pursuit of sin. There are many other institutions in the society whose positive contributions to the society are remembered but not their negative performances. For example, the corrupt behavior of politicians, the wasteful, inefficient, corrupt and repressive behavior of Government departments including government hospitals and the police, the noise polluting and violent behavior of religious organizations or the rallies and meetings organized by political parties, the privileges and luxury at taxpayers’ money enjoyed by ministers and politicians, etc do not count for social irresponsibility..

CSR Movement Rationale
3. So, given the irrational and biased yardstick of assessment of social institutions’ positive and negative contributions, the black image of businesses and corporations may survive for ever and will generate increasing scope for the proliferation of the movement of CSR and CG. The premises is that if CSR and CG movements are successful, then corporations and business enterprises will not be managed by evil operators without societal control mechanisms and therefore this will reduce the chances of businesses producing large adverse impact of their operations on the society. The underlying idea that businesses are socially useful organizations but since their managements tend to operate selfishly for maximizing profits thus generating considerable adverse impact on the society, makes it necessary to control these managements through CG processes and making them accountable for CSR.

Fashion of Joining CSR Club
4. If the above view, however fallacious, gains ground, what would businesses managements do? They would try to demonstrate that they have adopted good CG and very active on CSR. Only by demonstrating this they can improve their individual corporate or corporate sector image. So, the corporations and businesses in general nowadays are highly active CG and CSR oriented and take the help of academic institutions, social activists, government officials, politicians, analysts and rating agencies to create an environment that helps generate a general sense of relief that businesses are no more dangerously toxic as they were in the past. Amidst conferences on all of society’s various problems, there are conferences and seminars on CSR & CG, there are social accounting reports generated by big corporations (the smaller businesses like the transport operators who use more polluting engines and fuels as also accident-prone drivers apparently need not be accountable to the society), there are agencies publishing rankings of corporations on CSR and CG performance (the government departments, hospitals, police and political parties apparently need no such ranking) and there are plethora of awards and prizes for CSR and CG performance for corporations and their managements. Yet, there has been little relief to the society: companies continue to fail at the same rate as in the past with disastrous impact on stake holders, and the society continue to be plagued by environment pollution and degradation, deteriorating quality of life, poverty, unemployment, corruption, violence, malnutrition, high percentage of illiterate and uneducated population – all continue to exist.

Business Growth & Profits Sustains on Social Responsibilty
5. Irrespective of the image that big businesses enjoy in the society, irrespective of the elite activists’ of CG and CSR and irrespective of the fact none seem to care about who has to take the social responsibility for the wasteful fragmentation of cultivable land by agricultural businesses, the air pollution effects of make-shift restaurants on the street pavements, the accidents caused on busy roads that cannot be crossed without enormous risk, CG and CSR have become an organic component of big businesses for their survival and sustainability in the competitive market place: companies with effective CG and CSR are likely to produce more profits and survive longer periods. The bigger companies are increasing using the concepts of CG and CSR for enhancing their profits and building capabilities to sustain for longer and longer periods. Not that all big corporations have this motivation for CG and CSR. Some are providing lip service importance to CG and CSR. Some others just want to adopt the fashion of CG and CSR. Still others see advantage in getting mileage in terms of reputation and brand-building that would help them hide some of the socially-adverse impact of their operations or help increase the sales of their products. Some participate in the CG and CSR movement to get closer to the Government and get support. But only a few companies have realized that CG and CSR is an essential part of their competitive business planning and strategy: they belief that with proper CG and CSR, they can make greater profits and stay in business much longer, reducing the risks of survival. The companies motivated by this organic market-compatible discipline of CG and CSR derive all the other benefits as well even if they are not geared by such motivation: they enjoy sustainable reputation in the society, they see a greater demand for their goods and services, they get the awards and prizes, their brands get boost and so on. But the basic motivation behind CG and CSR in these few companies is to reduce costs, get higher sales and make higher profits on a sustained basis rather than purely for the short-term.

CG: Organic Part of Profit Driven Business
6. How do CG and CSR contribute to reducing costs, increasing sales and sustainable profits and growth? Let s first take the application of the concept of CG as an organic part of businesses. Corporate Governance is essentially a set of process or mechanisms that guide, direct and control the entire set of activities and the persons involved in such activities of acquisition and transformation of resources and time into valued added outputs: corporate governance processes and mechanisms ensures that the decisions and activities of a business entity are consistent with the corporate goals, its values and its obligations and commitments to the various providers of resources and services, the customers, the society at large and in harmony with its charter, the laws of the land and regulations. The corporate governance processes and mechanisms provides for regular monitoring and review of performance as also their accountability of all persons in an organization in accordance with the powers of decision-making they enjoy. As CG processes and mechanisms are documented, disseminated and implemented in a business enterprise, the costs may increase but the benefits increase more than proportionately in terms of prompt detection of and prompt and effective remedial measures against inefficiencies, negligence, corruption, violation of corporate standards and codes of ethical behavior, violation or transgression of laws and regulations, dissatisfaction of customers and failure to keep commitments to various stakeholders. Thus, the more effective the Corporate Governance mechanisms and processes, the greater is the likelihood of achieving the maximum potential profits from the business operations. Reduction in inefficiencies, negligence, and corruption contribute to savings in costs. Avoiding violation of laws and regulations reduces unproductive, avoidable costs of penalties. Avoiding deviations from corporate values, standards of ethical behavior protects image and reputation that builds brand equity, customer loyalty and employee loyalty. All this can contribute to the growth and sustainability of sales. The CG mechanisms also seek to ensure that the corporation is not lured by excessive greed that exposes the corporation to risks that may jeopardize the very existence of the corporation. Avoiding failures in keeping commitments to stakeholders helps the corporation to get the maximum cooperation and collaboration from its stakeholders. CG therefore is less of costs and more of benefits in terms of profits and their sustainability. Surviving in a competitive market place requires competitive edge derived through effective CG.

7. The above line of reasoning may be contested. One argument is that CG increases costs of procedures that are by themselves unproductive. This is true. But it is equally true, when the CG processes are externally imposed by regulators and the corporations do not apply their minds to introduce them in a cost efficient, logical manner, organically integrated to the corporations functioning, the costs of CG is higher and therefore effective CG can reduce the costs of CG itself. Second, effective CG brings in lot of cost savings and productivity gains. Another argument is that too much CG kills initiative, risk-taking and dynamism of managers. This again is true when CG is viewed as externally imposed. An organically integrated CG, however, generates incentives for initiative and risk-taking and promotes dynamism so long as they are consistent with corporate sustainability.

CSR: Organic Part of Profit Driven Business
8. Now, it would be proper to illustrate how organically integrated CSR is necessary for maximizing and sustaining profits in a competitive market place. All businesses come into existence for societal reasons: first, they serve to meet demand for different goods and services from various sections of the society. Second, there are certain legal and regulatory requirements imposed by the society and the businesses enterprises have to meet these requirements as well while trying to meet the demand for goods and services. And, finally, the business enterprises have to make adequate profits to survive and grow after meeting all cost obligations to various stakeholders in the society who provide various resources and services to the businesses. Businesses are therefore born with social responsibility. If any of the above three basic social responsibilities are not adhered to a business enterprise cannot hope to carryout its operations and survive, unless the environment is corrupt and there exists little competition in the market place. So, social responsibility is basic to the existence of business corporations. Unfortunately, businesses generally do not adequately assess the society’s emerging demands and needs and the emerging resource constraints to be able to align their operations and activities that make for sustainable profits and growth. If businesses were to assess the societal needs and constraints properly, they would continuously re-orient their strategies and operations. Let’s identify some of the societal needs: society wants eradication of poverty, malnutrition, inadequate health care, air pollution, noise pollution, inadequate education. Let us also consider some of the constraints faced by the society: drinking water shortages, food shortages, rapidly dwindling stock of exhaustible natural resources. Businesses can only make money if they cater to satisfying the above social needs and overcome or ease the constraints faced by the society. How would a corporation or business hope to generate sustainable profits and growth given these societal needs and concerns?

CSR for Cost Competitiveness
9. Many businesses consume lot of water and they have land with them where they can do rain harvesting. The company can therefore try to become net zero water consuming while producing and selling goods. Yes, rain harvesting may involve initially additional investment and costs, but over the long-term the company insulates itself from rising water costs as water becomes scarcer as is happening now. Company may produce something using fuels and processes that cause air pollution. The society is going to impose progressively greater restriction on such processes and impose penalties on carbon releases in to the air at rising rates. The company would do well to shift from such fuels to using wind-power, solar energy – this may be initially costly in terms of investments but will make the company more cost competitive in future as the prices of coal and petroleum oil rises and the carbon emission penalty rates rise. The company will have greater chance of sustaining growth and profits if it pursues these policies. Thus, profit and growth motives force social responsibility on businesses.

10. There are other ways through which social responsibility of businesses becomes vital to cost competitiveness. Companies always look for replacement of high cost, rapidly depleting mineral resources or newer processes that substantially reduce the consumption of such materials per unit of output. Paper manufacturers have resorted to paper-waste recycling, reduction in use of chemicals and energy consumption in paper manufacturing and promotion of forestation. All this reduces the long-run costs just because it contributes to sustainability of environment and ecology, besides promoting employment in social forestry. Cost competitiveness compulsions are dependent on businesses being socially responsible. Businesses that are not socially responsible cannot sustain their profits and growth, even if they make high short-run profits.

11. The processed foods and confectionary businesses sustain their profits and growth by contributing to agricultural productivity and sustainability. They often undertake various promotional measures to assist farmers and fruit growers as also those engaged in animal husbandry, dairy, fishing and poultry to increase their production and productivity so that they are assured of long-term availability of raw materials at low enough costs. It is the natural forward and backward economic linkages of business activities that forces social responsibility as the fundamental driver of business. Where it does not happen is because of the State or the elite in the society being irresponsible.

CSR for Developing Loyal Consumer Franchise & Competitiveness Through Differentiation
12. Hospitability and long-distance transport industries, in particular, hotels, restaurants and airlines, daily produce or purchase buys large volume of highly perishable food. But the entire production/ purchases are often not fully consumed or used up and thrown away. Socially responsible teenagers have shown enterprise and imagination to attract collaboration of these businesses to set up efficient systems of collection, transportation and distribution to reach food that would have been wasted and simply thrown into the gutters, to the poor and the needy in far away places. In the processes, the businesses earned goodwill publicity at virtually zero-cost. Businesses have organized more efficient, cost effective systems to reach education, education infrastructure and supporting inputs like stationery and school equipment to rural areas than the State machinery could do and created goodwill and loyalty among their future customers and thereby enhance the chances of sustainability of their future growth and profits.

A Real Life Example of CSR Integrated Business
13. Let us consider some real life examples in India. An Indian company has set up the largest digital rural infrastructure in the World that enables the farmers to obtain the ruling market prices in the mandis (markets) far away before he takes his produce to the mandis or sell to locally to a buyer near his farm gate. The company considers this infrastructure that it has built over several years at great cost as a “unique source of competitiveness” to its packaged foods business. The same digital network infrastructure is used to make available neem-based organic manures with superior efficacy in soil nutrition and crop management and thereby help spread the practice of chemical-free sustainable agricultural practices”. The company has declared: “In the coming years, stringent environmental regulators and civil society pressures will force businesses to integrate environmentally sustainable practices more comprehensively in their operations. The cost of compliance will go up significantly for those who pay scant attention to this vital area” of business planning and operations. The same company, thanks to its substantial investment in social farm forestry with high-yielding disease resistant clones of plants, this leading paper manufacturer is reached a stage where its “entire source of hardwood pulp is today derived from renewable social and farm forestry operation” that created millions of person-days of sustainable livelihood in tribal areas.

14. The company recognizes that “Sustainable manufacturing competitiveness will require aggressive strategy to reduce specific energy consumption”. Its hotel in Kolkata is the first hotel in the world to earn carbon credits. Over 30% of the total energy consumed by the company in its wide and large network of plants and offices is from renewable sources and carbon neutral fuels. This company is “the only company in the world, of its size and diversity, to achieve the 3 major global environmental milestones of being Carbon positive, water positive and solid waste recycling positive.

Source of Social Irresponsibility of Businesses
15. The reason that businesses appear to be and actually become socially irresponsible is because of socio-political milieu that encourages businesses to concentrate on short-term profits and restrict businesses from planning their operations on the basis of sustainability. That many businesses have ignored the organic link between their planning and operations for sustainability and the societal needs and concerns that give rise to business opportunities, is only to a small extent due to the short-term profit-orientation of the businesses but largely because of the unimaginative ways the State and the elite of the society have tried to constrain businesses to operate in their own and hence the society’s longer-term interest. The emphasis has been to assume that the interests of businesses are not consistent with those of the society and businesses must be controlled externally by the State or Social Activists to make businesses socially responsible. The State has always been trying to limit private sector initiative in education and make education more Government-dependent and in the process raise more taxes to fund government initiative in education and literacy as also provide some incentives to the private sector to contribute to the spread of education as an activity not organically linked to business operations. The elite and social activists, especially of the so-called leftist varieties, have sought to shift their own social responsibility on to the businesses and enjoy participation in the business-funded social activities.

16. The unimaginative and artificial approach to societal dealing with businesses has encouraged businesses to be socially irresponsible. Consider for example the case of road transport in cities. The State has either run its own large fleet of public transport at great losses in the name of providing cheap transportation facilities to the city’s common denizens or allowed small operators to run their fleets with tariff controls and infeasible quality controls. This has encouraged private ownership of personal automobiles for travel and rapid growth of motorbikes and cars in the cities leading the great social costs in terms of road congestion, slower movement of traffic, air and noise pollution, loss of life and limbs through accidents on the road and corruption among traffic police. Is this a socially desirable situation? Or, consider the many individual physicians attending to patients in their residence-cum-heath clinics without adequate space to handle large crowds of sick people including those afflicted by highly contagious diseases, causing lot of health hazards and risks to the permanent residents in the localities these doctors live. Or, consider allowing businesses to set up retail shops along the streets without adequate free passage and parking space within the shops premises, resulting in private use of public roads and pavements for private business use. If the leaders of the State and the social elite encourage the growth of such socially irresponsible small businesses, the credibility of their motivation to lead CSR for big businesses would remain in doubt even if the double standards of the leaders are not noticed by the common people attracted by newsworthy struggle against big corporations reported in the media. Social Responsibility

17. Consider suggestions of some genuine social activists: they would like cigarette manufacturers to be socially responsible and hence set up cancer hospitals. This is the height of social irresponsibility. One does not care to stop cultivation of tobacco at least with a phased time-bound plan, nor does one ban manufacturing and selling of smoking sticks. One does not ban smoking except in airplanes, offices, restaurants, theaters, etc. They want the cigarette smokers who contributes to 10% of the sticks smokes in India to pay for the cancer hospitals that would treat cancer patients who were never a smoker or user of tobacco, or who were from the bidi-smoking community accounting for consuming 90% of the tobacco-based stick smoking, or whose chewing consumed much more tobacco than the cigarette-smokers. Such inconsistencies weaken the social justification of existence of the leadership of the State and the social elite. One day hopefully, the world will see the last user of tobacco: but much before that lot of damage would have been done socially irresponsible behavior of social activist elite and the managers of the State..

18. Social responsibility should be the basic justification for any activity or any person or any entity to operate within the society – whether in the field of business or religion or politics or philanthropy or art or culture or sports. Unless this basic attribute is cultivated in the society in every part of life from home, to club, to government, to politics, to recreation, to public service, emphasis on mere CSR will not change the society in a significant manner, notwithstanding the fact that some businesses will do outstanding work reflecting the high degree of integration of CSR in their business planning and operations. Corporate leaders should take up their personal social responsibility to campaign for socially responsible behavior on the part of all non-business entities, rather than merely turning corporations into socially responsible entities. One company has identified two important drivers that will help create a new paradigm of development through creation of markets for socially responsible sustainability practices: a. “the imperative need to align policies and regulations to encourage the conduct of business in a manner that results in achievement of a positive carbon footprint and also supports the creation of social capital” and b. “civil society, by exercising their consumer franchise in favour of sustainable enterprises, can unleash a powerful force of market incentives to reward sustainable practices.”

Another Illustration of Contributing to Sustainability
19. It is well recognized that corruption, bribery, leakages in Government expenditure, money laundering, terrorist funding, generation of fake currency, false citizen-ship, bogus ration cards are some of the societal diseases that needs to be eradicated for sustainability of the society. These concerns are being addresses in some way or the other by various agencies. But can businesses contribute towards this in a commercially sustainable way. It can by using imagination, vision and use of modern technology. If all adults and high school-going children are obligated to open an Universal Financial Access Account with an unique number and these account numbers are referenced/ linked to all bank accounts a person/ citizen may have as also the Unique Identity Number that the citizens are going to have under the National Project that has been undertaken it will be great move forward. When each person uses a mobile phone does all receipt and payment transaction using the mobile phone whose number is linked to all his bank accounts and the Unique Identity Number, there would virtually be need for any cash/ currency for usage, provided apart from individuals, all shops, establishments, firms, companies, trusts, clubs, schools etc are also required to open the Universal Financial Access Account and have their own Unique Identity Number. It is possible to think of large commercial banks in collaboration with telecom companies to capture this concept in their business model to make a sustainable business growth possible while addressing the social concerns mentioned at the beginning of this paragraph. The mobile phones for Universal Financial Access may be given free to the poor people everywhere and especially in un-banked and far flung areas. by banks and telecom companies because of the substantial rise in deposits without the need to have branches and ATMs near the doorsteps of every citizen. The audit –trails can easily spot suspicious movement of money for terrorism funding, bribery and corruption. The poor people who work under the National Rural Employment Guarantee Scheme would then get paid directly in their Universal Financial Access Bank Accounts instead of the current system of cash disbursements where a part of the money is siphoned away by corrupt people involved in the administration of the scheme. The behavior of transactions will help each person to be rated for credit worthiness by independent reputation bureaus. Even the procedure of giving votes may be adjusted to link the Unique Identity Card Numbers, the Universal Access Account Numbers and Unique Identity Devices so that false voting becomes impossible and no one is forced to abstain from voting in an election. This concept therefore enables some banks and telecom companies to integrate corporate social responsibility in their business growth and sustainability models. For details on this concept I would like to refer those interested in this to http://www.ufa-india.org .

Social Responsibility Is Universally Applicable
20. What is relevant to businesses is equally relevant to non-business entities – political parties, civil society groups, sports organizations, educational institutions, government departments and agencies, municipalities, local clubs, families and individuals. The society needs to make everyone and every entity socially responsible instead of everyone asking everyone else to become socially responsible. Just to illustrate a few cases consider the following. Political parties come into existence for the commonweal – they need to organically integrate their plan and operations to social responsibility. Wild-cat strikes, frequent strikes, rallies in the heart of the cities (instead of in far-flung areas) and use of violence are not consistent with social responsibility, especially when alternative forms of communications like video-conferencing, television network and internet network are available. Rallies consume more fuel and create inconvenience to the people at large: strikes and bandhs reduce fuel consumption but also lead to production and income losses, besides causing inconvenience to people in urgent need to travel.
Creating panic and unfounded fears is easy but is far from social responsibility of media and civil society: the responsibility of disseminating correct information and influencing public opinion on issues of social concern can be carried out without creating panic. Religious activities that create traffic congestion, closure of certain roads to traffic movement or produces noise pollution cannot be said to be socially responsible acts. The governments that allow buses to use roads, pedestrian walkways and petrol pumps as bus terminus / depots parking cannot be said to be socially responsible. The practioners of the noble profession of healthcare carrying on health care of patients forced to use public pavements and roads as waiting and reception space for the private clinics is not a socially responsible conduct. Not cleaning roads, not removing garbage lying on the streets and allowing animals stray on the roads is not a socially responsible act of municipalities. Educational institutions that encourage use of the public roads for parking of students’ pick-up cars and buses cannot be said to be socially responsible. Hospitals that do not keep their premises clean of dirt and refuge and allow anti-social elements free passages are far from being socially responsible. Educational institutions that operate with inadequate infrastructure and teaching manpower in place are not socially responsible. Government departments that spend a lot on employee benefits and welfare but delivers inefficient and delayed service to the people are far from being socially responsible. While these are not businesses or big businesses, these create the environment for corporate social responsibility.
The society cannot hope to progress with islands of responsible corporate behavior in a milieu of social irresponsibility flourishing everywhere else.

Concluding Remarks
21. Corporate Social Responsibility is not corporate philanthropy: spending shareholder money as donations or grants for social causes including funding of election expenses may be good activities. Corporate Governance warrants that such grants or donations are made with the approval of the shareholders. Such grants and donations may add to goodwill and may even bring in some awards and image enhancement. Besides, all corporations may not make large enough profits to get into philanthropic endeavor. Those who distribute large profits have the choice of leaving philanthropic acts to individual shareholders rather than use their money for grants and donations. Similarly, using corporate resources like manpower for social purposes like blood donation camps or flood relief are acts of philanthropy but not acts emerging out of the obligation to conduct activities in a socially responsible way. Operating in a socially responsible way demands that the resources drawn from the social pool are used and deployed most efficiently to meet the various needs of the society on a sustainable basis. A business entity’s social responsibility performance depends on how consciously it integrates social responsibility in its planning and execution of its operations. And, this performance is measured in terms of the impact of innovations that it makes to use more of the surplus human and abundantly available renewable resources, to enhance the skills of human resources for sustainable livelihood, to become water positive, to enhance solid waste recycling, to reduce consumption of fast depleting natural resources, to reduce greenhouse emissions, to reduce air, noise and water pollution, to promote similar social responsibility in activities that are linked backward and forward to the activities of the business and to become a source of inspiration to other businesses and non-business entities to integrate social responsibility in their planning and operations.
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Notes: 1. Views presented in this paper are purely personal.
2. Source of all quotations in this article is the Speech by the Chairman, Shri Y. C. Deveshwar at the Ninety-Eighth Annual General Meeting of ITC Limited on 24th July 2009,
http://www.itcportal.com/sets/chairman_frameset.htm
3. On Universal Financial Access, visit http://www.ufa-india.org/forum/topics/inclusive-growth-with-ufa-bank , http://www.ufa-india.org/forum/topics/ufabac-killer-application , http://www.ufa-india.org/forum/topics/ufabac-national-pension-scheme

Risk-Reward Relation in Banking

2009-09-05T00:01:00.000-07:00

Refining Risk-Reward Relationship in Banking: Implications for Borrower Clientele
Dr. Basudeb Sen
(Content of speech at the CII Banking Colloquium 2009 on September4, 2009 at Kolkata)

In an industry- bank meet of the type we are participating today to Redefine Risk-Reward Relationship in Banking would tend to focus on (a) how the banks credit decisions are affected by the risk-return relationship, and on (b) how the bank-borrower relationship is affected by risk-return trade off facing the banks. Both are inter-related issues.

Clientele’s Risk
2. Borrowing clientele would always like to have a better insight into the banks’ credit decision process so that they could do something about making themselves worthy of relatively low interest, adequate amount of credit in periods when banks are constrained by shortage of liquidity or when banks wary about lending as they worry about future return flow of funds from industries in view of anticipated or actual economy or demand slowdown, or when the banks themselves are in financial crisis. When the economy and the demand are growing and the banks have considerable excess liquidity, the industry is less worried as banks compete to extend credit at competitive rates. However, his variability in the banks’ stance from being aggressive to being passive and vice versa over time is a risk that the individual borrowing client has to manage.

Risk is the Variability of Reward
3. What is this Risk Reward Relationship between banks and their borrowing clientele? Reward is positively related to Risk. Higher Reward is only a possibility from assuming Higher Risk.

4. But Risk is nothing but the volatility or variability of Actual Reward from Expected (average) Reward. Higher Reward is only a possibility from assuming Higher Risk: but negative rewards are also possible.

5. So, it boils down to choosing what level of Risk the bank can afford to take at ay point of time. It cannot take an aggregate portfolio risk that has both high positive as well as high negative reward that could threaten its existence.

Low Risk absorption Capacity of banking business
6. How much risk can a bank afford? There are different types of risk. But few are critically important.

7. First, a bank cannot take such high level of risk that may bring a reward in the form of falling into a liquidity trap resulting in a run on its deposits or a failure to meet its commitments to disburse money? So, it cannot deploy funds in giving credit or making investments were the return flow of funds has the risk of being less than the levels committed or expected. Here the reward is the return flow of funds deployed.

8. Second, the bank cannot take an aggregate risk that is associated with a very high return as well as such low rate of return that is below a minimum reward in the form of interest spread over its own cost of funds and largely fixed cost of its operation including loss or provision on account of non-performing assets or impaired assets. If it fails to earn the minimum reward, it cannot meet its obligations to pay interest to depositors or fail to protect the interest of its shareholders.

9. Third, the bank lending business is inherently exposed to high risk even to earn the minimum return. Because banks are highly leveraged: almost all their funds are borrowed and the interest margins are relatively thin.

10. Fourth, if one bank fails to meet its commitments, it can induce systemic risks that can put many other banks into trouble.

11. So, the limits on banks’ ability to assume risk are very clear: banks cannot assume large risks if they wish to sustain operations without bailout by the society at a great cost to the taxpayers. It is only when they are lured by high greed to earn higher and higher rewards or are forced by environmental pressures – political or competition - banks would not take on aggregate risks that can threaten their very existence. ‘Too large to be allowed to be fail’ may lead to such high level of risk taking: the consequences of such risk taking to the borrowers in general and the economy as a whole has become clear in the last two years.

Variability of Risk over time & Banks’ appetite for lending
12. The banks’ risks increase during periods of economic slowdown and recession: the borrower- clients get into difficulty and the return flow of funds to banks gets adversely affected. Banks become wary of increasing lending and more selective in choosing borrowers. They ask for higher interest rates and more security from borrowers to drive away borrower customers from their offices. So, the relationship of banks with their borrowing clientele sours and the banks are then called “Fair Weather Friends”. That is the ultimate definition of risk-reward relationship. This relationship cannot be redefined however much refinement we try to incorporate. Most borrower clients will not get the low cost funds from banks when they need them most. The borrowers have to carry on with this eternal risk-reward relationship with the banks.

13. This perception of banks being fair-weather friends has been there for decades and possibly throughout the last 110 years. However, during the period of fully-government owned banking era of the 1970-90, the Indian industry could lobby when in distress and could force Government and RBI to ease credit whenever needed including pumping bank funds for sick units that had very little chance of being revived or rehabilitated. All that was at a great cost to the society and the economy. Such banking and finance regime could not be sustained and had to be given up.

14. After the economic liberalization process started and banks went for direct public and foreign institutional shareholding by diluting government stake, it has become difficult to lobby and win low cost and large volume of credit when the industry is in distress, though the Government and RBI policy continues to be to ensure adequate flow of funds so that no viable industrial operation or project suffers due to shortage of bank credit.

15. In the aftermath of the Balance of Payments crisis in 1990-91, interest rates shot up to dizzy heights in the 17%-22% range. It then fell down to 13%-15% range. Again, when RBI became concerned with high inflation in the mid-1990s, interest rates rose again. A recession would soon grip the economy and interest rates plummeted. For a period prime borrowers took bank money at 8%-9% interest rates. The economic growth rates of an average 9% for about 4 to 5 years at a stretch in this decade was partly aided by the low interest rate regime. But such good borrowing periods come and go.

16. In 2008, especially as the global slowdown accentuated by the financial crisis that broke-out in August 2008, a tightening of credit markets was witnessed. But before long, the extra-ordinary stimulus packages and monetary easing helped interest rates to soften and credit flows remain fairly adequate, despite industry complaints of banks’ reluctance to take risk of extending credit and not reducing interest rates across the board.

Lessons for Borrowers
17. Industry always need low cost credit and large leverage. But industry cannot expect this need fulfilled in certain periods. The ultimate risk-reward relationship between banks and their borrowers hold true. Some borrowers understand this writing on the wall and therefore manage to remain always credit worthy and as most sought-after banking clients even in periods of depression and tight credit policy. They do not stretch their finances and leverage in anticipation of corresponding over-stretching of their bankers. They build up cash and easy-to-liquidate risk-free cash equivalents instead of using up all cash for expansion or investments in land, buildings and stocks.

18. Not all borrowers are able to do that. Among them, those who anticipate difficulties in repaying bank loans as per schedule and discuss with their bankers for debt restructuring or re-scheduling of debt repayment do a better job of managing their risk than others who default to banks before asking for rescheduling. Among those who ask for rescheduling or restructuring, those that come up with additional security and/ or asset-sale cash proposals do a better job of managing their relations with the bankers. Those who merely depend on banks to rescue them after they have defaulted are essentially passing their risk management failure costs to their bankers and are likely to consider the banks as fair weather friends. Not to become a non-performing client in the books of the banks will always remain the prime responsibility of the client. That is the implication of the risk-reward relationship in banking: borrower clients need to anticipate their failure in meeting obligations and the banking system’s liquidity and capital adequacy scenario much in advance to manage their relationships with the banks.

Excellence Thru' Globally-Oriented Leadership (2006)

2009-08-01T09:52:00.001-07:00

Excellence Thru’ Global Leadership
Dr. Basudeb Sen
(www.senland.com)

This paper advances the proposition that the pursuit of sustained excellence in performance (results or impact) in modern day world forces individuals and organizations on to a path (or an ambition) of global leadership. Global leadership does not appear to be attainable overnight or within a short period of time. Again, it is generally over a long period of time that an entity strives to improve its performance, attain excellence and sustain excellence. The operating environment of an entity operates changes over time often in unanticipated ways and sometimes in a dramatic manner. Scientific and technological advancement and breakthroughs have at certain points of time radically altered operating environments, living styles, demand patterns and the structure of economic activities. Similar has been the impact of demographic changes that take a long time to show up in perceptible manner in the population/ demographic statistics. The pattern of exchange of goods and services among different countries takes time to change even after protracted negotiations conclude specific bilateral, regional and multi-lateral trade agreements. But the trend towards greater economic and trade relations among nations produces major impact from which it is becoming increasingly difficult to insulate even the smallest of entities in the World. The natural environment (global climate and temperature, distribution and timing of rainfalls, the quality of drinking water, the state of the forests and the movement of people and other living beings) also changes in imperceptible ways over a long time before suddenly the accumulated changes make their impact felt in significant measure on different aspects of human life (like health, food availability, communication, and etc.).

2. Virtually no entity can remain unaffected for long from these technological, economic, social, demographic and natural environments because of the global nature of these changes and the widely spread impact of these changes. To achieve excellence in performance, the leadership of an entity needs to visualize/ anticipate these changes and their probable impact and generate (and be ready with the plans for implementing alternative) options to make the best use of the environment changes for survival and growth. From a leadership point of view, even surviving certain crises/ threats arising from the adverse external forces may constitute an excellent performance. Sometimes, however, the environmental trends and their probable fallout are anticipated and options are readied for exploiting the opportunities for achieving excellence in growth in sales, market share and profitability. Ensuring organizational flexibility and readiness to meet the challenges of the future can constitute excellent performance on the part of corporate leadership. This journey necessarily involves a progressive upgrade of the leadership to enable it to ensure that the organization’s mission, vision, goals, strategies, structures, systems, practices, resources, skills, cultures and mindsets are and remain relevant and appropriate to the emerging global environment. The quest for excellence is thus a journey towards or in global leadership.

Definitions & Illustrations

3. Before a discussion on the proposition per se, it is necessary to define the terms and illustrate them. In the absence of such a specific glossary of terms for this paper, there is a higher degree of miscommunication risk. This is all the more so in view of the varying meaning and connotation of terms used in different discussions on the subject of leadership. In this paper, leadership will either mean the position/ role/ activity of a leader / leaders. So, sometimes we may refer to the act of leading as leadership and sometimes to the leader as leadership. A leader is an entity that leads certain other entities in a field. A field is a set of connected or unconnected activities in which one or more entities may be engaged in.

4. An entity may be an individual or a group of connected individuals. Examples of entity are I (as a person), a family, a club, a business firm, a cricket team, an orchestra, organizations of various types, a trade union, a chamber of commerce/ industry, a religious order or community, a political party, a section / department of an organization, a legislative body, a Government, a cabinet of ministers, a nation, an army or a police force, an international organization like the UN or the WTO or the World Bank, a terrorist organization, a smuggling mafia, a non-governmental non-commercial social service agency, a municipality, a co-operative and a cultural association. Clearly, different entities operate or are engaged in different sets of activities and therefore are in different fields. Many entities may be operating in the same field. For example, there are many firms manufacturing biscuits, many clubs playing cricket, many religious bodies engaged in preaching and community worship, many groups of ministers or bureaucracies administering governance (though in different countries), many political parties engaged in the business of politics and competing for access to use of power, many service sector firms providing telecommunication facilities.

5. Each entity has a leader or leadership. In the case of an individual man/ woman/ child, he/she himself/ herself is a leader in his own field of activity of studying or working as an employee or as a singing. This is sometimes referred to self-leadership. A person as an entity may also be a leader of a group of students in the field of pure studying or he may be leader of the students’ association engaged in the field of protecting and advancing students’ common interest. While one entity may be leader in different fields, another entity may not be a leader in any field. Those who are not leaders are competing or allied followers.

6. An entity may be part of a bigger or larger entity. A person may be part of a family. This person may be a leader in a field of activity but not the leader of the family. Often, father is the head or leader of the family. But in many situations the wife or a particular child may lead the family. In many families, there is joint leadership: no single individual leads. And, it is possible that different members of a family provide leadership in different fields in which the family operates. The father may lead the field of educational and career building activity while the mother may take up the leadership in the area of shopping and health affairs. The incidence of joint / distributed leadership may be observed in large commercial organizations, clubs, societies and governments.

7. At this stage, it may be worthwhile to distinguish between formal leadership and real leadership. While a person may think that he is the leader in the field of his own affairs, his friends may actually be leading him. A father may be the formal leader of a family, but the real leader may be one of the children gifted with greater intellectual, communication and inter-personal skills. The chairman may be the formal leader of the company while the real leader may be one of the directors who is intellectually stronger and more capable than others or a coterie of self-serving directors. This paper is primarily concerned with the real leaders rather than the formal leaders (i.e. assumes that the real leaders are part of the formal leadership).

8. It is also necessary to distinguish leadership within an entity and leadership in the field of an entity. When we say that company xyz is the leader in its field, we are talking about the company being the leader in field of producing/ selling some product/ service. But when we talk about the leader of its company as an entity, we are talking about that component/ part of the company that leads all other components in the company. This important distinction is to be kept in mind while evaluating the proposition being advanced in this paper. The board of a company may be the leadership within the company as an entity. At the same time, this company itself may enjoy the leadership in the field of its operations i.e. leading an entire industry. While the leadership within is generally one, even if not compact and coordinated, there may be competing leadership companies in a single field. In many fields, one may observe one or more leaders with significant market shares with a large number of small players with varying but much lower market shares. These latter firms may be called followers or start-ups, though a follower, particularly a start-up may be an emerging leader. A few years ago, ICICI Bank was recognized as a start-up commercial bank that later emerged as a leading bank with substantial impact on the banking industry practices/ policies.

9. Performance of a leader or leadership is judged in terms of (a) the impact the leadership within an entity makes on the realization of the mission, vision, goals, objectives and strategies of the entity by its operation in the chosen field / fields and (b) the impact the leadership within an entity makes on all fields including the field of its operations by establishing the entity’s leadership in the field/ fields of its operation. For example, the leadership within the entity called Microsoft (Bill Gates and others) made an impact on its own business growth and profits as well as on return to its shareholders – the goals that would have driven the Microsoft to operate in its chosen fields. At the same time, by establishing its leadership in its chosen field in terms of innovation, market share and customer reach, Microsoft also made an impact on the entire information technology industry. Or, take the example at home: ITC Ltd. Not only delivered sustained improvement in its financial performance in the last decade, but also has made an impact on the way agricultural commodities are procured from farm gates and also the way consumer products, and agricultural inputs reach rural customers by combining its resources of information technology, research on consumer tastes and preferences and bio-technology, retail marketing and distribution and brand building. Or, take the example of new generation private sector banks like ICICI Bank, HDFC Bank and UTI Bank that not only achieved significant market share within a small period of time but also established their leadership in using modern information technology applications and marketing of products forcing larger public sector banks to follow them.

10. Finally, one has to consider the focus and order of leadership. Leadership of an entity may be localized, globally oriented or global order depending primarily on (a) the perspective/ approach to standards and practices with which its leadership within operates and (b) the scale of impact it makes or seeks to make on its chosen field of operation and other fields. The leadership that benchmarks its management practices, corporate governance and operational standards to its geographically local competitors is essentially a localized order leadership. The biscuit manufacturer that caters to consumers within a small geographical locality is most likely to be a localized order leadership within, despite its high local market share. The leadership that aims at standards and practices better than those that prevail in its local environment is a globally oriented leadership. Contrast the contest among the leaders like Britannia and Parle and the new entrant ITC with the localized biscuit brands. Similarly, the leadership that has already established / seeks to establish it leading position in an extended market beyond its local environment is also at a globally oriented leadership level. It is necessary to point out at this stage that all globally oriented leadership may not be of the same order. There is a continuum of globally oriented leadership scale along which a leadership can upgrade itself over time at varying pace. It is for the purpose of simplicity that anything between localized leadership and global leadership is referred to as one category called globally oriented leadership.

11. The leadership that benchmarks its standards and practices to the best in the World and possibly also seeks to establish/ retain its leading position in terms of market share in the whole world is a global level leadership. It is better to note that a relatively small firm operating largely in the local environment may have a globally oriented leadership. Firms like TCS and Wipro were until a decade ago small firms in their fields but were emerging global leaders. Similarly, Infosys or Bharat Forge took very little time to become a leading global player. One would have observed how ICICI Bank, UTI Bank and HDFC Bank began their innings with globally oriented leaderships and excelled in their performance to emerge as competitive leading players in India banking. Even consider the impact of leadership of the Indian Railways on its financials as well as on the focus on passenger comfort and convenience in the recent period, though it is too early to make a real assessment. The way the Indian Postal Services or the parts of the Ordinance factories have responded to the market forces after economic liberalization in the 1990s points to the global orientation of their leaderships. Turnaround leaderships are almost always globally oriented leadership. Consider the case of Japan and Germany after the World War, IBM, Citibank Group, etc. Even in India, many private sector industrial companies that were on the verge of permanent sickness due to the change of the market place after economic liberalization were fortunate to have globally oriented leadership that brought about real turnarounds. Some of these companies are today well entrenched in the global market.

Elaboration of Proposition

12. As an entity moves from localized leadership to higher order, it essentially seeks to improve its performance. Further, as it moves to global leadership, it sets itself an ambition to attain excellence and sustain excellence. Thus, the path to excellence is a path to higher order leadership. The path to sustained excellence is the path to maintain and enhance global leadership. It is not however guaranteed that an entity on the path of higher order leadership will attain excellence or an entity that has attained global leadership will retain its leadership position, given the dynamics of competition in the field. All the above (and what has been mentioned in the initial paragraph of this paper) is only a proposition. The theoretical and empirical foundations of the proposition need to be examined. In this paper, however, no attempt is made at scientific empiricism that demands lot of data on companies at various levels and their performance over time. This paper does not also seek to formulate a theory from which the proposition of the paper can be deduced or inferred. What is attempted here is no more than an elaboration of the proposition that can only serve as a prelude to subjecting the proposition to tests of theoretical and empirical soundness.

13. For an entity that is not a leader in the field there are three options: align with the existing leadership in the field, or challenge it, or live so long as the competitors including the leaders allow. For an entity that is already a leader, there is generally some entity or another already in the field or a new entrant to the field somewhere in the world who is trying to put up better performance over other existing players in the field. Mere pursuit of excellence therefore cannot not guarantee that excellence will be attained and/ or sustained. Of course, the journey towards excellence is facilitated by the associated journey towards globally oriented or global leadership. But there is often a competition among entities with globally oriented and global leadership. Also, global leaders of yesterday may become complacent and falter, even fail to sustain its commitment to retain its global lead. This dynamics causes the standards of global leadership to change. Thus, today’s global leader may fall behind and new global leaders may emerge in different fields. Why did Enron fail? Why could Enron retain/ establish its leadership in the field of power generation, distribution and power/ power derivatives trading? It did not really have commitment to sustain global leadership practices. Why did Citibank or Motorola remain in the reckoning for global leadership despite disasters afflicting them? It was the commitment to global leadership. How did ICICI survive when the development bank model of the 1950-1985 became obsolete and uncompetitive? Because ICICI had a committed globally oriented leadership that had an alert, effectively utilized corporate mind capable of transforming the ruins and potentials of ICICI into a vigorous universal commercial bank with leadership position in Indian banking. Global leadership position in a field once attained may be lost and regained provided the global leadership (quality) within remains in tact.

14. But how does the movement from localized leadership to globally oriented leadership takes place? It may be useful to construct some examples. Consider the field of residential housing development in different States of India. There are players of different sizes and hues. Some use the most modern equipment and systems. Some operate in different cities in India, while others restrict their operations to a State or even a small locality. Consider the smallest entity in the field. He has limited financial resource raising capability but contacts that help acquire land/ old houses to construct four-storied residential apartment buildings in the locality in which he lives and operates. He depends on local subcontractors for supply of materials, equipment and masonry/ carpentry/ electrical/ plumbing other skilled/ unskilled labour. He also commissions part-time services of a locally resident civil engineer as architect cum design engineer. The same is true of the legal services he needs to enter into contracts. He himself acts as the knowledge base of all operations and construction including the safety requirements, though his knowledge is extremely limited and poor to say the least. What does he deliver other than poorly designed apartments, unsafe electrical wirings, shabby quality doors/ windows, low height stairs, inadequate and inconvenient space for common utilities and narrow passages. It is like creating another slum for middle class/ lower middle class families. He makes a huge profit and wishes to expand his business. He has two options: be a localized leader and continue generating same quality flats with the same systems and vendors or become globally oriented, expose himself to the activity of players outside his locality who are building better designed and better quality flats for decent living. The latter option implies a better organization of activities, employment of more professionally competent engineers, more quality conscious carpenters, masons and plumbers. This would mean benchmarking to standards and practices that are better than those adopted by his competing builder-developers in the locality. Only a vision of providing better quality residential flats and a decent surrounding for the households occupying the flats can motivate the builder-developer to upgrade his leadership. This may involve a higher cost for him, but in the long run better reputation, higher price realization and greater demand for his services. This may in turn force other builders to adopt better standards and practices. He may or may not do business outside his locality but he would have made an impact in his field by forcing other local players to adopt better standards. Moreover, even within his own locality he can carve out a niche market offering services for renovation of flats and buildings to higher quality levels. His methods of identifying individual flat-owning customer’s renovation needs, planning, design, procurement, labour deployment, organization structuring, execution, monitoring, quality control and delivery scheduling would be far superior to the competing run of the mill builder developers. This is how pursuit of excellence is related to moving up the order of leadership from localized to global orientation. But why does this particular builder developer upgrade to a higher order leadership while others in similar position do not do so? Before this issue is discussed, more examples are in order for proper elaboration of the proposition of the paper.

15. An individual is first a leader of himself so far as his own personal decisions are concerned. Many individuals are self-leaders, while others are followers. Different students of equal merit and examination results take different approach to their education and career choices when they leave the college. Most fall in the bandwagon: study computer applications or engineering or medicine or accountancy. Some do not. They look for information on specialized careers. Some join courses in event management, TV programming, animation, pharmacy, biotechnology, Chinese language, acting, photography, painting, etc. Some just join the family business with college education as a subsidiary activity. Yet, some others do multiple things at the same time: study commerce, join an accounting firm as a low paid assistant and assist NGOs as volunteers so that they acquire diversified skills. This is providing globally oriented (self) leadership to one’s own life at an early stage. They want to establish their leadership in niche fields that they feel will make the best use of their talents. Why do some adolescents take such decisions is an issue to which one can revert back later?

16. Consider the case of Sourav Ganguly, the former Indian cricket captain. He had first established himself as a lead batsman and later as a Captain. He could have operated in the single field as batsman. But as he took the opportunity of playing as a skipper, he operated in a different field – one of captainship. He wanted to establish himself as a leading captain. And, he did that not merely as the most successful captain of Indian cricket but also a captain of a different variety: one who is aggressive in approach to deal with aggressive captains of opponent teams, to establish an active role for skipper in team selection and coach selection, to work on a strategy that makes the team less dependent on the batting performance of the few top batsmen, to support the younger rising star, etc. He would have known that leadership as batsman and as captain cannot continue for long. Yet in the process he has acquired considerable exposure that has built into him the capability to deal with politics in cricket, to enable him to move to different operating fields as lead selector or commentator or coach in future. Developing capabilities for leadership in newer fields and retreat from fields where leadership is under attack from juniors is itself an example of globally oriented leadership traits. The reality may not be as simple as it is narrated above. But the cricket career of Ganguly does indicate a departure from the run of the mill, lead cricketers of India. He has ensured that lead batsmen or bowlers will never again get a chance to captain Indian cricket team merely on the strength of their capability only as batsman or bowler or all-rounder. He needs to show the characteristic of a general who leads from the front not only in the game of cricket but also on the selection of the coach and the players for the series and each match. The days of meek, docile captains keeping a distance from other players are over.

17. Who was the leader in the epic Mahabharata? There were so many leaders. Arjuna was the lead archer, warrior and commander. There were many other such leaders. Some were older like Dronacharyya and Bheesma. But many were in comparable age group like Karna and Duryodhana. Yudhisthira, Bheema, Satyaki, Salya etc were also lead warriors and commanders. Not all the leaders were globally oriented leaders. The entire Kaurava leaders were localized leaders in the sense that they were contesting the Pandavas only in the field of monarchy they both inherited from their forefathers. King Dhritarastra, himself a capable leader in his younger days, was only the formal leader and not the real leader. Yudhistira had the objective of establishing himself as the leader of dharma rather than as a King of subjects or an elder brother or as a commander of army. But what does one place Krishna? He had established himself as a great warrior at a young age, yet in Mahabharata he was seldom seen to fight and when he did fight to win, he fought reluctantly and as a last resort. In Mahabharata, Krishna was establishing himself as a leader in a different field. He was a global leader in that field – the field of sharing love and wisdom, reducing tension, extending care and peace-making diplomacy. There were many other leaders who could have tried to excel in this field. In terms of age, experience and warrior skills, Bheesma or Drona could have taken up this role. So could both Yudhisthira and Karna. And, Dhrirastra himself could have brokered peace. But they were not global leaders in this particular field but in different fields. Krishna alone was a global leader in different fields including the field in which he mostly operated in Mahabharata. And, he performed much better than the modern day United Nation Secretary General or Mahatma Gandhi. He averted conflicts among/ with warring sides many times with his sweet nature, words of wisdom and diplomacy. With the same qualities, he remained in the midst of a war without fighting for any side and guided the war that had become inevitable to eradicate the era of conflict between Kauravas and Pandavas. And, his words of wisdom that he uttered to Arjuna during the war remain the most treasured treaties on human life in the history of civilization. This is global leadership par excellence.

18. From epic to modern day world again. But before one reverts to business/ corporate world, one needs to make a short tour of some more fields outside as well. Who is the global leader in Science and Technology? India is certainly not the leader. The leadership in this broad field lies in the West starting with USA. But 200 years ago, the leadership position was occupied by the United Kingdom. In robotics, Japan is among the top leaders. In science, US’s leadership may be soon threatened by China and India, given the latter two countries’ large and growing scientific and engineering manpower. But do India and China reflect a progressively higher order of leadership to compete with the west in the next two decades? Does India and China really have globally oriented leadership within to aim for leadership in the field? What is the scenario in the field of Athletics? The leadership of US, Russia, China and a few other countries may continue for some more time. Even as the US starts worrying about the impending contest for leadership by China and India in the field of Science and technology, India’s leadership within does not seem to be moving up the order of globally oriented leadership in these fields. In hockey India lost her leadership long time back and in football (soccer) the position was never glorious (India had improved her performance to lead Asian countries some decades ago and slipped since then). In contrast to the above, India lifted its position to global leadership and continued to be among the leaders during the last 15 years. Indian cricket leadership within has been globally oriented and established her rights in the ICC thanks to Mr. Dalmia, now disposed off the President’s chair of BCCI. The cricket is the most popular game in India now. A comparative analysis of the formal leadership of different sports/ games fields in India could be rewarding but this paper does not seek to venture into that.

19. Consider filmmaking industry. India produces the largest number of films in different languages and probably in a single language. It commands a leadership position in this field. Examine the attributes of the leadership of Indian film industry and identify its globally oriented characteristics in terms of risk-taking, global viewer ship, technology imports and interaction with and copying from film industry leadership abroad. The global orientation of Indian top newspapers, stock exchanges, and television channels has come about within a much short span of time. But is India, despite being the largest democracy, anywhere near global leadership in the performance of Governance and civil administration or justice administration? On the other hand, in terms of performance, India ranks among the top in the field of corruption. Yet, the leadership has been successful in passing the Fiscal Responsibility and Budget Management Act and the Right To Information Act. Is the political leadership in India globally oriented? What explains all this? Consider also the trade union leadership. Globally oriented leadership anywhere would not demand protection but would face threats to survival and growth in the same as leaderships in other areas would do. Terrorism and striking at the roots of existence of organizations whose performance would determine the employees’ ultimate fate in the organization are clearly counterproductive strategies. The evolution of a concept similar to labour is the primary challenge trade union leaderships must address first before they talk of trade union rights in the 21st century organizations. The labour-capital-management exploitation organizational perspective is relevant to organizations that are now virtually extinct. Is it possible to have globally oriented trade union leaderships that would deliver excellent performance to (which) labour?

Corporate Leadership

20. It is time to move to corporate leadership now. The discussions in the previous paragraphs, however, are equally relevant to the corporate leadership discussions. But a few more definition of terms at this stage would be required. Corporations are hierarchical in organizational structure with almost always a single person at the top. The leader at the top is almost always the center of interest for study. This is natural as people like heroes and stories about heroes. Indeed, some great top corporate chiefs achieved such amazingly great transformation in their organizations during their tenure of being at the helm that they deserve to be worshipped as heroes. But even those transformations involved the creation of a vibrant structure of coordinated leadership structure all down the line. A single person at the top did make a difference but no person, however, great can sustain a process of transformation without placing leaders at various crucial functions and levels of the organization. Even just below the top, a team of leaders supporting the leaders at the top. Thus, organizations have what one may term as leadership structure.

21. The existence of leadership structure does not necessarily mean a command and control structure or a bureaucratic structure or a functional structure. Leadership structure in most corporations is now flatter and represents largely a multi-layer network of both functional/ strategic teams and also task/ project/ assignment-oriented collegial teams whose membership changes over time. Even within each team the leadership role shifts from one member to another. It is more like the cricket teams in which sometimes the captain is in the lead and sometimes the coach and at times the junior most batsman or bowler. The process in which this multi-point, multi leader teams function in a network of teams is difficult to comprehend and may cause difficulties to the company. Witness the Ganguly-Chappel controversy in Indian cricket!

22. How the leadership structure functions depends on the leadership culture. And, leadership structure and leadership culture may or may not be impacted time to time by leadership struggle that involves fair/ unfair/ overt/covert competition among leaders in lower leadership positions within the formal leadership structure to acquire higher leadership positions in future, and by leadership breeding that reflects an organization’s culture to identify, acquire, develop, support and encourage emerging leaders at various levels. Both leadership struggle and leadership breeding are essential for a corporate leadership to sustain continued supply of quality personnel for its leadership positions at various levels in the leadership structure. Yet, these two processes or elements of the leadership culture may sometimes be working in a counter productive manner. A culture of leadership struggle helps throw up the best available future leaders, but it may also encourage bitter fights and unfair games that may hurt the organization’s interests. Leadership fights at one level may lead some individual leader or group of leaders to sabotage the leadership breeding process and frustrate emerging leaders in their incubation at various levels. Similarly, leadership breeding may generate impulses for undesirable leadership fights because of mismatch between available formal leadership positions at various levels and the generation of potential leaders generated by breeding. The output of leadership breeding needs systematic absorption through creation of adequate challenges internally or outside the organization. The ability of leadership and its structure in a company to continuously upgrade the quality of its globally orientation depends on how these processes work out and are managed.

23. Can leadership be sourced from the market? Market for leadership (including for potential future top-level leaders) play an important part in the sustainability of journey through the continuum of globally oriented leadership to global leadership. Leadership is certainly about assessing the future global environment and targeting opportunities, setting vision, mission, goals, objectives and benchmarks, formulating and implementing relevant strategies, structures, systems and practices. But this is also about responding to the global market for leadership. Clearly, leadership breeding can mean breeding for the organization as well as the market. But it also means opportunities for acquisition and effective absorption of leaders at various levels from the market. Not all organizations are equally prepared to exploit the opportunities in the leadership market. Real good globally oriented leaders tend to flow where the challenges attract them. Some organizations with complete reliance on internally bred leaders or seniority of leaders as a basis for deployment in formal leadership positions may lose out, while completed dependence on the market for top formal leadership positions may find difficult to sustain globally oriented leadership. In a situation of growing opportunities for challenges emerging for the businesses to expand and diversify, the market for globally oriented leadership becomes vibrant. Retaining leadership talent becomes a major issue.

24. Excellence has no upper bound. The size of the market, rather the size and diversity of the fields in which an entity seeks to operate and limit its vision to, determines the order of global orientation of its leadership. Greater the external space (products, inputs, geographical markets, technology and innovation, the underlying risk factors, etc) that the leadership considers relevant as its domain of environment, the higher is likely to be its challenge to sustain excellence and higher is the order of global orientation required of its leadership. An empirical validation of the above is not possible without detailed knowledge of the actual state of affairs in different companies over time. But questions may still be raised about broad categories of companies in India. Do most largely family owned businesses believe in Leadership Structure and Leadership breeding? Isn’t the top family leadership very careful about nipping any leadership struggle in the bud? How then do they encourage competition in the movement up the leadership hierarchy? And, when the family leadership divides at the top (as it started in the case of Reliance Industries a few years ago), what happens to the leadership structure and culture before the division get sorted out? The professionally managed, widely held with very little promoter group shareholding in the private sector may not have the exactly same issues to deal with. But many of the large professionally managed and widely held large companies diversifying and expanding very fast has to broaden its leadership structure. How exactly do they do this? Does the market for leadership talents help in acquisition? And, do those who set up subsidiaries or plants abroad assimilate foreign talents in the leadership structures?
How do the public sector respond given that seniority is the overriding factor in movement towards the top and the selection at the top is dictated by an owners whose choices are, to say the least, arbitrary though always rationalized? In listed companies, major investor- shareholders keep a close watch on the companies they invest and have shown an increasing tendency to take up important issues with company managements. Though the investors are outside the entity of a company, they become part of the organization when situations so warrant and contribute as part of leadership within to force changes that would bring better performance. The market for corporate control provides for globally oriented/ global leadership in search of organizations that need them. In family managed businesses the families take active interest and except when inter-family conflicts arise the leadership within is always under pressure to deliver performance. But in the public sector, the major shareholder’s representatives have little to lose by intervening in any manner they like. Doesn’t the talk of MOUs with ministries and autonomy of public sector management point to a limit on the extent to which public sector leaderships can upgrade to higher orders of globally oriented leadership except by chance?

A Summing Up

25. To sum up, this paper advances a proposition that is almost like a tautology and therefore whose proof is not necessary. The paper raises various issues connected to the performance of leadership of organizations insofar as such performance has any relationship with the global orientation/ exposure of the organization or its leadership quality. The paper points to the need for looking beyond the top leader into the leadership structure and leadership culture. It also emphasizes on the dynamics within the leadership structure and culture over time and the interaction with the market for leadership talent. Equally importantly, it seeks to view the relationship between global orientation of leadership and its performance as a generic issue across all type of entities from individuals to families, from NGOs to Clubs, from Universities to Governments, from sports bodies to multilateral, international organizations, from service industry commercial enterprises to large corporations with diversified businesses across products and countries/ regions. The paper seeks to elicit and interpret the experiences of the readers in the framework in which it discusses about global leadership.
@ Paper presented at GHlobal Leadership Conference in 2006 at Kolkata

Concept of Global Leadership: A Different View (2005)

2009-07-31T11:06:00.007-07:00

Global And Globally Oriented Leadership
- An Indian Perspective
Basudeb Sen

Leadership Distinction
In the past decade or so, India has taken the opportunity to tread the path of economic globalization. Being in this path demands leadership of a different character and quality than the leadership required in a closed, slowing growing poor economy of the decades prior to 1991 when India rescued herself from bankruptcy by reforms for progressively freeing her citizens from the iron chains of the Government and its oppressive operating agencies and progressively opening up the economy to the world outside. Even though the reforms were/ are introduced with great resistance and reluctance, India has made substantial progress along the path of economic globalization that in turn has led to some measure of cultural and social globalization. But the extent of globalization of the Indian economy is as yet far behind many of the advanced, high-income or middle-income economies of the world. It may take few decades before India becomes a true globalized economy. We need effective leadership to steer us in our long travel through the process of globalization, before India can become an important part of the global leadership. The tasks of the leadership of a globalizing economy and the tasks of global leadership are different: the nature and quality of leadership for the different tasks are different. Global leadership may therefore have different connotations and the leadership requirement for nations that are accepted global leaders today are not the same as those for nations that are on the path of globalization, like India or China. This distinction is important from both analytical and practical point of view and is consistent with the aspirations of nations to become globally accepted leaders of the community of nations.

2. Most human beings or groups or societies aspire to be leaders, a few actually become and still fewer succeed in making a significant impact on the environment, the fields or organizations they lead and the rest of the world. That India will in a time of a few decades will be second or third largest economy of the world ignites our imagination and dreams of establishing our leadership, at least in economic and business sphere. Without trying to undermine such dreams, it is necessary to understand the situation of global leadership today and what the prospect of economic prosperity of India means in terms of the requirement for and scope of assuming global leadership.

3. At the time of Indian Independence, a vision of assuming the role of global leadership led to our initiatives of non aligned movement that might have caused a great sensation in India and that the World, at best, ignored. The initiative did bring nothing of significance to Indian economic history or the global political scenario. Maybe, trying to play the role of a leader in the global arena cost us something in terms of economic and social progress. Leadership does not come from a mere desire to lead: it emerges from the interplay of challenges in the environment and nation’s/ person’s capabilities and focused goals.

Scope of Global Leadership

4. Let us look at the current environment. Who are which nations provide global leadership today? Irrespective of whether the present leadership is successful or not, do we have a leadership role that we can effectively discharge or are expected of by the community of nations? Do we have the capabilities or strengths that would help us assume the role of global leadership in any field like Peace and Anti-terrorism, economic prosperity, military and weapons power, Science and technology, Education and Quality of Life, Environmental Protection, Sports and Culture, World Politics and Diplomacy or Business, Trade and Commerce? How do we stand in all these fields in relation to USA, European Union, China, Russia, Japan, Australia or the Arabs countries?

5. Even within business, trade and commerce, where do we excel and capable of beating international competition most because of our productivity, innovation and/ or economy in scale of operation? Is that in steel manufacturing, iron-ore mining, oil refining, shipbuilding, construction, entertainment, tourism, aviation, space travel, nuclear technology, information technology, molecular bio-technology, medical treatment, school education, management education, toy making, etc? Or, for example, in rice and wheat production is our farming productive enough. Can we impact international prices in some products because we are the dominant buyer or seller or both? The answers will determine where we need global leadership of what type. There is no need, however, to seek detailed answers to these questions and debate here. We should be fairly clear where we stand. We know in which areas we have flourished and won global recognition and to which extent. And, what our future prospects are.

6. Let us then look at the prospects for the next two/ three decades. We are projected to be the second or third largest economy in the World in terms of National Income (Gross National Product). But when we reach the size of the US economy, an average Indian will still be one-third as rich as an average American (in terms of per capita income on purchasing power parity basis). Our standards of living will still be poorer than many of the existing advanced countries. Will that be an adequate strength that would make the whole world search for India to provide global leadership? The answer to this question lies with the time: time will tell. But one can identify a few strengths may be demanded of future global leadership in any field/ activity. These would include, besides the strength of economic prosperity, considerably high trading and economic relations with countries spread over many regions, military capability, power of innovation and progress in the some of the emerging fields of science and technology, a transparent and open, democratic society with very limited role for corruption and bribery.

Emerging Nature of Global Leadership

7. In future, no nation or organization may be expected to be the supreme leader in any business or politics or technology of significance. Some groups of nations or groups of companies/ organizations or groups of individuals will be part of a global leadership coalition. That is the way the world is evolving. Unless one participates in the global activity in a substantive way and with significant stake, others are not going to accept one as part of the global leadership. Acceptability will not come from the strength of population or size of economy, but from the extent of global exposure and experience in the relevant fields/ activity. Global leadership will not attract followers. Global leadership will be recognized by their impact and influence on the future of the global economic, political or social activity of each type. Absolute large, commanding leaders will fall: in economics and business due to competition regulation and freer international trade, and in politics because of diversity of views and cultures. Those who get into the global leadership of any activity will be respected as friends rather than as formidable foes or adversaries. Global leadership in future will involve leading coalitions of networks of entities across the globe – networks that are able to enhance effectiveness, value and contribution of each entity and collaborative effort in scientific research, technological applications, economic integration and prosperity.

8. There is no need to bring in specific illustrations to elaborate on global leadership. We all know how mobile, inter-net and entertainment companies collaborate to establish and maintain their individual industry leadership positions. How credit card businesses and retailing business or airlines businesses collaborate. We know of the collaboration of research institutes and universities in the field of scientific research, or of the collaboration among different nations against money laundering, terrorism and global warming. Yet, businesses are operating under increasing competition and competitive threats.
Global leadership is now beyond competition: it is more about meaningful collaborations.

Role of Indian Leadership

9. It is this context in which India needs to view its role in global leadership. Currently, however, India is far from the stage of being part of global leaderships in most areas/ fields of significance. The only record it has is of sustained high economic growth in the last 12-15 years achieved mainly through economic liberalization from the suffocating web of State control and oppression and transition from a closed, isolated economy to an open economy. India’s trade and capital flow links with the world economy have strengthened, though yet very tiny in relation to the size of the economy. Indian businesses have just started acquiring businesses abroad. India is yet to make her impact felt on the international market for goods and services (except in the case information technology enabled services and other business process outsourcing from foreign countries). India is still not a major power in WTO negotiations and is yet to get a permanent seat on the UN Security Council. Many Indians may be engaged abroad at the frontiers of scientific and technological research, but India’s own achievement has not been significant enough to attract global attention. Indian democracy has a long way to go beyond mere elections to ensure civil liberties, responsive and performing governance, human rights and justice and to eradicate bribery, corruption, illiteracy and oppression of the women. It is difficult to envision a global leadership role for India in the near future.

10. This does not mean, however, that India does not need to build up her leadership strengths. The sustainability of India’s high economic growth performance and India’s rapid progress on the path of globalization is itself critically dependent on the development availability of sufficient mass of globally oriented managers. The new leadership that will steer us through a long period of sustained, high economic growth to a position of recognition in the global market place and the global society, would be different from the past leadership so afraid of international competition, international capital, international investors and international trade and so fond of controlling and directing the economic, social and cultural lives of Indian individuals. The new leadership in India has to first provide leadership to India before it can dream about providing leadership globally or become part of the global leadership.

11. The new leadership will make the Indian economy more open, will welcome more global exposure and exchange than less, will be prepared to deal with the situation post full convertibility of the Rupee, will not be scared off military, nuclear power and other economic collaboration agreements with different countries of the world, will not be scared of imaginary loss of sovereignty to foreigners and will not be dependent on government policies and initiatives or blessings. A coward leadership, however wise but afraid of the national/ provincial Govt. or foreign powers, cannot lead a nation to any pride of place in the world economy or the community of nations.

12. The mass and quality of globally oriented leadership among Indians need to grow. Leadership of an entity may be localized and yet globally oriented (or, of global order) depending primarily on (a) the perspective/ approach to standards and practices with which its leadership operates and (b) the scale of impact it makes or seeks to make on its chosen field of operation and other fields. The leadership that benchmarks its management practices, corporate governance and operational standards to its geographically local competitors is essentially a localized order leadership. The leadership that aims at standards and practices better than those that prevail in its local environment is a globally oriented leadership. Similarly, the leadership that has already established / seeks to establish it leading position in an extended market beyond its local environment is also at a globally oriented leadership level. It is necessary to point out at this stage that all globally oriented leadership may not be of the same global order. There is a continuum of globally oriented leadership scale along which a leadership can upgrade itself over time at varying pace. Thus, India needs more and more globally oriented leadership at higher and higher levels on the continuum of leadership of global order as India herself lifts her level of globalization over the years.

13. This new leadership is fast developing in the country. They believe in their competence are acquiring expertise and experience working along with foreigners as colleagues, partners, competitors, consultants, clients or employers within the country or abroad. Whether the Indian leaders are in small or large businesses, or whether they are in education and training or in administration and government or cultural activities or sports, whether they are operating in India or abroad, or whether they are in the private or public sector, they are all becoming progressively more globally oriented leaders than before.

Globally oriented leaders are a scarce and very valuable resource with high demand worldwide. If India does not offer them opportunities and freedom to face the challenges of India in an increasingly global sing world, foreign countries and companies will draw them. Many of the Indian private sector companies, some public sector companies and all foreign companies operating in India are incubating numerous globally oriented leaders who are Indians. Even as they take up higher positions of leadership, they all will be either locally operating, globally oriented (LOGO) leaders or globally operating, globally oriented (GOGO) leaders. Many of them are frequent travelers both within the country and across the globe.
They are constantly monitoring the international environment; tracking the India’s economic and political developments over mobiles, inter net and other devices. They are agile, vibrant, dynamic, lively, competent and full of confidence.

14. The process of globalization itself breeds globally oriented leadership. In the last decade, leaders of various levels from far more globalized nations and foreign companies have started operating in India. Many Indians with global exposure as also foreigners with similar exposure have been leading their companies global/ regional/ local businesses from their Indian offices. Even Indian companies have hired foreigners to lead their businesses in India. Indian businesses that have begun operations abroad are using India-bred employees to lead those operations from offices located in different countries. This has contributed to the fast growth in the availability of globally oriented Indian leaders for India’s local and global businesses. The owner- manager driven companies are also traveling the path of progressively higher order of global orientation. Although the demand for globally oriented Indian leaders is far in excess of the supply, international investors are eagerly searching for globally oriented Indian leaders to entrust their funds for acquiring, managing and expanding businesses in India and abroad. The impact has been so great that the leaders groomed in the earlier closed and govt. controlled regime, especially in the public sector, have been forced by competitive circumstances to become globally oriented simultaneously with their much younger colleagues. Within a period of another decade, millions of globally oriented Indian leaders, operating both in India and abroad, will start shaping businesses and impacting the global economic environment. Maybe, that is when India would be economically and politically globalized enough to be respected as a useful part of the global leadership.

15. The voyage along the path of globalization and the path of winning acceptance as an important part of the global leadership is laden with many challenges. Such challenges for India’s globally oriented leadership will involve exploitation of new opportunities and enhancing new skills. Globally oriented leadership will be attracted by the need to lift 30-crore Indians below the poverty line to minimum living standards not through subsidies, reservation and employment guarantees but through improving the pace of economic expansion. The leadership is already engaged in making technical and general education as a thriving business: but it quality needs to be enhanced considerable to meet India’s human resources needs. The challenge of the leadership in this area would most likely involve alternative systems that bypass the Government’s ineffective and expensive systems of licensing and control over education in India. The argument that in almost all countries the State (Government) leadership in education has been both desirable and essential has already been proved invalid in India. The huge scale and diversity of the task of reaching quality education and skills to support India’s aim of global leadership is beyond the capability of the institution of Government anywhere in the world. This task can only be fulfilled by private business initiatives in an open, competitive market environment. Continued reliance on govt. for support, especially for land in exchange of freedom to cater to the needs of the market demand, is already proving to be great bottleneck for India’s economic prosperity. Such public-private partnerships do not speak highly of India’s leadership. Freeing the farmers from the stranglehold of small-scale farming is yet another challenge. So is the need to break the mental barrier that retailing vegetables can be done effectively by anybody (Some politicians think we need not have to learn from Wal-Mart how vegetables have to be sold. They are right. We need to first forget the most inefficient and costly way in which vegetables are retailed by millions of small and large traders in India. The current system of retailing vegetables and fish in India is essentially a network of monopoly- oligopoly nexus and so oppressive to the consumers that they need to go at the earliest).

16. There are many other challenges along the path of globalization. Managing in different cultures across the globe and developing internal network of leaderships and people of diverse nationalities, cultures and background located in different countries demand leadership of a different type than in the past. Converting the concern over global warming into opportunities of businesses that could contribute significantly to the welfare of the global society and India is a challenge more important for India than even the most advanced countries today. If we are to be global leaders we cannot continue to depend only on the West for technologies that would contribute to reduction of global warming and dependence on the rapidly depleting mineral fuels. The same is true of emerging technologies in areas like molecular biology, genetics, disease control, nano-technology, space technology, nuclear technology, etc. If a nation cannot be a substantive partner in some of the emerging technologies, its pace of globalization would slow down and the dream of becoming part of global leadership would fade into the distant time. Two more important aspects of global environment will have to be faced: terrorism and the certainty of the instability of the financial systems. Anti-terror efforts will no longer remain the business of the governments only: businesses and civil societies will get increasing involved in dealing with terrorism. It maybe worth while using the network of globally oriented leaderships to create socially and economically meaningful products and services. Living in a continuously innovating and fast changing financial sector environment that would remain unstable and prone to repeat crises and yet thriving is going to be another challenge for global leaderships. Instead of trying to make the financial systems stable and rely on the comfort of having installed regulatory systems, the real leadership challenge would be surviving and growing despite recurring crises. Today that may be called risk management. Tomorrow this may be called art of surviving under uncertainty. How business leaders in India envision and deal with the challenges in these fields will be a test of their globally oriented leadership strength and their success. The vision of tomorrow is no longer what one wishes to become but how one deals with the unfolding environment.
@paper presented at Global Leadership Conference at Kolkata

On Intellectual Property Rights (2004)

2009-07-31T11:06:00.005-07:00

Impact of Intellectual Property Right on Indian Industry and Financial Sector:
A Framework for Assessment @

Dr. Basudeb Sen

Creators of new ideas, knowledge and technology with actual and potential applications seek the right to prevent others from unauthorized use of their creations (inventions, innovation, research output). This Intellectual Property Right (IPR) constitutes an important foundation of the progress of civilization and economic exchange. Social and legal acceptance of the IPRs has facilitated technological progress, expansion of national and international trade/ commerce, and economic growth. Yet, such social and legal acceptance of IPRs has not come easily. The debates over the desirability of IPRs are not new. The issue of IPR is indeed a very old and settled one. However, the forces of economic progress, especially in countries that sought to benefit from expanding trade among themselves, have slowly but steadily made IPRs an essential feature of modern open economies. Debates still arise every time one or more countries try to simultaneously pursue two contradictory objectives: enjoy the benefits of international trade and deny IPRs to foreigners. The fears of the unknown and of the higher technological/ financial strength/ power of the advanced nations have also influenced such debates. This is true for India as well. Since the beginning of the last century and particularly after Independence, India has enacted various laws on IPR protection and provided for their enforcement. Notwithstanding this long period of experience, India’s IPR regime did not witness much improvement in line with international developments. In a rather closed and State-controlled economic framework, India’s real exposure to IPR issues was relatively insignificant until the early 1990s. Compelled by the natural economic forces, India started dismantling her closed, controlled economic environment and sought economic regeneration through economic liberalization and greater participation in rapidly expanding and increasingly competitive international commodity, services and capital markets. As a result, India could no longer avoid dealing with IPR issues and being impacted emerging cross-border IPR regimes. This paper is an attempt to explore various analytical approaches to facilitate objective assessment of the impact of emerging IPR regime on Indian industry and financial sector. Inputs from such objective analysis can help Indian industry plan respond effective and purposeful response to the emerging IPR environment.
An old, continuing issue
2. One approach to objective assessment is to look at the history of IPRs. More than a century ago, fourteen countries signed the first major international treaty to protect the people of one country from unauthorized use of their creations. This agreement signed as early as in 1883 is known as the Paris Convention for the Protection of Intellectual Property (covering such aspects as we now call patents, industrial designs). Soon thereafter, in 1986, some countries signed the Berne Convention for Protection of Literary and Artistic Works. This agreements helped nationals of one country to obtain protection of their rights to control and receive payments for the use, in other countries, of the creative works like novels, poems, stories, plays, songs, operas, musicals, drawings, paintings, sculptures and architectural works. In 1893, the offices of these Conventions merged to form one forum based in Berne and, after several decades of successful contribution, this gave birth to the World Intellectual Property Organization (WIPO).WIPO with about 180members signed a cooperation agreement with the World Trade Organization in 1996. This history shows that IPR is not a new and unsettled issue in economics or commerce. IPR issue is not just a product of the recent negotiations at or related to the World Trade Organization. Nor has fresh fundamental research has broken new grounds on the benefits/ advantages and costs/ disadvantages of IPRs. The recent arguments over IPR are largely over the coverage of items/ areas under IPR. There are also differences over the likely time profile of the positive economic impact of newer IPR regimes on the various types/ classes of participating countries, especially those who now intend to abandon their closed-economy characteristics and substantially increase their exposures to global trade and
commerce. The debates seeks to find solutions that would enable weaker countries intending to enjoy the benefits of international trade to better adjust to the new IPR regimes. The obvious question is whether, with the adoption of new trade-related IPR regimes, the weaker economies will face severe economic growth constraint arising from unaffordable rise in costs of imports. Or, will they suffer severe unemployment as local manufacturing units have to be prevented from continuing unauthorized use of foreign intellectual property through methods such as ‘reverse engineering’ or ‘ process differentiation’. Alternatively, will the advanced countries gain more relative to the gain of weaker economies in the bargain?
Positive Impact on Active Traders
3. The history of nations participating in cross-border IPR regimes for the past 50 to 100 years can help answer these questions and assess the nature of impact India may experience with her transition to the new policy IPR regime under WTO. Analysis of the experience of different nations actively participating in cross-border IPR regimes in the past decades can be useful in this context. Though such detailed analysis is beyond the scope of the paper, it is possible to suggest broad hypotheses on the nature of impact of IPR regimes on industries in WIPO member countries. The history of the evolution of the IPR regime over the last 120 years indicates the substantial progress of international trading partners to work out IPR regime solutions to reconcile the two opposing effects of IPR. Inventions and innovations have been encouraged through IPR protection to the creative people of the trading-partner countries. Also, the jointly agreed limited tenure/ periods of each item under IPR protection regimes ensured that the ultimate benefits of better technology, better quality products and lower cost are available to the nationals of all trading partners. The advanced nations benefited from trading among themselves. Their industrial growth and sophistication have radically improved over the period. The industries in these countries have generally benefited from continuous surge in international trade and diffusion of technological progress resulting from the continuously improving IPR regimes. Some of these countries have been able to build up innovation expertise in particular industries/ products. At the same time, they continued to rely on innovation expertise of other countries in other areas/ industries to lift the general level of their technological sophistication, productivity/ efficiency and the comfort/convenience of their people. In many areas/ industries/ sectors, several countries continue to compete in the market for generation and supply of newer intellectual properties even as old intellectual properties complete their pre-specified IPR protection tenures.
Strategy of Closed Economies
4. In contrast to the above countries, some other countries have taken little interest in ensuring cross-border IPR protection. Remaining effectively outside a cross-border IPR protection environment, these countries have sought to secure the best international prices for technology and sophisticated machinery imports through bilateral trade agreements. In the absence of growth of competitive export industries, these countries have preferred to negotiate the items of export, the prices and the quantity off-take under (largely, barter) bilateral trade agreements and had to encourage domestic industries to export by giving them special benefits and subsidies. Exporting high cost goods (at the cost of subsidies paid out of taxpayers’ money) has not helped hiding inefficiencies: the loss due to inefficient use of the country’s resources has adversely affected growth/ inflation performance. An export-led policy oriented economy may initially adopt (and benefit from) ‘reverse engineering’ methods inconsistent with cross-border IPR. Such an economy may also be successful in reaching progressively higher levels of technological competence and acquire strong enough research and innovation capability.

Strategy of Opening Up
5. At some stage, such a country may have to adopt progressively more effective and stronger IPR protection regimes to sustain its technological progress and economic growth. The stronger a country is capable of commercializing new ideas/ products/ materials/ technologies, the more interested it becomes to protect its own innovations and exploit their commercial potential across the borders. This country now seems more interested in shopping all over the world to secure the best prices (and quality/ deals) for its exports and imports. At this stage, such a country may find it attractive to implement effective IPR regimes for the protection of IPR of foreigners as well. Depending on (a) how fast such a country can improve its capability, it reaches (b) the stage when adoption of more effective IPR protection regimes becomes an attractive strategy for sustaining the technological and economic progress of that country. However, some countries that are unsure of building up adequate technological research and innovation capability, continue their reliance on bilateral (largely barter) trade agreements and on reverse engineering and adopt weak cross-border IPR regimes. Some other countries, despite their bleak technological prospects in the medium term future, do not wait for their dream of competing in the international market for generating innovations to come true; instead, they adopt a strategy of conforming to global agreements on IPR regime implementation and make the best use of the innovations of foreigners. This is another strategy for economic survival and growth.
6. The above possibilities lead to the expectation that the impact of implementing strong IPR regimes on domestic industry may vary across countries depending on the technological conditions in terms of strength or latent potential of innovation capability and prospects as well as the strategies adopted. Some suggests that Indian industry will overall experience a time profile of negative impacts or relatively lower benefit flowing from the emerging IPR protection regime. This suggestion may remain a matter of belief until one proves that all opening up strategies is are inferior to remaining closed and ignoring cross-border IPR protection regimes. Given the dramatic change over the last decade in the exploitation of latent potential of Indian research and technological capabilities, the spurt in flow of foreign direct investments, this may be difficult to prove. This is especially so because the potential of larger gains from bilateral (barter) trade agreements has considerably reduced over the past two decades and because the benefits from the bilateral free-trade agreements and free trade zones (which have seen a great spurt in recent period) cannot sustain without strong IPR regimes.
Intra-country IPR
7. Another approach to assessment of the impact of cross-border trade-related IPR regime is one of comparison of domestic trade with and without domestic (intra-country) IPR protection. In other words, a comparative study of experience of two (largely) closed economies, one with strong domestic IPR protection regimes and another without any effective domestic IPR regime may help assess the nature of impact of international trade-related IPR protection regimes on local industries. The hypothesis to be tested is that the country with strong domestic IPR regime is likely to have stronger and more efficient domestic industry. Interestingly, it may be difficult to find the instances of many open economies with strong domestic IPR remaining weak in cross-border IPR protection for long periods in history. If the existence of strong IPR regime within a country has a positive effect on domestic industry, would not strong cross-border IPR regime produce similar results on all the trading partners? A related question that needs examination is whether cross-border IPO regimes encourage research, innovations and inventions in weak, technologically backward countries. Or, whether strong IPR protection regime for foreigners helps accelerate domestic industrial research and innovations in a world of rising foreign direct investments and growing competition among multi-national companies to outsource activities based on competitive advantage calculations. Strong IPR for nationals and weak protection for foreign innovators are increasingly becoming infeasible to practice in today’s world.
Industry-specific Experience
8. Another approach to study the impact of IPR regimes is to consider the experience of specific Indian industries facing international IPO regimes. For example, consider the pharmaceutical industry’s experience. Many foreign pharma companies had withdrawn from India as state controls and weak IPR regimes hurt the economics of their operations in India. The local pharma companies fully exploited the resultant space created and expanding rapidly, though largely through reverse engineering or process differentiation methods. The deregulation and decontrol measures of the 1990s gave a further impetus to local pharma companies. They expanded their exports effectively competing with foreign companies in segments of the world market. They changed their strategies to exploit the research and development expertise they had developed during the period of fast growth. They prepared for the emerging global environment of trade-related IPR regimes. Therefore, they have been considerably successful so far in making the most out of the trade-related IPR regime obligations. The foreign pharma companies are now considering resuming operations in India now that the state controls have gone and a stronger IPR regime is likely to be under effective implementation. The hypothesis to be tested is whether the local pharma companies have indeed found a strategy to survive and grow in an environment of strong trade-related IPR regime.
9. The multi-national pharmaceutical companies are closely assessing the progressive improvement in the IPR regime in India and the withdrawal of the Indian Govt. policy of dictating the industry. Many MNCs are considering return to India to set up production facilities. Contract research outsourcing to India has already progressed. These would mean considerable increase in competition among MNC in India and introduction of new products in India. This would benefit the Indian consumers/ patients. The local industry will also benefit from competition. The ongoing of opportunity of producing patent- expiration drugs will continue to remain for the internationally competitive local drug firms. A new area of competition will be the herbal drug. The MNCs and the medicine researchers at the best laboratories in the world are vigorously studying the old texts in various languages available in different countries across the world. The search is for ideas to identify medicinal properties of plants and herbs so that modern pharmaceutical plants can produce drugs based on such plants and herbs. The local pharmaceutical industry is also giving considerable attention to this area. These are all going to have positive impact Indian industry and consumers. Both local firms and MNCs may try to get some new products based on Indian Ayurvedic/ Unani medicine patented. Not all such products will get patent easily (use of old knowledge to produce in a chemical plant a medicine more refined than the manually-made medicine of the past will not be adequate to obtain patent: even if some such medicine did get patent in one country, there will be disputes on them raised by players within the industry). It is inconceivable that products essentially equivalent to traditional Indian products like churangoli or chyavanprash, panchhon, puri, rassogolla, or roti will be acceptable for patent registration because these are not innovations and certainly not products backed by lot of R&D expenditure. Irrespective of how many herbal drugs are patented in future, the use of traditional Indian medical knowledge for improved products means that India gains (and not loses as some tend to believe). Those who can prepare ayurvedic medicines (like mixture of lime and turmeric in warm water for sprains) at home may continue to do so without any restriction: those who can not will be able to buy the products (e.g., readymade lime-turmeric paste) of the pharmaceutical companies. Clearly, pharma companies can develop brands for such products. There is always a benefit from brands competing in the market place: assurance of quality at competitive prices.
10. Similarly, researchers can study the impact of IPR protection on foreign exchange earnings of Hindi films and Indian music. The weak IPR protection enforcement has hurt domestic earnings of film and music industry. If India is not part of international trade-related IPR protection regime, this will hit their earnings further. Indian heroes, heroines, musicians and singers have potentially a large international market to protect their earnings both nationally and internationally. Should weak IPR protection regimes encourage piracy-based low quality products to constrain the long-term interest of these industries? Again, consider the case of IT and ITES industry. IPR regimes in foreign countries protect the continued growth of Indian IT and ITES industries. These cases point to the hypothesis that a number of high-growth Indian industries need strong domestic and international IPR protection regimes. These industries need researchers’ attention.
11. A more generic study would concern itself with India’s own history of IPR. As for the period till 1990, the hypotheses to be tested include whether the weak IPR regime in the relatively closed economy (a) hinder the pace of technological capability formation, (b) hurt the rates of technological progress, industrial growth, exports and (c) raise the cost of goods to the Indian consumers. Research may be able to verify whether India missed any great opportunity to spur technological innovations and industrial growth because of weaker IPR regime. Economic policies like industrial licensing and rehabilitation of sick units, rather than encouraging innovations, promote a bias against innovations. A closed economy with inadequate resources for investment tends to trap itself in to a policy that discourages innovations with potential to displace extant technology-based manufacturing and employment. Maybe looking too far into the past may not interest many researches.
12. They may be more interested in examining whether the movement towards WTO-compatible IPR regime since 1999 has any potential to enhance industrial competency and capability of India. True, India has ratified the World Trade Organization Agreement including the Trips Agreement that has come into effect in 1995. As a developing country, India enjoyed a transition period of 5 years ending January 2000 (for product patent protection to areas of technology hitherto not protected like pharmaceuticals and agricultural chemicals, the transition period of 10 years, ends in January 2005). India revised various laws to make them WTO compatible in the very recent period. These include Indian Copyright Act of 1957, Trade and Merchandise Marks Act, 1959, the Designs Act, 1911 and Patents Act, 1970 – all through amendments by Parliament in 1999 and 2000. Besides, India passed a new law, Geographical Indications of Good (Registration and Protection) Act, in 1999. How far have these measures enhanced India’s potential? The effectiveness of India’s new IPR regime would not depend merely on the establishment of laws relevant to IPR protection and the adequacy of the legal provisions but also on the quality and adequacy of administration, monitoring, enforcement and dispute settlement machinery relating to IPR laws. It may be difficult to prove that Indian IPR regime has attained the desired standards in respect of all these. Both domestic patent/ copyright holders and foreigners complain of lax enforcement of IPR protection laws. They also complain about lack of confidentiality of information submitted to obtain patents and procedural delays. An effective TRIPS regime changes the attitude of the local industry and inventors from being defensive and prone to unauthorized copying to being alert, opportunistic and aggressive. An effective IPR protection regime should lead to growth of employment of persons to monitor and study IPR protection regimes in other countries as also to enforce internationally agreed laws and rules recently adopted in India. This helps the domestic industry to become all the more pro-active in safeguarding its own IPR through monitoring and access to WTO mechanism for relief and compensation against infringement by others as also dispute settlement. There are no signs yet that all these have happened as expected. The effectiveness of Indian IPR regime is still low. A less than effective IPR regime can have negative impact on the future of local industries: future of a nation cannot be build on prolonged encouragement to unauthorized piracy and reverse engineering.
Impact on Financial Sector
13. IPR regimes influence the financial sector in two ways. First, the impact depends on its exposure to industries varyingly sensitive to Trips obligations. The risk management processes in banks and other financial services firms, including investment management for mutual funds, pension funds and insurance are now gearing up to take into account the impact of IPR regimes in different ways. In a competitive world, tracking the progress of innovations is essential for anticipating the impact of new product patents of one company on other companies. Again, the news about the likelihood of a new product patent clearance tends to move the share prices of pharmaceutical companies in the stock markets. Correspondingly, reports of likely failure to obtain a patent on a product under development with substantial investments, result in decline in stock prices. The success or failure of companies to obtain patents has also implications on their capability to service loans taken from/ debt instruments issued to banks and investment institutions. Even getting into legal disputes concerning infringement of IPR-laws has implications of both financial penalty implications and goodwill/ reputation. The lenders and shareholders of the companies have to assess these implications before and after taking exposures in companies dealing with IPR-issue sensitive products.
14. The second way in which the IPR regimes can affect the financial sector is the direct influence of the innovations, inventions and ideas for the financial sector itself. Financial services firms can consider patenting their designs, products and brands. However, as of now, it is difficult to imagine proliferation of patented intellectual property in the form of designs and products. The IPR for the financial sector itself is difficult to evolve outside the areas of brands, trademarks and copyrights. Product patents may be limited to proprietary computer software embedded models of portfolio management and securities trading. The overwhelming part of the financial sector firms’ activities are based on too simple and too widely used concepts and ideas, allowing very little scope for developing intellectual property that can be given more than a few months of natural protection from copying. Moreover, Government appointed/ controlled supervisors who tend to force standardization of industry practices and products will continue to rule the financial sector in all countries. Financial sector regulations generally inhibit company-specific product innovations. Such innovations tend to become industry-level standards at the instance of the regulators. Maybe in future situations may change. At present, more than IPR, the issue is one of freer trade in financial services. Free trade in financial services across borders may take a long time to mature. Maybe India can benefit from both import and export of financial services. The scope for specialization in the financial sector may increase, at some stage, to such a degree that helps generate large research and development expenditure induced and ‘difficult-to-copy’ service products that can be patented.
Long-term Perspective
15. The impact of IPR regimes on domestic industry needs assessment in the light of longer-term direction of the international economic exchange. Adam Smith’s ideas ushered in the era of maximizing economic gains through free trade in all areas other than those areas where non-economic considerations (like defense) are more important to the society. He showed the irrationality of the ‘mercantilism’ objective of maximizing trade surplus through State regulation of imports. David Ricardo enunciated the ‘comparative advantage’ foundation of mutually beneficial exchange among countries with varying natural endowments and competencies in production of goods by different countries. The progress of free trade was continuous since then despite John Stuart Mill’s infant industry argument and the lack of perfect, perfect competition and presence of externalities. The movement towards free trade also hindered by closed economies and communist blocks for quite sometime. Yet, the GATT progressed over time since 1948 through negotiations and better understanding as well as the recognition of societal concerns over the impact of free trade on infant industries, relatively poor and technologically backward countries. As technology, knowledge and goodwill/reputation became progressively more important to civilization than the product itself, IPR became the key issue in further progress of technology, product development and free trade. Extent of protection and enforcement of IPR varied widely over the countries as intellectual property became more important in trade. All this led to tension in international economic relations. New internationally agreed rules for intellectual property rights became necessary for order and predictability in the conduct of international trade (including more systematic resolution of trade disputes).

16. The emerging international IPR regime seeks to contribute to open, fair, predictable and undistorted competition environment free trade with minimum barriers. At the same time, it seeks to provide adequate safeguards for minimizing the duration of IPR protection and access to protected technologies in case of societal urgency in respect of public health and spread of technology. Clearly, the new era has a great potential in altering the industrial structure of different economies. In the past, technologically advanced nations exited the low technology manufacturing areas to less developed countries. This trend will gather further momentum with business process outsourcing by enterprises in richer
countries. The rapid expansion of market demand in China, India, Brazil and Russia will alter the scope of division of labor and specialization. All this together with the changing proportions of knowledge-based workers in the workforce will imply potential for changes in the comparative cost advantages of different countries. The actual impact on Indian industries will of course depend on how India turns the emerging WTO and IPR protection regime to her advantage.
-------------------------------------------------------------------------------------@Abstract of this paper was presented by the contributor at the Seminar on Intellectual Property Rights & Related Issues organized by Department of Business Administration and Department of Commerce, University of Kalyani, West Bengal on Sept. 3, 2004

Security Analysis & Portfolio Management Course Outline (2003)

2009-07-31T11:06:00.003-07:00

A course on Security Analysis & Portfolio Management ( 30-35 hours)

1. What is a Security? Examples. Traditional and new. Equity, Debt, Hybrid,
Units of pools. Securisation and Pass through certificates. Future/Forward
Contracts. Options.

Why securities? The purpose they serve. Acknowledgement of financial
Claims. Legal implications. Enforcement of contracts.

Need for contracts.
Savings investment. Lending Borrowing. Risk sharing. Future contracts..

Trading in contracts. Liquidity. Market . Nature of Markets.
Price determination.

Infrastructure Intermediaries. Institutional infrastructure. Technological Infrastrucure,
Knowledge and Skills Infrastructure. Regulatory Infrastructure.
Systems Risk Minimisation.

2. Why analyse securities? What do we want to find? Objectives.
Issuer of Securities, purchaser and sellers. Rating agencies.
Advisors to purchasers. Different classes of purchasers and sellers.

What does analysis involve? What factors/ parameters? What relationships?
The theory of relationships. The Content of Analysis. The tools of Analysis.

3. What is Portfolio? Why portfolio? Natural availability to Diversification for risk
containment.
Problem of uncertainty. Problem of risk. Definition of Risk.
Measurement of risk.
Relationship between Risk and return. Criteria of risk-adjusted return.

Management of Risk. Sharing, transfer and pricing of risk.
Risk immunization. Risk Insurance

Investment Portfolio Management. Investment. Divestment. Objectives of Design,
Construction, Holding and changing/ re-balancing /churning Portfolio.
Objective.
Return. Increase in Value through Dividend, Interest, benefits,
Gains on selling at higher price.
Return in excess of costs. Return in excess of opportunity cost.

Cash outflow and inflows spread over time.
Problem of aggregation. Time value of cash flows.
Predictability of future cash flows.

What does management of Portfolio mean? Activities related to
Portfolio Management.
Relationship between Security Analysis and Portfolio Management.

4. Time value of Money. Discounting and compounding. Time intervals.
Present Value. Net Present Value. Internal Rate of Return.
Perpetuity. Annuity. Yield. Yield to Maturity. Current Yield.
t. t
Related Mathematics: P (1+r) = A. PV (1+r) = TV
t
PV = TV / (1+r) > Numeric. 100 = 110/1.10
t
PV (Si) = Sum (t= 1…n) of Dt /(1+r)
t-1. t. t-1
or, Sum D(1+g) / (1+r) = Sum [ {D / (1+r)} * {(1+r)/(1+g)} ]
= D / (r-g)
t. t
Sum D/(1+r) = (D/r) * { 1 – 1 / (1+r) } = D/ r as n tends to infinity.

PV (Si) = PV (D1) + PV (D2) + PV (D3) + PV ( S3) Numeric ex.
t.
PV = b * Sum E / (1+r) + (b * E)/(r-g) = b * E/r

P / E = m. From PV = (b * E) / (r-g). m = b/r or b/ (r-g)

Value of a Firm: Fair Market Value : FMV
= PV of the stream of future after tax free cash flows to debt & equity holders.
= EBIT (1-t) + Depreciation – Investment
FMV firm = FMV of equity = FMV of debt.
Value of share = FMV equity / no. of outstanding shares.

5. Efficiency and Safety of Markets.

Design of Markets and Market Practices.
Markets & Market Infrastructure. Stock Exchanges.
Stock. Issuer. Company? Finance? Listing> Corporate Governance and other
Standards. Listing? Listing Rules.

Primary Market. Issue fresh. IPO. Additional Issue. Rights Issue. Bonus Issue.
Book building. Gilt Auctions. Intermediaries. Investment Bankers. Registrar.

Secondary Market . Trading . Buying and Selling of securities. Intermediaries.
Brokers. Trading Rules, Procedures and Practices.
Order-driven and Quote-driven Systems.
Trading Ring. Open Cry system. Electronic Exchanges. Screen-based Trading.
Dematerialisation of Securities. Paper-less system. Depositories.
Settlement Systems. Clearing House and Banks.
Rules concerning record date, book closure. Partly paid share. Multiple listing.
Kerb trading. Trading of small co shares/ unlisted paper. .

Rules relating to Insider Trading. Rules relating to Takeover.
Rules relating to Accounting. Audit and Information disclosures.

Speculation. Greed & Fear. Margin Trading. Short selling. Various requirements.

Spot Market vs : Futures Market.

6. Regulatory Infrastructure.
Design of Regulation, regulators, regulatory powers,
regulatory zeal. Costs of regulation. Risk of regulation. Enforcement of regulation.
Efficiency of Regulation. Regulation knowledge and information intelligence..

7.Fundamental Value of a Security. Present Value of Future Earnings.
Fundamental Analysis.
Cashflows of the Future. Predicting Cashflows. Earnings and Debt servicing.
Capability. Reliability of estimates. Relevance of the analysis of the past.
Importance of what is likely to happen rather than what has happened already.I Issuer Evaluation - operating, financial and management efficiency & reputation: past & reliability of future

Economy/Industry/Input market / Technology prospect Evaluation

Instrument Market Evaluation
 Continuous assessment =monitoring
 Entry & Exit timing - continuos review with reference to impact on risk, return and capital adequacy

Analysis of the Firm

Management. Corporate Governance
Human Resources
Intangible Assets. Brand, Reputation
Non-business Assets. Property . Investments.
Business Segment Analysis.

Balance Sheet & Profit/Loss Account strength & Weaknesses.
Net Worth. Book Value. Asset-Liability Match
Liquidity. Working capital management,
Leverage. Debt policy.
Turnover Growth trends, Market share, marketing and
distribution strengths,.
Profitability Ratios. Capacity utilization. Break-even Analysis.
Division-wise Analysis.
Cost of Capital. Return on Capital Employed. Economic Value Added.
Inter-firm cost & productivity comparison
Long-term agreements for sales, purchases, investments,
Contingent Liabilities. Derivatives Exposures.
Dividend record and Pay-out policy..
Accounts & accounts Information. Notes to Accounts. Auditors’ Report.

Systems & Procedures. Internal Monitoring & Controls. Risk Management.
Safety Systems.

Sensitivity to Industry Environment
Industry cycle. Product life cycle and Innovation.
Consumption Trends. Exports and Imports. International Trade. WTO.
Demand- Supply Trends and Gaps. Price trends.
Market Structure. Entry Barriers.
Input Supply Market Analysis.

Sensitivity to General Economic Environment

Economic Expansion and Growth Rates. GNP, GDP, IIP,
Sector composition & trends. Agriculture, Services. Infrastructure & Utilities.
Savings Investment. Productivity trends.

WPI, inflation rate, monetary and fiscal trends and policies.
Balance of Payments. Exchange rate. Forex Market trends.
International economic Relations. Impact of World economy.
Technological Advances.
Political and Bureaucratic Environment.

SWOT Analysis & Business Strategy.
Corporate Mussion, Plans and Targets. Capital Expenditure
programs and Financing policy,

Share Valuation :Financial Projections. Earnings estimates
with probabilities. Sensitivity analysis.

8. Market Psychology based Approach to Security Analysis. & Market portfolio analysis: why in addition to fundamental analysis? Short-term fluctuations in stock prices. Deviations from fundamental /intrinsic value. Time series of prices, every minute or hourly or daily or monthly (opening, closing, high, low, average) and so on. Study for discerning patterns. Interpretation of patterns. Anticipation of future movements based on past patterns. Development of trading rules and judgement. Trading based on such knowledge not identified by others. Profit/gains through trading based on such trading. Called technical analysis. Technical analysts or chartists.
Dow Theory. Dow Jones Co. Most stocks generally move up and down together with the market. Market Indices DJIA, DJTA. Study of impact of information on prices. Identification of Trend: Primary Trend – Tides, Secondary Trend (Waves), Minor /Tertiary Trends (ripples).
Primary 3 moves up: first accumulation by knowledgeable, then buying based on good earnings report corroborating knowledgeable traders anticipation, and finally entry of late comer masses influenced by spread of information. Prices rise high beating expert anticipation of fundamental value, knowledgeable exits, leading to 3 moves down. First as knowledgeable exit in hurry, then as earnings report show fundamentals cannot justify prevailing high market valuations, and as the information spreads panic selling.
Identification of trend reversal indicators for each trend, e.g. whether index crosses high of the previous secondary reversal. Identification of start of bullish/ bearish phase. Notion of Resistance / Reaction and Support levels.
Use of appropriate data on market indicators. Breadth of market and volume of transactions: rising index with rising volumes – unsatisfied demand- strong bull market, falling index with rising volumes- bearish, panic selling; rising index with falling volumes – end of bullish period; falling index and falling volumes – listless bearish phase.
Advance-decline ratio as indicator: no. of Scripps rising to no. of Scripps falling – how widespread is the rally or decline. Interpreting trend in AD ratio along with trend in volumes.
Support levels and Resistance levels marked on charts. Gaps between Resistance and support levels.
Concept of Channel, narrowing Wedge and widening gaps. Break out of boundaries. Direction reversal.
Other concepts. Triangle, Flag and series of flags, Head & Shoulders, Inverted H&S, Opening & Closing prices - Gaps between them,
Opening, closing, high & low and Candle stick.
Use of Moving average Lines: 5/10/30/90/180/365 DMA’s. Arithmetic and Exponential Moving Averages.
Concept of ROC (rate of change in prices).
Filter Rules as mechanical Trading strategies – x % filter: down x % from top requires exit.

Concept of Non-linear, stochastic dynamic price generating models.

Trading based Approach to Investing. Advice on Trading. Strict following of Objectives and Rules, stop-loss and no Greed and Fear psychosis.

9. Utility Theory & Portfolio of securities
Utility against Wealth curve. Shape of curve. Definition of Risk Aversion
First derivative positive, second derivative negative: alternative exposition –
Fait game: 50: 50 chance of A: 200 and B: 0 return against C: 100 investment.
Expected value of A and B is 100 equal to certainty 100 and yet risk averse investor prefers C.
Indifference curves.
Solution at tangency with efficiency frontier.

Portfolio of Securities.
Weights. Weighted return. Weighted mean. Weighted risk.
Concept of Mean-Variance framework.
Expected Return concept. Probabilities as weights, Expected Value as Mean Return
Portfolio risk. Portfolio variance equals Sum of weighted Co-variances: two-security case and extension to n securities case.
Risk diversification as the number of securities increases to 30?
Efficiency Frontier on Risk-Return Space. Draw graph
Concept of Risk-averse Investor
Example of A 150 or 50 with equal probability and not-A choice.
Concept of Utility function and indifference Curves.
Maximise Z as risk adjusted return of portfolio

Choose portfolio p such that Z= (rp – rm)/Sdp is max p {wi, Si}
First derivatives with respect to weights to equal zero. N equations to solve

Introduction of Risk-free security and Risk-free return.
Market portfolio.
Systematic risk and specific risk.

Capital Asset Pricing Theory (CAPM).

Capital Market Line.
[R(p) –R(f)] / [ R(m) – R(f)] = SD. (p) / SD. (m). Draw graph
Capital market equilibrium; market portfolio in equilibrium for all.
Security Market Line.
[ R(i) – R(f) ] / [ R(m) – R(f) ] = beta of i. draw graph

Bi = cov. (i, m) / var. (m) = Corelation. (I, m ) * Sdi / Sdm
= Measure of systematic risk for security I

10 assumptions of CAPM: No transaction costs, infinitely divisible security,
No capital gain or income tax, perfect competition and all price-takers,
Decision within mean-variance framework by all, unlimited short-sale allowed,
Unlimited borrowing and lending at risk free rate allowed, identical expectations by all, homogenous investment period, all securities/assets are marketable (tradable).
Relaxation of assumptions one at a time and model valilidity. Simultaneous relaxation of two or more assumptions and validity of CAPM.
Empirical tests on CAPM validity.

CAPM as one type of Single Index Model: R (I) = a (I) + B (I) r (m)
General Multi-index Models: R (I) = A (I) + B (i1) I (1) + B (i2) I (2) +…B (L) I (L) + e (I)
Where E (ei)=0 E (eiej)= 0, E (ei) (Ij) = 0
These can also be expressed in terms of differences between indexes.
Are factors. B (I) s are factor loading.
Use of statistical techniques, principal component analysis. Factor Analysis.
Standard Statistical packages available to determine / estimate As and Bs.

Alternatively, to pre-specify the indexes and do standard empirical testing.
Firm level & sector data: beta, dividend per share, bond beta, size market cap, sector dummy.
Macro-economic factor model: differences in expected and actual inflation, short-term & long-term govt. bond yields, etc.
Alternative sets of portfolios as Factors: Small stock and large stock, high and low beta, G-sec and corporate bonds, etc.

Multi- index Models for Bond Valuation.

10. Bond Portfolios:
Concept of bonds.
Tradable bonds.
Coupon.
Marurity.
Yield to maturity. Yield to call/put
Interest Rate Risk: Reinvestment Risk and Valuation Risk
Inverse relationship. Examples.
Concept of Duration
Pure discount bond. Any bond can be reduced a series of pure discount bonds.
Weighted Average duration.
Pb = C/ (1+r)^ T
DP/P = -T * D(1+r)/(1+r)
So, coupon bond P = Sum 0ver 1 to T Ct/ ( 1 + r ) ^t
DP= - {……………………………………+ Ct/(1+r)^T}
DP/P = Sum weighted present values of each coupon and return flow with -t as weights. Divided by the present value of cash flows without weights = - D * d (1+r)

Concept of Convexity
Taylor Series Expansion – f(r+h) = f ( r) + f’ ( r ). H/ 1+ f” (r). H^2/2*1 + ---------

[P (r + h) – P (r)]/ P (r) = - Sum t * Ct/ (1+r)^t D (1+r) + Sum t. (t+1) Ct/(1+r)^t d (1+r)^2/ (1+r)^2
= - D * d (1+r) + C * d^2(1+r)
Why concept of convexity required:

Interest Volatility and Bond Portfolio Immunization - Exact Matching of assets and liabilities cash flows
Barbell Strategy: Match average duration.
Focussed Strategy: match around liability cash flow duration
Rebalancing of Portfolio. Hedging with swaps. Floating to fixed or higher to lower rating bonds. Costs of hedging.
Index Bond Portfolio Investing. Choice of rating, and maturity mix.
Single Index Vs Multi Index Bond Models

11. Concept of Market Efficiency
Weak form all historical information data get promptly reflected in future prices
Semi-strong Form: all publicly available information gets quickly reflected in future prices.
Strong Form: all publicly available and insider information get quickly reflected in future prices.
The speed with which information gets reflected/ incorporated/ discounted in the market price of stocks better it is: this implies on an average no one will be able to benefit extra from information compared with others.
Results from empirical testing of these concepts of market efficiency.

12. Treatment of Taxes:
Tax adjusted returns.
Different tax regimes: ordinary investors, traders, tax exempt categories (mutual funds?).
Treatment of Interest income on bonds, G-sec, tax-exempt instruments.
Treatment of dividend income, Capital gains tax- short-term and long-term,
Distributions on winding up.
Permissible deduction. Cost of financing investments.
Shares acquired at different points of time, bonus shares, and rights shares & rights renunciation.
Convertible debentures,
Effect of company mergers and issue of new shares. Indexsation.
Carry forward of capital losses.
For Traders: Sales + closing stock- purchases- opening stock
Stock Valuation of FIFO or Average basis?

13. Asset Allocation & Stock Picking
Strategic assets allocation among equity, bonds, money market instruments. Implication on portfolio beta and duration.
Asset allocation based on target beta and duration.
Target return based asset allocation.
Tactical Asset allocation and Portfolio revision.
Type of Investors and Investment behaviour:
A. No market timing skills and No stock picking skills: simply a diversified portfolio, passive management, -- some bonds and index funds or low beta stocks--- target low beta.
B. No market timing skills but with stock picking skills: 60%-90% in diversified portfolio and rest up to 405 in undervalued stocks, generally a concentrated portfolio with constant target beta.
C. No stock picking skills but with market timing skills: have a diversified portfolio but actively manage beta to gain from market timing.
D. Both market timing and Stock-picking skills: Concentrated and not very diversified portfolio. Active and aggressive management with fluctuating beta with a long-term target beta.

14. Portfolio Management Performance Evaluation:

Self-evaluation, comparative evaluation – across time, across portfolio managers, against benchmarks.
Need for portfolio view: individual buy/sell/hold decisions do not matter, portfolio matters.
Period and frequency of evaluation. - Short periods may be misleading, average over cycles of boom and bust. – Return performance over 1m, 3m, 6m, 1yr, 2 yr., 3yr, 5 yr.,

Risk adjusted return performance criteria:

Taylor measure = risk premium over risk free return / beta

Sharpe measure = risk premium over risk free / total variability i.e. standard deviation

Jenson Measure = excess over expected return,
where expected return = Rf + beta (Rm – Rf).

Fama Decomposition:
Portfolio actual return =
Risk free return
Rf

+ Premium on systematic risk beta
( Rm-Rf)

+ Return due to imperfect diversification
{(Std dev of p/ STD dev m) – p’s beta} ( Rm- Rf)

+ Net gain due to superior selectivity
[(Rp – Rf) – (std dev of p / std dev of market) ( Rm - Rf)}

Example: R f= 12 %*

T = (Rp – Rm)/ beta = (70.6% - 12%) / 1.121 = 52.3
Market earned = ( 41.2 – 12.0)/ 1.0 = 29.4

Sharpe ratio = (70.6 –12.0)/ 41.31 = 1.418 where std.dev.of p = 41.31
As against required of : (Rm – Rf /std dev. of m = (41.4 –12) / 19.44 + 1.512
Showing that performance is not as good as desired

Systematic Risk return = 1.121 ( 41.4-12) = 32.95*

Imperfect diversification: ( 41.31/19.44) ( 41.4 – 12 ) - 32.95 = 29.52*

Jenson measure = 70.6 { 12.0 + 1.121 ( 41.4 – 12)} = 58.6 – 44.75 = 13.65

So, Fama decomposition = 12.0 + 32.95 + 29.52 – 3.27

Explanation of performance: Inadequate return due to inadequate / improper diversification and poor selection of scrips.

Concept of Value at Risk.

Derivatives

Financial Contracts. Involving time between investors private or exchange traded.
Forwards, Futures, Options
Swaps, Warrants
Example of Thale ( Aristotle 2500 yrs ago). Knowledge of weather. Crop farmers, crop crushers, oil output.
As forward contract to buy use of crushers
As call option for right to use
Strike price or exercise price. Market price. Underwriter/option writer
Right to buy or right to sell.
Example. Sp , Mp, and Premium : profit, loss
Call/ put graph for purchaser and for seller (writer)
Graphs for combinations:
Straddle 1 put + 1 Call
Strip 2 puts + 1 call
Strap 1 put + 2 calls
Naked call Vs: covered call
Short selling of share Vs derivatives: short sell, sell now at given price and deliver in future at that price… borrowing share at margin.
Long buy of share: buy now takes delivery later.
European vs. American Call
In the money and Out of the money options.
Options on Stocks, bonds, Gilts, currency, indexex, commodity futures, and financial futures.

Summary Chart: Put Call

Buy Right to sell , pay premium Right to Buy, pay premium
Max. Loss = premium cost Max Loss = premium cost

Sell Obligation to buy, collect premium Obligation to sell , collect premium
Max. Loss = SP- MP – premium
Max. Loss = MP- SP- Premium, unlimited

Is delivery necessary for options? Useless. - Contracts bought back much before expiration date.

Fair Value of Option = Intrinsic Value + Time Value
Time Value = Time to expiration & volatility of stocks,
Intrinsic Value of Put: SP – MP >= 0, Call: MP – SP >= 0
Value of American call >= Value of European Call
Value of longer call >= Value of Shorter duration call
Value of higher strike price call <= Value of lower strike price call

Use of derivatives for Hedging. Hedging by portfolio managers
Reducing risk means reducing return or loss of opportunity to make higher gains.

Valuation Models: Binomial Model
Black Scholes Model
Interest rate derivatives. Housing loans.
Fixed to floating interest rates.
Indian history. Mind sets. Forward trading repeatedly band. Emergence of Badla. Liberalisation in 1991.
Derivatives introduced only in 2001.

References:
1.Modern Portfolio Theory and Investment Analysis by Edwin J. Elton & Martin J. Gruber, John Wiley
2. Portfolio Management, Samir K Barua, V Raghunathan & J R Verma, Tata Mcgra-Hill Publishing, New Delhi
3. Thoughts on Markets, Securities, Contracts & Portfolio Management, Basudeb Sen , Yet to be written

Questions for Examination.

1.Contrast Fundamental Analysis and Market psychology based
Analysis Approaches to securities valuation. Why do academics
generally dislike Technical Analysis and yet practitioners use
Technical Analysis? How do the Chartists interpret
Moving Averages?
OR
1.Briefly explain the contributions of Bachelior (1950) and
Elliot (1938) to Technical Analysis.What is Dow Jones Theory?
What does Head and Shoulders formation signify
in Technical Analysis?

2.Who laid the foundations of Modern Portfolio theory in 1951
and what was his contribution? Define Risk Averse Investor
in terms of the shape of his utility function. Will a risk averse
investor invest Rupee one in a project which is expected to
generate total benefit of Rupees Two or NIL (zero) with
equal probability of 0.5?

3.State the three forms of Efficient Market Hypothesis.
Distinguish between Security Market line and Capital Market
line. Given the variance and covariance of returns from various
securities in a portfolio, derive the formula for portfolio return
variance. Why is the exercise of an American Option unlikely
before the expiration date.
OR
3..What are the plausible interpretations of the following:
Triangle, (b) rising price of a share along with increasing
volume of trade and (c) declining Advance-Decline ratio
along with rising market index. What do the terms Theta,
Delta and Vega mean in the context of options pricing?
Contrast between European and American Options and their values.

4..Given that the investor’s objective is to maximize the Excess
portfolio return over the risk free return, derive the simultaneous
equations that will determine the weights of different securities in
the optimum portfolio. Assuming that all the investors choose the
market portfolio in equilibrium to prove that the following
relation holds: r(i) = r(m) + beta times { r(m) – r(f).}.

5..What are two major risks associated with investing in corporate
bonds? How are the concepts of Duration and Convexity relevant
to interest rate Risk Management? Derive the formula for Duration
and Convexity from the relation between the price of a bond
and the cash flows.

6..Distinguish between Single Index Models and Multiple Index
Models with suitable examples. What is Arbitrage pricing theory?
State the assumptions underlying the Capital Asset Pricing theory.
What happens if these assumptions are relaxed?
OR
6..What are the different ways of immunizing a bond portfolio?
How should the investor who has both market timing and
stock picking skills design and manage his portfolio compared
with an investor who has no such skills.

7.State the formula for Black Scholes model and explain the
factors that determine the value of an option? Explain the
terms in the money and out of the money in the context of a
call option on a stock. What is a straddle and when does an
investor adopt a straddle strategy?

8..Critically evaluate the growth of Indian mutual fund industry
during 1992-2002.Why is the Indian financial asset market not a
fully competitive and efficient one as yet? In what manner can a
mutual fund use derivatives for the benefit of its investors?

9.What prudential safeguards are taken to prevent misuse of the
facility of short selling? What does a Collar mean? Explain how
a Swap helps manage risk giving suitable example. Explain the
concepts of Put option, call option and buying and selling options
with their implications on risk and return

10.(a) Compute cost of equity and value of a share with the
following data:
r (m) = 0.1, r (f) = 0.06 , beta = 1.2 , effective tax rate=0.2,
present value of future free cash flows = Rs.42000 ,
future value of debt = Rs.12000 , debt-equity ratio = 2:1
and number of outstanding shares = 1000.
(b) The current price of a share of company XYZ is Rs.100.
The company is expected to give annual dividend of Rs.5 per
share in the next three years. At the end of the third year the
market price of a share is expected to be Rs.132. Will an
investor looking for a minimum return of 10% invest in
this share for three years?
© Compute the fund performance measures suggested by
Treynor, Sharpe and Jenson on the basis of following
information on the market (m) and portfolio (p):
r (p) =70.6%, r (f) =12%, r (m) = 41.4%, beta = 1.121,
standard deviation of market returns = 19.44 and
standard deviation of portfolio returns = 41.31.
(In answering question 10 (a), ,(b) and (c), you may
make other suitable assumptions, if necessary):

Indian Economiy 1999-2000

2009-07-31T11:06:00.001-07:00

SUSTAINING GROWTH ACCELERATION
Basudeb Sen *

The economic scenario for 1999-2000 painted in July (ET-17.7.99) seems to be coming true : the end-October RBI assessment broadly confirms this. With four months to go, the scenario for the year looks as follows : GDP growth close to 6.5%, industrial growth of over 7%, services sector growth close to 8.5% and average inflation rate for the year below 5% (though end-March point-to-point rate may touch 6%). Balance of payments will remain under control, current account deficit at comfortable level and exchange rate below Rs 44.50.

Economic Scenario
99-00
(July) 99-00
(Oct) 99-00
(Dec) 00-01
(Dec)
GDPGrowth (%) >6% 6 - 6.5 6.5 6.6-7.2
Industrial Growth (%) 7.0 7.0 >7.0 7.0-8.0
Services Growth (%) 9.0 - 8.5 8.5-9.0
Inflation (%) <5.0 <5.0 <5.0 5.0-6.0
Exchange Rate (Rs/$) 43-45 - <44 <44.5

2. Our July hypotheses on market dynamics continues to hold : (a) demand is growing though at a slow rate for many sectors, (b) capacity utilisation is improving while excess capacity situation still remains and therefore
(c) upward pressure on prices is not yet strong especially in view of domestic and import competition. Corporate profits will grow though at a slower rate than growth in sales value. Interest costs have declined (sharply for highly
rated companies with lower dependence on high cost borrowings and greater efficiency in working capital). However, many companies in the midst of large grass-root project implementation are yet to benefit from lower interest rates. Most banks are likely to report better profits.

3. Can the growth acceleration witnessed this year sustain in the next year? Yes, a GDP growth of 7% is possible in 2000-01. Industry may record a growth of 7.5% to 8.0% and services sector 8.5% to 9.0%. Agriculture may grow by about 3% in 2000-01. The growth drivers in 2000-01 will include higher crop output in the Eastern and North Eastern Region, competition-induced modernization investment and associated productivity gains in industry, revival of demand for clothing and housing, wealth effect on purchase of consumer durables, additional construction demand in Orissa and border areas as also surge in entertainment industry, tourism, financial services (demat, mutual funds, financial re-engineering/consultancy, securities placement and trading), IT, telecom and internet related services. Growth of many of these economic activities will require relatively low Bank/FI credit, while some others will avoid high cost debt. Strong growth in OECD and SE Asian countries and lower import duties should help export growth. Agricultural exports will rise. Software export growth will sustain. However, sharp rise in industrial capacity investments may not take off till September 2000.

4. Price situation may not be as favourable with a point-to-point inflation rate of about 6% in April 2000. As subsidies are reduced and ‘administered’ prices and user charges freed/raised, inflation rate will tend to rise as capacity utilisation levels will have increased substantially by August-September 2000. Strong price-dampening factors will include domestic competition (except those like textile and paper where consolidation and closure of uneconomic units may lead to some price rise), lower input duties, greater access to imports and control on M3 growth. Net effect of all these may mean an average inflation rate of 6% in 2000-01.

5. The imbalance in the savings investment-loanable funds market may become too severe to avert further decline in interest rate : banks may not find adequate opportunities for low-risk lending at interest rates above 12% while strong growth of 10% - 10.5% fixed deposit continues. With more buoyant government revenues (as growth acceleration continues) and sharp rise in PSU divestment, Government may be able to borrow at much lower rates in 2000-01. Even State Governments may seek to reduce their cost of borrowings on bonds/small savings. As a result, G-Sec may not remain so attractive avenue for deploying high-cost deposits and the resistance to reduce deposit/lending rates may weaken. Falling interest rates can be both growth-inducing and inflation abating. At lower interest rates, capacity investment may pick up. Especially, long-gestation infrastructure projects require low cost debt funds to be viable if the infrastructure services tariffs are to remain low. Also, capacity locked-up in companies unable to continue because of high-interest burden may get released as lenders begin restructuring debts at lower interest rates. Moreover, enhanced commercial attractiveness of capacity-creating investment may lead to higher growth of import. This may help arrest upward pressure on the Rupee consequent on stronger FDI and FII inflows expected next year.

6. While market dynamics suggest sustainability of growth momentum with some rise in inflation, economic policy can stand in the way or strengthen the positive market dynamics. There are constraints on freedom of economic agents (including PSUs) in responding to varying market conditions. To remove such constraints, economic agents may be prohibited from referring their commercial decisions to any State agency/official for consultation or approval. Rather, the State may facilitate and encourage individual and corporate initiative. The economy will also benefit from speedy implementation of reforms agenda already announced and the first set of mega road/bridge projects, as also from re-allocation of government spending away from subsidising income-earning citizens to strengthen infrastructure for health and primary education. Thus, the scenario of 7% GDP growth, less than 6% inflation rate and higher investment rate in 2000-01 reflects realistic macro-economic objectives. The Economic Survey and the Budget in February will indicate to what extent the advantageous market dynamics and efficiency gains from further liberalisation of individual enterprise are sought to be leveraged to achieve these objectives.
______________________________________________________________
* Executive Director, Unit Trust of India. Views expressed here are his own.

Six Lectures on Portfolio Management- Synopsis (2003)

2009-07-31T11:05:00.005-07:00

Refresher Course (November 2003) at Dept. of Economics, Jadavpur University 700032
Synopsis of Six Lectures by Dr. Basudeb Sen on Portfolio Risk Management & Mutual Funds
The theory and practice of modern portfolio management reflects the high quality research efforts of a large number of economists, specially mathematical and financial economists and econometricians, during the last five decades. This area of economics however owes it origin to the contribution on general equilibrium of multiple markets by Walrus (1874) and the contribution on interest theory in a finite period sequence economy by Fisher(1930). The formal incorporation of the economic reality of uncertainty / risk in the Walrusian and Fisherian frameworks was the challenge taken up by economists like Hicks (1939), Markowitz (1952), Arrow (1953), Modiglani & Miller (1958), Tobin (1958), Sharpe (1964), Linter (1965), Stiltz (1969, 1974) and Black & Scholes (1973).
Financial Markets
An understanding of the nature and complexity of financial markets facilitates better appreciation of theory and practice of portfolio risk management and mutual fund markets. Financial markets essentially deal with contracts involving time / future. The agents who buy and sell contracts are of various types and transact on the basis of their preferences and needs of transferring /redistributing their incomes among current and future periods of time and their views about what is likely to happen in the future. In all markets, self-interest and opportunism also influence transactions of economic agents. Efficient financial markets therefore require a reliable medium of exchange, mechanism of market-making and trading, monitoring and enforcement of contracts for exchange and an effective, speedy dispute settlement systems. Financial markets constitute a giant machine of inter-temporal transfers to solve a civilized society’s problem of matching/coordinating consumption and production over different periods of time. Usually, the financial markets deal in financial securities of various types like Equity, Debt, Hybrid, Units of pools, Pass through certificates, future/ forward contracts and options. Trading in securities leads to price determination. Analysis of securities is important part of portfolio management.
Portfolio: Return & Risk
A portfolio of securities may be defined in terms of weights of each security in the universe in terms of the money value of the respective security relative to the money value of all securities in that portfolio. Therefore, each portfolio has a weighted average return and weighted portfolio return. Portfolio management is concerned with managing and risk of portfolio of securities. This demands understanding the concepts of return, risk and diversification, their measurement and their interrelation. The issues that need to be explored are criteria of risk-adjusted return; sharing, transfer and pricing of risk as also risk immunization and risk insurance. Given specified objectives, management of portfolio risk is carried out through construction, holding and changing/ re-balancing /churning of portfolio.
The usual framework for portfolio management is the mean-variance framework; Mean return is the expected value (as defined in terms of probability theory). The volatility or variance of the return measures the risk. Each portfolio has an expected (mean) return and a variance or risk and is represented by a point in the risk-return space. On this space one can order the portfolios in terms of the preference of the economic agent holding or intending to hold and manage portfolios. This is similar to consumer indifference curve family. Again, risk is assumed to vary with return in a positive relationship. The choice is to be made only among those portfolios lying on the efficiency frontier in the risk-return space. The general theory of portfolio choice is therefore one of choosing that portfolio on the efficiency frontier that maximizes the utility of wealth represented by portfolio of securities. For consistency of solution, it is assumed that the economic agents are risk-averse investors (which is true in most cases), where risk-aversion is reflected in the negative sign of the second derivative of the utility function with respect to wealth.
Capital Asset Pricing Model (CAPM)
CAPM is the most popular model of capital market equilibrium and one of the cornerstones of modern portfolio risk management theory. Assumptions of CAPM include: no transaction costs, infinitely divisible security, no capital gain or income tax, perfect competition with all as price-takers, decision-making in mean-variance framework by all, unlimited short-sale, unlimited borrowing and lending at risk-free rate, identical expectations by all, homogenous investment period, all securities/assets are marketable (tradable). Empirical test of CAPM indicates the validity of the model even if one assumption is relaxed at a time, but there are problems if two or more assumptions are relaxed simultaneously. The mean-variance framework of portfolio risk management theory is the result of the contributions of Markowitz, Sharpe and Linter. CAPM relies on the concept of beta which measures the volatility of a security’s (or, portfolio’s) return relative to the volatility of the market return and the concept of risk-free return security. If beta of a security is or a portfolio is unity, the security / portfolio is expected to yield the same return as the market. The investor is supposed to choose the portfolio with the highest risk-adjusted return (or return per unit of risk or mean return per unit of standard deviation of returns). This Markowitz approach establishes that systematic risk cannot be diversified away but diversification up to a certain point can reduce risk depending on the covariance of returns of different securities in the portfolios. CAPM has a great influence in the way value of the firm and hence the value of equity in a company is estimated. Fair Market Value is defined as the present value of the stream of future after-tax free cash flows to debt and equity holders where these cash flows equal EBIT (1-t) + Depreciation – Investment; EBIT being earnings before interest and tax and t the tax rate.
Concept of Market Efficiency
As in all other areas of economics of markets, the concept of market efficiency in terms of the speed at which all information gets reflected in the prices is very important to financial markets and CAPM. Three levels of market efficiency are empirically tested: weak form, semi-strong form and strong form. The speed with which information gets reflected/ incorporated/ discounted in the market price of stocks better it is: this implies on an average no one will be able to benefit extra from information compared with others.
Portfolio of bonds
The portfolio management approach has given scientific basis of the age-old wisdom of diversification of risk: ‘not to put all eggs in the same basket’. Portfolios may consist of same or different classes of financial assets. Different classes of assets have special characteristics of their own. There are special features of portfolio management depending on the nature of financial asset class represented in the portfolio. A portfolio of equity shares can be compared with the portfolio of all shares traded in the stock market. Similarly, a portfolio of bonds may be compared with the portfolio of all bonds traded in the market. However, bonds are different than equity shares in terms of the nature of their future stream of cash flows. The value of a bond changes inversely with the changes in the interest rates. But, the cash flows are subject to reinvestment rate risk if the interest rate changes; though the relationship is positive between reinvestment rate and interest rate. The bond portfolios are therefore often managed in a manner to cancel out the above two opposite effects of a change in interest rate. This gives rise to the concept of duration of bonds and convexity property. To immunize bond portfolio values from interest rate volatility, strategies like exact matching of assets and liabilities cash flows, duration matching, etc are adopted.
Portfolio Hedging
Portfolio managers may hedge risk in different ways. One of the way to hedge risk is to invest in / buy /sell derivatives. There are various kinds of equity and credit derivatives. However hedging has a cost because the risk is transferred. Reducing risk means reducing return or loss of opportunity to make higher gains. One type of derivative is option which gives right to the buyer of an option a right to exercise the right (not an obligation) to buy / sell a security at a price specified at the time of contract within a specified future point/ period of time. Options as rights have values. Fisher Black’s valuation model for stock warrants involved calculating a derivative to measure how the discount rate of a warrant varies with time and stock price. The Myron Scholes joined Black to work out an accurate option-pricing model by making considerable improvement of a model developed earlier by A. James Boness in a Ph.D. dissertation. Black and Scholes' improvements on the Boness model come in the form of a proof that the risk-free interest rate is the correct discount factor, and with the absence of assumptions regarding investor's risk preferences.
Portfolio Performance Evaluation

The performance of investment portfolios is assessed in terms of the risk-return framework. Performance evaluation is done across time, across different but comparable portfolios and against benchmarks. Standard risk-adjusted return performance criteria include the
Taylor measure (risk premium earned over risk free return / beta), Sharpe measure (risk premium over risk free / total variability i.e. standard deviation), and Jenson measure ( return in excess of expected return where expected return is linked to beta. Analysis of portfolio performance is made through Fama decomposition of actual return into risk free return, premium on systematic risk, return due to imperfect diversification, and net gain due to superior selectivity.

Mutual Funds
Mutual funds mobilises the savings of the different classes of economic agents in different pools to invest in portfolio of financial assets / securities of different classes. Thus, they represent common investment vehicles in which investors can participate with the benefit of professional portfolio investment managers by paying a fee for such service. The common investment vehicles with their portfolio of financial assets are owned by the investors in proportion of their contributions (number of units) but fund/ asset management companies in accordance with the relevant regulations manage the portfolios. On behalf of the investors (unit-holders), Trustees supervise and deal with the asset management companies and the performance of the funds. In the case of an individual investor managing his/her own portfolio, his/her own preference, objective, analysis, views and experience guide the investor. In the case of mutual funds, the objectives of different mutual funds are published / disclosed up-front and cannot be change without unit-holders’ approval by majority. The unit-holders depend on the views and analysis as well as actual performance of the managers based on regular disclosures by the managers. There are various types of mutual funds (in India called mutual fund schemes) like aggressive growth equity funds, value equity funds, index funds, sector equity funds, balanced funds, equity income funds, bond funds, liquid funds, debt-income funds, money market funds. These different types of funds by their names try to convey their objectives and style of portfolio management. The funds are generally open-ended (i.e., investors can enter and exit the fund at any point of time at net asset value of the funds). The performance of different funds is tracked by different publications. The standard portfolio performance evaluation criteria are applied to asset the performance of funds.
The origin of Indian Mutual Funds may be traced back to 1964 when Unit Scheme 1964, a mutual fund type (open-end, net asset value (NAV)- based) investment vehicle, was introduced by Unit Trust of India (UTI). Over the years, UTI introduced a variety of other vehicles like Unit Linked Insurance Plan, Children Gift & Growth Fund. In the initial decades of operation, UTI invested only a small percentage of funds in equity shares. By the early 1980s, UTI started offering Monthly Income Schemes (MIPs) offering assured returns. These MIP-investment portfolios contained more than 90% debt papers. UTI introduced the first fully equity-oriented scheme, Mastershare. However, it was a closed-end scheme (even though it was referred to as a Mutual Fund). Meanwhile, US-64 had become popular because of its consistent dividend record, perception of absolute safety leading to steady inflow of investors’ subscription with very low percentage of repurchases/exit by investors as also tax concessions to investors in UTI schemes. US-64 soon became attractive to companies both as long-term investment as well as for parking of short-term funds for better liquidity management. At present there are more than 30 mutual fund (MFs) players with widely varying sizes in terms of the value of assets managed. The number of MFs increased from 9 in 1992 to 34 in 2002. The number of schemes managed by the MFs increased from 100 in 1992 to over 400 in 2002.There is a great variety of schemes (and options) for investors to choose from. More than 50% of the asset management companies have foreign equity participation. Open-end schemes (the true mutual fund schemes) account for 75% of the total number of schemes and about 70% of the total assets managed. The regulatory framework has improved since 1993 in phases and currently reflects the best standards of transparency, investor-friendliness and use of modern technology. There is now a greater awareness among the investors about the concept and nature of mutual funds and they recognise that MF investing is associated with varying levels of risk and not an assured return, absolutely safe proposition. The market value of assets managed has increased more than two-fold during the last decade. However, the share of mutual fund units in household financial savings continue to remain low (average of 7% during the four year period to 1992-93, average of about 5% during the six year period to 1994-95 and average of less than 2.5% during the seven-year period to 2000-01).

Sharing Business Risks by Stakeholders (2002)

2009-07-31T11:05:00.003-07:00

Sharing the Risks of Business Growth Objective

Dr. Basudeb Sen

1. Man remains mortal despite increased life expectancy. A child may grow fast into an adult, but ageing process starts at some point. Death comes through a natural process of decay, if not earlier due to high risk habits or accidents or environment induced diseases. Does that same law apply to organisations? In the midst of continuous birth of new organisations, some organisations die or transform into different organisations. A family grows to transform into different families after a few generations. A family grows and after generations transform into different families. A religious group grows for long time (even over millennium) but splinter groups develop their own distinguishing characteristics to establish separate identities after sometime. Universities and hospitals may live centuries, but many of them transform over time. Instead of quantitative growth in terms of number of students/patients and departments, they shift over to qualitative growth aiming at winning recognition as centres of excellence and knowledge. Some collaborate with others to make their impact felt on discoveries, innovations, technology development, policy making, etc.

2.Commercial business organisations (CBOs) have shorter average life. Many become extinct within a short period (high infant mortality) but some live for long periods and a few cross centuries retaining their original identity. Growth has not been continuous throughout for any CBO with a long life : at some point of time before extinction/transformation, a CBO may go through periods of stagnation or decline. In economics literature, researchers have attempted to develop theories of ‘life cycle of a firm’. Some management experts have made empirical studies to identify reasons for firms that seemed to ‘built to last.’ Some CBOs get transformed (merged) into some other CBOs even while growing. Some CBOs announce their winding up suddenly. Some of the CBOs die or transform after they become sick and unviable. Despite the record of CBO mortality, almost all CBOs consciously or unconsciously pursue all the time an objective of growth. Is there an organic need for growth for a CBO and are there limits on its growth?

Growth Objective

3. For a variety of well-known reasons CBOs pursue growth. First, the status of a CBO is measured commonly by its size in the product line(s), industry, sector or region. It has to grow in order to be recognised as one among the appropriate category of big business league who are able to influence investors and establish mutually helpful relationship with various sections of the society including the political and state establishments. Second, just being big in size of operations is not enough. The big league CBO should make big enough and growing profit required to finance further growth itself (and attract finance from lenders and shareholders). If others grow faster than a particular CBO, it loses its relative position. One has to grow fast enough to retain its place. Third, growth is a way of enjoying power by the Managers over larger number of people, especially among the influential sections of the society. Fourth, growth in size may have significant economies of scale while growth through diversification may yield synergy benefits. Fifth, growth enables an organisation to fight competition better. Finally, the stock market prices may go up if a company’s future earnings growth is expected to be maintained or improved. Given these various considerations, growth is likely to be perceived as the only meaning of existence for a living CBO. As a result, in most CBOs, the shareholders, the Board of Directors, successive layers of management and other employees take growth as the CBO’s sole objective.

4. True, some learned people talk of social responsibility, of environmental protection and of ethical behaviour as objectives. But what they essentially mean is that CBOs should not pursue ‘growth’ objective by neglecting social responsibility, by damaging the environment and by unethical behaviour. So long as a CBO behaves in socially responsible way, takes care to protect environment (from any adverse consequence of CBO’s operations) and maintain ethical standards, a CBO is encouraged to grow. For, growth in size is also perceived to enhance CBO’s ability to discharge social responsibility, protect environment and maintain ethical standards. So growth remains the single fundamental objective (other considerations being more in the nature of constraints on the manner in which ‘growth’ is being pursued).

Risk-Associated with Growth
5. Let us assume that a CBO is socially-responsive, environment friendly and ethical in behaviour. The question remains whether it can pursue growth as an objective all the while. If the pursuit of growth generates stress on the organisation’s resources and infrastructure, it may give rise to high risks of failure. Thus, growth may lead to sudden disaster or sudden death. Whether the pursuit of growth generates high risks of failure will depend on the circumstances of the CBO and the emerging environment. A risk analysis can reveal the sources of risk associated with growth. It is known growth places considerable demand on the management, financial resources, systems and procedures, manpower, vendors, suppliers, distributors and the infrastructure available in the environment in which a CBO operates. Any one or more of these may fail to deliver in various degrees. Symptoms of such failure tend to be ignored when a CBO pursues growth with its managers and employees always optimistic and not willing to accept any constraint as being un-resolvable. Such attitudes are normal. But ultimately the risks may become reality. Servicing infrastructure may not be able to handle the increasing load leading to customer complaint and low suits which in turn may increase cost and unproductive use of strained resources. Financiers/lenders may lend money at high rates of interest because the CBO agrees to and lenders may not as yet perceive the high risks. Senior management may show fatigue or other weaknesses that were not evident in the initial years of growth. Systems and procedures may not be upgraded to keep pace with growth and as a result outdated controls will fail and new controls will not be in place. Prudence in borrowing and choice of customers may become a casualty. Potentially unviable products may get launched to beat competition. All this are great risks that may cause disaster. One would argue that these risks should always be taken into account, specified as constraints in the form of risk limits and CBOs should pursue the objective constrained growth maximisation. Mathematically, it sounds well. But management is also about removal of or overcoming constraints. Risks arise from the way such constraint - management is done on an on-going basis in response to surfacing of internal constraint, identification of weaknesses of the systems external to the CBO but on which CBO depends (the banking system, the utilities, regulatory framework, the macro-economic policies) as well as the strategies and tactics of the competitors in the market.

6. To pursue growth objective, a CBO may be required to invest in capacity creation and/or acquisition. This may imply drawing down of liquid assets and/or additions to equity and/or increase in debt. If a CBO already has significant unutilised capacity, it may require greater amount of working capital, both due to higher production and longer credit period as market competition intensifies. In both cases, the risks to both lenders and shareholders rise, especially if intensifying competition means higher promotional, advertising and marketing costs, ‘adverse selection’ of customers buying on credit as also falling or stagnating sales prices and margins. Consumers may benefit but at the cost of deteriorating health of the CBO. If some of the competitors do not exit and competitive pressures depresses profit margins, a CBO may soon lose its viability.

7. During certain periods of time, consolidation and stagnation may help avoid disaster and a CBO may not prefer to pursue growth. By attempting continuous growth, a CBO may at some stage sow the seeds of inevitable decline and death. With complete certainty of success and no risk of failure of products, systems, infrastructure and management, growth may be pursued eternally. Reality, however, is fraught with uncertainty and risk. It may be argued that because of uncertainty and risk, the growth objective becomes all the more important. A CBO that does not try to grow when others do, may lose out on market share and economies of scale. Competition may knock it out of existence. This argument is too simplistic. If a CBO cannot create barriers to competition, despite all cost advantages, it may hurt its viability by trying to grow. If an industry is expected to witness fast demand growth, it may attract many new competitors and most existing competitors may try to expand. This may result in excess capacity/ supply and falling profit margins ( or even turn negative). In this situation, the CBOs that produce more are likely to lose more. A CBO can hope to survive if it has the financial strength to absorb such losses till other competitors are forced to exit because of the growing burden of losses. The financial strength to absorb losses varies from CBO to CBO. If the financial strength is low, it may not be desirable for a CBO to pursue growth.

Alternative to Growth Objective
8. If growth is likely to be risky and has strong potential to damage the CBOs viability, can the CBO adopt a passive strategy of maintaining its activity at current levels to protect its viability. One may argue that such a strategy of not putting resources for achieving growth can be equally risky. Especially, in competitive markets, loss of market share may ultimately erode ability to operate on a viable scale. The difference between pursuit of growth and passive play may be turn out to be a choice between fight to fail and fail without a fight. If the likelihood of failure is equally high under both strategies, the choice may be made on the basis of conservation of resources provided by the investors. If a CBO accepts to stagnate or shrink in size, it conserves financial resources rather than fritter away the investors/lenders money in a fight that is highly likely to lose. It may be better to organise for orderly liquidation or merger. Also, a passive strategy of accepting stagnation or decline for a while may allow a CBO to observe if its competitors grow into bankruptcy and make space for the CBO to return to a ‘growth’ objective. This is a contrarian strategy of allowing others to grow and fritter away their financial and managerial resources in a progressively intensifying competition. When a CBO’s financial and managerial strength to run competitors out of breadth is not adequate, it is better for it to allow competing CBOs lose strength before it considers to embark on ‘growth’ objective again. ‘Strategic Retreat’ rather than ‘growth’ may be a desirable strategy in certain time periods. When competition intensifies, some are likely to go bankrupt sooner or later. Let others get hurt in the competitive market place. Then, when they have suffered adequately and their fight in the market have weakened them, a CBO may come aggressively with its conserved energy to drive out the bruised and gasping competitors and re-establish its hold on the market. But ‘strategic retreat’ may be fatal as well. A CBO with such a strategy may not be able to return back to the market if during the CBO’s wait period some major leaders establish dominating market shares and brand equity. This risk has to be weighed. The ability to return in time to effectively fight those who were already in battle is the key.

9. One might argue, when competition hots up in a CBO’s existing product market, it may diversify to meet its growth objective. Diversifying, however, may also mean entering markets where competition is likely to intensify. This is back to square one : fighting competitors when the chances of failure of a CBO with inadequate financial and management strength is high. A CBO may also strive to grow by vertical integration to reap synergy benefits and build competitiveness along the value chain. This is feasible if the CBO can muster adequate financial and management strengths. But the CBO which does not have or cannot hope to muster such strengths may have to shift away from the growth objective. Following management literature, a CBO may concentrate on those business areas in which the CBO has core competence and endeavour to be number one or two in the product market areas it wishes to operate. Clearly, all CBOs can not succeed in this by definition as only the top few may share among themselves (say) 40%-60% of the market. The prospect of becoming a marginal player may mean stagnation or decline for a CBO. Such a CBO may (a) exit in an orderly phased manner, or (b) merge/sell out to the bigger players or (c) somehow survive and wait till the big players exit the particular product market, if that is likely to happen soon. During the period of exit or sell out or wait, a CBO cannot pursue a growth objective. Alternatively, the CBO may change its strategic positioning : it may continue to remain as a small ‘niche’ player in some product/service market (and diversify into a new business area where it can compete better as a leader).

10. A CBO may have with substantial underutilised capacity and little financial strength to take on competition from bigger players. It may be desirable for it to consider a sell-off and exit. If it’s capacity utilisation is reasonably high, it can explore ways and means to cut costs, conserve financial resources, preserve loyal and good paymaster customers, create brand image in the as yet untapped market segments, etc. Another possibility is to diversify into some related but less competitive business that would not demand substantial fresh investment and considerable managerial resources. The choice of the new business areas may be determined by the extent of dependence the competition in the existing business area is likely to have for supply of inputs from the new areas in future.

11. Being a marginal player or not being among the top may not be a
bad idea. In many industries and markets, such players are in the majority. Many of them follow the price of the leaders or hawk their wares in market segments in which leaders may not like to penetrate. These players may or may not grow, but they generate profits and do not put large resources to high risk. Once in a while, one may see some such players take advantage of opportunities and grow into significant players. In economics literature, attempt has been made to develop a theory of the optimum size of the firm. There may be firm specific optimum size, even though for the industry there may be different options for different firms depending on their concept of an economic
limit to growth for firms (CBOs).

Indian Examples : 1990s.
12. First, the examples of pursuit of risky growth strategy. The number of sugar producers in India has always been large. In the past four years, many have been expanding capacity and/or trying to increase their capacity utilisation amidst falling/stagnating prices, falling margins and mounting finished stock inventory (to about an year’s demand ……). Hardly any strategic exit been made consciously to avoid getting into financial distress. The adverse consequences are now being faced. In the steel industry, new entrants set up substantial capacity to produce……finished steel. A domestic excess capacity situation together with global slow down in demand and protectionism adversely affected the financial health of steel units. In cement, fresh capacity investment slowed down but continuous marginal addition through balancing equipment continued. Even unofficial cartels failed to arrest declining sales margin. A few mergers and acquisition took place. The acquisitions in some cases paced heavy strain on the finances of the acquirers. The consequences are now being faced. In all these industries the expected big consolidation did not take place and players are only hoping the early return of a demand boom for their survival.

13. In the financial sector, many non-banking financial intermediaries (NBFIs) had built up asset portfolios at a rapid pace during the first half of 1990s. Industrial high growth in a competitive market resulted in ‘adverse’ selection of clients/high risk assets. The consequences were to be faced later : high non-performing assets, return on standard assets falling below cost of funds, asset-liability mismatches, high provisioning required against doubtful assets and strained capital adequacy, many NBFIs had to close down, while many others are still struggling for existence. Pursuit of high growth forced some NBFIs forced themselves into violation of regulation and risky decisions. Investors in NBFIs had to suffer.

14. In the second half of 1990s the commercial banks continued to witness high deposit growth but credit growth rates declined both due to fall in demand and rise in risk-aversion. following delayed recognition of legacy of non-performing and weak assets. With interest spreads falling, those parties which can achieve greater market share would force others to stagnation/decline in funding business and erosion of viability. Many mutual fund asset management companies targeted high growth in the early 1990s. Some got into problems of inadequate investor servicing infrastructure, besides facing uneconomic size of operations as net inflows to equity fund slowed down and NAVs failed due to sliding share prices. Too many players trying to compete increased the costs and risks of growth strategy. Only a few thought of consolidation or exited in time.

15. There are examples of alternative strategies. In the sugar industry, a number of medium sized players are still making profits. Instead of trying to expand, they concentrated on their advantages of being located in high sugar recovery zones and cut costs. In the steel industry, those who set up new integrated steel plants suffered. But some of the small players who concentrated in specific items like - - - - - and on geographical segments where competition was less intense were able to weather the impact of the overall slowdown in steel demand and fall in margins. In the NBFI sector, a few moved away from fund-based businesses to non-fund based services like distribution of debt instrument, issues of companies as also consultancy on mergers, acquisitions, privatisation of public sector companies, etc. Some firms concentrated in geographical segments where competition was less intense. In the consumer goods sectors, large all-India brands compete and yet small local brands also survive with their ‘niche’ market segments. This is true of products like tea, biscuit, toothpaste, soap, detergents, etc.

16. A few big companies which pursued high growth strategies survived the impact of high risk because they had the financial and managerial strengths to absorb the losses from failed diversification/expansion projects. In the early 1990s, many large private sector companies in fast moving consumer goods sector, steel sector, textile and cement diversified into financial services, power, petrochemicals, information technology and telecommunications, etc. Only a few of them succeeded, some exited from failed businesses at the earliest and survived because they had the financial strength, while others virtually ruined themselves (even unable to either abandon their projects mid-way or complete their projects). All this shows that growth strategy proved to be low risk or within their capacity to assume risk for only a few. The extent of riskness of growth strategy varied depending on the nature of demand-supply forces in the market in which the CBOs operated or entered and their relative strengths.

Growth falling from the Heaven

17. There are times when a CBO’s growth is exogenously induced. A CBO may pursue growth but may not succeed initially and then certain external events just places it into a high growth orbit. This happened to some information technology (IT) companies in India as the Y2K problem led to high overseas demand on Indian IT companies which was followed by high overseas demand for less expensive software services from Indian IT companies. But all IT companies could not sustain fast growth and many failed by the wayside after a sudden break in overseas demand growth and/or shift in demand from one type of IT services to another. Only a few companies sustained growth because they conserved cash and invested in human resources management and infrastructure to deal with varying trends and composition of overseas demand for IT services. Even many established resourceful companies diversifying into IT did not succeed as well as the leading IT (only) companies. Initial growth was shared by all players, very few of them ever dreamt of such high rates of growth. It is later, after having grown due to the impact of spurt in overseas demand, they consciously adopted a growth strategy and prepare themselves to tune to the changing market conditions. Those who succeeded in pursuit of growth showed brilliance in management tuned to the market forces. They (could have, but) did not diversify into other areas remained focussed. There are smaller firms who also did the same thing to remain in focus but did not force their pace of growth by leveraging. Many others who tried to grow fast failed at the cost of investors who subscribed to the equity or debt issues. Thus, even under conditions of relative certainty of rapid growth in the size of the market, all CBOs could not succeed with their strategy of growth.

Sharing Strategic Responsibility
18. Everyone likes growth. A nation and the Government wish its CBOs to grow. The shareholders, the lenders, the regulators, the consumers and the employees all want the CBOs to grow and grow fast.. And, certainly the Board and the managers desire growth. Everyone, therefore, supports the growth objective (even if some insists that CBO be socially responsible, ethical and environment friendly). The reason is simple, if growth takes place, everyone could enjoy some benefit or other and share the glory of achieving growth. But when in pursuit of growth, a CBO gets into a disaster, it causes pains to many - employees, lenders, investors, customers, regulators and managers. No one, however, is willing to take responsibility for failure from risky growth strategy. The Board and the top management is to own up the responsibility of failure of Strategic Management, according to currently received management doctrine.

19. For different CBOs, the riskiness of growth strategy varies. The risks are required to be assessed and addressed so that one can determine whether the specific strategy is desirable from the point of view of the shareholders, lenders, customers, suppliers and others. Such risk assessment may not always be made or shared publicly. It is inconceivable that a strategy will be considered highly risky and yet agreed to by the Board. Even if the risk assessments were disclosed, the risks remained. Therefore, a CBO’s growth strategy is explicitly or implicitly approved by all - the managers, the Board, the shareholders, the lenders, the Government, the regulators, the suppliers, the employees, the customers. True, Corporate Governance has seldom been of the highest order. But what matters is not the formal process of Corporate Governance. Regulatory permission is often required to be taken to expand capacity and implement diversification/modernisation projects. The lenders extend additional finance to fund such projects/capital expenditure. The managers and workers cannot be aware of a CBO’s growth plan. Generally, companies inform the shareholders at the Annual General Meeting, if not trumpeting the growth plans through the Press. If they do not support the strategy, the employees could have left the CBO to avoid the risks associated with its growth strategy, the Board could have formally disapproved the strategy, the shareholders could have objected to or sold off their shares, the lenders could have stopped extending further loans, the regulators could have sent in warning and the suppliers could have snapped their business relations. So could the customers. Yet, only when the risks materialise with adverse consequences,
everyone tries to blame the managers or the regulators. This may be natural, but inconsistent, unfair and irresponsible. If all encouraged growth and growth strategy is seldom riskless, all have to share the responsibility of the strategy failure and its consequences.

20. All businesses carry the risk of failure. If businesses fail, the consequences have to be borne in the same manner as the gains of business successes are enjoyed. The existence of highly paid managers, board of directors, auditors or regulators cannot remove the reality of business risk. Each individual or institution connected with a CBO has to have his/her/its own risk analysis and set acceptable risk limits. Only if the risks are within the limits, one should support a CBO or be associated with it. Whenever risk assessment shows that a CBO be better wound up to avoid the risks that it is going to face in future, a CBO should be encouraged to do that and disengagement with such a CBO should begin. A society cannot continue with perverse incentives for long where the benefits of business successes are shared by all and the costs of business failures by a section, strategic responsibility of CBO lies with each individual/group associated with the CBO directly or indirectly. One has supported growth strategy or alternative strategy of a CBO, the resultant risk has to be borne by him/her. He/she may lose his/her job/loans/investment in a CBO just as he may have gained from his association with another CBO. Both the gains and losses result from sharing the responsibility of the strategies of the CBOs.

The Emotional Model
21. It is difficult for societies to accept this reality. The prevalent model in modern societies is as follows. The Board and the top management determine the strategy of a CBO. They are responsible for strategic decisions and their implementation. The shareholders assume that the strategy adopted by the Board and Management will maximise shareholder value in terms of dividend or stock returns. The lenders, the employees, the suppliers and the customers rely on the company’s track record, credit rating and equity analysts’ assessment. The model also assumes that (a) Board and top management are the agent of the (Principal) shareholders and the agents’ interest may be in conflict with the interest of the Principal and (b) being insiders, the Board and the top management have more information about the CBO than the shareholders and lenders who suffer from asymmetry of information access. The regulators seeks to reduce the risks of agency-principal interest conflict and asymmetry of information by a regulatory framework consisting of, in the main, independent auditors for quarterly/annual accounts, disclosure standards, shareholders’ voting rights in respect of key corporate decisions including appointment of directors, fixing managerial remuneration, changes in charter, large investments and resource raising though borrowing beyond a limit, or though fresh issue of shares. Despite the host of regulations, a CBO may fail to deliver the results and even go bust. In many cases, such incidents may be related to managerial fraud and violation of regulation by managers and/or auditors. But in many more cases, failures arise from CBO’s strategies that proved inadequate in the competitive market place. The shareholders, lenders and employees ultimately face the consequences of failure, but do not admit the responsibility of having accepted the risk of business failures when such failures take place.

22. If there are occasional business failures, these are taken in stride. When a large number of failures occur within a short period, there is a loss of confidence among investors, savers, consumers and employees. The emotions become strong to find out the villain. Public outcry during such a crisis demand the political establishment to respond, which the later does by showing aggressiveness in commissioning investigations, taking companies and directors to courts and initiating regulatory reforms. The crisis passes by and the society forgets about the past crisis till a new one affects it. And, history repeats itself.

The Rational Model
23. This behaviour model is not consistent with rationality and reality. Reality demands that failures be accepted in the same spirit as successes. While frauds and regulatory violations by failed as well as successful CBOs (and their directors/managers) have to be dealt with through effective control mechanism, vigilance (monitoring) and enforcement, the risks of business are by definition assumed by all those associated with the CBOs. When firms compete in the market place, the more efficient CBOs and the CBOs with greater strength are expected to survive and weed out the inefficient, weak ones. The winners and the losers cannot be identified in advance. In the market, today’s champions whom the nation adores may be the loser tomorrow. This is dynamically consistent realty which no rational individual and society can refuse to accept. In this perspective, there cannot be any loss of confidence when businesses fail or economic depression occur as they are bound to take place..

24.The rational model recognises the realty that risks of business failures cannot be eliminated and that the responsibility of business strategy failures lies with all those likely to face the consequence, though formally the Boards and managers may be responsible for strategic decision-making. In the rational model, no one can assume an implicit guarantee from the State or the Board/Management that those affected by business failures will be compensated or their anger respected. In this model, therefore, the investors, the lenders, the employees, the supporters and the society would tend to prepare themselves better to face the risks of business failures and count the returns from business successes. If this is exactly what a single-owner small CBO and those associated with it have to do. The same law applies to all the stakeholders of large CBOs as well.

25.In this rational model, the importance of regulation and regulators, audit and auditors, corporate governance and risk control as well as the punishment to those who causes fraud or violate laws/regulations - all these remain. But the responsibility assumed by (thrust on) the State to protect or compensate those who lose due to pure risk of business strategy failures is removed. Neither is witch-hunting allowed to assuage emotional outcry from losses. Nor is award necessary for CBOs (and CEOs/directors/managers) for their heroic contribution through business successes. Each citizen (as investor, lender, employer, manager, supplier, shareholder) is fully responsible for bearing the consequences of business failures without complaint. Government may, however, provide help to those who become destitutes or very poor as a result of business failures. Such help may be limited to meet basic needs (possibly through amount insurance cover on investments, loans, salary). The tendency to relate all business failures to fraud and cheating get eliminated. No individual is regarded as a weaker party because of reasons like asymmetry of information or principal-agent conflict of interest. Each individual has to take the responsibility of managing risk on an individual basis.

26. Once this alternative model ( based on reality of business risk as the condition of contracts/transactions), citizens (investors, lenders, shareholders, workers, managers) will consciously assume the risks and not cry foul whenever they lose. Business and consumer confidence will not be affected by business failures or downturn as these will be taken as fallout of past decisions. The regulators and enforcement agencies will be relied upon to minimise the incidence of frauds and violations rather than creating an atmosphere of doubt and uncertainty through after the event prolonged investigations and court trials capable only of hitting newspaper headlines. The State will not have to show their aggressive stance in reforming systems. in response to large-scale failures and mechanism for controlling frauds and violations will continuously evolve. Failures would still mean that directors and managers of CBOs will lose their jobs and the State be under pressure to avert/control the magnitude of economic depressions.

Global Crisis - The other view (2008)

2009-07-31T11:05:00.001-07:00

The Current Global Economic and Financial Crisis is really a Two-in-One State-created Market-distortion Induced Crisis. There are two crises that merged into one:
A. Unsustainable Trade Imbalances and Market Distortions created by State/ Governments that dominate their economies finally bursting, and
B. Financial crisis emerging out of State policy-led distortions in financial market mechanism in the US.
Together A and B accentuating each other form a formidable Crisis.

Unsustainable Trade Imbalances & Market Distortions
Over a decade poor nation provided subsidized credit/ investment funding to profligate rich nation’s spending for consumption. China ran continuous trade deficit with the US. China grew fast economically and provided employment to millions by producing low value added consumer goods giving low wages to labor and sold them cheap to the US, investing the surplus dollar earnings in low interest bearing US Treasury bills and helping US keep the inflation rate low. Such abnormal economic situation can never sustain it had to burst. Chinese policy of controlling the exchange rate of its currency, Yuan, to neutralize the adverse effect of its huge and growing trade and current account surplus on its export competitiveness had to burst. At the same time, energy market imbalances accentuates with rapid economic growth of populous, poor nations. Energy prices soared, energy profits and petro-dollars aggravated asset inflation and also funded/ sponsored- terrorism business. Distortions rose to alarming proportions in energy, exchange rate, commodity, labor and weapons markets. Such unsustainable market distortions can get corrected only through thru’ economic Recession / Slowdown
Financial crisis - Crisis of Confidence
Populist dreams were sold by political regime through market interventions. This sowed the seed of the financial crisis. How? Just go through a rewind of the sequence of events.
Currently (Time Zero), all Political Regimes are in Coordinated
Bailout, Fiscal Stimulus and Monetary Easing Actions throughout the World. These actions include:
Raising and expanding Deposit Insurance
Buying illiquid, impaired hsg. loan assets
Guaranteeing inter-bank lending
Infusing capital
Relax Marked to market capital adequacy and provisioning and market price based financial reporting, etc.
What happened before that? Follow the Event chronology in reverse: here BC means Before Crisis or Bailing out of Crisis.
BC1: US Banks flushed with funds but not lending amongst themselves and to others. They were flush with funds because
BC2: US Fed pumped liquidity to encourage bank lending because
BC3: Banks stopped inter-bank and other lending because
BC4: There were Run on US banks because the fear spread that banks are insolvent and people started withdrawing deposits. This happened when the Political Regime Lost in the Woods of Economic Greenery they were trying to exploit without knowledge and responsibility. When they had lost their minds under pressure of economic forces they allowed
BC5: Fall of Lehman Brothers as they faced
BC6: Uncertain Political Stance on Pvt. Cos./ executives Bail out : election pressures
BC7: Rescue of AIG, Freddie Mac and Fannie Mac
BC8: No Rescue of failing Small banks & Troubles at ML, etc
BC9: Rescue of Bears Stern

BC10– BC12: Ignore signals

BC10: Rating downgrade call on Investment banks/ financial institutions exposed to housing mortgages
BC11: Bond prices fall; Mortgage defaults soar, Interest Rate rises- 1% to 5% (homeowner liability increase 40% with 2% pts rise in interest rates), inflation rises
BC12: Signs of Mortgages defaults & house price downturn in 2005: excess supply, price & leveraging risk of financiers increase: Marked to Market Regulation continues
BC13 – BC16: Political Regime Basks in Glory

BC14: Surging Housing boom, employment and growth: house price to income ratio crosses 190% in 2002 and crosses 200% in 2004 - 25% of house purchases for speculation
BC15: War on Terrorism, Rise in Defense Spending & Budget Deficits, Dot.com bust neutralized
BC16: Interest rates continuously fall, even as trade deficit rises
Political Product Selling: American Dream

No shortage of homes, but 40% households not homeowners - they must own – irrespective of their income levels a
Use Govt. control and influence over banks, Freddie, Fannie, investment banks, insurance companies and regulators. (CDS market 100b in 2000 to 60t in 2008)
Encourage players and regulators to neglect prudence and norms to achieve unsustainable Social Dreams ( instead of building transparent market, State deliberately distorts market mechanism)

Sowing Seeds of Crisis: Distort Market Mechanism

Encourage Sub-prime home lending, remove Mandatory 20% down payment
Prod Freddie/Fanny: home ownership affordable to poor
Encourage Investment bankers & unregulated high leverage (LB 30/ PEF 4 to 6.5 avg)
Encourage Discount mortgage innovation: Variable/ Adjustable Mortgages
Political State in Wonderland
Distort Market Mechanism…..

Allowed high leverage & housing portfolio concentration
Regulatory ambiguity continued to enable political influence to keep at bay standard risk management in financial sector
(Commodity Futures Modernization Act, 2000)
Credit default insurance arranged - Laws against such insurance removed in 2000
Attract foreign investors with implicit State Guarantee

A Summary: Political Regime
Acting God
Distort Markets to sell political dream
Benefit politically connected house builders (buy land cheap thru’ influence, profit by transferring risk to banks and financial institutions)
Leave economy imbalances unattended: use housing for growth
Prod & implicitly protect pliable players & regulators
Ignore signs of breakdown and hide Truth

God concedes defeat to market
Market ultimately forces the Truth out - Costly crisis emerges
Blame Regulators and Private Sector executives & others
Regulators reveal incompetence - Greenspan shocked at lending institutions ignorance of self-interest, says ignorant about sub-prime mortgages till 2005, and blames securitization, foreigners demand to invest and Freddie-Fannie involvement
Bailing Credibility of Political Regime God In
Shareholders and bondholders loose money & shout
Huge Job losses – elections campaigns affected
Public confidence on political regime slides
Bail the political regime out

US Economic Crisis – Impact of State Socialism
National Debt 68% GDP;
Current Account Deficit 6.5% of GDP
Housing prices fallen by 30%
Rising Inequality
Loss of Confidence in US $ and economy.
Record Debt Rate - growth financed by consumer borrowing- credit gdp > 3.5 (2.7)
Credit Crunch - Loss of confidence in banking/ financial system : Threat to Political Regime

Responding to Questions
Market mechanism failed or political regime distorted markets?
Inadequacy of Regulation or State directed absence of Regulation?
Greedy Corporate executives or pliable players?
American economic dominance is about to end?
Capitalism is under test or collapse?
How Great is the Depression?

Looking Ahead:

Will Financial Crisis End and When?
How intense will the global slowdown be and when is the turning point ahead?
Any implications on Regime after recovery?
Economic Crisis : Markets will Correct
Faster, if the Current Big Keynesian-ism is consistent with market corrections
Slower, if that is conflicting with market corrections
But consequences of both market corrections and Keynesian-ism will not be same for all countries and all people : conflicts over this will cause delays
How Severe ??
US, Japan & Europe in recession: 2008 4% fall? – 2009 1%-2% more fall? Recovery signs in 18 months?
Large Fiscal stimulus/ bailout effect
US unemployment rate 6.5% - how fast it approaches 10%: not exceeding 12% - a sign of recovery?

Financial Crisis: Market itself Rebuilds Confidence & Corrects
Faster, if competitive markets are allowed to grow, distortions removed and markets’ institutional regulatory needs met
Faster, if new bankruptcies are managed with protection to common investors
Faster, if real sector turnaround is early
Confidence once eroded takes time to rebuild
Market Mechanism Efficiency Development Globally Hurt
Basle –2 to get hurt
New International Fair Valuation Reporting to await State clearances & business resistance
Development of competitive markets to deal with uncertainty through insurance against contingencies (like CDS) may slow down: to hurt market efficiency
(CDS market helped reduce Financial Crisis Impact)

Positives so far…
Commodity, esp. Oil Prices have fallen sharply – inflation fall helps recovery
Job losses not yet so dramatic – new job creation has fallen sharply
Banking & Trade Credit may be stagnant but not sharply declining in a deflation
FII outflows to West surged – peaked already ?
India: Actions so far…
Monetary Policy: Bold & quick, ok. BUT
- Weak force & liquidity trap: limited scope
- Impact on exchange rate
- Long-term inflation potential
Fiscal Stimulus: Bold, ok. bold stance: BUT
- Deficit spending: Crowding-out Pvt. Investment?
- Inefficient Govt. spending & Waste
- Long-term inflation with 7% Fiscal Deficit

India’s policy response so far
Protection & Subsidies: Ok, BUT
- market distorting & efficiency reducing
- excise cuts protect firms - little passed on
- export incentives ineffective in globally depressed demand
Art of Balancing & Sequencing
Vulnerability to success/ failure of other countries

India: Outlook
Global Financial Crisis limited impact but hard hit by Global recession
Growth falls: near 7% in 2008-09 & 5% in 2009-10 . Rebounds from 4.5%?
8% Inflation still strong - Impact of oil & commodity prices fall helps – CAD 2-3%
Further Economic Reforms could help but unlikely- State grab new opportunity

Organisational Mind (2002)

2009-07-31T11:04:00.006-07:00

Organisational Mind & Response to Paradigm
Shift in Business Environment in India

Basudeb Sen
(published in International Journal of Human Resource Development, Inderscience Publishers, Jan. 2003 issue)

1. Business organisations respond as changes in operating environment take place generally gradually over time. Successful organisations anticipate medium and long-term changes (like business cycles, technology developments and competition) and implement appropriate strategies to survive and build their future. Such strategies often involve change in business-mix, business reengineering, changes in use of new technology, financial re-engineering, work processes, marketing and R&D. They generally do not warrant all round transformation of the entire organisation within a short span of time. But when a sudden paradigm shift in business environment takes place, business organization do not have much time to plan their strategies and have to start immediate mobilisation to fight a war of survival. Fighting such a war warrants a prompt and total response of the entire organisation.

Paradigm Shift for Indian Business

2. In the early 1990s, Indian businesses faced a fast developing paradigm shift in the operating environment. A largely state-controlled, closed economy began a quick transition to a market-oriented, progressively open economy. Within a short span of time, business organisations found in the midst of an environment where the State (Government) was rapidly dismantling all its controls on capacity creation, production, distribution and pricing of goods and services and these decisions were being left to forces of supply and demand in the markets. The barriers to internal and external trade were being removed. Even the hitherto dominant public sector monopolies/oligopolies found their State protection being withdrawn. The financial resource flows, hitherto directed by the State’s policies and priorities, were being progressively left to be determined by market forces. The high degree of protection of employment and income of organised sector labour force started waning. State subsidies to manufacturing sector stopped expanding. This new business environment threatened the survival of most organisations.

3. The new environment posed perhaps the greatest challenge to Indian business organisations since India became independent. Many organisations failed to respond effectively to this challenge, while a few succeeded. Their experience has not yet been extensively documented and researched. It is possible, however, to undertake a general overview of this Indian experience. This paper makes such an attempt from the perspective of the influence of the ‘Organisational Mind’ (OM) on the response of Indian organisations to the paradigm shift and relate how OM might have contributed/hindered the process of formulation, resource mobilisation and implementation of strategies to fight the war of survival.

Concept of Organisational Mind

4. Organisation Mind (OM) is in the nature of collective mind but is better understood in terms of what OM does. Although there may be alternative conceptualisation of OM [1], for the purpose of this article ‘Organisational Mind’ - is identified by three functions : (a) recognising and thinking about organisation’s problems and possibilities and, on that basis, coming to conclusion about action(s) required, (b) willingness to act as required with confidence and (c) influencing organisation into action (OM may have many other functions, but we do not consider them here). Just as an individual’s mind think logically about present and future, identify problems, solve them analytically, generate new ideas, work out imaginative solutions and then set the individual to act accordingly, OM does the same with respect to the organisation. Just as an individual’s mind is itself influenced by its prejudices, preferences, greed, fear and its past experiences, OM also exhibit the same.

5. Since an organisation functions based on the efforts of a collection of individuals, OM may be thought of as representing a collective mind [2] of individuals. However, OM is not a mere collection of minds. Nor does the existence of OM depend on the homogeneity of individual minds in the organisation. The extent of interaction of the minds of a large number of individuals in the context of the organisation is a property of OM. A process of aggregation through interaction of the minds of shareholders, members of the Board, the managers, the supervisors and other employees gives shape to the Organisational Mind. Usually, the minds of only a few individuals (like CEO, CFO, top managers and corporate planners) are more active components of OM. However, when an organisation records a major achievement/milestone (like a breakthrough product launch/a significant acquisition or merger, completing 50 years of existence) or lands into a major crisis (a large financial loss, loss of dominant customers to competition), many more individual minds become active parts of OM. However, the process of interaction and aggregation of individual minds does not completely describe the OM.

OM Properties

6. In this paper, we consider three specific properties of OM. These are OM Intensity, OM Mood and OM Quality. Just as an individual’s mind can be more or less intense (more or less active), OM can display higher or lower intensity (activeness). Again, as in the case of an individual mind, OM can display a mood of enthusiasm, confidence and optimism or indifference, pessimism and defeat. Finally, the quality of OM is reflected in the relative ability to analyse, innovate, anticipate and solve problems.

OM Intensity

7. The relative activeness or intensity of OM is measured by the intensity of participation of the constituent individual minds in the process of identifying organisation’s problems and their solutions. It is possible to gauge the intensity through service among an appropriate sample of individuals across various levels. The intensity of OM may increase simply because certain events impact a large number of individual minds or the regularly more active component of OM (i.e., the CEO, top managers, planner) use appropriate communication to activate other minds to specific organisational needs or problems. In shaping the response of an organisation to changing environment, the top management and the planning staff play a major role. But their ability to succeed in implementing changes to face the external environment changes may be limited by the dormant (less active) constituents of OM. The longer an organisation spends in a relatively stable condition, the greater is the likelihood that the OM will have more dormant parts and hence low intensity. A low intensity of OM implies that most people are not being aware of the organisation’s health and the environmental challenges it faces. Not being aware means not being able to think for the organisational interest, not being able to understand the logic of certain changes being made by the senior management and not being motivated to use the power of thinking through problems and the power to innovate. A high intensity may not also be good. A mind that is agitated over problems may not necessarily produce good results. However, if the intensity is high, there is a possibility that the minds of many individuals get tuned to organisational needs. A sudden organisational crisis may cause dormant parts to become more active. If OM intensity is at a high level, it may contribute more positively to the organisation’s response to dealing with problems or crisis. When OM perceives that an impending crisis may strike at the survival of an organisation within a short period, the intensity of OM tends to increase. The extent to which dormant parts of OM can be reactivated promptly and the intensity of OM can be increased in advance, the organisation may have a better chance to mobilise organisation effort to deal with a brewing crisis (and eliminate the crisis). A delayed increase in OM intensity may not, however, help as the crisis may overtake or overwhelm the organisation. What an organisation benefits from is a sustained high intensity of OM that allows the opportunity to get the OM tuned to organisation’s emerging needs for changes.

OM Quality and Mood

8. The latent quality of OM and OM Mood are equally important. The quality of OM is reflected in its ability to think logically, to recognise and analyse problems, threats, opportunities and potentials to determine actions to deal with them and to spur the organisation into action. The quality of OM depends on the quality of individual minds constituting OM. The ability to think logically, come up with innovative solutions and anticipate future developments varies from individual to individual. Quality of OM depends on the quality of individual minds and the quality of individual minds depends on the skill and training that individual minds have absorbed. Similarly, just as the mood of minds varies over time, the mood of OM may vary. The Mood is reflected in the confidence and optimism with which OM faces challenges. An enthusiastic and confident OM reflects a positive mood. When OM gets overwhelmed by the problems and adopt a defeatist and pessimistic stance, it reflects a negative mood. Those organisations which have experienced major problems in the past and solved them with strong application of OM and determination are likely to have a better quality and positive mood ‘OM’ than others. Those organisations which replaces senior managers with obsolete knowledge low analytical abilities, low level of confidence and lack of determination by new recruits with desired attributes are likely to have a better quality and greater positive mood ‘OM’ than others. Some organisations may have ‘quality’ individual minds but such minds may not have had the chance of being utilised in the past. Once the orgnisation starts using this potential latent in the organisation, the quality of ‘OM’ improves. When superior quality minds of individuals at various levels come together to solve problems with highly intense activity and positive mood, the OM gets an edge in dealing with crisis on the horizon.

Dynamics of OM

9. Paradigm shifts in business environment can sow the seeds of a crisis threatening the survival of an organisation. When the process of paradigm change begins, very few individuals or organisations recognise this possibility. Thus the intensity of OM may not increase when a paradigm shift begins. But as the threat gradually surfaces and the more active parts of OM tries to agitate the other dormant parts, the intensity of OM may increase if most parts of OM are willing to accept that a threat is on the horizon. These dormant parts (generally the minds of workmen and supervisors but often the minds of a section of senior managers, board members and shareholders), conditioned as they may have been by a long period of stable environment and performance, may refuse to recognise that a danger may be developing. This delays the initiation of a total organisational action/effort beyond senior management action. However, as the signs of impending crisis becomes clearer over time, the intensity of OM increases rapidly. This may not necessarily produce effective organisational action. For the OM mood may turn gloomy/negative. OM may get overwhelmed by the likely adverse impact (loss of jobs) of the fast evolving crisis. There may be lack of confidence in taking action to stage of a fight back. Some parts of OM (members of Board and older employees at junior levels) may blame other parts of OM (senior management) for not initiating action in time or committing mistakes in the past. Again, some other parts of OM (relatively young and new entrants to the organisation) may start thinking of withdrawing from the organisation (looking for jobs elsewhere or resigning). In other words, as the crisis intensifies and the OM intensity level rises, the quality and mood of OM may suffer. This may lead to a failure in mobilising all out action for survival. While senior managers may attempt changes in strategy and work processes, the entire organisation may not be prepared to implement them with speed and efficiency. In some organisations, the OM rises to the occasion with speed : the intensity, the quality and the mood improves as the crisis develops. The dynamics of OM influences the extent of success of an organisation in facing the threats arising from a paradigm shift in operating environment.

10. Since OM pervades the entire organisation (and not limited to the top-level think-tank) and is conditioned by previous experience, influencing the ‘OM’ effectively is not an easy task. How the top management and leadership itself perceives the paradigm shift and how this perception percolates amongst employees, the Board members and the shareholders (and the lenders) determines the extent to which ‘OM ‘ gets attuned to the fight for survival. If the ‘OM’ gets quickly and adequately activated to recognise the paradigm shift as a threat to survival, it becomes easier for ‘OM’ to be willing to take up the fight for survival. As the willingness to fight for survival develops, sacrifices become easier to mobilise. New strategies (including strengthening of the OM quality) and new work processes to meet the challenge of survival become easier to formulate and implement.

The Indian Experiences during Economic Liberalisation

11. Indian economic liberalisation began in 1991. Those Indian organisations who appear to have succeeded in meeting the challenge of the paradigm shift can be distinguished by their success in activating ‘OM’ early and upgrading its quality, besides sustaining a positive Mood. Often this has involved taking the help of competent consultants, recruitment of relevant expertise and fresh blood, retirement of employees (including senior Managers) with rigid mindset or with low potential to work in competitive environment. However, when the majority of the employees or Board members failed to promptly recognise the ‘threat’ (delayed recognition did not help), ‘OM’ could not play an effective role. Even if the leadership recognised the threat early and could formulate appropriate strategy for survival, ‘OM’ could not play an effective role in implementing the strategies as most employees failed to perceive the ‘threat’ or did not develop the confidence to fight the survival war or did not appreciate the changes in work processes and organisation structure sought to be effected. Sometimes, the OM mood became negative as the owners (and creditors) of the organisation were willing to make the sacrifices in time (of the organisation failed, they bear the sacrifices anyway). The overview of the experiences of Indian organisations (both private enterprise and government-owned) presented hereafter covers the period 1992-2002. No individual organisation is named and the overall experiences are described in terms of strong/weak quality ‘OM’, high/low intensity of OM and positive/negative mood of OM.

Response of Private Manufacturing Industry

12. At the beginning of economic reforms, many private sector manufacturing organisations perceived the emerging paradigm shift merely as an opportunity to expand capacity and diversify into new businesses through new group companies. While the new opportunities were easy to understand and generated a positive Mood of OM, the ‘OM’ quality did not help visualise the requirements of the discipline of the emerging competitive markets. The quality of OM was not upgraded by inducting individuals who would have the ability to work out the requirements of market discipline. The impact of the likely pressure on profit margins in a competitive economy that is progressively opening up to freer imports, was not analysed or understood adequately. Risk capital was raised from the market as investors (including institutional investors) initially showed great degree of optimism in India’s economic growth, but the implications of the burden of meeting investors’ expectations in future were not recognised. The “join-the-band wagon” investments made by private manufacturing industry were soon to create an excess capacity situation making new capacities economically unviable and hurting the margins of existing business operations as well. Lenders lost confidence even as many firms set themselves on a programme of severe cost cutting and productivity enhancement. While some organisations greatly benefited from these measures, all these proved ‘too little too late’ for many others. Clearly, the more active components of ‘OM’, namely, the minds of the dominant shareholders (in India they are referred to as promoters), the board and top management did not reflect adequately strong quality ‘OM’ while formulating the expansion/diversification strategies even though OM mood was highly positive to being with. Many of these firms had members on their Boards who were sort of relatives and friends (of promoters), mostly aged, with little idea of the emerging environment of competitive markets. Even as the problems started emerging, these were not attended to by inducting strong quality individuals to strengthen ‘OM’. Many industry houses were family managed business (even if the equity shares were widely held). The quality of minds of many of these owner-managers or their loyal protégé managers were not top class. There was also a reluctance to abandon problem projects or sell them off. As the survival crisis deepend, many family shareholder - managers lost confidence in themselves and lobbied with the Government to halt the progress of trade liberalisation, to get tariff protection/subsidy and to make Government spend more to generate higher demand for the industry’s output. The OM mood became negative. The cost cutting measures introduced under competitive pressures were not always well planned. Changes in work processes to enhance efficiency took time to be implemented as the usually dormant component of OM, namely the minds of supervisors and workmen failed to appreciate the need for the changes sought to be introduced. They interpreted these changes as an attempt to cut jobs/displace labour. Thus, the intensity of OM was not sustained at a high level from an early stage to tune the OM to the needs of the organisations. There were, however, exceptions. Some firms did exhibit OM of strong quality, high intensity and positive mood. Some of them quickly exited from certain existing businesses and even abandoned new projects to consolidate their resources into businesses in which they were capable of holding their fort against competition. They established strong communication channels down the organisational levels to reach the lowest level of workers (and where necessary with labour associations) to speed up changes in work processes and incentive systems.

Government-owned Manufacturing Sector

13. At the time when economic reforms were introduced, major Government-owned manufacturing firms held dominant market shares. This in itself was a factor explaining their low intensity and ‘weak’ quality OM. OM was not strong enough to test the belief of their management that competition cannot easily displace them from their dominant position. Their think-tanks (top management and planners) were used to strategising in an environment in which their funding was largely arranged by the Government, in which the Government depended on them for ensuring adequate supplies to meet demand and maintaining job-security to a large number of people, in which the future ‘demand-supply’ scenarios were those handed down by the Government’s Planning Commission. Their ‘OM’ was clearly not prepared for the paradigm shift in the operating environment. Their boards often included Government officials, retired bureaucrates, lawyers and chartered accountants. Very few of them could have had the ability to anticipate the forces of competition and their impact, let alone suggesting concrete strategies relevant to competitive markets. There was relatively high intensity of OM in many public sector organisations : workshops / seminars/ conferences to review strategy were frequent and even junior level executives got opportunities to participate. The trade unions being strong (as also executives’ associations), there was considerable application of mind in many public sector organisations. Yet, most of these organisations felt that they had considerable time to adjust to the new situation. This reflected a negative mood of complacency. Time, indeed they had. But they did not have the luxury of bidding time for introducing organisational and work process changes to enhance their efficiency. Thus, their responses were slow. Government as the shareholders was also slow. While as part of economic reforms, the Government was committed to reduce its equity stake in most public sector companies through disinvestment / privatisation, this was getting delayed. Many public sector boards and managements took advantage of the slow pace of Government to delay the process of privatisation. They argued that government ownership was not a factor hindering competitiveness of public sector undertakings. They found a natural ally in the trade unions. With little effort to change strategy, structures, systems and work processes, many of these organisations soon started losing on competitiveness in the market. Ultimately, privatisation did start taking place or the organisations had to be liquidated by retiring the workforce in some cases. Clearly, the quality of OM was also ‘weak’. Not that there was a lack of talent but there was very little initiative by top management to utilise such talent or recruit quality minds. The intensity of OM increased with time but led to emergence of a defensive stance amongst employees. The organisational response to paradigm shift in operating environment was not to speed up organisational change but to resist change. Despite a reasonally high level of OM intensity, the OM could not be tuned to the organisational needs. Even after the Government had sold a part of their holdings in the market, the OM was most reluctant to accept the new shareholders as owners. It took quite a while for them to treat the new shareholders with the respect they deserve as part of minimal corporate governance. Very few public sector organisations had a positive mood and strong quality OM that would have enabled them to exploit the opportunity to get freed from the shackles of State officialdom and benefit from the transfer of shares to private sector owners. Rather, with the legacy of doubt about the integrity and competence of potential private sector owners, OM of public sector organisation in many cases focussed on resistance to change.

Financial Sector

14. In the financial sector, the commercial banks were among the first to recognise the problems emerging from the paradigm shift. Some existing private sector banks responded well. New private sector banks also came into existence and targeted high pace of growth. Some did well but some others got into problems. Most of these banks adjusted quickly to the new competitive environment and the new regulatory environment since they had very little or no burden of legacy of pre-reform period. They inducted high quality minds as executives and board members. The OM was generally of higher quality and operated at fairly high intensity. Many individual minds (from Board Members to cash dispensing clerks) in some of the private sector banks participated in the fight for survival. But the dominant public sector banks suffered due to the legacy of non-performing loans. Under State policy, they had long provided finances to risky projects and sick business units in the name of development. Suddenly, these were being classified as non-performing loans. Again, new income-recognition and provisioning requirements adversely affected their profitability and capital base. Notwithstanding their adverse financial condition, fresh deposits continued to flow from the public because of government ownership of these banks. The regulatory environment and the day-to-day interaction in the financial markets led to considerable increase in the OM intensity in public sector banks. The shareholder (the Government) had to arrange for recapitalisation for some of these banks). The quality of OM started improving gradually in response to demand, even though the obligations that Government ownership imposes remained (they continued to engage in certain non-commercial operations). Despite all the obstacles to recovery from non-performing loans under the prevailing legal framework, the banks made some measure of progress in collecting their dues. They also embarked on a programme of technology upgradation and early retirement of surplus manpower. Most of these measures were initially undertaken at the instance of the regulator. Even though these banks had the strongest trade unions, many bankmen had started realising that their skills have become obsolete and were prepared to bargain for better compensation for early exit. Over time, the public sector banks got better quality mind CEOs (new CEOs came from amongst the best talents of other banks experiencing the same fight for survival). The OM quality became progressively stronger in most banks and they are still fighting the war of survival. As some successes occurred, the mood of OM in these banks turned positive. Another advantage the banking sector experienced is the tightening of regulatory supervision by the Central Bank : such supervision is itself a force to make banks’ OM work for survival. The very purpose of regulatory supervision is to minimise chances of failure. However, government ownership still undermined the effectiveness of their fight.

15 The non-banking financial services firms were mostly in the private sector but they were relatively small in size. Most of them failed to survive in the market place. Their OM intensity was generally high. The OM mood was highly positive (enthusiastic to exploit the opportunities of liberalisation). But their owners lacked adequate resources both in terms of risk capital as well as quality of directors (on their Boards) or managers although at the lower levels, they could mobilise highly motivated and hardworking personnel. Only a few non-banking financial services firms did survive because they could gather enough risk capital as well as high quality mind personnel at top Management and Board level.

16. The development banks (DBs) were the worst hit by the paradigm shift in the operating environment. They could clearly work out the implications of (a) the withdrawal of concessional resource inflows assured earlier by the Government, (b) their high intermediation costs relative to commercial banks, (c) the new opportunity for their borrowers with strong financial health to directly access the savings of the households by issuing rated bonds/debentures and equity shares, and (d) the rapidly declining margins on their high-risk project finance asset portfolio. DBs generally had a high quality OM. But they had also inherited strong beliefs and convictions about their role. They did not want to give up their traditional developmental role. They argued that long-term bond markets will take time to develop in India and DBs will continue to have a role to play in funding capital investment in large capital intensive projects especially in the infrastructure sector. So they made efforts at convincing policy makers about the need to continue support to them. As in other developing countries in Asia and elsewhere, Indian DBs suffered from lack of clarity of vision : they wanted to become commercially profitable even while continuing a developmental role in financing such risky projects or socially-oriented projects which no privately-owned commercial lending organisation will fund. In their bid to become commercially viable, the DBs went about diversifying into all sorts of financial services from investment banking, trusteeship, depository, mutual fund, investor registry, and so on. They even set up their commercial banking subsidiaries. All these indicate a positive OM mood. Unfortunatley, they did not anticipate the skill set requirements of the new areas they entered (DBs financed diversified companies with quality management but they themselves never managed diversified businesses in a competitive market place). Some DBs could get rid of a large number of senior and middle-level managers who resisted fast change and could not upgrade their skills for new businesses. Some also raised substantial risk capital to expand the level of operations of diversified businesses. But those which were owned predominantly by Government or Government owned agencies could not progress fast on these lines. Quality of OM became progressively weak with the rising rate of attrition of pro-active strong quality minds (while the rest waited to extract best possible compensation for early retirement).. The OM mood slowly turned negative.

Services Sector

17. The services sector was the fastest growing part of the Indian economy in the last 15 years or so. Economic liberalisation gave a fillip to this sector. This sector was largely in the private sector and somehow escaped the burden of the complex web of State controls (which for over four decades focussed mainly on industry). Many of the firms in the services sector (including entertainment and information technology services) were relatively small and highly motivated to compete in the market place (unlike this, many small firms in the industry sector failed as they were patronised by the Government through reservation of capacity, fiscal concessions and subsidies). By their very nature, services firms had to survive on the basis of strong quality OM and high intensity OM. Creativity and flexibility across the various levels in these firms were high because they were set up to fight for their share in the market place. The relatively bigger firms in the services sector remained in business if they had been able to arrange for adequate risk capital injection and induct high quality minds at various levels in the organisation. They trained people at front office, middle office and back office in a manner that the intensity of OM remained high. That some of the employees knew that they had limited tenure contracts all the more helped keep the OM intensity level high and quality of OM strong. The employees recognised that their future prospects did not lie on the survival of the company but on their experience of participating in the survival war these organisations were fighting in the competitive market. Not that all organisations survived. For example, in the civil aviation industry, which was the monopoly of a single Government-owned organisation till economic reforms in the 1990s, only two out of the many new entrants survived. Even these two survived because the Government-owned airlines could not protect its turf as the hitherto state monopoly could not keep strong quality minds highly active on a sustained basis. However, not all private services firm succeeded. Their failure was due to inadequate risk capital in comparison with their requirements. They tried to grow fast even before establishing themselves in their small-scale. Initially, they had recruited strong quality minds but later they could not retain them because of inadequate risk capital.

Conclusions and Lesson for the Future

18. The analysis of the experience of Indian organisation’s response to paradigm shift in operating environment shows that

(a) Organisations which had highly intense OMs and could sustain strong quality, positive mood OMs, succeeded in putting up more effective response. Others failed because of weak quality and low intense OMs or negative mood OMs. New organisation did not suffer from legacy-based burdens on OMs. But new organisation entering financial services business area requiring large-scale diversified operations failed since they had limited risk capital and unable to put together sufficiently large number of strong quality individual minds.

(b) Long period of virtually monopoly or State protection, affected the quality of OM on the public sector. Many public sector organisations had strong and high intensity OMs, but Government-ownership imposed hurdles to effectiveness of OM.

(c) In the private sector, those who could not quickly exist from diversified operations to consolidate their OM resources into focussed areas of business failed as they entered into negative OM phase. The successful private companies benefited from early initiatives in raising the intensity of OM, strengthening of the quality of OM by induction of strong quality mind individuals and retirement of ‘weak’ quality mind senior managers. Their leadership concentrated on sustaining a positive mood OM.

19. In future, Indian organisations will be facing new challenges as global competition impact the Indian market place. In preparing their OM the conclusion of this impressionistic study may be helpful. However, case study research on OM based on the 1990s experience are likely to provide greater insights. Moreover, psychometric tests specifically designed to measure and monitor the three properties of OM, (intensity, mood and quality) at regular intervals will be helpful to the leadership.
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[1] Ian I. Mitroff - ‘Stakeholders of the Organisation Mind : Towards a New View of Organisational Policy Making’

[2] Whitehead A N - Collective Mind - Cambridge History of Pholosophy

Dr. Basudeb Sen is Chairman & Managing Director,
Industrial Investment Bank of India Ltd., Kolkata

Development Finance Lessons (2003)

2009-07-31T11:04:00.005-07:00

LESSONS OF INDUSTRIAL DEVELOPMENT BANKING EXPERIMENT IN INDIA

Dr. Basudeb Sen@

[This article appeared in Arthbeekshan, Vol12, N0.2 Sept,2003, Kolkata ]

India has more than 50 years of experience in development banking. The

Indian development banks (DBs) made significant contribution to support the

planned economic development efforts of the Indian Government (State). Most

Indian DBs, however, are sick and facing the prospect of extinction. In this paper

an attempt has been made to identify the lessons from the experiment of

DBs India in the context of the concept of development banking as it emerged

internationally.

An International Perspective

2. As the Industrial Revolution progressed in the United Kingdom and spread to

other countries, the utilisation of new technology for meeting human economic

wants generated a large demand for long-term capital. The expansion of

international trade and the emergence of trading companies had also led to the

demand for long-term capital. Long-term finance for investment in both machine-

embodied new technology and international trade was associated with high risk,

but offered possibilities of high return (possibilities of loss as well). In the

beginning, those who took the initiative to arrange finance for these ventures

were not all very well known and included fly-by-night operators? Despite all this,

savings of individuals, particularly from wealthier classes, flowed into this high-

risk ventures. Those who had taken the initiative of mobilising and channelising

long-term savings to high-risk ventures were in a sense “a kind of industrial

banks”. With the passage of time, as Industrial Revolution and international trade

@Dr. Basudeb Sen is a Management Professional & Business Economist

gathered momentum, mobilising long-term savings from households and channeling them into high-risk ventures had become a specialised activity. This had led to the emergence of investment and merchant bankers in the second half of nineteenth century. These investment bankers had started underwriting and distributing financial securities issued by companies to meet their long-term capital needs. This, in turn, led to the development of the capital market (in contrast to the loan market, which was essentially short-term finance extended by commercial banks).

3. The capital market facilitated the flow of long-term savings of individuals into high-risk ventures in industry, transport (e.g. railways) and international trade. Everything had been going on fine with the capital market until the US stock market crashed in 1929 - a year marking the onset of a deep economic depression affecting many regions across the World in the 1930s. Subsequently, the devastation caused by the Second World War had also to be faced. These adverse developments led to two major economic policy responses from the societies/nations. First, the great fury among the investing classes affected by the stock market crash had to be pacified by inquiries / investigations and then extensive capital market reforms. In the US, many regulatory changes were made in regard to the stock market practices, involvement of investment bankers in fund raising and the relationship between commercial banks and investment banks. The regulation on investment trusts and investment companies was strengthened. Over the years, the regulatory reforms helped the growth of the capital market as well as expansion in the role of investment/merchant bankers in facilitating flow of household and institutional savings into industry and trade to meet their long-term finance needs.

4. The second response was the rise of international economic cooperation and the theory of development economics. In the area of international trade and payments, the IMF, the UNCTAD and subsequently GATT were to contribute towards the emergence of a new international economic order. Equally significant was the establishment of the International Bank for Reconstruction Development (World Bank) as a major initiative by the governments of a large number of countries to deal with the problem of reconstruction of war-ravaged economies as well as the development of the backward economies. The emphasis was on multilateral as well as bilateral aid for economic reconstruction and development. Even as the influence of development economics grew, most of the developed world’s financial sector continued to depend largely on the market-mechanism for efficiency and growth. In some developed countries, new institutions were created to facilitate housing mortgage financing. But the first set of development banks came into existence in the less-developed/ developing world in Mexico, Chile and Venezuela during the Great Depression. The proliferation of development banks in developing countries was a post-World War II phenomenon.

5. Development Banks were only a small part of the concept of State-led and State controlled developmental planning and implementation. All projects taken at the initiative and funded (often with the help of bilateral/multilateral economic aid) by the State was the major part of development planning and finance. In some countries, commercial/cooperative banks were allocated certain responsibilities to reach out and fund small, private-sector enterprises, especially those set up by entrepreneurs of small means in rural areas. Development Banks (DBs), mostly owned by the State, were to facilitate flow of funds to private- sector projects of large size. The DBs were generally sectoral in nature: separate DBs were set up for industries, for agriculture, for area development, for transport, for small-scale industries, for rehabilitation of sick units, and for infrastructure. In many cases, the central banks of the countries were involved in the setting up of DBs. The logic of development economics was that the growth of capital-scarce economies needed strong State-intervention to facilitate financing of high-risk projects by private entrepreneurs (with long pay-back periods). The theory assumed that although such projects would not be financed on a commercial basis they could contribute significantly to the transformation of the national economies. The long-term finance for large and capital-intensive projects with high-risk and uncertain return could not be met by commercial banks on the basis of the relatively short-term liabilities they created. Nor would the investment banks be able to mobilize sufficient amount of long-term savings of the household sector in poor countries for the purpose of financing large industrial projects. It was assumed that capital markets could not be developed easily in these countries especially because fly-by-night operators could shake the confidence of the investors and the public. Therefore, the State had to set up DBs to act as lenders of last resort to the private sector undertaking high-risk projects likely to have a major favourable impact on the economy and the society. The DBs would select projects for financing on the basis of economic and social, rather than pure commercial, attractiveness of projects. The OECD prescribed an appraisal manual and the UNIDO a set of guidelines on economic appraisal. The concepts of the Social Cost Benefit Analysis, Economic Rate of return and Domestic Resource Cost were introduced as part of applied welfare economics and development economics.

6. Most of the DBs were created with special charters approved by legislative action. They were completely controlled and regulated by the Government (various Ministries, mostly Ministry of Finance). The Government departments and agencies decided every aspect of the operation of DBs. They set the parameters of appraisal. The approved the procedures to be followed, the schemes for financing, the eligibility criteria for projects and the ceiling on amounts that can be lent. They indicated industries that can be considered for financing and the preferred project locations. They decided the amount of resource inflows to the DBs and the interest rates at which DBs could borrow and lend. In the initial phase, DBs financed projects by extending long-term loans. Their resources came mainly from Government’s budget allocations and bilateral/multilateral aid/credit lines to Governments.
Emergence of DB Network for Indian Industry
7. Soon after India gained Independence, the Industrial Finance Corporation of India (IFCI) was set up as a wholly Govt. of India owned agency. It is the first DB for India's industrial sector. Subsequently, a large number of DBs were set up. Industrial Credit and Investment Corporation (ICICI) was set up with the participation of international agencies as a private sector DB even as India introduced national economic planning. In different parts of the country, the State Financial Corporations (SFCs) and State Industrial Development Corporations (SIDCs) were set up to promote industries through financial assistance. All these were in the public sector. In 1964, Industrial Development Bank of India (IDBI) was set up in the public sector as the Apex Development Bank. Small Industries Development Bank of India (SIDBI) was set up by IDBI. These were all in the industrial sector. Many DBs were set up for other sectors as well. To mention a few of them are Agriculture Refinance Corporation, National Bank for Agriculture and Rural Development (NABARD), Power Finance Corporation, National Housing Bank, Housing and Urban Development Corporation, Shipping Credit and Investment Corporation of India. However, it is the industrial sector that had the largest number of DBs and they together formed an integrated network of infrastructure for financing industrial development through private and joint sector. The nationalisation of banks in 1969 and linking them to development banking considerably enhanced the financing strength of the DB network. Till the late 1980s the glory of development banking continued. However, during the 1990s the development banks started crumbling. Most DBs could no longer hide their inherently weak financial foundations. Being the public sector they are still in operation, awaiting formal liquidation or in the process of exiting from development banking business. For an analysis of this great fall of development banking, it may be helpful to keep in mind the changes in the economic environment during the last two decades of the last century.

8. By the 1980s, while many developing countries had started facing external debt servicing crisis, many DBs had started showing weakening of financial position. The DBs’ loan portfolio exposure was mainly to high-risk projects prone to suffer time and cost overrun and sucking in additional finance from DBs. The national governments were finding it difficult to support the DBs through increased fund allocation from their budgets. The bilateral and multilateral agencies providing aid to support the DBs were concerned about the financial sustainability of DBs.

9. At the same time, the capital (rather, the financial) markets were rapidly changing. The investment banks and even commercial banks started expanding their roles and introduced new concepts of financial engineering, derivatives and structured finance. This environmental pressure and the weakening financial position put pressure on DBs to modernise their roles. DBs started entering the fields of investment banking, restructuring finances, consultancy and advisory services, besides supporting programmes for development of capital market, new entrepreneurs and environmental protection. With expanded role, DBs acquired a new name as Development Finance Institutions (DFIs). As a paradigm shift in the financial market environment occurred in the late 1980s and the 1990s, the nature of the financial markets in many State-controlled countries changed. In response to the rapid spread of market-mechanism and progressing globalisation, the DFIs/DBs now had to re-establish their relevance in the modern financial markets. The withdrawal/decline in subsidised funding of DFIs by Governments facing severe resource constraints forced the DFIs to raise substantial amount of funds directly from the household sector and institutional investors. But inherently weak balance sheets (financial soundness and profitability) made it difficult for many DFIs to raise funds in the financial markets without the support of sovereign guarantees. The DFIs had also to search for solutions to the past legacy exposure to high-risk projects. The new regulatory regime for financial markets categorised many development loan exposures of DFIs as non-performing assets requiring de-recognition of accrued income not received and higher provisioning against assets suspected to have suffered impairment. That these loan exposures had to be taken as part of economic development measures did not carry any special significance to the modern financial market operation and regulatory environment.

10. The DFIs started looking for quick solutions for upgrading their skills, systems and infrastructure to enhance their competitiveness vis-à-vis the investment banks and commercial banks. Many DFIs are still in the search for viable business models having a balance between both developmental and commercial roles. Such a viable business model by DFIs that would sharply distinguish their role from those of commercial/ investment/universal banks in the competitive market place is not-yet in sight. The search so far has been illusive. True, at times when financial markets face systemic problems and private investments remain sluggish for long, political pressures develop to provide sops to DFIs so that they may, as part of State policy, be able to take up the role of reviving investment activity for limited. But that would give DFIs to retain the traditional development role only for short periods depending on the economic/business cycles. But for survival, DFIs have to depend on the basic principles of commercial operation. Such commercial orientation needs a clear focus on strong balance sheet and profitability. It also requires facing competition with other players in the financial market. It is impossible to accommodate past developmental role with losses from high-risk exposures in the modern financial markets. The DFIs/ DBs cannot focus on cleansing their Balance Sheet off doubtful and other non-performing assets inherited from the past developmental banking era and simultaneously pick up potential NPA exposures while acting as instruments of State policy.
Survival Threat to Indian DBs
11. The Indian DFIS / DBs had to face the survival test ultimately in the 1990s when the economic environment drastically changed and the development banking model became incongruous with the new environment. For long, Indian DBs operated in a protected environment that ensured their survival and growth. First, there was no dearth of resource flows to DBs. They could raise as much finance as the Government allowed them every year by issuing Govt. guaranteed bonds to principally commercial banks, provident funds and other public sector institutions (as these bonds were eligible investments for maintaining Statutory Liquidity for banks and treated as safe investments). They were also allowed to issue bonds to retail investors who considered the public sector DBs as more or less part of Govt. and hence safe. As the Govt. started withdrawing the facility of providing Govt. guarantee, DBs had to issue bonds rated by external credit rating agencies who would soon start closely examining the real worth of the DBs’ asset portfolio and the balance between their future cash inflows and outflows. With many of the loans stuck in projects which faced cost and time overrun and many of the borrowers enjoying rehabilitation finance, it was almost impossible for the DBs to maintain for long a credible ‘triple A’ credit rating to enthuse investors to lend money to the DBs. A resource problem was bound to arise and would affect the DBs’ growth. Second, earlier with higher and higher volumes of business, it was possible to make higher profits even if the and then started defaulting in meeting its obligations from 2000. The government offered repeated bailouts to keep it going. ICICI avoided a credit-rating downgrade first by raising substantial equity from international investors and then turning itself into a fast growing margins were fixed. But with the withdrawal of automatic facility to raise resource, the DBs had to look for better margins. But higher margins were not available in a competitive market except when on lends to highly risky borrowers. The better companies had much better balance sheets than the DBs and therefore could raise resources from the market at effective costs lower than the interest rates at which DBs could raise in the market. DBs virtually lost this segment of the credit market. The earlier regime of Govt. determined interest margin on lending and borrowing yielded to an era of uncertain margins but declining margins. This implied a viability issue. Third, the DBs were now required to be very aggressive in recovering the loans from defaulting borrowers. But the defaults increased as the most Indian companies setup under the State-controlled, protective regime found themselves as cost-inefficient producers in the face of both domestic and foreign competition. Their ability to repay loans was seriously affected. Legal action for recovery yielded hardly any significant results. The relevant laws for smooth recovery of dues from defaulting borrowers were never enacted. Rather, statutory institution like Board for Industrial Reconstruction had been set up whose basic purpose was to delay any recovery effort by lenders so that a borrowing company could survive even if it’s operation had not been viable and it had been making losses. Half-hearted legislative measures to help speedy recovery were made in the late 1990s and naturally made little difference to the ground reality. Therefore, the effective scope for improving the finances of DBs through recovery remained marginal.
12. Given all these, the DBs would soon enter a vicious circle of decline and financial weakness. Their balance sheets were not strong enough to raise low cost resources. They could not expand. With high cost of funds, they could not compete in lending business in the market. With high NPAs and growing defaults from borrowers inheriting non-competitive, non-viable businesses from the era of State-controlled economic regime, This regime determined, on completely administrative basis, the location of factories as well as the prices, capacities, production, movement and distribution of most goods. As the State-controlled regime failed and the economy started imbibing competition as a mechanism to derive efficiency, the failure of non-viable businesses could not be hidden any longer in the 1990s by such ad-hoc, unsustainable mechanisms as rehabilitation financing and revival financing (though use of the concept of debt restructuring continues, it will not be able to hide non-viable business units for long). Once the State-controlled regime failed to sustain under the pressure of its own inconsistencies, the associated mechanisms like development banking would naturally crumble. The state-controlled regime had to ground to a halt once it had
succeeded in lifting the Indian economy to great heights of low productivity, cost inefficient scales and technology of production, alarmingly high fiscal deficit and domestic debt, and a huge balance of payment crisis. As the regime started crumbling, so did its supporting components like development banking. Essentially the economic regime and its components were unsustainable.

13. IFCI saw its credit rating being downgraded commercial bank to absorb the shocks of losses from its development banking legacy assets. Many SFCs and SIDCs are virtually bankrupt. IDBI has already received extensive bailouts by Govt. and does not show any prospect of sustainable operations without further bailouts and subsidies. Yet, in some quarters, the thought persists that development banking may still get a fresh lease of life. Some believes that DBs can evolve new mechanism for participating in a limited way in the developmental role of the State for short periods in the larger interest of the society. Such mechanisms, however, is unlikely to allow them to take high-risk exposures on their books. They can only lend services of appraisal and monitoring. They could also attempt timely foreclosures to attract wealthy investors with high-risk appetite through special purpose vehicles outside their balance sheet. But it is unlikely that any entity in the modern, competitive financial market can hope to survive by doing business of lending to commercially non-viable and high-risk projects, however socially desirable such projects might be. A development bank cannot compete with commercial finance organizations in the business segment of viable and low risk projects. It cannot remain viable if it lends to non-viable and high-risk projects without the Government agreeing to pick up the losses of development banking. Unfortunately, the capacity of the Governments to provide such subsidies is virtually zero now and is unlikely to improve in the next decade. And, if Government has the ability to subsidise, it may use such funds to directly finance industrial ventures. The need for development banks arose only in the State-controlled economic regime as one among many supporting devices to hide the real costs that such a regime inflicted on the economy.
Lessons of DB Experiment
14. A few hard lessons can be derived from the Indian experiment of development banking in India. The first major lesson is that development banking was an integral institutional component of the State-led, -dictated and –controlled, developmental planning economic regime in India. In terms of it’s the objectives, goals, priorities and processes as well as the achievements - both successes and failures, developmental banking was completely linked with and virtually depended on the economic regime. To the extent the economic regime was successful –and for such period it had been successful, development banking was successful. Similarly, to the extent the economic regime was faulty and failed to deliver, development banking was faulty and failed to deliver. Development banking could not have been more successful than the State-controlled economic planning regime, its failure are the reflection of the failures of the economic regime. It would not be meaningful to say that development banking contributed towards so many new industrial projects and associated investment, income and employment generation. For all these were the results principally of the industrial policy, priority and licensing Raj. Similarly, it would not be meaningful to assign the responsibility of the failed projects, the cost and time overrun of projects, the high cost and the inefficient technology/scale of the projects to developmental banking. All these were again the result of industrial policy, the Licensing Raj and the numerous state controls on land acquisition, utility connections, production, distribution, international trade, prices etc. Development banks constituted merely a conduit to ensure the flow of financial resources to projects in accordance with the economic plans, policies and priorities of the State. Therefore, as the economic regime faced the survival crisis and had no alternative but to begin giving up its controls, the bankruptcy of development banking became transparent and the development banks lost their relevance. As the economic regime of the past failed to sustain under its own dead weight and the process of structural reforms and liberalisation started in the1990s, modern financial markets began developing. Development banks’ monopoly over long-term financial intermediary business was lost. And, by the very nature of their objective, structure and operations, the development banks could no way compete in this business. Essentially, non-market entities cannot be expected to exist in the market place. Unfortunately, this truth was not realised and appreciated fully as the economic reforms began in the 1990s and appropriate actions to deal with irrelevant institutions were not taken. The cost of carrying non-market entities in the emerging market-mechanism environment had therefore to be borne by the society.
15. The second lesson of development banking in India is that the network of development banking institutions was inefficient even in terms of the logic of development banking as an integral institutional component of the past planned and controlled economic regime. For the industrial sector there was no need to set up development banks in the first place. The Industrial Development Ministry could have had an Industrial Project Finance Department with offices in different State capitals to finance private sector projects with budgetary allocations with usual Planning Commission inputs. In any case, the amount of finance for public sector projects arranged by Government of India’s various departments was of much higher than what the development banks handled for private sector industrial projects. The creation of an additional layer was clearly avoidable and desirable. The appraisal, monitoring and co-ordinations skills were already available within the Govt. Even if the Govt. had, on an ad-hoc basis, decided in favour of public sector development banking, it could have set up just one industrial development bank. It could have set up one National Industrial Development Bank with all the Governments at the center and the federal states as equity partners. In any case the three all-India development banks (IDBI, IFCI and ICICI) had a consortium sharing formula of 2:1:1 for most projects, IFCI was a subsidiary of IDBI and state-owned/sponsored agencies like insurance companies and UTI had a significant shareholding in ICICI. The rationale of multiple DBs is indeed weak. It does appear that the network of DBs had evolved through ad-hoc decisions at different points of time rather than based on any exercise in optimisation of institutional network design. This basic deficiency in the design of development banking infrastructure not only implied additional costs of development banking function, but also created difficulty in dealing with the future of a large number of development banks that lost their relevance in the post-reforms period.
15. A third lesson of the development banking experiment is that development banks in the public sector exhibited strong resistance to exploit the opportunities of transforming them into most competitive entities in the emerging financial services market environment. While they had all the strengths to exploit the new opportunities, they suffered from organisational myopia and resistance to change. Before the structural reforms started and in the very beginning of the reforms process, some of the development banks took a number of initiatives to set up modern institutions relevant for the emerging financial markets. They set up credit rating agencies, capital market trading outfits, mutual funds, and commercial banks, modern stock exchanges (OTCEI and NSE). They entered investment banking business and even thought of going into insurance sector. At the beginning of 1990s, they were therefore in the most advantageous situation to exploit their strengths and capabilities to transform their own organisations into most vibrant financial market entities of the future. But within a decade they became sick requiring costly bailout. They failed to plan an orderly exit from the unsustainable and dying development-banking business of the past. Nor did they try to contain the adverse impact of the past development banking portfolios on their future financial strength. Rather, they continued their emphasis on development financing activities that would further erode their financial strength. They continued to do what they did in the past with vigour, ignoring the potential of the new businesses that they spun-off into new subsidiary organisations. Only ICICI though belatedly, understood the writing on the wall and successfully transformed into a universal banking organisation and rapidly exited out of DB businesses. Since ICICI was the only private sector organisation, they could do this with little resistance and with missionary zeal and induction of relevant skills. But public sector entities like IDBI, IFCI, SIDBI, Exim Bank, most SFCs and SIDCs could not because of strong internal resistance as well as lack of support from their major shareholders. It seems development-banking mentality by its very nature obstructs development and not tuned to learning lessons from its own experience.

Future of Indian Fiancial Markets (2002)

2009-07-31T11:04:00.003-07:00

A Financial Sector with Competitive Markets

Dr. Basudeb Sen*
[published in VYAPAR Annual Number, November 2002,Mumbai]

The Tenth Five- year Plan is ready and reflects India’s Future Economic Strategy. It is not clear whether this Strategy seeks to throw off the legacy theories, structures, systems and procedures of the obsolete developmental planning era. The willingness to make a transition to a market economy structure was conspicuous by its absence ever since 1991 when the economic reforms began. The faith and sectional vested interest in the theory of State-led Developmental Planning Economics continue. Does this help enhance India’s ability to achieve and sustain an economic growth rate of 8%, eradicate poverty and create annually fresh productive employment of 10 million? Does fixing a set of such target objectives an act of planning after 10 years of structural reforms or continuance of a ritual practiced since 1951? Given the performance record during 1951-91 and 1991-2002, can we continue to believe that State initiated and directed planning can significantly enhance the economy’s ability to face future economic challenges, grow to its full potential and substantially improve India’s relative economic strength in the international economy? Is the 10th Plan Strategy based on economic theories followed in the past and on continuation of structural reforms as in the past to generate growth impulses and remove built-in systemic inefficiencies? Answer to these questions and actions based on them will determine India’s economic destiny irrespective of whether the 10th Five Year Plan targets are achieved or not.

Financial Sector, 1991-2002

2. If the answer to all the four questions above is YES, the future of financial sector will merely be an extrapolation of the past trends. Since 1991, there have been considerable changes in the real sector as well as the financial sector thanks to economic reform initiatives. But the results in terms of efficiency-gain-induced economic growth, vibrancy and expansion of productive potential has not been encouraging, though the performance has been better than the achievements of the first three/four decades of Indian economic planning. In the financial sector, controls on interest rates and issuance of securities have been mostly withdrawn. Financial repression has been lowered, entry of new financial services firms allowed, greater competition developed, many new financial products and services introduced. Except for the restriction on investing abroad by ordinary Indian citizen, India has moved fast towards capital account convertibility and a freer foreign exchange market. Along with dramatic step up in the use of information and telecom technology, greater transparency, better regulation, lower transaction costs and higher service standards have been achieved by the financial sector. There has been a significant increase in the volume of trading activity in secondary market for equity shares (Stock exchanges
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are now the most modern and safe) as also in the secondary market for Govt. securities. Banking services has vastly improved with competition, though the public sector financial institutions and banks continue to suffer heavily on account of the legacy non-performing assets (NPAs) acquired in the past from sectors that were under State intervention. True, some banks had problems but re-capitalization has solved such problems. Appropriate bailouts have been or are being arranged for some major institutions that face serious crises.

Inadequacy of Reforms

3. All the above developments in the financial sector create a feeling of great achievement: so much has been done in a decade of reforms. Reality is that the conditions still do not encourage efficient, competitive and vibrant financial markets to develop. India’s faith in the super-human capability of State machinery and the fear of free markets are still strong. Vested interest sections have been agile enough to ensure that freer real sector and financial markets do not develop fast to weed out parasites like them. The structural reform process has already run a decade and with so many things yet to be reformed, the process can be easily extended for another decade. The new `business’ of controlling economic reforms (i.e. debating, analyzing, decomposing into components, planning, prioritizing, phasing, stalling, reviving, designing and reviewing economic reform measures) has replaced the four-decade old, expanding business of exercising and designing economic controls.

4. One may cite only a few examples of the delays, inadequacies and ill-designed reforms. In the real sector, the State (both central and state levels) continues to run businesses directly and through undertakings in many areas, which have nothing to do with national security and defense. The infrastructure sectors like power, transport and telecom suffered from delayed reforms as well as ill-designed reform measures. Value-added taxation is still not on ground. In the financial sector, key interest rates like those on the banks’ savings bank account, provident funds, postal savings continue to be arbitrarily fixed. Secondary markets for debt instruments other than Gilt-edge securities are yet to develop after a decade of reforms. Integration of different financial markets is even now expected to take place gradually. Reforms in insurance sector started only recently and pension fund reforms are delayed. Restructuring of development financial institutions is yet to begin. Govt. still continues to dominate ownership of practically all major and many small financial sector entities and banks. The mutual funds reflect a weak industry structure with most firms below economic size. The share of mutual funds in the household savings in financial assets remains very low after a decade of trial and error process of regulatory evolution. Restructuring of UTI has remained pending since 1993. The setting up of laws and companies to deal with non-performing financial assets have received some attention only very recently.
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The debt recovery tribunals have made little progress until recently and lack infrastructure to be effective and prompt. Number of sick companies with BIFR
continues to be large. Legal reforms in this area of dealing with borrower defaults, as in many other areas, have been delayed or proved inadequate. Given all this, it is hardly surprising that the country does not have active and efficient financial asset markets. Till such markets develop to allow the forces of market demand and supply generate market-clearing prices in respect of each and every major financial asset, the financial sector can be neither efficient nor effective in providing support to economic growth.

Cost of Inadequacy of Reforms

5. Economic reforms aimed at using market mechanism were expected to yield considerable economic growth-enhancing benefits at small short-term cost to certain sections. Inadequacy of reforms reduced the benefits and increased the costs. The costs that delayed, improperly designed and arbitrarily phased reforms inflicted on the economy may be indicated here. First, delays have adversely impacted investment decisions of companies and entrepreneurs. This implies loss of opportunity for generation of fresh financial assets as reflected in the decline in amounts raised in the primary market in the last six/seven years. Second, the possibility of delay and improper reforms have led to increased uncertainty over the future of certain investments already made. This meant a lowering of the risk-adjusted return on existing investments. The investors have suffered. One can look at what happened in stock prices of PSU (divestment of Govt. shareholding in public sector undertakings) and telecom sector. The stop-go halting process, arbitrary phasing and ambiguities have lowered the market valuation of PSU shares, increased their share price volatility and caused greater uncertainty of returns on investment in these sectors. The investor interest has been hurt. Again, continuation of inefficient units and hurdles in the way of restructuring/mergers and acquisition implied irrecoverable costs to the economy. Delays have resulted in permanent erosion of viability of units that could have survived through restructuring packages in time.

6. Third, the potential resource reallocation benefits had to be foregone. Continuation of non-market mechanism of price and output determination in many industries/sectors not only affected the efficiency of these but also other sectors/industries where market mechanism had been allowed. Simultaneously operating market mechanism across most real and financial markets can only contribute to efficiency/growth enhancement. Phased introduction of market mechanism is not necessarily better than its non-introduction: counting the number of sectors where markets have been allowed can not indicate progress of reforms. The longer it takes to debate misleading concepts like first/ second generation or soft/ hard -------------------------------------------------------------------------------------------------------

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reforms, to arrange political consensus and to allow adjustment, the greater is the cost
to the economy in terms of non-realization, delayed realization and partial realization of efficiency gains from reforms in both the real and financial sectors. One has to complete reforms to allow operation of free markets for most goods and services within a short time to be effective and to reduce the cost of the reform process. The choice is only between complete reforms and no reforms (phasing of reforms over a long period of time is no reform). Ten years already used up by reform process is inordinately long. The issue is not about when to reform which area/sector for allowing market mechanism to come into play. The issue is one of imparting to the economy the highest possible market orientation within the shortest possible time and managing the short-term pains that reforms aimed at using market mechanism may cause to the poor people displaced from work: they only need to be helped by the State.

Towards A Strategy Repeat

7. India is likely to continue to be fearful of competitive market mechanism with vested interest sections alert in sabotaging attempts at quick and complete transition to market economy. Therefore, the economic strategy of the 10th or 11th Plan cannot but be essentially a copy of the 8th / 9th Plan with certain changes in facts, targets and projections with some new languages and programs to emphasize infrastructure, exports, savings, investment, employment etc. The strategy will be to continue reforms in the same way as in the past with the State machinery busy debating, analyzing and designing various components of structural (?) and other reforms. It will be ensured that the some key parts of the real sector and the financial sector do not allow free play of market forces and remain under State control so that the overall integration of the real and financial market remains low. If the markets remain non-integrated because of the State-imposed barriers to free play of demand and supply forces, the financial sector cannot function effectively. And, that will demand strong measures by the State to control the financial sector. The financial sector strategy will necessarily have to involve revival and maintenance of development orientation among financial institutions and public sector banks, even as they take new nomenclature of universal banks. The network of such (Central/ State Govt. owned/controlled) agencies will need to be financially strengthened so that they can support fund flow to accelerate growth. They will have to be more accountable and transparent to the Govt. They will have to improve customer service. Their productivity must improve. New financial products and services including sophisticated derivatives will have to be introduced. More stringent regulations will be introduced (if necessary, new regulators to be put in place). Latest technology, appropriate risk management, stricter corporate governance and audit will have to be introduced. All this will have to be accomplished at the initiative of the State.

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8.Yes, all this sounds very familiar. This is history repeating every five years in India. Of course, the results that will be achieved in future will also closely resemble what
India has achieved in the past. There will be continuation of distorted price structure
that will have very little relation to relative scarcity and relative costs. India will remain a high cost economy with misallocation of resources, non-competitive exports, non-viable capacities in State-directed/- preferred projects, non-performing assets, long-drawn legal process to recover dues from defaulters, and so on. Why does history repeats itself? Because of the operation of a vicious cycle as described below: (1) since India is scared of competitive market mechanism, she is not able or willing to muster courage to make a speedy transition through reforms to a competitive market economy, (2) the vested interest sections take advantage of this scare to subvert any attempt to move toward market economy (this scare-mongering is facilitated when market economies elsewhere faces problem of low growth and scams due to economic crimes), (3) India sticks to the incoherent, incomplete theory of State-controlled developmental planning, (4) since developmental planning is not founded on any logically consistent theory or principles and has not been able to develop empirically-tested non-market mechanisms that can ensure economic efficiency and growth, developmental planning fails to deliver the desired results, (5) this leads to periods of introducing reforms to allow competitive market mechanism to operate, (6) but such reform effort is half-hearted because of (1). And, the vicious cycle goes on.

9.The economic theory of competitive market mechanism is extensively researched. All its shortcomings and weaknesses are well known. Theoretical, empirical and experimental research is continuously coming up with improved market mechanisms and non-market tools of State intervention to deal with such weaknesses and shortcomings as absence of rational choice, imperfect competition, externalities and incomplete markets. However, the developmental planning theory lacks a coherent logical framework and has not been able to prescribe solutions to deal with its own weaknesses and failings. So, whenever India gets into severe crisis in managing the economy with its development planning theory of economics, she plays for a while with market mechanism based economic theory only to revert back to developmental planning addiction as soon as the crisis appears to be over. Unable to develop consistent economic principles of her own, India has borrowed economic theories developed outside and preferred to adopt those that are incoherent but appear socialistic. As this dependence or addiction is likely to continue, Indians will have to bear the risk and pay the price for choosing an inferior economy structure and economy management policies based on incoherent economic theories. These theories are developed by disparate contributors including the international agencies whose primary business was one of expanding, developmental lending/financial support to State-initiated and directed economic development. Interestingly, most Indians believe these to be India’s own economic development theories. In the last decade, India has created further inconsistencies in the economy structure and economic dynamics by trying to implement economic policies based on ad-hoc combination of market
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economics and development planning economics. The Indian financial sector naturally reflects these inconsistencies.

The Alternative Strategy

10. While it seems most unlikely, lets consider a perspective where India really muster the courage and honesty to plunge into the sea of market mechanism undistorted by State control and interference. Then, she may decide to achieve the following within the next two/three or maximum five years:
(a) Avoid all costs of delayed, phased and improperly designed reforms in future,
(b) Complete all reforms so that Govt. does not directly or indirectly set prices (and any interest rate) or outputs for any good and services,
(c) Fully remove Govt. out of all commercial businesses activities and close the business of economic reforms,
(d) phase out the concept of sector-wise and industry-wise ministries/ departments for energy/ power, transport, industry, industrial development, chemicals, fertilizers, IT, telecom, coal, and
(e) Abandon Five-year Economic Planning.

Under this scenario, free-market competition with transparent and unambiguous regulation and simple laws will be the driver of economic growth and social justice. If India happens to adopt this, State-directed economic planning will give way to macro-economic management, public sector character will yield place to character of efficiency and loss-generating units will yield place to vibrant viable units. The certainty of State planning failures will yield place to success and failures of citizens’ enterprise. The owners of obsolete knowledge, facilities and skills will yield place to the relevant and competent. Independent regulators will take care of economic offences, monopolies and disputes among economic agents/ players in the market. The State will restrict itself only to macro-economic management. The past experience with tools of State controls by fiat will not help and act as a constraint. To manage public finance, fiscal balance and fluctuations in aggregate demand, employment rate, exchange rate, inflation and balance of payments in a dynamic competitive market environment, Government economic administration will acquire new skills. If the State does not like certain outcome/results of the competitive market mechanism, it can use budgetary/fiscal policies to achieve adjustments in resource allocation and income distribution, besides countering output and price fluctuations. However, the State will be accountable for any adverse/perverse effect of its budgetary/fiscal policies, as the market will be free to react to such policies.

11. Under this scenario, the financial sector will have a chance to evolve into efficient markets for financial assets, products and services. The flow of funds and the transformation of savings into investment will be determined by market forces and not
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by the directives of the State to market participants. Of course, the State can use its
Budgets to directly channel resources to reduce unemployment, to provide subsidies to the poor, to purchase goods/services in the market and to facilitate international, regional and bilateral economic cooperation as part of macro-economic management and public finance programs. Large capital investment ventures will be financed if the banks or other lenders in the market feel comfortable. The means of financing projects will not be as per any scheme devised by or in consultation with the Govt. but will be result of market forces and may vary from case to case. None will be allowed to complain that finance could not be organized for the project. If the market rejects to fund, the project has no place in the economy unless Govt. decides to fund it directly from the Budget on social considerations/ priority. For market players, there will be no such State determined priority to be followed. What happens to large-scale industry? The promoters have to bring as much resources of their own for a project as the market wants or drop the idea and possibly try out projects as are within their own means. Market determines which project is likely to be viable not classroom appraisals. What happens to infrastructure? The same principles apply here. If the market outcome is leading to infrastructure bottlenecks, the Govt. and regulators have to find out if any price and distribution or other State control is still causing barriers to market pricing of infrastructure services or the inputs that go into producing infrastructure services. The Govt. has to make its BOT projects attractive to the financial market. What happens to agricultural and small business finance? Again, the same principles will apply. Any productive economic activity has to be productive enough to attract savings (finance) of the citizens through the market. None can have access to others savings to get rich just because he is of small means or has a great idea. If externalities or social considerations warrant, the Govt. has to remove market barriers, if any, that adversely affects the economics of the project or activity. Or, the Govt. may fund these out of the Budget directly by its departments or through NGOs with market credentials or through market participants by purchasing their services in the market.

12. When the State adapts to competitive market mechanism, there will be no need for the State to have any ownership in any firm or company in the banking and financial services market. What happens to the exiting network of such participants? There are various market-oriented mechanisms for the Govt. to exit out of these entities. One aggressive reform measure would be as follows. The State can simply offer its ownership in all such firms at one go to the public (individuals with PAN numbers only) at whatever price the State desires. If the public buys less than the entire shareholding of the Govt., within a month the Govt. compulsorily auction the balance to the bidders without any reserve price in the same manner as fresh issue of Govt. securities are now auctioned by the Central Bank (RBI). Debating over timing, the value realized and fate of the employees should be of no concern to the State since
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such debates are wastage of money and inflict a great cost to the economy. The employees will have to face the market and deal with the new owners. If any of these firms have no takers or the employees strike work, these may be closed down with
depositors’ and performing creditors’ accounts electronically transferred to private sector banks at the request of the clients. The non- performing assets and investment assets may be electronically sold to Asset Reconstruction Companies and private sector banks and finance companies through the market. This will require advance preparation over a year or so and all public sector banks’/ financial institutions’ clients may be given a notice to this effect. However, many Govt. owned financial sector institutions may not attract buyers of their shares. If the Govt. is unable to sell the shares for whatever reason, these entities may be simply closed and liquidated. This may cause disruption cost to the economy, but such cost will be lower than Govt. continuing to own these entities. To minimize such costs, the Govt. can declare its intention and notice to the public a year in advance. The clients of these entities will have ample time to take their own decision to shift. This may cause a run on these entities. Such runs can be managed smoothly to match liquidation of assets to meet the liabilities. It may not be necessary to adopt such an aggressive program as given above; only the Govt. may be prepared so that the vested interest sections can give up their efforts to sabotage the process of Govt.’s exit from ownership of financial entities. Also, many of the Govt. owned entities have basically eroded their viability and relevance: some may require immediate closing down operation, while others may transform through splits and mergers. Many nationalized banks and financial entities could do well to split themselves into performing asset and non-performing asset parts and then merge the performing assets parts into one and the non-performing parts into one Asset Reconstruction Company.

13. What happens to food credit? The principles remain the same. The minimum buffer stock remains with Govt. and funded by Govt. The excess stocks are to be carried by the private sector trade to the extent they want and are able to carry with their own funds and to the extent the financial markets allow them to raise money based on their prospects and credit rating. What happens to Govt.’s borrowing programs? Private sector banks will buy Govt. paper as much as they can in the market at market prices. Shortfall in fresh Govt. borrowings can be met by Govt. with new money. Moreover, the interest rates on bank savings deposit and postal deposits will get completely deregulated and safety/return assurance withdrawn and interest on provident funds linked to the earnings rate of provident fund investments. The efforts at encouraging households to directly own Govt. bonds will succeed and compensate for the lower mobilization from postal deposits and national small savings scheme. Merely because small savings are shared, they need not be continued. Govt. borrowings remain the same irrespective of the form: security/bond or deposit certificate.
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Realization from sale of securities through post offices can also be shared. It may be observed that under the new scenario, interest rates on deposits may vary from bank to bank and day to day. This will enable integration of the ‘deposits’ market and the secondary market for financial assets including Govt. bonds and treasury bills.

14. What happens to cooperative banks? Their ownership may continue to remain with their members, except that Government involvement will end both
in terms of ownership and management. The cooperative banks will be subject to same regulatory framework as the commercial banks. In case they so desire or face bankruptcy, they can be closed down or taken over by other commercial banks. The reorganization of all development banks at state, regional and all-India levels will take place based on the same principles of competitive markets. They have to participate in the financial markets without subsidies and without Govt.-ownership and also have to comply with the same regulatory regime for the commercial/universal banks and non-banking financial intermediaries. If the Governments wish to allocate resources to any commercial activity, they can do so through their own organizations that do not raise any resources in the market through issue of securities or deposit certificates.

15. In future, no participant in the financial markets can afford to expand without commensurate increase in its own capital in compliance with capital adequacy norms. Also, if risks of default or market risks actually materialize to the extent that provisions or losses to be borne bring capital adequacy below minimum prescribed levels, fresh capital has to be arranged to even maintain the same business levels. This implies that those financial services firms, which are unlikely to be able to make and plough back sufficient profits and/or attract fresh equity capital, will be always under pressure to close down. Or, they may be taken over by stronger financial service firms which are capable of mobilizing adequate shareholder funds, provided the former have some value in terms of organizational, human, brand and financial assets. The financial sector entities will be able to run businesses with lower shareholders’ funds than most real sector business firms, but the shareholder fund requirement for the former will be much higher than in the past. This will be in the interest of the depositors, lenders, bondholders and insurance policyholders of financial sector firms as well as the safety of the financial system. The question arises who will bring in increasing amounts of shareholders funds to enable the financial markets to deal with growing amounts of savings, investments and financial assets that have to be dealt with by the financial sector. The 10th Five- year Plan projects sharp increases in savings, investment and gross capital formation rates. To support this the financial markets will require substantial increase in shareholder funds. The Govt. is going to exit from the business of owning business firms in the real and financial sectors. The Indian investor is generally reluctant to take large fresh equity position in financial sector. _________________________________________________________________

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Then, from where does the financial sector raise the required fresh equity? This issue can be addressed provided one is certain that India is really committed to complete structural reforms, allow competitive markets to flourish and ensure withdrawal of Govt. from commercial businesses.

16. What does all this imply for the common savers and investors? They are no more assured of return or safety. They can choose absolutely safe but low return
instruments issued by the Govt. or high return, high risk other instruments or any combination of different instruments with varying risk-return profile. The notion that a saver is the most important individual in the society will no longer be valid. The importance of the saver and the value of the savings will vary over time depending on the market forces of demand and supply in the financial asset markets. A saver who happens to be retired and relatively poor may draw sympathy of the society to draw some assistance as a poor senior citizen. Whether to save, how much to save and in what instruments to save for post-retirement life are a matter of individual preference and choice. The society may encourage such savings by offering tax deferral benefits but cannot assure any return or safety that guarantees comfortable post-retirement life.
If the per capita income grows and the economy is able to sustain growth, if the productivity of capital and employment grows and if the Govt. can be effective in macro-economic stabilization policies, the retired will be able to generate adequate income from past savings to live a comfortable life. If the individuals did not manage the country’s economy and his consumption and savings habits well during the long period of their active employment, they cannot demand a comfortable post-retirement life from the society. However, a competitive financial asset market will offer lot of choice to the savers. The banks, NBFCs, Mutual funds, insurance companies and pension funds will compete fiercely to serve the interests of the savers so long as the savers are actively monitoring the performance of these entities. The mutual funds and pension funds will thrive as the financial sector turns itself into an efficient, liquid, integrated and competitive market for financial assets and related financial services. asset markets get more

17. All this will call for a great change in the mindset for Indians. Will India ever make this change or remain happy to be in the League of Poor Nations?

Emerging Areas of Economics

2009-07-31T11:04:00.001-07:00

Emerging Areas of Demand on Economists’ Knowledge

Dr. Basudeb Sen
(1968 Batch Alumni)

The environment for use of Economists’ knowledge has radically changed in India over the last decade. This has implications for undergraduate and postgraduate studies and research in Economics in Indian universities. An attempt is made in what follows to highlight some of the major changes in the environment to help facilitate a better appreciation of the nature of emerging demand on economists’ knowledge. The purpose is to indicate a few specific areas of knowledge in which more focused study and research may help the young generation of economists to become more relevant and useful to the management of households, companies and other economic agents including local, state and central governments in India. Research in these areas may also help add new knowledge in economics as a discipline.

Using Market-mechanism

The major environmental changes, since the early 1990s, are a gradual dismantling of the four-decade-old all-pervasive State -controlled and -dictated economic framework in India and the gradual transition towards greater and appropriate use of market mechanism. This has given rise to the need for application of economists’ skills in the development and use of efficient markets for improving resource allocation, raising productivity and reducing wastage in the economy. The knowledge of how markets work and conditions under which they fail (both in terms of delivering economic efficiency as well as capability to withstand shocks) are available to graduate students in India. The challenge for universities is to develop in them the expertise to design innovatively structured, efficient and robust markets for various products, services and contracts.

Efficient Reform Design

The new environment has also given rise to the need for analysis of efficiency / optimality (in terms of relevant net present value of benefits) of individual and sets of economic reform programmes / policy instruments. One may not like to reform but reforming reluctantly may cause shoddy design and implementation of reforms leading to loss of potential gains and avoidable additional costs to the economy.

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Emergence of Financial Markets

One of the areas of Indian economy that has undergone a sea change is central banking, monetary policy framework and financial sector. Understanding RBI’s reform measures and the monetary policy requires vastly different and higher level of economist skills than were necessary a decade ago. Associated with this change has been the radical structural change in the Indian financial sector and the natural demise of State-sponsored, -dictated and -subsidized, monopolistic entities for long engaged in financial intermediation and services to and in the interest of the State. For the first time since Independence, financial service firms have emerged whose survival depends on their ability to meet the needs and interest of the households, companies and other economic agents. This is forcing the development of new regulatory systems and structures, which are to be completely independent of the Government departments (though this is being resisted/ diluted by the bureaucracy). The new / reformed regulatory bodies need to formulate their operating strategies firmly grounded on sound and coherent economic principles rather than on administrative convenience or political ideology as in the past. The survival of regulators in the new environment is not assured any longer. Their performance are being assessed continuously in terms of the consistency and optimality of the regulations they evolve, introduce and enforce and the actual results they obtain in terms of efficiency and integrity of the markets they regulate as well as the nature of innovations they encourage. This implies, as much accountability on the regulators as the regulated economic agents unlike in the past decades. As a result, application of the state-of-the-art knowledge in the economics of different financial markets (assets, contracts and services) and their inter-relations have become important. This is especially so for economists employed in financial intermediaries/service providers and economists serving users of various financial services (like households, companies, trusts, and especially economic agents with portfolio of financial assets to manage. Today, economists without a fair understanding of the economics and econometrics of financial markets may not be considered useful to the society in the same way as economists with vague understanding of theory of the firm or the laws of demand would have been considered useless a century ago.

Challenge of an Open Economy

The substantial opening up of the economy since 1992, another important part of the environmental change, has widened the scope of application of the budding Indian economists’ knowledge compared to the earlier generation economists whose experience was limited to a closed economic environment. The challenge of the new generation economists is to acquire knowledge of those parts of economics that would help them devise business strategies (buying, selling, networking, innovating and investing) to help enable individual companies to be effective competitors in domestic and international markets. Today’s Indian economists cannot afford to make such prescriptions as imposing ‘export obligation’ on Indian producer importing capital equipment (equivalent to wishful import obligations on other nations). They have now to prescribe non-discretionary economic policies to government to encourage both imports and exports so that they significantly rise as a proportion of GDP. They have to devise policies that keep the current account balance within manageable limits without using direct controls on foreign trade or exchange rate. There is no longer any scope for getting applause for Indian economists by making trivial recommendations for rupee devaluation or forming an appropriate trade-weighted basket of currencies as benchmark for pegging the Rupee to. This is an era of continuous evaluation of the strengths and weakness of various currencies in the world and making dynamic adjustments in fiscal and monetary policy and intervention in foreign exchange markets. It is no longer an issue of optimal quantity or percentage of foreign exchange reserves. In the dynamics of an open economy, experience of administering a plethora of static, ad-hoc foreign exchange control gimmicks will not help an economist. For today’s economists in government, Reserve Bank of India, large corporations, export/import organizations, banks or financial institutions, the general level of awareness and understanding of both the theory of and trends in international economics, trade and capital is required to be of much higher order than in the past.

Accountability in Macro-economic Management

One of the fundamental changes in the environment is the decline of the status of all-pervasive State-dictated economic development planning that failed to deliver speedy economic growth for four decades. The possibility of failure of market-mechanism to ensure efficiency or welfare is no longer accepted by the citizens as an adequate justification for continuation of State-dictated and -controlled economy, however centralized or decentralized, given the historical record of countries like India. With India reforming, albeit reluctantly, to a progressively open and market-mechanism using economy, the expertise of economists specializing in State-dictated national economic planning models and drafting planning documents is no longer in demand. The emerging economic environment puts economists tempted or employed to advise the Government against a great challenge in the application of dynamic macro-economic models with significantly higher linkages with the rest of the world. For generating policies with potentially positive impact on the growth of the Indian economy, Indian economists cannot any longer assume away uncertainty and risk, if they are to be useful to the government or the corporate businesses or the households. Economists comfortable with public finance in a state-controlled economy may find it difficult to retain their relevance in the new environment unless they are able to quantify the efficiency and growth impact of the taxation and government spending proposals advocated by them. It is no longer merely a simple issue of social justice and income equality; it is now involved intrinsically with sustainability of fiscal deficits in an open and competitive economy. All this demands a much higher quality of understanding and application of economic theory than those required in the past. Knowledge and / or application of economics were not essential (rather might have been a deterrent to) to economic policy-making in the State-dictated developmental planning mechanism of the past. It is hardly surprising therefore that economists in the past advised the stepping -up annual flow of bank credit to 60%-65% of bank deposits for deployment, at concessional interest rates, in public sector, food stocks and high-risk, low-return State-dictated economic activities. It did not matter even if this was sought to be achieved through unsustainably high liquidity and cash reserve ratios as well as ad-hoc and high preemption of credit. The same is true of suggestion to create State monopolies in mining of standard commodities such as coal or State distribution control mechanisms for steel and fertilizers.

New Areas of Applications

Completely new areas for application of economics have arisen, thanks to the advance of information technology, telecommunications, internet networks and global business process outsourcing. The significant change in the sectoral composition of GDP over the last two decades, resulting in the dominance of the services and decline of agriculture and industry, has made it virtually impossible to use administrative techniques of economic planning by the State. The economics of the different service sector activities, especially those in areas of information, telecommunication and entertainment are just being investigated. Intervention by the State on the basis of limited knowledge (or lack of it) in these areas has often proved counter-productive and costly. The viability of pay-as-you-go defined benefit pension is being questioned and alternative, sustainable ways of old age income and heath security are to be devised. State and local governments need to utilize the knowledge of economists to keep them viable and yet socially useful. Whole range of entertainment and education economics is still uncharted. Only a handful of economists in the country have given proper attention to legal environment /foundations of economic transactions. Eliminating corruption and reducing associated transaction costs to raise economic efficiency is another area for economists to work on.

Economics Discipline: New Expectations

As a discipline, the pressure on reducing the zone of ignorance has been rising. The emphasis on modeling long-term economic growth and technological progress may continue to be relevant. But, the issue of effectively anticipating and dealing with recurring economic crises/ shocks of varying types and their cross-border contagion effects are emerging as equally challenging and respectable areas of research, much beyond what post-Keynesian economics school could imagine as part of the crusade against Neoclassical synthesis. The rapid growth of markets for contingent contracts, equity and credit derivatives, index futures and options as well hedge funds have radically altered the nature of functioning of economies. All this is attracting young economists to research on the economics of these areas, specially the issues relating to bounded rationality, market micro-structure, transaction cost of contract enforcement and dispute resolution, efficiency of equilibrium in incomplete markets, etc. In the next decade, excitement in both theoretical and applied research in these areas may parallel the early twentieth century research activity in quantum mechanics and electro-thermo dynamics.

Widening Boundary of Economics

At the same time, the pressure of reducing the zone of ignorance is making the need for multi-disciplinary research acutely felt. It may be no longer sufficient to attract physicists, mathematicians and statisticians to economic theorising and empirical validation of theory. The use of the methodology of experiments in psychology and clinical tests in drug development and other social sciences may lead to collaborative efforts by economists, psychologists, social scientists and bio-statisticians. The preferences and tastes implicit in the behavioral assumptions relating to consumers, firms, investors (both as individuals and in-group), regulators and economic administrators may attract researchers attention. The economics of organisation structure and decision-making processes of non-individual, non-household economic agents will be another emerging area of study. Simultaneously, new work is likely on history of economic thought to cover the contributions during the second half of the twentieth century. Similarly, research in the near future will focus on recent history of economic development in Asia, Latin America and Eastern Europe. In particular, the lessons from the rapid growth of Asian tigers into developed nations (while India continued to remain among the poor developing nations) and their impact on World trade and international flow of private capital are yet to be fully captured in the theories of economic development.

True, poverty eradication, empowerment, income-distribution and social justice will continue to receive researchers’ attention. But the emphasis is likely to be on economic laws, economic efficiency of legal and contract enforcement systems, immigration and labour mobilty, subsidy to producers, corruption and economic efficiency of political systems and government administration. Many of these emerging areas of research may be multi-disciplinary and considerably extend the boundary of economics as a discipline.

Preparing Economists for Tasks Ahead

The implications of the above discussion on attuning the study and research in economics in Indian universities are clear and broadly three-fold. First, in all the emerging areas of demand for application of economics, there will be much greater need for quantitative and modeling skills in dealing with refutable hypothesis rather than mere normative opinions. Second, the new generation economists will also need to be exposed to the rich literature emanating from significant research work outside India in many of the areas of interest to new generation of Indian economists. These include financial economics, financial econometrics, theory of incomplete markets, international capital and currency markets, globally distributed business process linkage-based international competitiveness, world trade and intellectual property negotiations, market for contribution to environment protection, dynamic macro-economic modeling and applied quantitative micro-economics. Third, in some areas, economic research may become multi-disciplinary tasks and involve collaboration with many other areas of social science including law, besides mathematicians, statisticians and management sciences.

It is true that currently economic students cover some of these areas in their graduate and doctoral studies. But it may be advisable to check our current course coverage (in terms of both expanse and depth) with the coverage of these areas by students in the US and British universities. Similar checks may have to be done with the course coverage in a few foreign universities where economics departments collaborate with finance/management or mathematics departments in separate masters degree programs in financial economics and mathematical finance as also in guiding PhD students in these subjects. In India, the Indian Statistical Institute offers a masters programme in Quantitative Economics. It is also necessary to check with the economics-related subjects in MBA programmes at Indian Institutes of Management.. Based on such comparisons, B.Sc., M.Sc. and M.Phil. programmes in Economics may be approriately modified to make students’ learning in economics relevant and readily useable by business, regulation, governments, households and others.

Such modifications may not be easy to implement. First, there may be an apparently puritan objection that these new areas referred to in this paper are not really part of economics proper. Such a view may be based on inappropriate definition of economics, contrary to the emerging reality of economics teaching worldwide and also against the interest of the career of the new generation of students of economics. A study of the topics of Ph d. dissertations approved by the US and British universities and the contributions of many economics noble laureates will help demolish the basis of such a view. Many economics noble laureates have been recognized for their work in areas of financial economics and financial econometrics. Many of them became interested in applied and theoretical economics via mathematics and statistics. Moreover, their contributions have enriched the theories of general equilibrium, capital, interest, incomplete markets and financial asset prices (as extensions of the concepts evolved by Walrus, Fisher, Hicks, Keynes, Simon, Arrow, Patinkin, Tobin and Modigliani). It is unfair to economics students if the latest developments on the areas in which Stiglitz, Miller, Marcowitz, Fama, Sharpe and Linter contributed, are not fully reflected in the scope of economics. Mere reference to Engel and Granger as contributors to analysis of economic time-series can hardly be adequate: the applied economics graduate will really become handicapped unless fully trained in the use of the techniques developed by these noble laureates and their co-researchers.
A second hurdle against effecting the desired modification to economics syllabus may arise from the dearth of teachers with specialization in these areas and the requisite mathematics knowledge of the students. But this difficulty can be removed by concerted efforts. Moreover, an economics graduate not exposed to these areas of knowledge will need to incur additional educational expense. For, the knowledge will have to be acquired by attending separate skill up-gradation programmes in financial economics, financial econometrics, public finance, regulation of markets, international trade and capital movements, etc. Such programmes are / will be offered by management schools and other non-university academic institutions. The net loser on all counts will be the economics departments that hesitate to make them relevant to the emerging environment.

Economics departments need to take the initiative to modify and rearrange the whole structure of course content and coverage from undergraduate level through graduate studies to Ph.d programmes to accommodate new topics and ensure consistency. The specialization areas or electives papers may need to be redesigned. Moreover, certain topics may have to be dropped or made optional or made part of a combined topic. For example, history of economic thought till the end of the nineteenth century and standard growth models, development economics and state planning techniques may be taught at only undergraduate level. Evolution of economic thought only during the twentieth century may be covered at masters level, along with the history of post-1950 economic development in Asian tiger countries, China, East European countries and India. At the post-graduate level, current international economic issues and trends should be a compulsory subject along with Indian economic trends since 1992. Financial markets and financial economics should also be compulsory at masters’ level. A specialisation in financial economics may be offered which would also include training in use of computer packages for quantitative modeling and financial econometric applications. Economic laws and regulation should be a compulsory credit at masters and Ph.d level. The entire syllabus of Indian economics may have to be redesigned to cover the developments in and efficiency of specific real sector markets and financial markets. Other topics mentioned in this article may be incorporated at masters’ level within the ambit of the prevailing credits. For some of the new topics, teachers from abroad and business schools in India may have to be enlisted for help in the initial years. But this does not mean that the modifications be delayed till then. The university teachers generally have flexibility in the topics they cover and therefore can begin the re-orientation process right away.

India Budget 2005

2009-07-31T11:03:00.002-07:00

I. A Defensive Strategy Budget

Media’s intellectual and popular budget entertainment notwithstanding, Budget 2005 promises only a marginal impact on growth and distribution of income in the near term. FM maintained the ritual of long speech laced with clap inducing, attractively titled schemes/ concessions for the common/ poor man and poetic-relief generating literary quotes. But ensured that there is enough “human face” content in Part A of the speech for his party men to play to the public gallery and disarm the supporting left from monopolizing the market for selling human face rhetoric. The fact is that after spending 16% of GDP in 2004-05 and planning to spend 15% of GDP next year, the Government anticipates economic growth of 6.9% in 2004-05 and 7-8 % in 2005-05 as against the ratcheted-up trend rate of 7 %. The liberalized, decontrolled economy has become much less dependent on the Budget now. For successive years, Budget expenditure plus the States’ share of taxes constituted nearly one-fifth of GDP. Net of all resource transfers to States/ PSEs, Central Govt. expenditure exceeded one-eighth of GDP. This high level of dominance of the State has been continuing for long. There is no scope for raising the Budget size in relation to GDP in a liberalizing economy. T FM therefore must be complimented for not yielding to the pressure of non-accountable populists and planners attempt to make the FRBM Act inoperative. Rather, he has shown performance in achieving revenue deficit and fiscal deficit
Targets in relation to GDP and shows confidence and ignored the suggestion to raise the effective income tax rates for (officially) wealthy individuals and companies as well as higher duties on items of consumption of the rich. Higher taxes would have lowered net revenues through negative effects on investment, risk-taking, work effort and productivity as also increased expenditure on tax compliance. Therefore, FM lowered the effective income tax rates to soft-land withdrawal of most exemptions. This is indeed a good strategy to simplify taxation.

The FM has done a commendable job in describing the action plans, progress and achievements of NCMP-induced State intervention in favour of the poor. He has shown that social spending has already been substantial under various schemes and Yojanas and missions for child nutrition, education, health care, housing and rural employment. Such social spending for empowering the weak and help them take the advantage of economic reforms will have higher allocation in 2005-06 as well. It is only that the Expenditure Budget presentation format did not reveal the high social spending of our Budgets. FM of course did not highlight that the Government spends annually about Rs 20,000 crore for providing old-age income security (pensions) to senior citizens who had earlier served the government. Bulk of the subsidies, about Rs 50,000 crore are also in the nature of social spending since they help provide cheap inputs to the poor farmers, protect employment in inefficient fertilizer factories that would turn sick without subsidies and also protect the poor who uses or works for the postal services. Some social spending in this budget, however, has taken the form of duty reductions as in the case of crude oil, kerosene and LPG.

The Budget’s impact on efficiency/ productivity is also going to be marginal. The FM has not revealed any significant attempt to raise resources in a non-distortionary manner. He takes advantage of the sharp growth in non-tax revenues (excluding interest receipts) but does not disclose any measures to increase user charges. The spending leakage control measures do not find mention in the speech. Nor does the Budget attempts at harnessing emerging market dynamics and reducing the degree of state interference with market forces, except in the case of textiles. At least, the Budget numbers do not reflect such measures.

A new (and, perfectly logical) strategy has been to keep most economic policies other than fiscal and govt. expenditure policy, outside the Budget or Budget speech. Economic policy-making is the domain of the Executive and not the subject of approval or debate by the legislature. Only Finance Bill needs to be passed. Forthcoming legislation proposals (changes in Banking Regulation Act, RBI Act and Securities Contract Regulation Act need to be mentioned. More importantly, intra-coalition bargaining in economic policies is strategically better avoided when the Parliament is in session. At the same time, the mention of these future steps gives a signal to the market and outside World that the Government is indeed in pursuit of reforms without making the Budget reform-aggressive and attract anti-reform lobbying. That is why some may say this year Budget “mein dum nehin, majja nehin”.

Yet, the present Government is far to conservative and determined to not let go State’s command control over banking. Commercial banks and other financial institutions, as arms the State policy implementation, will now raise money from the free market but will deploy funds in accordance with (not the market forces) State directives. The good old days of State-control are soon to return what with special purpose vehicles for infrastructure projects and project viability gap funding. Financial sector reform proposal indicated in the Budget speech are a mixture of market-oriented ones and design of state-control. It is difficult to allow private sector micro-credit institutions function unless they provide a channel of influence on the rural electorate for the State.

With “Off-Budget” financing of State-directed projects and programmes, fiscal consolidation becomes easier. That partly explains the success of FM in adhering to FRBM revenue-deficit and fiscal deficit reduction targets. Partly, however, underestimation of non-tax revenues and low capacity of the Government system to absorb additional spending in twelve months help the FM. But largely, it is the high growth of the economy that will contribute to fiscal consolidation. And, of course, the bet is that VAT will not lead to much shortfall in States’ revenue collections and create a burden on the Centre. Finally, nothing is budgeted for disinvestments. But should a need arise, disinvestments may not take much time to implement to finance a part of social spending or plan capital
Investment. We may not have a dream budget, but a Budget that exactly fits the ground reality: a defensive-strategy budget.

II. Socialist Market Economy Budget

In the 2005-06 Budget, the FM has done a commendable job in describing the action plans, progress and achievements of NCMP-induced State intervention in favour of the poor. He has shown that social spending has already been substantial under various schemes, yojanas and missions for child nutrition, education, health care, housing and rural employment. Such social spending for empowering the weak and help them take the advantage of economic reforms will have higher allocation in 2005-06 as well. The existing Expenditure Budget format did not reveal the high social spending of our Budgets. The Government spends annually about Rs 20,000 crore for providing old-age income security (pensions) to senior citizens who once served the government. Bulk of the subsidies, about Rs 50,000 crore are also in the nature of social spending: they help provide cheap inputs to the poor farmers, protect employment in inefficient fertilizer factories that would turn sick without subsidies and also protect the poor who uses or works for the postal services. Some social spending in this Budget, however, has taken the form of duty reductions as in the case of crude oil, kerosene and LPG.
The Government will continue economic reforms for fiscal consolidation, trade liberalization, FDI and financial sector modernization as may cross the left barrier. Yet, the present Government is determined to not let go State’s command control over banking. Commercial banks and other financial institutions, as arms of the State policy implementation, will now raise money from the free market but will deploy funds in accordance with (not the market forces) State directives. The good old days of State-control are soon to return what with special purpose vehicles for infrastructure projects and project viability gap funding and what with building a network of private sector micro-credit institutions function tied to state-owned (51% or more) as a channel to influence the rural electorate. Financial sector reform proposal indicated in the Budget speech are a mixture of market-oriented ones and design of state-control. With “Off-Budget” financing of State-directed projects and programmes, fiscal consolidation becomes easier. The taxation of so-called fringe benefits (expenses on traveling to Delhi or State capitals to get clearances as well as expenses on travel to meet customers and bankers for extending services including debt servicing or negotiating loans or the restaurant bill for entertaining the sports celebrity) are going to be now taxed as benefits to employees) smacks of socialistic jealousy. It is in most cases not really an issue of neither the employer nor the employee not giving a tax on benefit consumed. It is an issue of what a business expense is. This is one of the two great innovations of the budget makers that will yield little but generate disputes and hassles in implementation. The other one is the tax on cash withdrawals. It is not clear how without a tax per cash transaction the transaction does not leave a trail. Or, how a tax 0f 0.1% will leave a trail (a 10 paise transactions tax then could have been equally effective!).

A Note on Development Finance Institutions (2004)

2009-07-31T11:03:00.001-07:00

A Note on Development Financial Insitutions in India

A DFI is essentially a non-market entity sponsored and supported by the State (or, charitable NGO) set up to provide
(i) financial resource support, (ii) financial services and (iii) promotional support
- all normally at non-market (subsidised) prices
to such economic endeavors, especially if undertaken by specific categories of economic agents, which on their own economic merit are unable to attract (i), (ii) and (iii) from market entities, because either
(a) financial markets (and/or real sector markets) are under-developed and narrow, or the private and social costs/benefits of these activities diverge even under an economic regime that is characterised by reasonably competitive and efficient markets in all sectors, or
(b) the State for its own reasons dislikes market mechanism and efficient market outcomes.

Accordingly, a DFI is set up as a marginal, state supported player in a primarily market economy or as an integral part of a State-controlled and state-dictated, non-market economic regime.

In India, DFIs were set up primarily because of (b). The Indian economic regime was, until recently, a largely State-controlled and State-dictated, closed economy with virtually very little scope for markets to operate in a competitive environment. The issue of under-developed markets or divergence between social and private costs/benefits did not really arise in a command economy geared to achieving national plan priorities and targets. DFIs were one among the plethora of instruments of the State to achieve the plan objectives and targets. There was no scope for markets to operate in a competitive environment.
Unlike the Indian DFIs, in competitive-market, open economies in the West, the scope of operation of the DFIs has remain limited and DFI activity never constituted any significant part of the financial sector. The State-sponsored DFIs in developed, open and market economies therefore have very little State involvement and required very little State support. Such DFIs largely operated as entities whose survival depended on their commercial success rather than State support. These DFIs, generally sectoral in nature (e.g., export-import banking, refinancing of housing mortgages), are required to contribute to the efficient operation of financial markets and at the same time become commercially viable without any significant State-support that would distort the financial markets. These are minor intervention of the State to help enable the financial markets to acquire greater depth and breadth.

Relevance of Indian DFIs in the current economic regime

In the economic environment that has emerged over the last decade or so and the likely more rapid pace of movement towards an open, de-controlled/ deregulated economic system in India, most of the DFIs, whether general or sectoral and whether all-India or regional, have lost their relevance. Except in the area of Exim finance), India does not need any of the existing DFIs at all. Therefore, these DFIs should be dismantled in a planned, orderly fashion within the shortest possible time. There are three main reasons for this recommendation:

(A) DFIs are no longer required to help in the process of turning savings into investments in accordance with the National Economic Plan priorities and targets. Unlike in the 1050s, 1960s, 1970s, 1980s and even in the early 1990s, today the real sector markets are virtually free from Government dictates on capacity, production, distribution and prices as well as exports and imports. The
growth of the economy is to reflect market outcomes of an open economy and not the mere wishes of the State or its Planning Commission document on targets. The death of the State-dictated, State-controlled economic regime implies the death of DFIs, which constituted an integral part of the economic development architecture or the pre-reforms era.
The financing needs of growth has to be largely met by commercial entities that can survive in competitive financial markets with strong links with international financial markets and not on arbitrary government mechanisms of channeling savings to a select group of DFIs. The stock markets and the debt securities market have witnessed a sea change in the efficiency of their functioning and the levels of their activities in the last decade. The flow of funds across the borders to finance economic activities in India has increased substantially. There are successful venture capital funds. Indian industry, trade and commerce do not require any DFI to help them. The current market-based, open economy cannot arrest the death of non-competitive and financially bankrupt industries/ industrial units seeking to prolong their lives at the cost of the Nation through so-called debt restructuring. Such experiments have failed even in a controlled economy as evident from the experience of Industrial Reconstruction Corporation of India since the 1970s and rehabilitation finance departments of IDBI, ICICI, IFCI and others during the 1980s and later till the BIFR remained in existence. Meaningful corporate debt restructuring does not require DFIs: market mechanism itself can successfully exploit profitable opportunities of debt restructuring by commercial financial institutions.

(B) Not only are DFIs irrelevant to our economic advancement in future, a DFI cannot really survive in the current environment. With market-mechanism being relied upon to pursue the National economic growth targets, any financial institution has to be a commercial institution capable of surviving in the market without State support in any significant way. Development efforts that are not commercially rewarding to a DFI undertaking such effort eat into its financial viability and sustainability. In today’s market, only such financial institutions and banks should be allowed to operate which can attract adequate capital by generating market rates of return adjusted for risk as reflected by their portfolio of assets and liquidity risk. The institutions which fails the above test should not be allowed to undertake any financial intermediation service any longer. They should be closed down within the shortest possible time but in an orderly fashion to minimise the adverse impact of the loss to economic agents connected to the liability –side of the balance sheet of these institutions and banks. Most DFIs in India belong to the later category.

(C) Finally, continuation of DFI operation beyond the least time required for its orderly dismantling, is already becoming a drag on economic efficiency and growth in India. The irrecoverable cost of running a non-viable business increases at an accelerating rate over time. Moreover, restructuring of corporate debt merely to keep the DFIs and their non-competitive clients afloat for a little longer hurt the overall economic efficiency of the system. Continued operation of a DFIs without sustainable balance sheet and the non-viable units of their clients have a spillover adverse effect on viable and vibrant entities in the market.

What should DFIs do if they have lost their relevance?

The issue of what to do with the existing DFIs is different from the issue of economic irrelevance and non-viable business model of DFIs.
DFIs had a golden opportunity to transform into banks or NBFCs in the 1990s. Those who have consciously planned and started implementing such transformation plans like ICICI have great chance of success in the new environment. Those who continued vigorously with their obsolete and non-viable development banking model during 1996- 2000 like IDBI, IFCI, IIBI, state-level DFIs have already lost the opportunity to transform. It is now too late to attempt organic transformation, for the cost of such transformation may be too large relative to building a new bank or a new NBFC.
The only solution now available is to split such DFIs into portfolios meant for ARCs and good quality asset portfolio: the former may be sold to or merged with an ARC while the latter portfolio sold to or merged with a commercial bank or financial institution.

Will that not mean loss of expertise built-up by DFIs over decades?

No. First, the major part of the expertise is not relevant any longer. Second, such expertise is embodied in development bankers and the brightest of such bankers have in large numbers already exited out of the DFIs in the last 7 / 8 years, either retired or joined new banks, NBFCs and other companies.

But who will replace the DFIs in project appraisal and project lending?

Over the last 6 / 7 years, the banks have in their corporate offices inducted a large number of highly trained or experienced executives for project appraisal and lending. Many large PSU banks and new generation private banks have as large and talented pool of CAs, engineers and MBAs deployed in credit/ project appraisal as the large DFIs had/ have. Commercial banks together have been taking up significantly large share of project funding in the last 6 /7 years. DFIs therefore do not require any replacement.

But are not the banks supposed to be lending only to low risk projects while DFIs are to take up high-risk projects?

The notion that banks will lend only to low risk projects may not be appropriate to a risk-based portfolio approach to bank management. Banks can combine high-risk projects with low risk projects to maintain a portfolio risk consistent with low risk appetite of banks. On the other hand, a DFI portfolio with credit concentration in high-risk projects may not be attractive to investors and depositors.

But how do we meet the country’s need to undertake high risk and long-gestation projects?

Yes, a country may choose as many high risk projects as it wishes. But it has to be prepared to take the consequential losses, however large. The design of financial architecture should be such that concentrated high-risk portfolios are avoided and the risks are spread across financial internediaries, investors and taxpayers. Optimal financial architecture design does not imply the creation of financial institutions that would raise large resources in the financial markets, especially from banks and retail investors, and deploy them in portfolios that would have high concentration of high-risk projects.

Without DFIs how can we ensure long-term finance for long-gestation projects because the banks do not raise long-maturity funds?

Banking systems seldom witness absolute decline in the amount of bank deposits. Moreover, the growth in short to medium term credit offtake from projects and non-project economic activities vary over the business cycle. Therefore, it is always possible and profitable for banks to manage with loan and credit portfolios that have average maturity periods higher than the average duration of their liabilities. Finally, the banks can hold long-term bonds for short periods, especially if the bonds are likely to mature in the medium term.
More fundamentally, long-term credit requirements should be largely met by accessing institutions that are created to deal with long-term contractual savings like the insurance companies, pension funds and provident funds. The share of these long-term contractual savings have increased by over 12 basis points over the last 7 /8 years. The challenge of financial architecture design is to establish credible inter-link between these savings and long-gestating projects like those in infrastructure. It is quite possible for banks and NBFCs to fund long-gestation projects with short-duration funds and then sells the assets to the mobilisers of long-term contractual savings. Even in the past LIC and GIC have directly participated in long-term finance.

But the development of long-term financing arrangements of the above type warrants the development of active corporate bond markets. This may take long time. What do we do in the meanwhile?

Instead of diverting our attention from the crux of the issue, we must concentrate on the development of bond markets. The problem is not of ensuring long-term finance to infrastructure but also of making available long-term financial assets for the absorption of the long-term savings generated by the household sector. This issue is best tackled by encouraging large banks like State Bank of India, ICICI Bank, PNB, BOI, BOB, Canara Bank and others to cooperate and coordinate with insurance companies and provident funds/ pension funds using the professional skills available with IDFC, Crisil, ICRA , Care and IL&FS. They can jointly develop the long-term non-Government bond market. We do not need DFIs for this purpose. In any case the existing DFIs do not have any special expertise in this area which the big banks, LIC, GIC and others do not possess.

Should not therefore IDFC be treated as a DFI?

The issue is not what we call IDFC as. The test is whether IDFC has a business model that is viable and consistent with the regulatory standards for NBFCs. If the test is positive, IDFC should be encouraged to do business with its model and prove that it can operate as a commercial entity within 5/ 6 years. We need the innovations of takeout financing, credit- rating enhancement, etc.
The problem of infrastructure finance has not been the shortage of funds but formulation / design of infrastructure projects that are commercially viable. Much of these problems lie in the State policies and procedures relating to infrastructure project land acquisition, law and order, and pricing of infrastructure services.

Future role and operations envisaged for DFIs in the emerging financial architecture

There does not exist any role for DFIs in the emerging financial infrastructure.
The emerging financial architecture cannot have institutions that raise resources from the market on the strength of Govt. guarantee / ownership/ sponsorship to do businesses that are not capable of generating market rates of return adjusted for risk.
If an existing DFI has a strong balance sheet, if its asset portfolio is not going to be far more risky than the average portfolio of securities of all commercially-motivated participants in the market, then such an entity no longer remains a DFI but becomes a CFI (commercial financial institution).
If a DFI has a weak balance sheet because of the quality of assets it holds or if a DFI is expected to hold high-risk asset concentration in their portfolios, it should not be allowed to operate in the financial market to protect the interest of the market. The State policy or the regulatory regime should not force such non-market entities on the financial markets.
If the State still wants to intervene to influence the competitive market outcome, such DFI activity should be undertaken as part of the Government within the ambit of the Govt. budget. In select areas like Exim banking (project exports), refinancing or trading of mortgaged-backed financial assets and the like, fixed-, short-, non-extendable tenure (maximum 8 to 15 years life) DFIs may be set up and fully funded by the Government.

Regulation for DFIs

No DFI with credit rating supported by Govt. guarantee/ govt. ownership/ sponsorship/ subsidy or tax-concession support/ subsidised financial resource support should be eligible to raise deposits or issue debt-securities in the market, whether by way of private placement or public issue. This is required to ensure integrity of financial markets.
DFIs able to raise deposits or issue debt-securities on the strength of the strength of the balance sheet, management competence and credible business strategies without any support from the Govt. may call them DFIs but they are CFIs. They should be subject to the same regulation as are applicable to NBFCs.
The regulation for NBFCs ( including DFIs) should be no more and no less stringent than the commercial banks, except to the extent the differences arise due to the fact that the banks are part of the payment system and NBFC are not.
The extent of on-site and off-site surveillance by RBI for the commercial banks and NBFCs should be the same. The regulatory framework should not be such as to make it difficult for NBFCs (including transformed DFIs) to convert into commercial banks or merge with comical banks.
The variation in regulation and supervision among different sizes of NBFCs should not be any more or any less than the variation in the regulation and supervision among different sizes of banks. This is necessary to ensure that a smaller NBFC is not constrained to expand and move over to larger size NBFC category.
Therefore, there should not be any difference in prudential income recognition, provisioning, valuation, accounting, disclosure, reporting, risk-based management and audit as well as capital adequacy requirements/ norms between commercial banks and NBFCs. Beyond a certain size, all NBFCs should be publicly listed or at least conform to quarterly and annual disclosure standards applicable to listed companies.
The limits on accepting deposits by NBFCs should not be based on multiples of net owned funds. The NBFCs should be allowed to accept deposits freely, so long as they consistently meet (on monthly/quarterly basis) all norms of risk-weighted capital adequacy, investment in approved securities/ gilts and all prudential accounting norms and provided they do not offer effective interest rates higher than the what the top 5 banks in the country offer for different maturity. However, those who fail to meet the basic regulatory norms as indicated above, RBI should set absolute limits on deposit raising on a quarterly basis based on funds flow forecast. The NBFCs consistently meeting all regulatory norms should also be allowed to raise resources through issue of credit-rated bonds of varying maturities provided they follow all norms of issue of prospectus of required quality as applicable to public issues and provided that the rates of interest offered are not higher than those offered by top 10 commercial banks for different maturities. Clearly, only relatively big size NBFCs can afford to have such freer access to deposits and bond/debenture market. Also, the regulatory supervision for them has to be more on-site and frequent and with greater emphasis on the asset-quality and maturity mismatch aspects.

The regulatory framework for NBFCs should allow tie-ups between NBFCs which are primarily focussed on their strength on retail savings mobilisation and those which are primarily strong on credit/ financial asset management. Such tie-ups could be in the nature of co-financing with responsibility of credit recovery primarily lying with the NBFCs of the latter type.

The outlook and role of large Residuary NBFCs

The large R-NBFCs have considerable strength in mobilising savings from individuals and firms which are more concerned about the safety of their savings and therefore satisfied with low rates of return on funds they keep with the R-NBFCs. These institutions through their agency network reach out to customers in a manner that post office savings bank and commercial banks are not interested in doing or are unable to do at low cost. There could be a segment in the R-NBCs’ depositor client portfolio who are not willing to provide as much client information as needed by post-offices and banks for proper customer identification and verification in case of need. These strengths and opportunities are likely to be eroded/diminished over time as the new-technology based commercial banks spread their activities in the areas where the R-NBFCs concentrate and it becomes difficult for citizens to keep their identity secret for verification from R-NBFC records. This may take time but has obvious implication for the livelihood of the agents working for R-NBFCs. But so long as the RNBFCs remain viable and competitive, their regulation and future transformation have to be envisioned. They can in future merge or have tie-ups with strong NBFCs with strong focus on asset management. At present both for their Govt. securities portfolio and the balance 20 % portfolio, they should be required to hire and use the best asset management skills either in-house or through outsourcing or both.
In future, they can help spread the culture of direct holding of Govt. securities by individuals.
(Based on Interview given to an Official RBI Working Group)

Cost of Delay in Financial Sector Reforms (2003)

2009-07-31T11:02:00.004-07:00

Cost of Delay, Design Deficiency and Implementation
Inefficiency in Financial Sector Reforms in India (1991-2002)

Dr. Basudeb Sen*

India embarked upon a program of structural reforms and macro-economic stabilisation in 1991 when the Indian economy was reeling under a severe crisis without any sudden or major external or internal shock. The severity of macroeconomic crisis was clearly the result of the progressively rising and alarmingly high degree of economic inefficiency and corruption of India’s State-dictated, public sector dominated closed economic structure developed over the previous four decades. It was also a proof of the non-sustainability of that bankrupt economic system and structure. In 1991, the political and administrative establishment had no other alternative to start, even if reluctantly, a process of structural economic reforms. The economic reforms aimed at allowing the emergence of competitive markets by dismantling State controls over the economic decisions of producers and consumers, allowing competition in various sectors, removing state imposed barriers to domestic and cross-border trade and liberalising international capital flows. The reforms also envisaged reducing Government participation in the ownership and management of business organisations, eliminating tax and tariff distortions as well as correcting fiscal imbalances.

2. Both the real and the financial sectors of the Indian economy have witnessed radical changes as a result of economic reform during 1991-2002. This has also resulted in better economic performance during the 1990s as compared with the performance during 1951-1990. In the financial sector, most of the State controls on interest rates and issuance of securities have been dismantled. Degree of financial repression has declined, new financial service firms have entered the market, and greater competition has developed with many new financial products and services now available. Except for the restriction on investing abroad by ordinary Indian citizens, India is very close to capital account convertibility with a virtually deregulated, competitive foreign exchange market. Use of information and telecom technology has intensified across the financial markets. Improved levels of information disclosure and transparency, better regulation, lower transaction costs and higher service standards have been achieved. The volume of trading activity in secondary market for equity shares (Stock exchanges are now the most modern and safe) for Govt. securities has increased manifold. Banking services have witnessed considerable improvement as competition intensified. The need to augment the risk capital of public sector banks has been addressed, even if not to the desired extent. Appropriate bailouts have been or are being arranged for some major financial institutions whose non-viability surfaced with the introduction of prudential accounting rules as part of reforms.
: this paper is based on a presentation made as a speaker at the Seminar on “Current Issues in the Indian Economy” organised by the Department of Economics, Rabindra Bharati University, ‘Emerald Bower’, 56A, B.T. Road, Kolkata 700050: Session II on Financial Sector Reforms on March 21,2003.

The Planned Economy Financial Asset Market Model
4. The UTI experiment was an integral part of the efforts at developing a financial sector/system that would enable the State to exert the maximum control over the flow of savings and investment. It was not merely a coincidence that the Industrial Development Bank of (IDBI) was set up as the apex development bank, wholly-owned by Govt. of India through another Act of Parliament in the year 1964. Soon, the nationalization of all the large banks was to follow in 1969 (after a brief period of social control on banks). In 1971, the Industrial Reconstruction Corporation of India was set up with equity contribution from public sector banks and institutions to finance sick industrial units. With out these measures, the State would have difficulty in continuing with the regime of development planning.
5. The financial asset markets in the prevailing Indian economic regime had to be under total control of the State. Correspondingly, financial asset price determination had to be largely an arbitrary, administrative process. True, the stock market prices were not State-controlled. But the administrative price determination in all other parts of the financial sector (including controls on capital issues and dividend rates) could leave only traders and brokers to play up and down the equity share prices in the stock exchanges. This would be considered as a problem of excessive speculation to be controlled through administrative measures and whenever necessary by booking offenders through investigation. With the overwhelming dominance of the Public Sector corporations/companies in India’s planned mixed-economy system, only a few large, growing private sector companies listed on the stock exchanges could have been expected to have low gearing and large floating stocks. Rather, most large private sector companies were expected to depend on public sector financial institutions and banks for raising funds. Also, forward trading would have been banned.
6. Indian development planning theories and models were not required to explicitly address the issue of how the financial assets acquired by UTI (and nationalized insurance companies) would be valued in the market. These theories had apparently assumed that there could not be any failure of investment under India’s development planning regime. The State-determined interest rates would automatically help determine the values of bonds and preference shares in the absence of default risk (assumption of nil or negligible proportion of assets turning bad). As for pricing of equity share, development planning theory in India had to stop short of devising a method of administratively fixing the daily prices of shares in the stock markets, though most prices (including prices of other financial instruments) were determined administratively by the State. As explained in the previous paragraph, it was only an issue of curbing excessive speculation through legal and administrative measures over share trading and share-brokerage activity. Therefore, it had never been clear as to how a State-sponsored institution like UTI could have been expected to contribute to the development of a vibrant, liquid market for debt, equity and hybrid securities issued by companies, leave alone synthetic and derivative securities. UTI could only have mobilized and channeled savings into investment in productive economic activities of the companies.
Major Achievements
(a) The great strides that the IMFI achieved.
The Opportunity Lost

16. Notwithstanding these achievements, IMFM and IFMI are still in the nascent stage of development and lost a great opportunity of development during the last ten years as the following would reveal:
The Impact of Reform Inadequacies
17. 90s.

Under this scenario, the financial sector will have a chance to evolve into efficient markets for financial assets, products and services. The flow of funds and the transformation of savings into investment will be determined by market forces and not by the directives of the State to market participants. Of course, the State can use its
Budgets to directly channel resources to reduce unemployment, to provide subsidies to the poor, to purchase goods/services in the market and to facilitate international, regional and bilateral economic cooperation as part of macro-economic management and public finance programs. Large capital investment ventures will be financed if the banks or other lenders in the market feel comfortable. The means of financing projects will not be as per any scheme devised by or in consultation with the Govt. but will be result of market forces and may vary from case to case. None will be allowed to complain that finance could not be organized for the project. If the market rejects to fund, the project has no place in the economy unless Govt. decides to fund it directly from the Budget on social considerations/ priority. For market players, there will be no such State determined priority to be followed. What happens to large-scale industry? The promoters have to bring as much resources of their own for a project as the market wants or drop the idea and possibly try out projects as are within their own means. Market determines which project is likely to be viable not classroom appraisals. What happens to infrastructure? The same principles apply here. If the market outcome is leading to infrastructure bottlenecks, the Govt. and regulators have to find out if any price and distribution or other State control is still causing barriers to market pricing of infrastructure services or the inputs that go into producing infrastructure services. The Govt. has to make its BOT projects attractive to the financial market. What happens to agricultural and small business finance? Again, the same principles will apply. Any productive economic activity has to be productive enough to attract savings (finance) of the citizens through the market. None can have access to others savings to get rich just because he is of small means or has a great idea. If externalities or social considerations warrant, the Govt. has to remove market barriers, if any, that adversely affects the economics of the project or activity. Or, the Govt. may fund these out of the Budget directly by its departments or through NGOs with market credentials or through market participants by purchasing their services in the market.

12. When the State adapts to competitive market mechanism, there will be no need for the State to have any ownership in any firm or company in the banking and financial services market. What happens to the exiting network of such participants? There are various market-oriented mechanisms for the Govt. to exit out of these entities. One aggressive reform measure would be as follows. The State can simply offer its ownership in all such firms at one go to the public (individuals with PAN numbers only) at whatever price the State desires. If the public buys less than the entire shareholding of the Govt., within a month the Govt. compulsorily auction the balance to the bidders without any reserve price in the same manner as fresh issue of Govt. securities are now auctioned by the Central Bank (RBI). Debating over timing, the value realized and fate of the employees should be of no concern to the State since such debates are wastage of money and inflict a great cost to the economy. The employees will have to face the market and deal with the new owners. If any of these firms have no takers or the employees strike work, these may be closed down with depositors’ and performing creditors’ accounts electronically transferred to private sector banks at the request of the clients. The non- performing assets and investment assets may be electronically sold to Asset Reconstruction Companies and private sector banks and finance companies through the market. This will require advance preparation over a year or so and all public sector banks’/ financial institutions’ clients may be given a notice to this effect. However, many Govt. owned financial sector institutions may not attract buyers of their shares. If the Govt. is unable to sell the shares for whatever reason, these entities may be simply closed and liquidated. This may cause disruption cost to the economy, but such cost will be lower than Govt. continuing to own these entities. To minimize such costs, the Govt. can declare its intention and notice to the public a year in advance. The clients of these entities will have ample time to take their own decision to shift. This may cause a run on these entities. Such runs can be managed smoothly to match liquidation of assets to meet the liabilities. It may not be necessary to adopt such an aggressive program as given above; only the Govt. may be prepared so that the vested interest sections can give up their efforts to sabotage the process of Govt.’s exit from ownership of financial entities. Also, many of the Govt. owned entities have basically eroded their viability and relevance: some may require immediate closing down operation, while others may transform through splits and mergers. Many nationalized banks and financial entities could do well to split themselves into performing asset and non-performing asset parts and then merge the performing assets parts into one and the non-performing parts into one Asset Reconstruction Company.

13. What happens to food credit? The principles remain the same. The minimum buffer stock remains with Govt. and funded by Govt. The excess stocks are to be carried by the private sector trade to the extent they want and are able to carry with their own funds and to the extent the financial markets allow them to raise money based on their prospects and credit rating. What happens to Govt.’s borrowing programs? Private sector banks will buy Govt. paper as much as they can in the market at market prices. Shortfall in fresh Govt. borrowings can be met by Govt. with new money. Moreover, the interest rates on bank savings deposit and postal deposits will get completely deregulated and safety/return assurance withdrawn and interest on provident funds linked to the earnings rate of provident fund investments. The efforts at encouraging households to directly own Govt. bonds will succeed and compensate for the lower mobilization from postal deposits and national small savings scheme. Merely because small savings are shared, they need not be continued. Govt. borrowings remain the same irrespective of the form: security/bond or deposit certificate.Realization from sale of securities through post offices can also be shared. It may be observed that under the new scenario, interest rates on deposits may vary from bank to bank and day to day. This will enable integration of the ‘deposits’ market and the secondary market for financial assets including Govt. bonds and treasury bills.

14. What happens to cooperative banks? Their ownership may continue to remain with their members, except that Government involvement will end both
in terms of ownership and management. The cooperative banks will be subject to same regulatory framework as the commercial banks. In case they so desire or face bankruptcy, they can be closed down or taken over by other commercial banks. The reorganization of all development banks at state, regional and all-India levels will take place based on the same principles of competitive markets. They have to participate in the financial markets without subsidies and without Govt.-ownership and also have to comply with the same regulatory regime for the commercial/universal
banks and non-banking financial intermediaries. If the Governments wish to allocate resources to any commercial activity, they can do so through their own organizations that do not raise any resources in the market through issue of securities or deposit certificates.

15. In future, no participant in the financial markets can afford to expand without commensurate increase in its own capital in compliance with capital adequacy norms. Also, if risks of default or market risks actually materialize to the extent that provisions or losses to be borne bring capital adequacy below minimum prescribed levels, fresh capital has to be arranged to even maintain the same business levels. This implies that those financial services firms, which are unlikely to be able to make and plough back sufficient profits and/or attract fresh equity capital, will be always under pressure to close down. Or, they may be taken over by stronger financial service firms which are capable of mobilizing adequate shareholder funds, provided the former have some value in terms of organizational, human, brand and financial assets. The financial sector entities will be able to run businesses with lower shareholders’ funds than most real sector business firms, but the shareholder fund requirement for the former will be much higher than in the past. This will be in the interest of the depositors, lenders, bondholders and insurance policyholders of financial sector firms as well as the safety of the financial system. The question arises who will bring in increasing amounts of shareholders funds to enable the financial markets to deal with growing amounts of savings, investments and financial assets that have to be dealt with by the financial sector. The 10th Five- year Plan projects sharp increases in savings, investment and gross capital formation rates. To support this the financial markets will require substantial increase in shareholder funds. The Govt. is going to exit from the business of owning business firms in the real and financial sectors. The Indian investor is generally reluctant to take large fresh equity position in financial sector. Then, from where does the financial sector raise the required fresh equity? This issue can be addressed provided one is certain that India is really committed to complete structural reforms, allow competitive markets to flourish and ensure withdrawal of Govt. from commercial businesses.

Under this scenario, the financial sector will have a chance to evolve into efficient markets for financial assets, products and services. The flow of funds and the transformation of savings into investment will be determined by market forces and not by the directives of the State to market participants. Of course, the State can use its
Budgets to directly channel resources to reduce unemployment, to provide subsidies to the poor, to purchase goods/services in the market and to facilitate international, regional and bilateral economic cooperation as part of macro-economic management and public finance programs. Large capital investment ventures will be financed if the banks or other lenders in the market feel comfortable. The means of financing projects will not be as per any scheme devised by or in consultation with the Govt. but will be result of market forces and may vary from case to case. None will be allowed to complain that finance could not be organized for the project. If the market rejects to fund, the project has no place in the economy unless Govt. decides to fund it directly from the Budget on social considerations/ priority. For market players, there will be no such State determined priority to be followed. What happens to large-scale industry? The promoters have to bring as much resources of their own for a project as the market wants or drop the idea and possibly try out projects as are within their own means. Market determines which project is likely to be viable not classroom appraisals. What happens to infrastructure? The same principles apply here. If the market outcome is leading to infrastructure bottlenecks, the Govt. and regulators have to find out if any price and distribution or other State control is still causing barriers to market pricing of infrastructure services or the inputs that go into producing infrastructure services. The Govt. has to make its BOT projects attractive to the financial market. What happens to agricultural and small business finance? Again, the same principles will apply. Any productive economic activity has to be productive enough to attract savings (finance) of the citizens through the market. None can have access to others savings to get rich just because he is of small means or has a great idea. If externalities or social considerations warrant, the Govt. has to remove market barriers, if any, that adversely affects the economics of the project or activity. Or, the Govt. may fund these out of the Budget directly by its departments or through NGOs with market credentials or through market participants by purchasing their services in the market.

12. When the State adapts to competitive market mechanism, there will be no need for the State to have any ownership in any firm or company in the banking and financial services market. What happens to the exiting network of such participants? There are various market-oriented mechanisms for the Govt. to exit out of these entities. One aggressive reform measure would be as follows. The State can simply offer its ownership in all such firms at one go to the public (individuals with PAN numbers only) at whatever price the State desires. If the public buys less than the entire shareholding of the Govt., within a month the Govt. compulsorily auction the balance to the bidders without any reserve price in the same manner as fresh issue of Govt. securities are now auctioned by the Central Bank (RBI). Debating over timing, the value realized and fate of the employees should be of no concern to the State since such debates are wastage of money and inflict a great cost to the economy. The employees will have to face the market and deal with the new owners. If any of these firms have no takers or the employees strike work, these may be closed down with
depositors’ and performing creditors’ accounts electronically transferred to private sector banks at the request of the clients. The non- performing assets and investment assets may be electronically sold to Asset Reconstruction Companies and private sector banks and finance companies through the market. This will require advance preparation over a year or so and all public sector banks’/ financial institutions’ clients may be given a notice to this effect. However, many Govt. owned financial sector institutions may not attract buyers of their shares. If the Govt. is unable to sell the shares for whatever reason, these entities may be simply closed and liquidated. This may cause disruption cost to the economy, but such cost will be lower than Govt. continuing to own these entities. To minimize such costs, the Govt. can declare its intention and notice to the public a year in advance. The clients of these entities will have ample time to take their own decision to shift. This may cause a run on these entities. Such runs can be managed smoothly to match liquidation of assets to meet the liabilities. It may not be necessary to adopt such an aggressive program as given above; only the Govt. may be prepared so that the vested interest sections can give up their efforts to sabotage the process of Govt.’s exit from ownership of financial entities. Also, many of the Govt. owned entities have basically eroded their viability and relevance: some may require immediate closing down operation, while others may transform through splits and mergers. Many nationalized banks and financial entities could do well to split themselves into performing asset and non-performing asset parts and then merge the performing assets parts into one and the non-performing parts into one Asset Reconstruction Company.

13. What happens to food credit? The principles remain the same. The minimum buffer stock remains with Govt. and funded by Govt. The excess stocks are to be carried by the private sector trade to the extent they want and are able to carry with their own funds and to the extent the financial markets allow them to raise money based on their prospects and credit rating. What happens to Govt.’s borrowing programs? Private sector banks will buy Govt. paper as much as they can in the market at market prices. Shortfall in fresh Govt. borrowings can be met by Govt. with new money. Moreover, the interest rates on bank savings deposit and postal deposits will get completely deregulated and safety/return assurance withdrawn and interest on provident funds linked to the earnings rate of provident fund investments. The efforts at encouraging households to directly own Govt. bonds will succeed and compensate for the lower mobilization from postal deposits and national small savings scheme. Merely because small savings are shared, they need not be continued. Govt. borrowings remain the same irrespective of the form: security/bond or deposit certificate.Realization from sale of securities through post offices can also be shared. It may be observed that under the new scenario, interest rates on deposits may vary from bank to bank and day to day. This will enable integration of the ‘deposits’ market and the secondary market for financial assets including Govt. bonds and treasury bills.

14. What happens to cooperative banks? Their ownership may continue to remain with their members, except that Government involvement will end both
in terms of ownership and management. The cooperative banks will be subject to same regulatory framework as the commercial banks. In case they so desire or face bankruptcy, they can be closed down or taken over by other commercial banks. The reorganization of all development banks at state, regional and all-India levels will take place based on the same principles of competitive markets. They have to participate in the financial markets without subsidies and without Govt.-ownership and also have to comply with the same regulatory regime for the commercial/universal banks and non-banking financial intermediaries. If the Governments wish to allocate resources to any commercial activity, they can do so through their own organizations that do not raise any resources in the market through issue of securities or deposit certificates.

15. In future, no participant in the financial markets can afford to expand without commensurate increase in its own capital in compliance with capital adequacy norms. Also, if risks of default or market risks actually materialize to the extent that provisions or losses to be borne bring capital adequacy below minimum prescribed levels, fresh capital has to be arranged to even maintain the same business levels. This implies that those financial services firms, which are unlikely to be able to make and plough back sufficient profits and/or attract fresh equity capital, will be always under pressure to close down. Or, they may be taken over by stronger financial service firms which are capable of mobilizing adequate shareholder funds, provided the former have some value in terms of organizational, human, brand and financial assets. The financial sector entities will be able to run businesses with lower shareholders’ funds than most real sector business firms, but the shareholder fund requirement for the former will be much higher than in the past. This will be in the interest of the depositors, lenders, bondholders and insurance policyholders of financial sector firms as well as the safety of the financial system. The question arises who will bring in increasing amounts of shareholders funds to enable the financial markets to deal with growing amounts of savings, investments and financial assets that have to be dealt with by the financial sector. The 10th Five- year Plan projects sharp increases in savings, investment and gross capital formation rates. To support this the financial markets will require substantial increase in shareholder funds. The Govt. is going to exit from the business of owning business firms in the real and financial sectors. The Indian investor is generally reluctant to take large fresh equity position in financial sector. Then, from where does the financial sector raise the required fresh equity? This issue can be addressed provided one is certain that India is really committed to complete structural reforms, allow competitive markets to flourish and ensure withdrawal of Govt. from commercial businesses.

16. What does all this imply for the common savers and investors? They are no more assured of return or safety. They can choose absolutely safe but low return
instruments issued by the Govt. or high return, high risk other instruments or any combination of different instruments with varying risk-return profile. The notion that a saver is the most important individual in the society will no longer be valid. The importance of the saver and the value of the savings will vary over time depending on the market forces of demand and supply in the financial asset markets. A saver who happens to be retired and relatively poor may draw sympathy of the society to draw some assistance as a poor senior citizen. Whether to save, how much to save and in what instruments to save for post-retirement life are a matter of individual preference and choice. The society may encourage such savings by offering tax deferral benefits but cannot assure any return or safety that guarantees comfortable post-retirement life.
If the per capita income grows and the economy is able to sustain growth, if the productivity of capital and employment grows and if the Govt. can be effective in macro-economic stabilization policies, the retired will be able to generate adequate income from past savings to live a comfortable life. If the individuals did not manage the country’s economy and his consumption and savings habits well during the long period of their active employment, they cannot demand a comfortable post-retirement life from the society. However, a competitive financial asset market will offer lot of choice to the savers. The banks, NBFCs, Mutual funds, insurance companies and pension funds will compete fiercely to serve the interests of the savers so long as the savers are actively monitoring the performance of these entities. The mutual funds and pension funds will thrive as the financial sector turns itself into an efficient, liquid, integrated and competitive market for financial assets and related financial services. asset markets get more

The Planned Economy Financial Asset Market Model
4. The UTI experiment was an integral part of the efforts at developing a financial sector/system that would enable the State to exert the maximum control over the flow of savings and investment. It was not merely a coincidence that the Industrial Development Bank of (IDBI) was set up as the apex development bank, wholly-owned by Govt. of India through another Act of Parliament in the year 1964. Soon, the nationalization of all the large banks was to follow in 1969 (after a brief period of social control on banks). In 1971, the Industrial Reconstruction Corporation of India was set up with equity contribution from public sector banks and institutions to finance sick industrial units. With out these measures, the State would have difficulty in continuing with the regime of development planning.
5. The financial asset markets in the prevailing Indian economic regime had to be under total control of the State. Correspondingly, financial asset price determination had to be largely an arbitrary, administrative process. True, the stock market prices were not State-controlled. But the administrative price determination in all other parts of the financial sector (including controls on capital issues and dividend rates) could leave only traders and brokers to play up and down the equity share prices in the stock exchanges. This would be considered as a problem of excessive speculation to be controlled through administrative measures and whenever necessary by booking offenders through investigation. With the overwhelming dominance of the Public Sector corporations/companies in India’s planned mixed-economy system, only a few large, growing private sector companies listed on the stock exchanges could have been expected to have low gearing and large floating stocks. Rather, most large private sector companies were expected to depend on public sector financial institutions and banks for raising funds. Also, forward trading would have been banned.
6. Indian development planning theories and models were not required to explicitly address the issue of how the financial assets acquired by UTI (and nationalized insurance companies) would be valued in the market. These theories had apparently assumed that there could not be any failure of investment under India’s development planning regime. The State-determined interest rates would automatically help determine the values of bonds and preference shares in the absence of default risk (assumption of nil or negligible proportion of assets turning bad). As for pricing of equity share, development planning theory in India had to stop short of devising a method of administratively fixing the daily prices of shares in the stock markets, though most prices (including prices of other financial instruments) were determined administratively by the State. As explained in the previous paragraph, it was only an issue of curbing excessive speculation through legal and administrative measures over share trading and share-brokerage activity. Therefore, it had never been clear as to how a State-sponsored institution like UTI could have been expected to contribute to the development of a vibrant, liquid market for debt, equity and hybrid securities issued by companies, leave alone synthetic and derivative securities. UTI could only have mobilized and channeled savings into investment in productive economic activities of the companies.
Major Achievements
The great strides that the IMFI achieved since 1992-93 may be appreciated by the following:

(b) The number of MFs increased from 9 in 1992 to 34 in 2002.

(c) The number of schemes managed by the MFs increased from 100 in 1992 to over 400 in 2002.
(d) There is a much greater variety of schemes (and options) for investors to choose from.
(e) The new entrants (since 1993) now manage about the same amount of assets as the old players including UTI.
(f) Foreign ownership of Asset Management Companies (AMCs) managing the Mutual Fund schemes is substantial: 18 out of the 34 players have foreign equity collaboration.
(g) Open-end schemes (the true mutual fund schemes) account for 75% of the total number of schemes and about 70% of the total assets managed by IMFI.
(h) The regulatory framework has improved since 1993 in phases and currently reflects the best standards of transparency, investor-friendliness and use of modern technology.
(i) IMFI has already seen exit of inefficient units through takeovers/buyouts of AMCs.
(j) Development of Fund Accounting and Investor Service as ancillary to Asset Management Business.
(k) Greater awareness among the investors about the concept and nature of mutual funds as compared to 1992: also, a recognition that MF investing is associated with varying levels of risk and not an assured return, absolutely safe proposition.
The Opportunity Lost

16. Notwithstanding these achievements, IMFM and IFMI are still in the nascent stage of development and lost a great opportunity of development during the last ten years as the following would reveal:
(a) The market value of assets managed by IMFI in 2002 is merely twice the asset size 10 years ago while bank deposits have grown at a higher rate during the same period.
(b) The asset size of IMFI more than doubled (absolute increase of Rs350 billion) during the four year period to 1994-95 as compared with an increase of 33%(absolute increase of Rs250 billion) during the seven year period to 2001-02.
(c) The share of mutual fund units in household financial savings continue to remain low (average of 7% during the four year period to 1992-93, average of about 5% during the six year period to 1994-95 and average of less than 2.5% during the seven-year period to 2000-01).
(d) The strangulation of UTI as a manager of pooled-investment vehicles implied a corresponding wastage/loss of infrastructure, image and goodwill and expertise built up over decades. UTI’s market share was anticipated to go down with competition, but the absolute decline in its size and now inevitable liquidation is a sad commentary on the development of IMFI during the last decade.
(e) Even as UTI has declined in size, the rest of the industry reflects a weak and unbalanced structure: none of the AMCs have yet been able to reach the asset size of Rs80 billion and 18 out of the 34 AMCs are below the asset size of Rs10 billion.

(f) Most AMCs have very little penetration among investors in semi-urban and rural areas,
(g) The level of transparency regarding the financial strength of AMCs and their sponsors remains inadequate to attract investors.
The Impact of Reform Inadequacies
17. That the IMFI has hardly made progress enough to increase its significance in the Indian economy and its financial sector is not surprising. The pace and manner of reforming the economy contributed to increasing the risks and lowered the risk-adjusted returns from pooled-investment vehicles that MFs represent. In the real sector, the economic reforms and macro-economic management since the 1990s have not been very conducive for sustained growth of MF industry. True, substantial reforms have taken place in the real sector. But, inordinate delays in and/or ad-hoc phasing of and/or ill-designed scheme of liberalization/reform measure in many areas (like power, transport, telecom, small-scale reservation, labour, education) have either reduced the generation of investment opportunities or increased the risks of investment. This, in turn, adversely affected the growth of tradable financial assets for acquisition and trading by MFs. In the financial sector, reforms in pension funds, insurance and development financial institutions have been delayed and as yet incomplete. The development of the secondary market for debt securities is still limited to Govt. securities. The emphasis throughout appears to have been on retaining, as much as possible, the State’s existing control/influence over the financial sector and keeping the interest rates downward sticky irrespective of the return on investments generated in the economy and the attractiveness of future investments. Even after a decade of reforms, the level and structure of interest rates are still not fully determined in the market. The rates of interest on savings bank deposits, postal deposits, small savings and provident funds continue to be fixed arbitrarily by the State. The public sector companies whose shares have been listed in the market are still not run on fully commercial basis by professional management given the continued interference by the State as the dominant shareholder. The market for risk hedging instruments (derivatives) could not be introduced until recently. All this stood in the way of the market determining the prices of financial assets with which mutual funds form their portfolio of investments.
18. The manner in which reforms were delayed or introduced in arbitrary phases gave rise to avoidable uncertainty and increased the risk of investment in financial assets by MF managers. US64 intended to invest part of its funds in securities traded in advanced markets to bring the benefits of risk diversification and better returns as early as in 1993-94/1994-95. But this was not allowed and MF investors had to burn their fingers by assuming only the Indian equity market risk that was high. UTI started thinking of forming a sponsor company for UTI and other financial sector entity as early as in 1992-93. This was not encouraged. In 1993-94, UTI proposed for its restructuring so that it can reposition itself with two entities: one dealing with non-banking development finance under RBI regulations and another for mutual fund operations under the regulatory framework of SEBI. This was not accepted. Again, in 1996, UTI proposed its restructuring to make it consistent with the evolving MF regulatory regime. UTI Act was not changed at that time to give effect to UTI’s proposal. In 2002, it is too late to undo the damage caused to the country and IMFM by the neglect of UTI-reform issue over a decade. The first MF regulatory Guidelines issued by SEBI in 1993 was ill conceived. Over the years, the Association of Mutual Fund Industry struggled hard to persuade SEBI to modify them. Again in 1996, SEBI allowed the introduction of assured return schemes based on appropriate guarantees and without reference to stress testing of portfolio asset allocation. This would subsequently cause a major problem to UTI. Thus, lack of reforms, ill-designed reforms and lack of reforms had adversely affected the development of the MF industry for most part of the 1990s.

Face of Indian Business (2005)

2009-07-31T11:02:00.003-07:00

Stronger Mind and Competence Shine on Business Face
Dr. Basudeb Sen
(Apperared in Diwali 2005 Annual issue of Vyapar, Mumbai)

The face of Indian business entities has significantly changed in terms of various features in the last 10-15 years and will likely to change for quite some time in the future. Overall, the face has become brighter, glowing and livelier. If we compare the faces of Indian business during the 1970- 1990 period, prior t economic reforms, during the initial period of economic reforms and during the last five years, the remarkable and progressive facial changes become noticeable.

Transition from Slavery
2. Prior to 1990s, the face of Indian business reflected complete slavery to the State and the Government. The major part of large Indian businesses in the manufacturing, mining, utilities (energy, communications, etc), trading, transport and banking and finance were the State-owned public sector undertakings whose boards were nothing but committees to take decisions as directed by the State/ Government and implement them. Their executives and employees were the captive servants of the Ministries. The business decisions of these large businesses, whether in respect of business strategy, diversification, expansion, product mix, pricing, distribution, procurement, organizational structure, recruitment, wages, labour policy – virtually all aspects of business, were determined largely outside the companies. Agriculture and related activities were outside the scope of business. The large private sector businesses, whether foreign owned or owned by resident Indians enjoyed some freedom of business decisions, but had to serve the directives of the State/ Government on creation of capacity, pricing and distribution in each area of business they were allowed by the State/ Government to operate. The smaller businesses in manufacturing, trading and other services had the opportunity to lobby and obtain various concessions from the State/ Government and operate largely as ancillaries to large public sector or public sector businesses or the State ministries. The face of the Indian businesses and the people associated (owners, directors, executives and employees) reflected this environment of serfdom to the political rulers and their administrators. Their faced reflected the reality that they had little scope for cultivating their aptitude of initiative, entrepreneurial risk taking, innovation, application of intellect, designing and implementing competitive business strategies. Their life styles and attire also reflected the boredom of the main business function, i.e., keeping the masters in good humuor, carry out the masters’ orders, fulfill their wishes and beg for favours from the masters.

3. For a while during the initial years of economic reforms, faces for some businesses started glowing in the belief that the period of serfdom was over and economic freedom had arrived. Soon most businesses realized that serfdom continued and will diminish in phases at the pleasure of their reluctantly reforming ruler-masters over a long period of time in the future. But most businesses realized that while the extent of slavery will progressively diminish and the scope of business areas will expand, they will also lose the Ruler-Masters’ protective shield against competition among themselves, competition with foreign businesses and the whims and fancies of Indian consumers who were simultaneously being freed from the regime of imposition of the ruler-masters’ tastes and preferences on what goods and services of what quality can be bought at what prices. Most business faces turned dim, reflecting anger against the State, their alleged foreign advisors and superior competitors within and potential foreign competitors. The sullen faces were visible all across among owners, directors, executives, and employees. With declining sales volume and declining margins in a competitive market they could no longer service their high debt or shareholders. No longer could a business in default paying dues to the creditors and survive in business; loans could only be renegotiated only on the basis of credible and viable time-bound programmes for making large and upfront sacrifices as well as committing to taking pains to drastically cut costs and inefficiencies as well as significantly raise productivity and improve output quality.

4. At long last the day of reckoning for the organized sector management and labour had come: they had to serve and satisfy the Indian and foreign customers directly and through the patronage of the Government. Otherwise, the owners of businesses would get replaced; the managers and workers will lose their jobs. The industrial license, the loans from government owned banks and financial institutions and registration with the Board for Industrial & Financial Reconstruction were no longer a guarantee to continuity. The existence of names on the pay rolls of a company, even if the company is in the public sector, and membership of a trade union was no longer a guarantee for receipt of wages and salaries. Clearly this was unacceptable to those who are affected. Their faces reflected those of prisoners of wars from the losers or the faces of patients suddenly afflicted by deep depression and high stress due to fear. Initially, they did try lobbying for government protection, appealed for slowing down the pace of economic reforms. But the ruler-masters could not stop the process of reforms or slow it down for their oppressive regime could not be sustained. Only continuing economic reforms could help the political and allied ruler-masters survive. There was no way they could protect incompetent, inefficient, uncompetitive businesses to survive. The only option available to the entrepreneurs, directors, managers, executives and employees was either to exit (to withdraw, voluntarily retire) or to change the way they operate and continuously enhance their competitiveness. Hospitalisation at government cost was no longer going to be available. The writing on the wall was clear: change or perish.

Successes in Transformation
5. Those who did not want to change for resisted change had to perish soon. We do not see their faces any longer. But more and more of Indian businesses slowly started facing the reality: they changed and are continuously changing since the late nineties of the last century. As a result, Indian businesses today reflect faces that are glowing, brimming with confidence backed by achievements and successes gained through application of intellect and hard work. They reflect faces of teams who have won wars, batters and competitions, faces of people who are willing and confident to face challenges of uncertainty and risk with their dynamism, faces of people who are creativity oriented, who do not believe in governmental guarantees. The Indian business faces today reflect those who have no baggage of the past, who established their credentials globally, who are prepared to take risks and manage the risks with responsibility, who do not depend on the State or the Government or the glory of their forefathers but on their own strength both inherited from the past and acquired on their own. At last we are seeing the faces of truly born-free who were not kept in captivity of the State and the Government. This is what it should be. More than 70% of Indians are those who were born after 1970 and their numbers are growing every year. True, many of them did not get the opportunities of getting educated. But those who got educated and also the exposure to television, electricity, information technology, multinational tourists, traveling foreign businessmen and global brands, are the emerging foundations of today’s businesses across industries, trade, commerce, transport, services, agriculture, media and the government. They do not have the inhibitions of those who lived under British rule: nor can they be influenced by the fears of parents with direct experience of natives of a foreign colony. Their faces do not reflect any worries, fears. This generation also includes many who worked for about a decade away from India in stranger locations with foreign colleagues, meeting expectations of international customers and employers. The faces of these managers and workers reflect the urge to face challenges and meet the unknown and explore. All this is what is reflected in the changing face of Indian Business.

6. How has this sea change of Indian Business taken place in such a short period of just a decade or so? This is not merely a demographic change or Government/ State intervention. Nor was this part of a plan implemented well. This has come about through hard, painstaking work by millions of Indians; mostly young who were willing to look at liberalization, privatization and globalisation as an opportunity to forge ahead for each one of them and for the country. Of course, they were led by a few from their previous generation who had, for a major part of their career, suffered the pains of managing business under an environment of slavery to the State/ government. But such leaders were few. The previous generations mostly opposed this emergence of freedom, tried to raise doubts about economic liberalization and instill a fear among the young. The younger generations with few leaders from the previous generations took the initiative to build the future for them and the Indian business with courage and confidence irrespective of the way the State would move on economic reforms. That was lot of hard work. And, this work has rewarded them with much stronger minds and substantially greater competencies. The enhanced strength of mind and competence is what is now reflected in the face of Indian Business.

Even PSU Laggards Change
7. It may be worthwhile getting into some detail of this process of building a stronger mind and competence by Indian businesses during the last 15 years or so. Let us take the public sector first, given all the hurdles and limitations. Among the public sector units (PSU) listed on the stock exchanges, some companies have responded well to the requirements of corporate governance of listed companies. While the newspaper may headline a personal conflict between the Chairman of a very successful and important PSU and some government secretaries, it takes courage of conviction and strong belief in liberalization to inform the common shareholders and the public at large that absolute slavery to the instructions of officials of the Government as a majority shareholder is not for which such PSUs exist today. This reflects a new face of the PSU organisations that can force a change. Earlier, the pro-liberalisation part of the Government sensibly avoided the possible embarrassment of a successful Chairman and Managing Director of a board-managed bank quitting at the suggestion of a PSU-shareholder of the same bank that the former gets his new term only as managing director, leaving the Chairman position to the shareholder-PSU. The managements of both the organizations that resisted the abuse of State power in the emerging corporate governance milieu reflect a new face of a part of Indian business – this was not possible a decade ago. These organizations have considerably enhanced their efficiencies, innovative capacity and leadership quality to improve their market standing and bottom-line. True, the new pricing policies for oil and gas helped but the subsidies on petrol, diesel, kerosene and LPG is still borne by them at the dictates of the State because of political and fiscal compulsions. Some PSUs that have gone abroad and set up companies have leadership alive to multicultural settings. The face of Indian Airlines on the ground and in the air has also changed, though the airline is still way behind many of the private airline employees’ customer care skills. At least, the realization seems to have dawned that the future of Indian Airlines employees does not depend on how the Government or the politicians like them, but on how the air travelers like them.

8. Not all PSU banks, but some have not only weathered the Tsunami arising out of sudden change from the government dictated policy of taking exposures in non-performing sick industrial units to taking hit on the bottom-lines by providing adequately against non-performing assets, but also has also eased out large number of surplus manpower through voluntary retirement schemes, successfully reorganized their organization structures and adopted new technologies to compete with the private sector. The pro-liberalisation section of the PSU bank employees show a much brighter, smiling and courteous face than their former colleagues a decade ago when their banks’ balance sheets were bleeding under the impact of new rules of recognizing non-performing assets, when the entire PSU banker community was being painted as the creators of non-performing assets and when the depositors and prime borrowers were flocking to the tech-savvy, customer friendly new private sector banks that were being set up. Not all PSU banks are yet in the pink of health, but most of them are healthy and looks vibrant. They may not be still as competitive as some of the new generation private sector banks; still customers are treated at many of their branches as unwanted visitors. But they are on a path of new surge. This is the new face of banking business in the public sector.

Large Private Sector Forges Ahead
9. Now, consider the private sector businesses. First, those that were hard hit by economic reforms, exchange rate changes and global market developments. We have the new private sector integrated steel plants set up in the early 1990s. Virtually all of them weathered the storm, given the state-of the-art efficient plants they had installed, thanks to their efforts at cost control, productivity improvement and financial liabilities restructuring. The face of the steel sector business management now appear more lively given the enhanced strength of minds and competence as well the higher level of confidence following their success in dealing with wide fluctuations in product and input markets. The same is true of many other businesses that had to take similar efforts besides efforts at rationalization, mergers, de-mergers and acquisitions. The numerous success stories of the private sector rejuvenation of many businesses during the last twelve years or so mark a stark contrast to the largely unsuccessful efforts of the State/ government for dealing with industrial sickness and revival through BIFR and other routes over the previous decades. These businesses include down-stream steel making, metallurgical coke, different engineering industries including transport equipment like automobiles, chemicals, fertilizers, cement, paper, pharmaceuticals and host of traditional industries in India. True, many industrial units closed down and many of their employees lost jobs, as was expected. But those that survived have come out stronger. And, many of them in these traditional private sector industries have used their internal surpluses and external finances to acquire, expand, up-grade technology, creating fresh employment. Indian business leaders and employees have achieved what they could not have imagined under the pre-liberalisation days. Talented managers and employees have moved to/ stayed with employers who started placing greater values on the farmer’s skills, competence and initiative rather than considering all managers and employees as equal. Managers and employees agreed to take a wage cut if they failed to a customer’s quality needs. The urge for raising productivity led to removing the mind-set of nameplate plant capacity: production from the same plant continuously increased. Some businesses expanded their operations overseas. We now have Indian manufacturers of metallurgical coke acquiring coalmines abroad. Some Indian pharmaceuticals now meet a large part of the international demand for certain generics. A few consumer durable producers are taking over plants abroad to meet international demand. Despite stiff competition within and from abroad, the Indian producers of various consumer goods and consumer durables (including TV sets, music systems, refrigerators, household electrical/ electronic appliances/fixtures, packaged foods to name only a few) have shown vibrant activity. Indian producers have significantly up-graded their price, quality, product variety, servicing-support and distribution capability. The managements of these businesses have shown flexibility and agility to the opportunity created by economic reforms - the rapid expansion of the market size of these products due to the rise new class of younger and high, performance-linked salary earners in knowledge, high-technology, retailing, financial services, media and entertainment, construction and real estate industries/sectors. All this success gets reflected in the face of Indian business.

SME sector also excels
10. The numerous small and medium scale businesses also witnessed a continuous struggle to innovate improve and upgrade. While many old establishments fell on the way, many others survived and expanded in the same environment of intense competition and more cautious bankers. Many new entrepreneurs have entered to face the challenges of uncertain, competitive markets and succeeded in establishing them. At the same time, the nature of small and medium scale business have expanded beyond the traditional manufacturing and servicing activities like down-stream steel processing, engineering and fabrication, auto-repairing and servicing, house construction, office supplies, bakeries, confectionery, textiles and textile processing, electrical appliances and fittings, building materials, printing and publishing, chemicals, leather and leather goods, goods transport, office equipment manufacturing and supplies, retail shops and restaurants, cinema halls and theatres, warehousing. While many of these businesses have expanded and many have undergone technological up-gradation, completely new businesses have also emerged and grown rapidly. Today, we have thousands of new entrepreneurs running small businesses that were not even imagined as probable businesses a decade ago. These businesses have as outsourcing within the country has progressed rapidly and retail demand has expanded fast (partly due to population growth and primarily due to higher purchasing power). Large number of new entrants to the labour market has been absorbed by small and medium businesses, to name a few, computer/ mobile repair and servicing, payment of household bills for electricity and telephones, home-delivery (of cooked food, grocery items, medicines, vegetables, etc) service, courier services, money exchange and transfer, air-ticketing services, telemarketing, direct sales agent network, website design and hosting, e-learning, risk-management consulting, accounting and audit services, regulatory compliance assistance services, beauty parlors, advertisement collection services for newspapers, mineral water bottling and distribution, event management, car rental services, household and office security services, club facility services, tourism services. There are numerous such businesses doing well in metropolitan and urban areas. The successes the entrepreneurs, managers and employees of these small and medium scale businesses have contributed to the brightening up of the face of Indian business.

Freedom Fuels Emerging Businesses
11. The new industries that reforms gave birth or significant impetus to, have also achieved remarkable successes. The information technology, telecommunications, Internet, entertainment and housing and infrastructure (road, port, bridge, office building, shopping mall) construction sector have seen rapid progress in scale, diversity and quality. The service sector has seen a virtual explosion. The private sector banking has led the way in introducing technology-driven, user-friendly and customer-relationship-based products that have changed the urban and semi-urban life-styles. The mobile and Internet service providers have done the same thing. And they have tied up with banks to broaden the product basket and lift the quality of service. Using the Internet, information and communication technologies some big businesses like ITC Ltd (e-choupals, social forestry) is already impacting a part of India’s agricultural activities in such a way that fresh efficiency gains and growth impulses are created for the farmers and consumer goods producers, and the same time creating efficient, low cost infrastructure for industrial products and financial services including insurance to be reached to rural areas. All this shows a great and broad-based revolution in business dynamism in just the last decade, a revolution that eluded India over successive decades of State that India could not achieve for fifty years since Independence. The confidence that this revolution has imparted to Indian businesses is what gets reflected in the face of Indian businesses today. All this in turn is reflected in the stock markets, with stock market indices soaring (even, allowing for a part of the sharp rise in the indices and the relatively long bull run due to investor exuberance, the stock prices mainly reflect the new found dynamism and strength of Indian businesses. The foreign investment flows continue abated, attracted by the returns that businesses in India are likely to generate. The domestic investors and the business-employees with stock options are also benefited in the process.

A Face Looking Ahead with Optimism
12. The face of Indian business definitely looks bright and smiling after the last decade’s successes against all odds. But the last decade was only the beginning of a long, enduring process of progressively greater dynamism that Indian businesses have to go through to enable Indian business to realize its true potential and in the process lift the standard of living of the country’s poor to decent levels. The face of Indian business looks at the future with optimism and confidence. If the vision is to be a real economic power of global significance, Indian business is continuously assessing the dimensions of challenges lying ahead. It is a great feeling that some foreign analysts expect India to become a super economic power within the next 40 years. But this expectation can only be met through superior performance by Indian businesses in so many spheres of economic activities. The challenges ahead are going to be formidable, implying continuing hard work, agility, up-gradation of competence, innovation and determination in the face of greater uncertainty and global competition in the years ahead. Indian businesses have to be ready for many-fold jumps in scale of operations, significant leaps in technology, massive absorption of foreign investment and rapid extension to foreign markets for both existing and equally importantly new products and services. And, all this has to be achieved in the face of political delays in policy implementation, bureaucratic red tape, shortage of energy and infrastructure facilities, adverse natural and international calamities, and general uncertainties in product and markets as well as advancement of technology. If the goal is to be close the gaps between India on the one hand and China (the top rising star) and the US (the most powerful economy now) on the other, we must at least assess the extent of the gaps to determine the challenges ahead for Indian business.

Assessing the Business Opportunity & Challenge
13. Let us consider first how the future opportunity for Indian businesses compare with those in US and China. In the league tables, India ranks as the 11th largest economy of the World in terms of GDP, while US ranks the 1st and China the 6th. Some experts may feel this nominal GDP is not a proper indicator. So, we may consider the GDP on Purchasing Power Parity (PPP) basis. On that basis, India already ranks as the 4th largest after US, China and Japan. The gap seems so small to be made up. It is really not so. US GDP is 4 times of India’s GDP on PPP basis (20 times on nominal basis). The gap is huge. And, it is awfully huge if we consider that India (also China) does not appear on the lists of top 70 countries in terms of both nominal and PPP basis. US ranks 3rd and 4th while countries like Poland, Chile, Croatia, Malta, Mauritius, Argentina and Taiwan figure in the lists. The gap to be closed/ reduced is quite substantial. Experts may say GDP is not a good indicator. Quality of life is what they think is important. Fine. Compare the manpower in the armed forces. China ranks 1st followed by US and India. China is in the list of countries with the lowest Environment sustainability Index. The ranking of most water polluting centers is as follows: China 1st, US 2nd and India 3rd. The number of birds under threat is the highest in China, while India ranks 6th and US 10th. Better still would be to scan the list of top 60 countries in terms of Quality of Life (measured by Human Development Index). US ranks 8th and UK ranks 15th, while India and China does not figure in this list. US hold 10th and 15th positions in the lists of top 40 countries in terms of economic freedom index and gender-related development index. India and China do not find a place in these two lists. The gap is again huge.

Widespread Growth Opportunity
14. Businessmen, unlike experts in economic development, prefer nominal economic quantities. Let us consider where India is among the top in the league tables. India with the 2nd largest population (28% less than China and three-and a half times the population of US, the 3rd largest) is a major consumer of many commodities. The ranking of India, US and China are as follows: Wheat - China (1), India (2), US (10); Rice: China (1), India (2), US (10); Sugar: India (1), China (3), US (4); Coarse Grains: US (1), China (2), India (5); Tea: India (1), China (2), US (8); Coffee: US (1), China and India not in top 10;Copper: China (1), US (2), India not in top 10; Lead: US (1), China (2), India not in top 10; Zinc: China (1), US (2), India (8); Aluminum: China (1), US (4), India (9); Rubber; China (1), US (2), India (4); Cotton: China (1), India (2), US (4); Oil: US (1), China (2), India (7); Natural Gas: US (1), China and India not in top 10; Coal: China (1), US (2), India (3);Energy: US (1), China (2), India (5). All this looks very impressive. It may look all the more impressive if we also see the list of commodities in which India is a major producer also. India is the third largest producer of cereals after China and US. The ranking in some other items are as follows: Meat: India (6), China (1), US (2); Fruit: China (1), India (2), US (4); Vegetables: China (1), India (2), US (3); Wheat: China (1), India (2), US (4); Rice: China (1), India (2), Us not among the top producers; Sugar: India (2), China (3), US (4); Coarse grains: US (1), China (2); Tea: India (1), China (2); Coffee: India (5); Copper: US (3), China (8); Lead: China (2), US (4); Zinc: China (1), US (5); Aluminum: China (1), US (4), India (9); Gold: US (2), China (4); Rubber: US (2), China (4), India (8); Cotton: China (1), US (2), India (3); Oilseeds: US (1), India (5); Petroleum Oil; US (2), China (5), India not in top 15; Natural Gas: US (2) , China & India not in top 15; Coal: China (1), US (2), India (4); Energy Consumption : US (1), China (2), India (4). It gives great satisfaction that India is in many cases close to US and China in terms of ranks. But the large growth opportunity arises from the fact that in many items of material importance, the absolute gaps are far larger than the gap in ranking would indicate. For example, the US consumes 4 times energy than India’s consumption of energy and the US is still more energy efficient than India (though not the best). The formidable challenge for Indian business is to assure adequate supply of energy to sustain high economic growth and raising the pace of improvement in energy efficiency. Business should not fall into the old trap believing that the State is capable of solving this issue; business will have solve this and similar problems by themselves, perhaps allowing the State to continue to believe that the politicians and bureaucrats are the only people who really solve such problems.

15. These absolute gaps point to the enormity of the challenges ahead for Indian business in the next few decades. Just consider the industrial sector. In terms of Value of Industrial output, India is the 12th largest (and China 3rd largest). But in absolute terms, value of Industrial output of US is 17.5 times that of India and more than 3 times that of China. US have the largest service sector output. China ranks 8th and India 15th. US service sector output is more than 25 times that of India and 14 times that of China. In the list of largest exporters, US tops the list (13.59% of world exports) while China (4.13%) ranks 7th and India (0.88%) ranks 29th. In the last decade, Indian businesses have made remarkable progress in information technology, media and entertainment markets. But consider the huge gaps. In terms of Colour TV Ownership, the US ranks 2nd while China and India do not find place among the top 50. US have the 16th largest CD Player market, while China and India are not among the top 29 markets. In Compute, US ranks 2nd, but China and India are not among the top 37. In Internet usage, US tops 1st, China and India not among the top 23. Ranking in terms of book sales, US top the list, China ranks 6th and India 13th, But the market size of books in US is nearly 40 times that of India’s or 10 times that of China. The US rank 15th in terms of circulation of daily newspapers but China and India do not find place among the top 30 country markets. In terms of music sales, US rank 1st and China 19th while India does not belong to the top 22 markets.

Gaps in Labour Quality and Infrastructure
16. To close these huge gaps with US and China, India will also need to close the gaps in labour force participation and quality as also in various infrastructure areas. In terms of percentage of population in labour force, China ranks 1st (57.8%) and US 25th (49%) while India is not in the list of top 40 countries. India is among the 20 least literate countries. China and India do not find place in the top 50 countries in terms of Life Expectancy, while US ranks 37th (77.1 years). In terms of availability of hospital beds US ranks 47th and China 51st, while India is not among top 58. Telecommunications has witnessed an explosion in India in the last decade. Yet, in terms of telephone lines, US are the 11th largest but China and India do not figure in list of top 44. US has the largest road network, followed by India with half of the size of US road network and China ranks 4th. Naturally, US have a higher car ownership with a rank of 12, while India and China does not figure in top 50 but are among the lowest 32. Imagine the gap to be closed in terms of airports and aircrafts. In terms of air travel, US ranks 1st, China 4th and India 23rd but India’s air travel is only about 2% of US. The longest Rail Network is in the US, India ranks 3rd and China 5th. . But US rail network is 4 times longer than India’s. India handles the 4th largest Rail Freight and China 3rd largest, India 4th, while US handles the largest rail freight that is 7 times larger than India. The ranking in terms of Merchant Shipping Fleet is US 3rd, China 5th and India 22nd. In terms of tourist arrivals, US ranks 3rd and China 5th while India is not even in top 40. US is the biggest Tourist Spender and China 9th largest, India is not among the top 20. All this indicates the potential for Indian business.

Business Vision for Realizing the Potential
17. A business face that does not have a vision comparable to the opportunity is destined to remain small. In global market environment, Indian business will definitely endeavour successfully to spread their wings abroad. But that is too narrow a vision for India to become a super economic power. Today, the three largest business corporations in the world are Americans. None of the top 44 business corporations of the world are Chinese or Indian, but 18 of them are American. Of the 45 largest banks in the World, none is an Indian but 9 are American (including the top 2) and 2 are Chinese (25th & 37th ranks). While most Indian businesses may have a vision to be the largest in certain narrow field of a business like a single product or a specialized field of software service or even a broad range of products, there must be at least a few Indian business corporations whose 5 / 10 year vision should be to get into the list of top 25 or top 50 largest business corporations in the world in terms of worldwide sales. Some Indian businesses should not only have significant share of global sales but should be able to establish a global brand that is among the top 50/ 100. It would be silly to suggest that such visions are nothing but wishful thinking, for many of the top 100 largest business corporations and global brands are corporations or brands that have achieved their present status from a small beginning in the last 15 to 30 years. Such big visions are necessary. Visions attract resources and talents to them to convert them into reality. And, when visions are great enough to attract resources and talents to work on them, global competitiveness increases, businesses environment improves and innovations multiply fast. Indian business has to close large gaps here. In terms of Global competitiveness Index, India ranks 30th far behind China (22nd) and US (1st). Ranking in terms of business environment for 2004 – 2008 was US 4th, China 38th and India 40th. India and China do not find place in list of top 44 countries in terms of Innovation Index and Information and Communication Technology Index, while us ranks 1st and 5th. In Business Software Piracy, India ranks 15th (China 2nd). India has to get out of this list. India has also to get in to the list of 30 least corrupt countries. Theft and corruption does not really pay, except for a short while, either for businesses or for nations. The vision of Indian business firms has to take this into account. Business is as much about accepting the challenge of exploiting opportunities and dealing with threats in the environment as about changing the environment for the advancement of the society. If businesses have to prosper, they need to create an environment where talents thrive and competition allocates resources and people according to their best productive use. If India has to be really a super economic power, she needs an environment in which not only businesses can thrive but also makes a society breed talents that win Nobel prizes (India and China do not figure among the top 5 countries in terms of Noble Prizes won in any discipline while US ranks 1st or 2nd) and Olympic medals (US ranks 1st. and China ranks 12th but India is not among the top 20).

Business Face of the Future
18. How will the face of Indian business change over the next decade? The two dominating features of the change are likely to be (a) a strong desire to go beyond reaching international benchmarks and set new international standards, (b) a greater willingness to directly establish strong economic links with the poor, with the consumers, with the labour, with the shareholders, with he students, with talents in all spheres of Indian life so that the business of making money through the use of citizen’s freedom-restricting power of the State becomes unviable. This will imply that Indian businesses will use the available market mechanism and openness of the economy to beat the politicians, bureaucracy and pro-interventionist policy advisers off their feet. The emerging business objectives will therefore be a large step up in investments in capacity expansion, diversification and acquisitions both in India and abroad, using as much as possible of the internal cash generation and simultaneously raising funds from the banks and capital markets within the country as well as abroad. The rapidity with which the economic and constitutional freedoms already available are used will determine the rate at which the State and the politicians will be forced to legislate greater economic freedom and de-legislate freedom-restricting laws that constrain India’s ability to achieve progressively higher economic prosperity. This would mean large deployment of business money and resources in education, health services, infrastructure and agriculture to make the National Employment Guarantee Scheme redundant. This would also mean a large step up of investments abroad and shift a significant part of India’s technical and managerial resources all over the world, thus forcing the State to re-orient its foreign policy towards protecting Indian’s economic interests abroad rather than getting busy in approving proposals for foreign investment abroad. For example, India can have at least five privately built and managed domestic-cum-international airports at metro-cities for exclusive use by Indian businesses, foreign businesses and tourists to compete with the State-owned Airports Authority of India (AAI). This will stop the existing 30,000 strong AAI employees from risking their future by going on strike at the expense of millions of passengers and others associated with air travel business. Thus, the face of Indian business is likely to emerge not merely more confident in domestic expansion mode but also more ambitious in establishing globally-spread operations and global brands (winning cricket test series on domestic as well as foreign turf). Simultaneously, Indian business face will seek to surpass the political parties and government administration in popularity among common citizens (like cricketers being more popular than referees, coaches, selectors and cricket administrators).