Archive for February, 2008

Union Budget (2008-09) and Economic Survey (2007-08)

February 29, 2008

Both highly awaited documents have been released.

The Union Budget is here and Economic Survey is here. I will post my comments later.

PS: This is a blog post number 500. This is a lot of blogging.


We would most likely be reading the budget document to fund out the fiscal deficit for the year, government borrowings, various proposals etc.

However, one must also look through this document as well. It tells you the promises made in last year’s budget and the status of the same. 


Assorted Links

February 29, 2008

1. Econbrowser has some great commentary on  Bernanke’s tightrope walk (balancing both low growth and high inflation) . It says:

In any case, the tightrope analogy seems a misleading way to frame the issue, in that it presupposes that there exists a choice for the fed funds rate that would somehow contain both the solvency and the inflation problems. In my opinion, there is no such ideal target rate, and the notion that we can address the difficulties with a sagely chosen combination of monetary and fiscal stimulus and regulatory workout is in my mind doing more harm than good. Better for everyone to admit up front just how bad the problem is, and acknowledge that there is no cheap way out.

2. WSJ Blog points to a thought on development from World Bank’s new chief Economist- Justin Lin.

3. WSJ Blog points Bernanke says situation could be worse than in 2001. But he also he doesn’t see recession ahead. But 2001 was termed as a recession. So what is going on? Read the first assorted link for calrity

4. WSJ Blog has good secondary sources.

5. Earlier, Rodrik deliberated on him taking political science early in his career. Towards the end of the post, he said he would explain later as to how he became an economist. Here it is

6. PSD Blog points to a surprising paper on socialism.

SEBI regulates advertisement in Mutual Funds- will it work?

February 28, 2008

India’s capital market regulator, SEBI has been in an overdrive mode for quite sometime. It has been passing regulations at a great speed.

This time it passes a circular on the advertising of Mutual Funds. It says:

The rapid fire manner in which the standard warning “Mutual Fund investments are subject to market risks, read the offer document carefully before investing” is recited in the audio visual and audio media renders it unintelligible to the viewer / listener. 

In order to improve the manner in which the said message is conveyed to the investors it has been decided in consultation with AMFI that with effect from April 1, 2008: 

  1. the time for display and voice over of the standard warning be enhanced to five seconds in audio visual advertisements. 
  2. in case of audio advertisements the standard warning shall be read in an easily understandable manner over a period of five seconds

In its earlier circular(in July 2003), SEBI had said:

In advertisements through audio-visual media like television, a statement “Mutual Fund investments are subject to market risks, read the offer document carefully before investing” shall be displayed on the screen for at least 2 seconds, in a clearly legible font-size covering at least 80% of the total screen space and accompanied by a voice-over reiteration. The remaining 20% space can be used for the name of the mutual fund or logo or name of scheme, etc.

So, SEBI has increased the time of the risk warning statement from 2 seconds to 5 seconds.

The rationale behind increasing the timing is that before people can understand the statement, it has already disappeared. So by displaying it for five seconds, people can understand that investment in MF is risky.

And the rationale behind the warning is that people do might not understand that risks are involved in a MF. Hence, the need for a warning.

I don’t really think that these warnings may help despite the best intentions to say so. The regulators believe that people are rational beings and can take care of their interests as long as information is widely and easily available. So, by issuing these warnings, they will evaluate the risks and take decisions accordingly.

However, numerous research in behavioral economics shows that it is actually opposite. Infact, people are predictably irrational and continue to make the same mistakes.

For instance, research tells me people start investing in equities when markets rises. Their investment is at its peak when the equity markets are also at their peak. The finance theory suggests people should be buying when equity markets are below fundamental values.

One can understand people making mistakes in 1991-92 when Indian economy was just opening up. but to see the same trend till 2006-07, suggests that people do not learn their lessons and invest in equity markets rises along with the indices and enter markets when risks are higher.  

Hence, to assume that people will act rationally by increasing the advertisement time might not work. Moreover, most of the advertisement would show a happy family, prosperous individuals etc the risk warning is more likely to be ignored.

Primers on Inflation

February 28, 2008

There are two good speeches explaining about inflation. First from Fed Governor Mishkin and Second by St Louis Fed President, William Poole.

Both are good primers on inflation.

Assorted Links

February 28, 2008

1. Bernanke presented his semi-annual testimony and presented the monetary policy to the Congress.

WSJ Blog summarizes Bernanke’s testimony. It also points to comments from experts at the Monetary Policy meeting.

2. Frankel says Euro might take over USD as reserve currency by 2015.

3. Mankiw points to an article on stagflation.

4. Rodrik on his early life as a political scientist.

5. DB Blog points to Easterly response to Bill Gates

6. TTR has an excellent post saying corporate leaders are not nobel souls as we believe them to be

Fed sees higher inflation low growth

February 27, 2008

I just missed this analysis. The latest FOMC Minutes of meetings held on January 9, 21, and 29-30, 2008. The last table shows FOMC members expect lower growth and higher inflation:

Range 2008 2009 2101
Growth of real GDP 1.0 to 2.2 1.8 to 3.2 2.2 to 3.2
October projections 1.6 to 2.6 2.0 to 2.8 2.2 to 2.7
Unemployment rate 5.0 to 5.5 4.9 to 5.7 4.7 to 5.4
October projections 4.6 to 5.0 4.6 to 5.0 4.6 to 5.0
PCE inflation 2.0 to 2.8 1.7 to 2.3 1.5 to 2.0
October projections 1.7 to 2.3 1.5 to 2.2 1.5 to 2.0
Core PCE inflation 1.9 to 2.3 1.7 to 2.2 1.4 to 2.0
October projections 1.7 to 2.0 1.5 to 2.0 1.5 to 2.0

So, despite their claims that inflation expectations are anchored we see most expecting higher inflation. Considering the fact that Fed isn’t very good at forecasting, the inflation is still expected to trend higher than previous estimates.

If we recall, many Fed Presidents have raised rising inflation as a concern but suggest risks from lower growth are higher.  They defended the rate cuts giving similar line of thought.

This does indicate that stagflation pressures are building up (I had suggested the same long back). It will be interesting to see the approach adopted by policymakers in times to come.

Assorted Links

February 27, 2008

1. Ajay Shah points to some links on India’s fiscal position and hedge funds coming to India

2. MR pointsto Obama’s economic advisers.

3. Econbrowser points to falling housing prices. WSJ Blog has a primeron the 2 indices widely used to track housing prices in the country- Office of Federal Housing Enterprise Oversight home-price index and the S&P/Case-Shiller home-price index.

4. WSJ Blog points to a new speech from Fed Vice-Chairman, Donald Kohn. Kohn believes low growth is a bigger risk than higher inflation.

5. Rodrik points to his article which says – we must curb international capital flows.

6. EPSA Blog on poor service delivery in India. Understandably the criticism is for public services. The situation is no better (perhaps worse) in private sector as well especially in after sales services. And for private sector one pays a cost so it hurts all the more. All the companies who make big claims over their products/services should check their various after sales services. I am sure they will be splitting their hair.

7. Econbrowser has an interesting post explaining the interest rate differentials in emerging economies

Ban on smoking by celebirities-right or wrong?

February 26, 2008

India’s Union health minister Ambumani Ramadoss has always expressedstrongly that celebrities like film-stars should be banned from smoking in public domains like movies. He believes it leads to other people copying the stars and leading to increase in smoking habits in the population.

His ire is particularly on Shahrukh Khan (SRK) and they have exchanged quite a few war of words since then. SRK even calls smoking a ‘creative liberty’.  SRK has many backers who believe in freedom and suggest better way is to educate public (see this for instance.)

Actually the war of words is indirectly between the neoclassical economics (SRK and the liberals) and behavioral economics/BE (Ramadoss ). Former believes consumers are rational and can take care of what works best in their interest. So if a person realises smoking is not good for him he will not smoke. Hence, the need to educate and let people decide.

And the latter believes people are predictably irrational and make the same mistakes time and time again. So to expect them to choose wisely is not the right thing to do. Hence, to expect them to not to take up smoking by seeing advertisements may work for some but not all. We all know how difficult it is for a person to quit smoking once he starts, so all that rationality might not work.

The BE camp would suggest people take up smoking in varied emotions like stress, excitement etc. This is quite true as most of us know some people do take up smoking trying to look cool, fashionable, copying some movie-star etc. The smoking product companies knew this all along, and that is why you have most ads showing smokers as cool, macho etc. Now, the ban has been imposed on such ads but it has already created enough damage.

BE camp might say people know the ill-effects but cannot resist the temptation. So, it is better to try and request filmmakers to not smoke in their movies. This can atleast stop the habit picked up due to imitation.

What do you say?

Education lessons for India from UC Berkeley

February 26, 2008

Robert Birgeneau,Chancellor of University of California has some valuable lessons for higher education in India. He offers couple of gems:

There is a focus on skill development in countries like India, primarily to meet the increased demand for manpower across the world. How do you visualise the role of universities in the skill development mission?

There is a need to understand the difference between education and skill development. Skill development is about training, it serves short-term requirements, it does not serve long-term needs. The responsibility of universities is to educate people not just to train them.

An education, which universities should provide, teaches people to learn to solve problems. Skill development doesn’t do that; it provides training. Consider this: 50% of those involved in management perform different skills from what they learnt. It is education that helps people make this transition to new roles and not skill development.

Next is the role of Ivy leagues:

How central is the state in providing higher education, especially in a country like the United States which has well-known universities which are not public education institutions?

Ivy League institutions account for less than 1% of those in the university system these are privileged sections. Fact is, 75% of students in the United States are educated in public institutions. When we talk of the impact on the American economy, we need to understand that it is totally dominated by public institutions. The state has a responsibility to provide adequate access, the private system is biased to the wealthy.

And finally the competition to retain faculty:

Higher education institutions across the world face the challenge posed by industry and the corporate sector when it comes to retaining faculty. How does an eminent public institution like UC Berkeley deal with this challenge?

Interestingly, it is other research universities rather than industry to which we lose faculty. At UC Berkeley, we face competition from other rich research universities for faculty. Industry doesn’t pose such a threat. We offer the opportunity to teach at a flagship research university. We also have a number, not a huge number, of faculty members who straddle both teaching and private sector jobs.

All this is quite different from what we believe in India – Universities need to address talent shortages, private sector should takeover education, the need to expand ivy league colleges in India etc. 

What is driving the housing prices in Mumbai?

February 26, 2008

I have often cribbed about the numerous housing problems in Mumbai (here, here and here). I have been noticing quite a few things lately about the housing market in Mumbai.

  • Houses are similar to equities/shares: Usually, the demand is inversely related to price i.e. if price goes up demand falls and vice versa. However, in equity markets we see that if prices rise demand for that sharte rises expecting further appreciation. This is infact not limited to just equities but commodities as well, which are traded in various exchanges these days.Similar behavior is being seen in housing markets. As prices have risen, so has the demand. I am yet to see slowing down of demand for houses in Mumbai.
  • This takes me to the next part of the analysis.  What is driving so much demand? Where is so much money coming from? How come people are willing to buy more and more at higher and higher prices. Most properites are already booked and you are oftyen told that only a couple of flats are left. And this is a common statement no matter which part of the town you are in.The people say it is due to the growth in economy which has led to higher salaries/incomes etc. I don’t really agree as economy has increased by about 30% in 4 years, the housing prices have increased by almost 200-300% in all the regions. I think a large part of the increase is due to the increase in equity prices. The high equity prices have led to increase in wealth which has been deployed in housing markets.
  • Another point to debate is whether the housing prices have reached to new highs and would not decline to the earlier levels. In economist jargon, whether the demand curve has shifted to the right indicating higher prices for each unit. Like we say Indian economy has moved to a new growth trajectory can we say the same for housing markets?Here, it has been seen that this is not the case as similar highs were reached earlier as well (around 1993-95). So we can’t say whether demand curve has shifted right or is it simply a movement  on the curve.
  • Another point is that information asymmetry is at its highest (and worst) in this market. How do you know whether the price is a correct one? How do you know whether the builder is a good one using proper construction material?I still haven’t figured out why we can’t have some regulation in this market to verify builders, prices etc. Given the huge costs and lifetime incomes, it is really surprising. The Banks do act as a quasi-regulator while giving loans but it is not enough. We still do not know whether the prices are right or is because of collusive practices.

The summary is the same- it is going to be really difficult to survive in this city going ahead.


I get some support from Govind Ethiraj. He expresses very similar views in his article and adds that RBI should only cut rates when property prices fall.

Assorted Links

February 26, 2008

1. WSJ Blog points to Alan Blinder and Larry Summers’ solutions for foreclosures. Infact the same post has some interesting articles.

2. PSD Blog points Harvard help for starting a business. It also points to a new report on social investment markets.

3. Chris Blattman points to economic text-books available for free download

Will subprime crisis lower global imbalances?

February 25, 2008

I have written a number of posts on global imbalances.

The subprime crisis also led to a discussion on whether it could help unwind the global imbalances or not? I also covered the issue here.

IMF in its latest analysis says imbalances are narrowing but more needs to be done. 

Human beings are predicatably irrational

February 25, 2008

Posting on behavior economics has become more regular over a few days. I just find this subject so fascinating that I just can’t get over it. The findings of how humans respond to different incentives is really exciting.

I got an email from Karl Lief Bates of Duke University pointing to a book by Prof Dan Ariely (has moved from MIT to Duke University) aptly titled – Predictably Irrational. This article posted on the Duke Research Centre website provides brief information about his book. This para takes the cake:

“We all make the same types of mistakes over and over. It has to do with the basic wiring of our brains,” Ariely says in an exuberant Israeli accent. “Wouldn’t economics make a lot more sense if it were based on how people actually behave, instead of how they should behave?”

And he is joining Duke to set up a Centre on Behavioral economics (wow!, we need more of these centres as I have argued in this paper; I am looking forward to research from this centre)

The emerging field that Ariely hopes to make a formal discipline at Duke is something called Behavioral Economics — the merger of mathematically pristine economic theory with the messy lust and greed of actual human nature. The field seeks nothing less than to understand why investors, employees and customers sometimes make ridiculous choices.

For those interested in his book, here is a very good review from Liz Kolbert. It is actually a review of two books- first by Ariely and second by Thaler (the BE stalwart) and and Sustein. Both tell you the same broad idea- we are predictably irrational.

Assorted Links

February 25, 2008

1. Econbrowser on crony capitalism in US. Though it defends saying it is not crony capitalism and US economy has reached a point where we just can’t say no to all that intervention. However, this is what crony capitalism is. Show you believe in free markets in good times and look to government in bad times.

2. MR points whether IMF should became a SWF?

3. Rodrik reviews Shleifer’s latest paper

4. Madahv Mehta offers valuation lessons. He also shows how there is distorted reporting of earnings that overstates incomes and trend of rising other incomes in Indian companies.

5. PSD Blog points to a micro-finance comic

6. WSJ Blog points to a new speech where he warns inflation fears. It also points to a Dallas Fed essay competition for students with the theme- Economics in the movies 

Economics of Indian Premier League

February 22, 2008

Indian Premier League has created a lot of buzz in the media. It is a twenty-20 cricket tournament run by Indian cricket board. The format has been picked up from English Premier League where respective clubs bid for best players and nationality is not an issue.

IPL has many lessons for budding economists. For instance, I have written an article looking at the auction strategies deployed by the authorities and how a better auction design could have lowered the stakes in the game.

Here are a few links where one can get bulk of the information:

Assorted Links

February 22, 2008

1. JRV on the problems with the credit histories.

2. WSJ Blog points IMF can handle $ 100 oil shock. It points another indicator indicating recession.

3. Mankiw points to a new paper from Shleifer

4. TTR has an excellent post on why management research is not read by professionals

5. Econbrowser warns about stagflation. I had written about it sometime ago.

Are India’s financial markets getting efficient?

February 21, 2008

I always keep thinking about the nature of efficiency in Indian equity Markets. Where are we placed? Are markets getting efficient or inefficient?

The usual wisdom is that equity markets are getting efficient by the day. This is because the infrastructure (regulations, technologies etc) needed to these markets more effcient has become much better. The trading is on electronic exchanges where arbitrage can be snapped in a fraction of a second. The people can see the various trades on their computer screens from anywhere across India.

However, we have other side of the story which tells me that markets might actually not be getting efficient at all. One good indicator is to see the performance of active finds vs passive funds (index/ETFs).  If markets are getting efficient one shouldn’t see active funds beating passive funds by huge margin and atleast the margin should be shrinking over the years.

As this story shows, passive funds have been increasing in India. But this analysis (and even this debate) says, active funds continue to beat the passive funds. Some might say that most of these analysis don’t point to the risk adjusted, expense adjusted return. Even if we discount all this, I think we should be seeing active funds outperform indexers over the years.

Another point is this story from Mint. which says the cost of fund managers has been increasing at about 300% and Indian fund managers might get the same salaries as those in London, Singapore etc. Now, if the markets are getting efficient we should see the salaries declining as arbitrage opportunities are at best getting limited and is not worth the cost.

So, which side do we lean? Towards efficient or inefficient side? If they are efficient, then active funds shouldn’t outperform. Why do fund managers get such huge salaries? Basically for outperforming markets. Does it mean we have many Buffets in India?

Raghu Rajan in his speech identifies 4 sources of alpha:

  1. One comes from having truly special abilities in identifying undervalued financial assets—Warren Buffet 
  2. Activism- This means using financial resources to create, or obtain control over, real assets and to use that control to change the payout obtained on the financial investment like a Venture fund, etc
  3. Financial entrepreneurship or engineering—investing in exotic financial securities that are not easily available to the ordinary investor, or creating securities or cash flow streams that appeal to particular investors or tastes. Of course, if enough of these securities or streams are created, they cease to have scarcity or diversification value, and are valued like everything else. Thus this source of alpha depends on the manager constantly innovating and staying ahead of the competition.
  4. Finally, alpha can also stem from liquidity provision. For instance, investment managers, having relatively easy access to finance, can hold illiquid or arbitrage positions to maturity: if a closed end fund is trading at a significant premium to the underlying market, they can short the fund, buy the underlying market, and hold the position till the premium eventually dissipates. What is important here is that the investment managers have the liquidity to hold till the arbitrage closes.

Rajan said the first three are difficult and most likely fund managers are retorting to fourth and could lead to a problem in stressful times. His prophecy was quite true  as the subprime crisis showed.(read my post here)

So, there are three questions- If markets are getting efficient, 1) How fund managers are generating alpha in Indian MF industry?
2) If they are not generating alphas, why such huge salaries? 
3) Should these salary levels be regulated?  

Or we can simply say, Indian financial markets are not getting efficient and there are still arbitrages and asymmetries to be profited from.

Assorted Links

February 21, 2008

1. With Indian Premier League drawing huge attention, economists in India should start looking at sports economics seriously. Ajay Shah points how economists can help get better results in football.

2. TTR on lofty investment  bank valuations. He also points to a different perspective on Northern Rock.

3. WSJ Blog points James Poterba is the next chief of NBER.

4. FED released minutes of its FOMC meeting on 29-30 Jan. WSJ Blog on what it doesn’t explain. It also points to a new speech from Bill Poole (of St Louis Fed)

5. Rodrik points to  a discussion – Is there anything useful in economics?

6. Fin Prof on latest Soc Gen finding:

“Societe Generale SA, France’s second-largest bank, failed to follow up 75 warnings on bets by Jerome Kerviel that led to a trading loss of 4.9 billion euros ($7.2 billion), independent board members concluded in a report.”

RBI implements learnings from the subprime crisis

February 20, 2008

One of the main lessons the subprime crisis pointed out was incentives could lead to higher risks in the entire system. (I have written a report on the various lessons)

This  behavior was first pointed by Raghuram Rajan in his excellent paper (read my previous post).  The magnitude of the crisis could have been lesser if the incentives were aligned towards more prudent behavior. 

RBI has learnt the lessons and has acted fast on the matter. This BS story says:

The Reserve Bank of India (RBI) has turned down IndusInd Bank’s proposal to pay its new managing director and CEO Romesh Sobti, a one-time joining bonus and a severance package.

The banking regulator has also objected to the bank offering employee stock option schemes (ESOPs) to Sobti at a price lower than that of the fair-price formula suggested by the Securities and Exchange Board of India (Sebi), banking sources said.

A banking source said, “RBI obviously does not want IndusInd Bank to set a precedent of offering a joining bonus and a severance package. This is a practice followed by foreign banks. The package offered by IndusInd Bank is not commensurate with the size of the bank.”

Another source said the basic objection to IndusInd Bank offering Sobti ESOPs at a price lower than the Sebi-approved formula was due to an equivalent impact on the profit of the bank.

RBI is being criticised by many economists/media for its policies. I am sure this move will be criticised as well saying RBI shouldn’t intervene in compensation policies of a Bank. But, it has set the trend amongst regulators for aligning the incentive structure in financial markets. I am hopeful we see more developments worldwide on the subject.

Assorted Links

February 20, 2008

1. Krugman on oil prices. Econbrowser summarises various analyses on rising oil prices

2. WSJ Blog points to food companies feeling the inflation pinch. It also points to France defending Fed moves and financial innovation

3. WSJ Blog points to Paulson saying no bailout like Northern Rock is needed. So far the authorities have said something done the opposite.

4. Mankiw says he and Summers think alike.

5. PSD Blog points to a news on Gemloc a program run by World Bank. What is Gemloc- Global Emerging Markets Local Currency Bond Program. They know how to come up with fancy names.

6. Madhav Mehta on loopholes in taxation in India (the end has a nice quote). He also has a nice thought– a need for an executive summary of  the IPO prospectus in India.

7. Ajay Shah criticises RBI for a different reason this time.

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