Archive for August, 2007

GDP estimate Q1: 2007-08

August 31, 2007

The newswires and business news channels are buzzing with the fact that our GDP for Q1 2007-08, has grown by a neat 9.3%. The press release and details from CSO is here. Some details:

Sector-wise

  • Last year Q1 growth was seen at 9.6%.
  • The surprise part is agriculture which has grown by 3.8% higher than 2.8% seen Q1 last year. Considering the fact that data is for Apr-Jun , which includes only the rabi crop, this growth is welcome.
  • Manufacturing, Construction, Hotel Services and Financial Services have grown at double digit growth rates around 10-12%

Expenditure-wise

  • As I had mentioned earlier, CSO has also started giving GDP data based on expenditure as well. Indian growth story has been consumption driven and economists had raised their concern that it needs to more investment driven.
  • The data based on expenditure helps understanding this aspect. In the earlier data we had  seen this was indeed the case and Consumption (Private Final Consumption Exp.) is about 55-60% of GDP for most of 2005-07. 
  • If one looks at the previous data closely one finds that consumption is usually the highest in Q1 and then goes down over the next quarters.
  • As this is Q1, we can’t say whether the consumption is indeed going down or not. However, in both 2005-06 and 2006-07 the figure was 60% and in Q12007-08 it is 58%.
  • Another +ve is that investment as a % of GDP is higher at 29.6% compared to 27.9% in Q1 2006-07.
  • Impact of rupee appreciation can be seen as exports have gone down and imports have gone up.

Things are still looking pretty good at the moment. As sub-prime meltdown was mostly post June, it will be interesting to see the next quarter figures to see if there is any kind of impact of sub-prime markets. Keep posted for further developments.

Assorted Links

August 31, 2007

1. Another primer from WSJ Blog. This time on Fed rate cut.

2. PSD Blog points to what new World Bank Preseident Bob Zoellick intends to do.

3. Today’s newspapers mention about RBI’s Annual Report. Here it is.

4. TCA in his Friday column, points to a paper from Prof Dilip Nachane.

5. BS has a nice edit on Indian Political Economy scenario.

Deepak Parekh Report on Infrastructure Financing

August 30, 2007

I have mentioned about this report many times in my blog. The newspapers continue to make a mention of the aspects of the report. Despite so many discussions in public domain, the report could not be found anywhere ( I make a note of the same here and here. I tried various govt. websites but could not locate the report. This was quite irritating. I could see in my Blog Stats, many people had come to the blog hoping to get a link to the report.  

Finally, I found the report. The report is put on a website (PPPIndia) floated by Infrastructure Division, Dept. of Eco Affairs, under Ministry of Finance (FinMin), India. On FinMin website, there is a seperate link for the Infra division but there is no mention of the PPPIndia website.

I had visited the PPPIndia website earlier and found the committee was formed by the above division. After visiting the website after a longtime I found the report.

I think Finance Ministry’s website should have atleast provided a link to the report. The report is pretty important and Finance Minister P.Chidambaram has mentioned of it in his Budget Speech this year.  

It would have been much easier to locate the report. I am not sure, how many knew the report is out in public domain. Even on the PPPIndia website it is not mentioned anywhere on the homepage and once has to go to a link named Policy & Procedures to find the report. When there is link called financing shouldn’t it have been there as well?

Anyways, go through the report now, as it should have some new ideas on financing the huge infrastructure deficit. Let me go through it and see if I can comment on the same.

Assorted Links

August 30, 2007

1. WSJ Blog as usual has some excellent posts. It points to a new research paper which says yield curve is a good predictor of recession. Another one points to the text of letter by Bernanke to Senator Schumer explaining Fed’s response to financial markets turmoil. Another one on US inequality. Finally, read the entire assorted section.

2. Willaim Buitler’s blog is getting quite popular for its super ideas. One should read all the posts especially his ideas on Central Bank as a market maker. He has put his idea in 4 posts.

3. Rodrik has 2 posts. One is Arvind Subramanian’s response to aid. However, it is the second one, which caught my eye:

Suppose a large trading nation is found to export huge quantities of products which have not been subject to proper regulatory oversight at home and create important risks for the buyers. And suppose further that importing nations have had to face serious repercussions as a result. When pressure is brought on the exporter of hazardous products to tighten its act and to increase regulatory cooperation with other nations, the country scoffs and says: “this is a domestic matter; we do not need any international oversight or pressure.”

No I am not talking about Chinese toys. I have in mind instead complex financial instruments sold by the U.S.–which having been improperly evaluated by U.S. rating agencies and hence mispriced, and having been marketed abroad in huge quantities, are now wreaking havoc in financial markets everywhere.

4. Fin Prof has a nice post on Fed’s functions.

5. Apurv has some nice posts on his blog. I am not a techie at all (those knowing me would appreicate the fact) but love the developments in the industry. First is on this firm which has managed to crack the i-phone code, Second on first ever website and third check out his video on Gmail.

6. Shankar Acharya is an economist who always provides caution on India growth story.  I had written about one of his papers here. In BS today, he points to more evidence, this time on health indicators in India. Pretty disturbing facts.

Paradox of Rich to Poor Capital Flows

August 29, 2007

Bob Lucas (Nobel laureate 1995) posed this paradox way back in 1990, Why does capital flow from poor to rich countries?

Ideally, it should flow from rich countries to poor ones as latter are capital scarce  and need capital to finance its growth plans. It also works for rich as it would give more returns going by the high risk, high return framework. (provided it is deployed in positive NPV (Net Present Value) projects, which is always the case) .

This fantastic paper from Rogoff et al explain further:

He rejected the standard explanation of expropriation risk and argued that paucity of capital flows to poor countries must instead be rooted in externalities in human capital formation favoring further investment in already capital rich countries.

Their idea however is unless the developing coutries (that are poor) improve their track record of debt defaults, we are not going to see much improvement. They explain:

There is no doubt that there are many reasons why capital does not flow from rich to poor nations yet the evidence we present suggests some explanations are more relevant than others. In particular, as long as the odds of non repayment are as high as 65 percent for some low income countries, credit risk seems like a far more compelling reason for the paucity of rich-poor capital flows. The true paradox may not be that too little capital flows from the wealthy to the poor nations, but that too much capital (especially debt) is channeled to debt intolerant’ serial defaulters.

So as per them, despite a huge default history, number of poor countries still get a lot of capital inflows. Nice insight and a nice twist on the head. I had covered the topic of sovereign defaults earlier as well, but that discussed whys and hows. This paper provides an extension of the thought.

A nice crisp read.

Inequality in Asia

August 29, 2007

I have posted quite a bit on this topic of inequality. It is increasingly becoming an issue with policymakers all over. Sustained growth and inequality have always been a problem with developing countries but even countries like US are reporting that inequality has been increasing.

I came across this intriguing report from ADB (thanks to SS Aiyar for providing the reference in his article which I covered here). It is titled ‘Inequality in Asia’ and the entire report is available for free download. As the full report is about 491 pages, there is a superb snaphot of the issues involved. It is a highly recommended reading.

For growth and development theorists, the main task so far was how do you design policies in a country so that there is sustainable growth and development. Numerous ideas have followed and Avinash Dixit provides a neat (full of humour; highly recommended) summary of the ideas. Raghu Rajan has two ideas (factor endowment and foreign leadership) and there is a different idea from Lant Pritchett as well (migration).

Now, some countries have grown and some have not. For latter theories continue (like for Africa), but for former inequality has become a big concern (like for India and China). The growth theorists have been thinking about this issue as well but with it increasing overtime more ideas would be needed to address the issue. Infact,  the paper quotes Arthur Lewis, the nobel laureate suggesting growth is largely inegalitarian in nature. This aspect was well accepted by growth theorists.

This report provides a lot of food for thought on the topic and discusses basics like what is inequality, how do we measure it, causes, how Asian countries have fared and finally the measures to reduce the inequality.

I have just read the snapshot and it alone set me thinking. Some broad ideas:

  • It is important the way one measures it. Whether you measure by Absolute inequality (say difference in income levels between top 20% and bottom 20%) or relative inequality (share of top 20% and bottom 20% in total income), the results are different.
  • Income levels alone are not enough. India and Pakistan may not have very high inequality compared to others when one looks at income/expenditure levels but when one looks at social indicators like underweight children, both countries show high inequality between rich and poor.
  • Income inequality has been rising in most Asian Nations over last 10 years
  • Inequality is not about rich getting richer and poor getting poorer but rich getting richer faster than the poor.
  • In China the inequality has increased between urban centres as well. So, it is not just rural urban gap but urban-urban gap as well.
  • Causes for increasing inequality are slow growth of agriculture, differences in skill-sets (as markets have expanded and liberalised, those with skills have managed to capture most of the available opportunities)
  • To reduce inequality, apart from usual stuff like creating employment opportunities, expanding skill-sets, one has to distinguish between inequality arising from efforts and circumstances. It is latter which must be addressed. Basically, a born poor should get opportunities similar to born rich to reduce inequality. Well said.

It is an excellent initiative from ADB with number of ideas. Once again, it is highly recommended.

Assorted Links

August 29, 2007

1. Greg Mankiw narrates this interesting story- The Magic Number 49.

2. The debate has always been there – Whether aid works or not? It has recently hotted up after this Arvind Subramanian article which says Aid has not been effective. Rodrik comments saying it is not whether aid works or not. What matters is how you can make it more effective. There are numerous instances of aid working and not working. So make it work.

3. ET has some good articles today-
a) Prithvi Haldea says we should not allow firms to list abroad. We should first develop our own capital markets by letting companies intermediate doemstic household savings via the market route and then go abroad. He says we may be talking of developed financial markets in India but reality is opposite. This article should raise some debate in India.
b) SS Aiyar shares his views on inequality.
c) Madan Sabnavis has an interesting article on huge credit growth in India.

4. BS has a nice debate on the hot topic- Should credit raters be rated? Any crisis, credit rating agencies are held at fault. Hightime something is done about them.

5. As we debate on the efficacy of entry load charged by Mutual Funds, MFs are tinkering with their exit loads.

6. WSJ Blog points comparison of sub-prime crisis to 1907. crisis. WSJ Blog points to this interesting development Sub-Prime crisis hits high-cost real estate markets.

Holding Companies in Banking groups

August 28, 2007

The morning newspapers are busy discussing  this concept paper from RBI on Holding companies in Banking groups.

There were a number of news items when both ICICI and SBI decided to set up holding companies in order to expand their business operations. SBI had applied to RBI and ICICI has received approval for the same.

What is a Holding company? Wikipedia explains:

A holding company is a company that owns part, all, or a majority of other companies’ outstanding stock. It usually refers to a company which does not produce goods or services itself, rather its only purpose is owning shares of other companies. Holding companies allow the reduction of risk for the owners and can allow the ownership and control of a number of different companies. Eighty percent or more of voting stock must be owned before tax consolidation benefits such as tax-free dividends can be claimed.

(A trivia from the same wikipedia link: Berkshire Hathaway is a holding company.Tata Sons is also an example)

So, the holding company does no business and its balance sheet shows a  few companies as part of its assets.

Holding companies have been there across sectors but it is in financial industry where it has become a concern. Why? The recent sub-prime crisis is an example. Banks themselves may have not given sub-prime loans but Banks supported entities did (HSBC, Lehman are examples). Similarly, Banks may not have invested in sub-prime mortgage backed bonds but Bank supported entities did (Macquarie and BNP are examples). In a nut-shell, Banks have these special entities which focus on a particular segment and if this segment goes into a problem, the impact is felt on the Bank as well. As banks are regulated by the Central Bank (like Fed in USA, RBI in India) or some other government agency (like FSA in UK), the entities are not regulated as mostly they are seperate companies and escape regulation. But as impact is felt on banks as well, it is raising concerns amongst regulators.

A question that comes to mind is – why do we need a holding company? Why can’t banks run seperate businesses like its subsidiaries? Answer- It frees up capital. If a Bank runs these various businesses as its subsidiaries, then there is a regulation in India which limits these investments to 20% of paid up capital and reserves of the bank. 

So say, if a Bank in India has Rs 100 cr (Rs 1 billion) of paid up capital and reserves, then it can only invest Rs 20 cr in the other businesses. Now, suppose Bank wants to expand these businesses only way it can is by raising capital itself.

And , businesses like insurance and asset management are increasingly becoming very capital intensive. So, the best way is, make a holding company, transfer these businesses into the holding company and let these businesses raise capital by listing, private equity etc.

The paper is quite a good one and explains all the nitty-gritties involved. It begins by explaining there are two kinds of Holding companies-

  1. Banking Holding Companies: The one which owns or controls one or more banks. This one is easy to regulate by a single regulator
  2. Financial Holding Companies: The one which owns or controls banks and non-bank financial companies(NBFC) as well. This one is difficult to regulate by a single regulator as each NBFC may come under a different regulator or may not have a regulator at all. For e.g. suppose there is a FHC in India, then Bank would be regulated by RBI, Asset Management Company by SEBI, Investment banking again by SEBI and insurance by IRDA.  

Clearly, the problems are most with a FHC that has a Bank and other non-banking financial company in its structure.

The paper then discusses various types of holding structures, comments on how these holding companies grew in USA (it was because of a legislation) and the issues for India of this structure and the way to resolve the same. It is a nice primer on the subject.

I have just given it a casual glance and cannot comment much on the paper. All I can say is RBI is not very comfortable with this emerging structure as it leads to regulatory arbitrage and is not in the best interests of the investors. Let me read some reference work and get back with my comments.

Meanwhile, one can see the various newspaper commentaries on the topic- BS, Bloomberg, ET, IE.

Assorted Links

August 28, 2007

1. Ajay Shah points to two articles on algorithmic trading. He also has a post on the recent SEBI move to do away with entry load. You might also like to see my post on the same. I have updated it.  

2. WSJ Blog has an excellent series of articles from top economsts – Larry Summers, Shiller, Jeff Sachs. Read all of them.

3. WSJ blog points to a paper which says US is crucial to world growth but not as much as we think it to be. Let me read the paper. IMF said more or less the same thing in its Outlook which I covered here.

4. Rodrik points to two papers on leadership in economics. I always believe leaders have a big role to play in development of nations.

5. PSD Blog points to a bang-on article from Arvind Subramanian:

“When celebrities such as Angelina Jolie or Bono highlight human tragedy to show that something can be done to alleviate it, the heart melts and the purse strings loosen. But the stars, alas, aren’t up on the economic literature. Research is increasingly questioning the benefits of foreign aid.”

6. PSD Blog also points to an Indian reality…growth is high but so is corruption.

SEBI initiates fast track issuance

August 27, 2007

SEBI is getting really active on various securities market activities. I had mentioned this earlier as well.

Now, we have some developments on the primary markets segment. SEBI has proposed selected companies can raise capital with minimum procedures. There is a criteria for the selected companies mentioned in the press release.

This is an excellent initiative and would help companies raise capital more efficiently. Read JR Varma’s views on teh development.

Newspaper coverage: ET, IE, BS

Mundell vs Friedman on exchange rates

August 27, 2007

I came across this debate on random surfing on Bob Mundell, the 1999 Nobel laureate who got the same for his work on exchange rates. His most famous work is what we call today as impossible trinity (see my few posts on this here and here)

This is a debate between 2 economics stalwarts and was done sometime in May 2001. It may be old but is very relevant even today and is a pleasure to read. However, to understand the nuances fully, one has to be on his toes and is a not a light read as I thought it would be.

They begin with basics of exchange rates (Mundell is for fixed, Friedman for flexible), then discuss Euro (Mundell lauds the success, Friedman sceptical about its success). They share their views on Bretton Woods, Gold Standard, and finally on World Currency. It is an excellent primer on so many topics.

Both have many differences on the topics. But there is a similarity as well. Yes, both are from Univ of Chicago :-)Friedman was  always in Chicago and Mundell has done majority of his research in Chicago.

Rudi Dornbusch has written a nice write-up in middle (page 11-14 of PDF) on the University:

Every so often there was a gladiator event, a workshop where for some reason faculty from different areas got together and got at each other. Mundell vs. Friedman were special events. Friedman obviously admired the sheer creativity of Mundell but would not let him get by, sparks would fly. Mundell  recognized Friedman as an icon but understood that he could play the bad boy with success. I remember the unspeakable from Mundell: “Milton, the trouble with you is you lack common sense”.  

Assorted Links

August 27, 2007

1. Ajay Shah throws some light on India’s pension system reforms. If there is so much delay on India’s most happening sector, I can’s talk about others.

2. WSJ Blog points out Fed has more ways to boost markets.

3. Rodrik points out to a blooper.

4. ET has an excellent profile of Dr. Rangarajan, Chairman, PM’s Economic Advisory Council. I like this one in particular:

Mr Rangarajan also has the patience of a good teacher who believes in explaining things painstakingly. Recently, ET asked him how policy makers determine the appropriate level of capital inflows from a macro policy standpoint. This has been hotly debated in the context of capital flows creating a rush of liquidity and stoking inflationary pressures.

Mr Rangarajan put it succinctly, “If your money supply growth target is 17%, then you have to determine what level of capital inflows are consistent with a 17% growth in domestic money supply. In my view, a net capital inflow of up to $26 billion, after meeting the current account deficit, is consistent with 17% growth in money supply.”

I am still thinking, how did that number $ 26 billion come from. I wonder, why didn’t his team explain these numbers and methodology for the same in the EAC report?

5. AV Rajwade on sub-prime.

6. CRISIL economists say agriculture growth to be around 3.2% to 3.6% in 2007-08. It is based on their DRIP methodology which measures rainfall deficiency in key regions and likely impact. I have my doubts whether agriculture can grow by that much.

7. Arvind Panagariya is bang-on on problems with Mumbai. This line says it all:

Intellectuals in India have been vigorously debating how to turn Mumbai into a Global Financial Centre by 2020. But they need to understand that this ambition is hollow if we cannot turn Mumbai into a global city. 

Report on agricultural loans in India

August 24, 2007

RBI has placed a new report for public comments. This one is on further simplifying the procedures and processes for agricultural loans, especially for small and marginal farmers.

The press release states:

It  may be recalled that the Reserve Bank of India had constituted a working Group under the Chairmanship of Shri C.P. Swarnkar, Chairman and Managing Director, Syndicate Bank to suggest measures to further simplify the procedures and processes, thereby reducing the cost and time for obtaining agricultural loan, especially by small and marginal farmers. The Report of the Working Group was submitted in April 2007 and Reserve Bank has already implemented the following recommendations of the Group in the Annual Policy for 2007-08 :

  • The banks were advised to immediately dispense with the requirement of ‘no due’ certificate for small loans up to Rs.50,000 to small and marginal farmers, share-croppers and the like and, instead, obtain self-declaration from the borrower.
  • Further, banks were advised to accept certificates provided by local administration/panchayati raj institutions regarding the cultivation of crops in case of loans to landless labourers, share-croppers and oral lessees. This would help overcome the problem faced by the banks in lending to landless labourers, share-croppers and oral lessees due to the absence of documents verifying their identity and status.
  • Recognising role of financial/credit counselling towards enhancing the quantity and quality of agricultural credit, each State Level Bankers Committee convenor has been asked to set up a credit-counselling centre in one district as a pilot and extend it to all other districts in due course.

On a quick glance over the report, the findings are largely what one would expect. The farmers have to spend a lot of effort in getting a loan  application done and numerous hassles are involved.

The suggestions are many. However, this para explains all the thinking:

The Group is of the view that while a lot of effort has already been made to simplify the procedures and processes of agricultural lending, the real benefit of simplification will accrue to the farmers if there is a substantial change in the lending methods and attitudinal change at ground level.

So enough preaching has been done. Time to practice.

Inflation Targeting and Impossible Trinity

August 24, 2007

I had written some days ago on impossible trinity. It covered a speech from BIS Deputy GM who explains the mechanics and presented evidence on the same. He says most Asian Pacific nations have been targeting exchange rates.  The currencies have hardly appreciated over the years despite capital inflows being a problem with most. Further, couple of countries have inflation targets as well but still seem to be targeting exchange rates as well.

Now, this was just about Asian- Pacific countries. How about others? Impossible Trinity says one you allow for free capital flows, a country can go for either exchange rates stability or price stability but not both.

Now, some countries have adopted exchange rate stability (by following some exchange rate regime) and some have adopted price stability (by following inflation targeting (IT)). So which is better so far?

This paper from Andrew Rose does answer the question in his own way. The title is also quite stimulating – “A Stable International Monetary System Emerges: Inflation Targeting is Bretton Woods, Reversed”. Infact,if you look at it the title reveals the findings right away. Inflation targeting is doing quite well so far. The abstract:

A stable international monetary system has emerged since the early 1990s. A large number of industrial and a growing number of developing countries now have domestic inflation targets administered by independent and transparent central banks. These countries place few restrictions on capital mobility and allow their exchange rates to float. The domestic focus of monetary policy in these countries does not have any obvious international cost. Inflation targeters have lower exchange rate volatility and less frequent “sudden stops” of capital flows than similar countries that do not target inflation. Inflation targeting countries also do not have current accounts or international reserves that look different from other countries. This system was not planned and does not rely on international coordination. There is no role for a center country, the IMF, or gold. It is durable; in contrast to other monetary regimes, no country has been forced to abandon an inflation-targeting regime. Succinctly, it is the diametric opposite of the post-war system; Bretton Woods, reversed.

Now why Bretton Woods (BW) reversed. BW advocated fixed exchange rates (backed by USD) and following an IT means floating exchange rates. As latter is quite successful, it is BW reversed.

This is a short paper (31 pages) compared to his peers and has a lot of food for thought. The paper focuses on IT and exchange rate stability is just an add-on. It is largely empirical but explains  the process and findings in English.

The evidence that took me most by surprise was that countries that have IT have lower exchange rate volatility than others.

This paper is different as earlier papers looked at whether countries that have adopted IT have actually managed to lower inflation or not? So, they compared countries that have adopted IT vs those that have not. Some found positive evidence, some found the evidence questionable. So as a result, IT despite being pretty popular has its criticisers as well.

This paper looks at the evidence from the foundations of Impossible Trinity i.e. exchange rate and capital flows. And yes, the evidence is IT so far looks a good strategy.

A nice paper. Very neatly written. If you can absorb the statistics a bit, it is an excellent read.

Assorted Links

August 24, 2007

1. WSJ Blog points Fed exempted Citi from the limit on how much its bank unit, Citibank N.A., can lend to its affiliated broker-dealer, Citigroup Global Markets.

2. Rodrik offers food for thought. This time on property rights and WTO.

3. PSD Blog points out to this excting development- Allianz would use Google Earth to monitor risk.

4. Saumitra Chaudury of ICRA explains the sub-prime crisis using mythology. BS points out to how sub-prime has started affecting corporate bond from Indian industry that are traded in foreign markets.

5. TCA points to a new paper on logistics. He is taking quite an effort to point to some titbit research done in Indian schools.

6. Ajit Balakrishnan points to interesting development in online education.

Why USA economy would continue to thrive

August 23, 2007

This time it is not a speech but an interview.

The interview is of Dallas Fed, Richard Fisher. I had mentioned about it in my Assorted Links today. On reading it, it was like wow, this is what an interview is all about.

Read it for all he says about strengths of US economy, the focus on research, his concern over talented people being allowed education in top Univs in US but not being allowed visas to work.

Clearing Corporations and their role

August 23, 2007

Clearing and Settlement C&S) Systems has a huge role to play in making financial markets more efficient. Most of us are fascinated by traders and there are plenty of books/journals on the successful traders and their strategies. And we do not know/care about the important role C&S play in development of financial markets.

The role of C&S is all the more important as technology has been integrated with trading activity. We now have screen based trading and with just a few clicks can execute a trade in few microseconds. If C&S also does not catch up with the growing trade volumes, the entire market would collapse.

Finance Ministry of India has a nice discussion paper on the role of C&S and how the systems have evolved in India from paper based to electronic systems.

In securities market, there are three distinct activities- Trading, Clearing & Settlement and the stock exchange members did all the activities within themselves.

Now, with demutualisation of exchanges and exchanges, it is important we seperate trading from C&S activity. This would bring transparency and bring more efficiency in the markets.

Hence there is a need to establish Clearing Corporations (CC) that are specialists at this activity. As of now,  NSE (National Stock Exchange) has its own clearing corporation

The paper says in order to further the role of a CC,  there should be competition, no conflict of interest and should have appropriate risk management.

It then discusses what provisions need to be made to recognise CCs, how to regulate clearing members and their role.

The paper also invites comments/suggestions from the public. But unfortunately, the date for doing so has passed. The last date for comments was 31st July, 2007.

However, a decent paper on the topic. Prof. JR Varma (0f IIM-A) shares his thoughts on the same.

Assorted Links

August 23, 2007

1. After Fed’s move to cut discount rates did Banks actually borrow. Yes, they did. MR points to a story. WSJ Blog also covers the story.

2. WSJ Blog points out to a nice interview with Richard Fischer. He doesn’t mince words.

3. Mankiw pointsout to an interesting profile of Susan Athey , the 2006 Clark Medal Winner.

4. Rodrik points to a new book which is making waves.

5. PSD Blog points to an extensive book on migration and economic development.

6. Econbrowser has an excellent post on emergence of slowing investment in US. Top Class.

7. BS says with many MNCs delisting from Indain bourses, the MNC specific MFs are struggling.

SEBI proposes to cut Mutual Fund costs

August 22, 2007

I have lately been quite impressed with SEBI (India’s securities market regulator) lately. The initiatives may not necessarily be in the right direction (for instance on corp bonds) but is certainly helping improve transparency in Indian securities markets.

They have started sharing/publishing data on segments of markets (which were otherwise unknown for instance on corporate bonds, venture capital), are sharing a lot of committee reports. It is also setting up an institute for development of knowledge base in Indian securities markets.

Now, the latest initiative is to attempt to cut down costs paid by investors investing in Mutual Funds (MF). The proposal states:

Keeping in view the interest of the investors SEBI is now considering giving a waiver in entry load for direct applications received by the AMCs i.e. applications received through internet, submitted to AMC or collection centre/ Investor Service Centre that are not routed through any distributor/agent/broker.

What is entry load? Suppose you decide to invest in MF. Say the price (in Mutual fund jargon it is called Net Asset Value or NAV) of one mutual fund unit is Rs 10. And the entry load is 1% then you would have to pay Rs 10.10 for one unit of Mutual Fund. See this to understand how much each MF equity scheme charges as front load. Most charge 2.25% so you end up paying Rs 10.225/- per unit.

This 10 paisa (multiplied by no of units you have purchased) is then kept in a seperate account and is used for meeting selling and distribution expenses. Or in a nut-shell this money goes to your broker. 

Now as we know, brokers are making more money than the mutual funds themselves. So it means most MFs are using brokers as the way to sell their schemes.

Now, as you would realise, as an investor you end up paying more, get lesser units and are on the loosing side. But then what should even MFs do? Most prefer to ride on the existing distribution system and sell via brokers.

Ajit Dayal of Quantum MF tried to sell MFs and cutting down on brokerage but could not win against brokers. No broker was interested in pushing his product. Now he could have given in and agreed to broker’s conditions. But he took them on and is selling the Mutual Funds via internet and word of mouth. But as distributors are very powerful (have you ever been recommended Quantum AMC) the equity fund run by AMC continues to struggle.

This initiative from SEBI is a welcome one. It would not only push down the costs of the Indian MF industry (and this would mean more returns in the hand of investor) but it would also provide more encouragement and support to likes of Ajit Dayal.

SEBI has invited suggestions/comments  on its proposal. I hope it receives support. It would have been good if SEBI actually published a report as well focusing on distribution costs. It would just help build better and stronger comments on its proposal.

Update 1: Reports from ET, BS.

Update 2: ET supports the move in its edit.

Update 3: Ajay Shah points to couple of articles and his views on the SEBI move. His view is that it is a great move but is a pretty small one and would not challenge the distributor driven model. In particular, read this article from Ajit Dayal in IE. He pours his heart out over the state of MF industry.

Dhirendra Kumar of Value Research (a MF rating agency) supports the move as well. His view is distributors are already in a state of panic. Great stuff.

BS (28 Aug., 2007) reports there is a mixed response towards the SEBI move. BS (29 Aug., 2007) has an edit piece on the same.

Update 4: In BS (30 Aug., 2007), there is a story that post SEBI move, MFs have started to expand their branches. As internet is yet to penetrate, MFs are expanding branches to penetrate investors. 🙂

Update 5: ET (3 Sep, 2007) reports that MF managers are split over the issue. They say with entry load waiver, the advisors/distributors of fin products might push insurance schemes ahead of MF schemes, as former offers more incentives to them.

Well, insurance is a financial products designed to sageguard oneself or his products/business from any mishap. Whereas MFs are supposed to help people gain some returns from parting with their savings now for some returns on the savings later. So they are apples and oranges really. The objectives are different. In the end, both might help in case of some mishap but MF may/may not give returns and insurance gives some benefit only if there is a mishap.

So, if a distributor recommends insurance ahead of MF, the industry people are instead saying the entire distribution set-up needs a relook.

Update 6: Ajay Shah points to this excellent article from Gautam Chikermane on the MF-distributor nexus.

Update 7:ET (17 Sep., 2007) reports the relationship managers in Banks (they distribute the mutual funds for banks) are feeling the heat.

Update 8: Ajit Dayal (Quantum AMC) and Nirmal Jain (Indiainfoline CMD) debate whether entry loads should be there.

Update 9: ( ET 24 Sep 07) Want a ticket for Twenty20 Indo-Pak final? You should have been a MF distributor.

Assorted Links

August 22, 2007

1. Fed’s recent move of hiking the discount rate has invited a lot of debate. Based on various ideas, WSJ Blog points out that they can be divided into 4 groups. I belong to “The Realist” group. Which one are you into?

2. Rodrik points out to a new paper by Acemoglu et al. To know more about Acemoglu read his profile here. This new paper would amuse Avinash Dixit all the more or perhaps irritate him.

3. Ashima Goyal in ET says we are understimating investment and growth rates in India. The article provides a lot of food for thought. But it could have  been simpler.

4. In these volatile times what are India’s Mutual Fund mangers upto? ET says most are using their time to read books. I think they should also spend some time in making the MF industry a better place. There are many issues which need to be discussed: number of me-too schemes within the same fund house, high costs, low retail money etc.