Thursday, October 21, 2010

Indian Stock Exchanges Going Global?

I have written previously about how global markets are getting more integrated and showing signs of high correlation.  Regarding this, I had also highlighted the point of imperfect information dissemination and how domestic markets have changed.  The previous article talked about how exchanges and other capital markets, which were earlier domestic in nature, especially of emerging economies such as India have now gone global or have initiated the process of doing so.

A valid concern then arises whether any of our stock exchanges have the ability and necessity to become truly global. Ability? Of course yes. India enjoys a strong technological advantage, thanks to its IT sector. Supplemented with the appropriate investor friendly policy environment, India has better chances in comparison to its competitors. Furthermore, necessity, as economics teaches us, arises from a near inelastic demand curve. And presently, I would say that this inelastic demand is present in the form of the huge investor interest in the growing returns of the securities of Indian capital markets.

As I write, the US short term interest rates are close to zero, and the US long term rates are around 2-3 %. The interest rate prevailing in India is currently around the 6-7 % range. Thus, this vast interest rate differential makes a compelling case for carry trade. But cash- laden investors in the West are looking for even higher returns in the form of equities.

The question we should be asking to ourselves is that, can Indian stock exchanges make it big on the international stage in the next 10-20 years? I say yes.

India is among the many emerging economies that they consider and competing for the same factors of production and markets for its production. The race to fight for these economic resources and markets for sale has only intensified since the economic crisis begun.

The race for other factors of production shall continue, but I would like to focus on capital as the most necessary factor for the coming years. Capital is a very important input for growing economies and if India needs to sustain existing growth levels of 9%, it has to tap external savings and investments. In simple economic terms, investments in an economy are equal to the domestic savings, budget surplus and net imports. Hence increasing capital inflows in the form of foreign investments on the NSE traded stocks will be a great boost to the Indian economy.

Just recently in May, when the government announced plans for compulsory 25% stake sale in all listed public companies, there was a lot of hue and cry over whether the market would have enough liquidity to absorb  so much of stake sale. The estimated amount of equity issuances over the next 3 years is around $30 billion. This amount is trivial in comparison to what large corporations in the US issue. For instance, HP is planning to come out with a $33 billion bond issue in the coming weeks.

Another important factor is competitiveness among the national exchanges itself. NSE is closely followed by BSE and another MCX-SX is waiting in the docks If not NSE then there will be some other exchange. But in my opinion, with its current position in terms of the market position, management and technology advantage, NSE is the most amenable to such expansion.  

NSE has recently signed a cross listing agreement for futures of flagship indices with CME and earlier with SGX, but these listings are just to give foreign investors a feel of Indian markets and assist  in portfolio diversification. The real deal will be when the NSE can convert the volumes and listing numbers the large foreign bourses boast about.

My last argument for having such high hopes of seeing an Indian stock exchange reach the heights of a global exchange is the comparative advantage Indian capital markets have over other emerging economies markets. In the recent World Economic Forum’s Global Competitiveness Index, although India fell two places to 51st rank, its financial markets were rated 17th across the world. This shows how the existing level of competitiveness in the Indian exchanges and the future can be built on this grounding.

Wednesday, October 20, 2010

The IMF or EMF??

We rise in glory as we sink in pride. This is what I have to say to the EU leaders and ECB officials, as they quickly dismiss any talks of an IMF rescue for Greece. The IMF seems to me the best way out for Greece with all its fiscal mess and politics involved in the matter. Let’s face it, that today no eurozone country is audacious or willing enough to get into this ‘delicate’ issue of sovereign default and debt assurance, specially after grinding through such terrible economic times. What Greece is looking right now is for some generous donor to grant an easy loan with low interest rates and in return it will promise to cut down its fiscal deficit by adopting real disciplinary measures.

Here are a few reasons in a nutshell as to why I feel Greece’s bailout is a ‘delicate’ issue:
ü      Any loan or bailout money provided to Greece would be along with a number of constraints attached to it. Nobody would be willing to give a ‘no-frills’ loan to Greece considering its past record of conceited accounting practices and inexperienced policy makers. It is obvious common sense that any entity would like to protect its investment and make sure it oversees its utilisation.
ü      Secondly, there is an inevitable political angle as well which needs to be looked into. There already massive protests across Greece by its unhappy citizens over the government’s resolute commitment to cut public spending and public sector pay freezes. Already unions have endured enough, and one feels that the tipping point is not far away. Thus, in such a heated political environment, having foreign country or interests dictate control and supervision over its policymaking will further add to the fire.
ü      Thirdly, all hopes of the Euro’s future are hinged on a quick, transparent and stable Greek recovery, as the fear of contagion spreading to Portugal, Italy and Spain is high. As a consequence, any hiccups in the bailout may cause sharp reactions from bond markets. Which leads to my argument that what is required is a patient and calibrated approach, but not many would be looking at long term scenario, except the IMF.

Who will take out the chequebook?
Setting aside the IMF as one major contender for this job, let us examine who are the possible contenders. First on the list is the EU, which cannot explicitly bail Greece out as per the treaty clause which governs its functioning. Second, would be unilateral loans form the rich and prosperous European states, which in its current circumstances narrow down to Germany. Germany is the real powerhouse of Europe, also being one of the main beneficiaries of the introduction of Euro currency. Thus, more than an obligation, the last thing Germans want is a euro collapse in a fragile recovery period of today.

But, the German public is outraged by the idea of bailing out the profligate Greeks with their hard earned savings. To me a German bailout looks less probable than a German supervision. This leaves us with only 2 remaining choices. One is a real institution with more than 60 years experience of handling such cases, none other than the IMF. The other is EMF, which is fictitious and is a yet to be started fund. And so one feels the idea of EMF is promoted purely on pride and less logic.

It drives me nuts to read how EU policy makers are so blindly hopeful on setting up the European Monetary Fund as it is currently named. The IMF is clearly a better alternative even though the setting up of EMF is great for future crises but not the present Greece concern at hand. In simple terms, on having met with an accident does a person go to a experienced and reputed hospital, or does one choose go to a new, inexperienced and a politically correct clinic. Of course one chooses the former over the later. Then why make a distinction here for Greece.

Greece certainly needs help, and IMF for me looks like the safest bet. Disillusioned European leaders and policymakers need to shun their pride and also look at another positive from it. An IMF rescue will set a good example for the rest of the eurozone nations. An EMF rescue even if possible will imply a ‘too big-to fail’ guarantee, which will make future defaults even more dangerous.

Saturday, October 16, 2010

Right To Banking??

Yes you read it right, coming shortly to a political theatre near you! After the super successful populist agenda on the Right to Education and the work in progress i.e. Right to Food, here comes the much awaited sequel ‘Right to Banking’!! If you thought two additional rights were enough to send you back to your Civics class in school, well here is another one.

Well I am not this hyper always, but the way the government is selling this in the newspapers does deserve such enthusiasm. Almost every other morning, there are articles by civil servants and the who’s who in the govt. pledging their allegiance to the cause of financial inclusion. The day is not far when ‘financial inclusion’ moves to the more populist and sympathetic name of ‘right to banking’.

The hype surrounding financial inclusion has been influenced our minds so much that we cannot even think beyond what is being presented to us. In a classroom discussion, when I raised my hand to put forward objections to the government’s drive to push and force commercial banks to open up more branches and extend services to rural India, I was told to keep quiet. It was as if I had committed a sin and even the slightest leaning towards capitalism in my speech would be enough for them to brand me an arrogant elitist. It came as a rude shock to me, has the issue become totally one sided? And if yes, what happened to our democratic moral of free speech and opposition.

One has to give some credit to the government for making financial inclusion a buzzword in pink papers. The RBI has tried moral suasion to ask banks to extend their services to the unbanked rural population. But now with the fresh issue of banking licenses to be issued by end of this year, the RBI is going to indirectly force more rural coverage by the prospective bidders as an important prerequisite for the license. This should be a source of worry for the existing commercial banks, especially the foreign banks which already having drawn big plans for urban expansion, might have to rework their strategy.

As a part of Manmohan Singh’s government’s pledge towards inclusive growth, financial inclusion is being seen as a separate issue altogether. Financial inclusion is really just one of the many a component of the overall inclusive growth strategy. Other things such as social inclusion, education, healthcare, infrastructure and energy requirements etc. must go hand in hand to make financial inclusion happen. By just simply opening bank branches will not help the cause.

Account Opened, Now What?
Infrastructure is needed in the form of roads connecting bank branches, security and law& order to protect deposits, communication to connect the banks computer networks and housing for the banks staff. Opening an account is not the last step; the average rural illiterate has to be taught how to operate the account, the details of interest and deposits, rules and nomination policies as well as the procedure for consumer grievance redressal.

Just handing out the money to the farmer is not the end of the story. The farmer also has to be supported and encouraged to improve productivity, has to be given access to electricity and meet his other energy needs, has to be part of holistic community development and most importantly, he has to be feel social included. Only then can the bank expect to receive back the principal with interest. Otherwise it would have to wait a few decades for another populist government to come and waiver off its loans. 

Friday, October 15, 2010

Greece faces a tough year ahead

For those of you who have just joined us and asking what in the world is happening. Here’s the situation: We’ve got in our hands the possibility of the first sovereign debt default by a Euro currency member. Greece has an external debt of 170% of its GDP and is currently running a 13% fiscal deficit. The nation’s problems are increasing day by day. Productivity and employment are at very low and painful levels, for the country to even think of self sufficient recovery.

Much of the panic subsided on Feb 3rd, as the government’s plan to reduce substantially it’s budget deficit to 3% by 2012, was supported by the EU. The plan proposes up taking very unpopular measures to control spending, like slashing public sector spending, pay freezes and wage cuts and increasing taxes. This hasn’t gone down well with public at all. They have already absorbed the 4% pay cut and are expecting the worst is yet to come. However, fear is again creeping into the minds of investors.

There is no doubt that this year's plan to cut deficit from 12.9% to 8.7% will be very difficult and regaining confidence even more.
The bond markets are increasingly skeptical about the government’s plan as the spreads on Greek bonds are rising. What Greece needs foremost is quick cash to refinance it debt which becomes due in a few months. The debt is estimated to the tune of €20 billion. It has been successful to raise €8 billion on Jan 25th through the sale of 5 year bonds. However the rate of interest was very high at 6.2%. With more speculation on Greece’s future going rounds, picking up further debt from markets will become next to impossible for the government at prevailing interest rates.

The government has tried to blame the speculators who have bought credit default swaps (CDS) to insure themselves against a Greek refusal to oblige on the debt. They have alleged that buyers of CDSs are driving up the spreads on bonds and have made borrowing more difficult. That in turn has made the Greek government helpless and led to its current state of affairs. While there have been some officials and economists in Europe who have sympathised on these grounds. But I have two words for them.

Shut up!
The Greeks have no one to blame than themselves. Markets don't show sympathy, they respect discipline and trust. Years of profligacy and dodgy accounting practices in an  attempt to fool the EU and the investors, has left them in a terrible position. There is increasing furore in France and Germany on why it should bail out a cheater. Their displeasure is completely understandable and rightly so.

Its time Greece did the right thing and took some excruciating steps to control the budget and announce some real cuts and meaningful trust-building measures. Passing the buck around, will neither impress the EU nor the investors holding Greek bonds. Its time it pressed the button of urgency and did things swiftly and not smirk around looking for easy deals with the EU or the big members. The more it waits. The more the threat grows, specially for the other European economies, which also have high debts to service, namely Portugal, Spain and Italy. Its time it pleaded guilty. 

NSE to NYSE !!

In a surprise response to my previous post, a lot of my peers have asked me how our exchanges can dream of going global, when after all they are 'desi'. One even quipped that beggars can't be choosers! But I stand firm with my belief and to prove my point, enlist the following things below, which could see NSE becoming another NYSE, along with the significant premise of India becoming a superpower.

Firstly, let me make it clear why I chose NSE over its bitter rival BSE. Ever since the launch of NSE and its electronic trading platforms, the BSE has been playing catch up all the while. So for me, amongst Indian stock exchange contenders, NSE comes above all. BSE has a lot to do to set its house in order.

Second, although NSE should dream global, it should currently set its target on regional dominance. In my opinion, the ideal strategy would be for NSE to try and spread its reach in the next 5 years or so by becoming the dominant stock exchange of the Indian subcontinent. The secondary capital markets of India’s neighbors are not known for their price discovery and liquidity. Thus, for the large firms in the subcontinent, which are looking for raising large capital NSE can be a more viable option instead of looking westwards.

The process of transforming the NSE to South East Asia’s major bourse will be a learning experience for the exchange and regulatory authorities. Many structural changes would be required, but these will only lead to the ultimate goal of being the world’s dominant stock exchange.

On the regulatory side it will require a lot of push and pull as well. This leads to my third point, about capital account convertibility. The foreign investment environment should be completely freed from any capital convertibility controls, which if present will be a big problem for expanding the NSE’s reach globally.

Fourth, its listing requirements will have to be adjusted from time to time, although I am bullish on the INR, it will be safe to assume that dollar could still be the unit of account. Looking at the short term i.e. in the next 7-8 years INR could continue to be in the listing norms and even the currency for transaction. Various macroeconomic variables in the future will decide whether INR will continue to be the global NSE’s transaction currency.

NSE should currently set its target on regional dominance... the dominant stock exchange of the Indian subcontinent... for the large firms in the subcontinent, which are looking for raising large capital NSE can be a more viable option instead of looking westwards.

Second on the regulatory radar and fifth overall, is the change in the accounting standards subjected to the firms listed on the exchange. Investor confidence is one of the fundamental requirements for building this global exchange. Therefore, a common measure to assess companies listed and the overall index products of the exchange would be facilitated by a recognized accounting standard. Maybe the IFRS or an evolved version the IAS; this only time will tell.

Sixth, we need to see rapid expansion on the products being offered by the NSE. Although it lost out to the Bombay stock Exchange for the country’s first IDR, this will serve as a rude wakeup call and set the ball rolling.  Foreign companies are looking for bullish and deep capital markets like India to raise money in the form of IDRs and foreign bond issues. NSE has to be ready to be able to provide that kind of platform and logistics to gain from the coming opportunity in times ahead.

Seventh, would be to build partnerships with other foreign bourses. NSE already has Nifty futures trading on the Singapore Stock Exchange, and just recently has tied up with the Chicago Mercantile Exchange for cross listing of index futures. Nifty futures will be traded on the CME, while the Dow Jones and S&P 500 futures will be traded on the NSE. The move is a step towards alignment to global markets.

This is a great opportunity for the clients in India who are looking for portfolio diversification. We have largely seen a homeward bias from clients so far, maybe because of a lack of opportunity from diversify, but I believe this will be beneficial for them in terms of their portfolios as well as having a global perspective.

The Hindu Business Line reported:
“According to market participants, trading in SGX Nifty futures has been happening almost a decade but volumes picked up only in the last couple of years. At the end of April 2010, open interest stood at 1, 91,741 contracts, which are 65 per cent more than a year-ago period, according to SGX. Trading volumes surged to 7, 79,641 contracts, which are 52 per cent higher over a year.

As part of the agreement, Indian rupee-denominated S&P 500 futures contracts will be listed for trading on the NSE and in return CME will list U.S. dollar-denominated contracts on India's benchmark stock index futures contract, the S&P Nifty.”
NSE faces many short term challenges and within them growth possibilities, which could very well decide its future. With an eye on global partnerships it needs to fend of a coming rival...

The National Stock Exchange (NSE) has signed a letter of intent along with London Stock Exchange (LSE) to evaluate cross listing of index products as well as explore joint strategic opportunities. Both the bourses have explored the possibility of a cross-listing agreement of their flagship indices.

While FTSE Group may license the FTSE 100 index to the NSE, the bourse would license the Nifty to LSE for trading option contracts. Initially, only Nifty options will be considered for listing at LSE as NSE already has licensed Chicago Mercantile Exchange (CME) for trading Nifty futures contracts.

Also recently, there were reports of NSE being in talks with Japan’s Tokyo Stock Exchange, exploring probably what reports suggested was cross listing of the two exchanges’ flagship index futures.

Eighth, NSE faces many short term challenges and within them growth possibilities, which could very well decide its future. With an eye on global partnerships it needs to fend of a coming rival, the Multi Commodity Exchange of India Ltd. It needs to fully exploit the growth potential in India before looking beyond its shores.

While researching online I found an interview of the CEO, NSE who was talking about his firm’s plans future plans in India:

“One is to go out increasingly to underserved market those that are smaller in terms of not being economically viable for intermediaries. To improve the economics of serving in those areas, they may try helping brokers by picking up the tab on public infrastructure. Increasingly, that will try to reduce the cost of commercial public infrastructure, so the brokers do not feel the disincentive to service them. That may bring in the so-called marginal investors.

Second, the derivatives arena will continue to evolve, unlike cash equity which typically moves at gross domestic product (GDP) plus (rates). The plus comes from some chunks of the unlisted economy becoming listed. Derivatives will continue to bring out newer products and services.

Third, the domestic institutional sector still doesn’t use derivatives. Domestic institutions are beginning to get used to these products. Mutual funds are beginning to use a bit but still a small proportion; that would increase.

Fourth, newer asset classes—currency, interest rates are classic products which really need hedging. Arguably, the two most important prices are currency and interest rates, but they are hard to hedge. That will build over a period of time.”

Sunday, October 10, 2010

Reforming the Monetary Policy

Monetary policy has become one of the most valuable tools for the administration and development of an economy. Its ability to control the money supply and influence interest rates has a far most influential reach than any other policy. One of the most significant reasons is that the time lag between implementation and result is the least among alternatives. Central bank policy reviews have become one of the most anticipated indicators, for both investors and general public alike.

The policy reviews provide and insight into the overall economic conditions and coming future central bank and government policy changes or tax alterations. The citizens eagerly wait for their newspapers to tell them if home loans are going to get cheaper, if the inflation is going to eat away their savings, is their neighbour going to buy a new car or a scooter, etc. On the other hand, businesses, foreign investors and economists get an analysis of the country’s current scenario and state of economy. Thus, that leads me to the point that how monetary policy has become a part of our daily affairs and that’s why it is so effectual.

However, with great power comes great responsibility. The central bank has to be more responsible about its  guiding principles. Thus, I feel the most significant facet of a central bank’s monetary policy is it’s objective. I say that because as we have seen in the past, different central banks set different objectives and so have varied approaches and of course giving diverse results. To keep it simple let me list down these broad objectives:
  • Price stability or inflation targeting
  • Economic growth and low unemployment

There has always existed a trade-off between these to policy objectives. Generally it is according to the history, social-political scenario or economic conditions of the country which configures the monetary policy planning.

The European Central Bank has its primary objective of monetary policy to maintain price stability. The ECB aims at inflation rates of below, but close to, 2% over the medium term. This conservative approach has been criticised by many to be neglecting growth and high unemployment. But, like I said there are social factors which influence as well. There are long memories of people in Europe specially Germany of hyperinflation. So they are sure to be conservative. On the other hand, USA’s fed follows a more aggressive policy of concentrating on economic growth. Although the fed has always claims to have been following a mixture of both.

What’s for the future?
This present crisis has exposed an unpalatable truth that the monetary policy has to be very dynamic and holistic in nature, in order to keep up with today’s ever-changing economic and international trade environment. A number of fresh approaches have come to light in the past one year.

One such is Macroprudential regulation. Financial stability was considered to be one of the ‘other’ objectives of the central bank. But, last year the banking crisis showed that we need better regulation of the system by the central bank which includes measuring cyclic macro prudential indicators and reviewing banks individually rather than setting just petty capital adequacy norms.

One of the other important roles of the central bank is the role of custodian of foreign exchange and maintaining reserves. This include policies targeting BOP surpluses and adjusting monetary policies keeping in mind the position of the current and capital account reserves. For some economies which have a fixed exchange rate system, this forex management forms a crux of the central bank policies. We could see central banks taking this up more seriously and making it one the core guiding principles, especially as globalisation has brought so many opportunities and equally challenging threats to domestic firms. Thus, it should get more attention then it presently gets.

Another interesting method is the multiple indicator approach with Reserve bank of India follows. It includes tracking a number of indicators on whose basis its monetary policy is drafted. I will discuss it at length in my next post.

As the world comes out of a difficult recession in many years, reform will not exclude the central banks as well. As an institution it has gained huge importance in our daily lives as well; and making it more robust, prudent and flexible should be the right way forward.

Saturday, October 2, 2010

Railways: India's story till now & the Budget

The Indian Railways sums up the current state of the Indian government’s PSU machinery and the bureaucratic setup of the country. It is a business entity controlling an important component of the economy, yet not realising its full potential. An organisation still split up by its social obligations, bogged down by red- tapism and inefficient public sector wages paid to its employees, who most probably joined because of the employment benefits and pension, than by the task at hand. Just like other PSUs it had seen a successful start, which fizzled soon after.

It is said that responsibility and accountability start from the top. For the Railways, corruption and jugaad originate from the top. There is always a big political hullabaloo before the cabinet is sworn in, and speculation on which political ally will be given the Union railways ministry always abounds. The ‘honourable’ minister is requested for favours for constructing stations or making trains pass through fellow parliamentarians’ constituencies. Adding to that, the preceding minister’s serendipity that it was a cash mine with profits of Rs. 9000 crores(in 2005) after years of successive losses.

The Railways after independence already had a network of around 53,600 route kms. Today, it stands at 65,000 route kms. An increase of just roughly 12,000 route kms of network in 60 years!
Well, the Railways has always been more or less a socio-political entity. But it wasn’t like this always. It was once the symbol of India’s economic pride and by numbers it still is. It has the largest railway network in the world under single management. The Indian Railways carries the most passengers (4 billion) in the world. It is also one of the largest employers (15.8 lakh employees) in the world.

However, it has also been under-performing and has shown relatively little and almost stagnant growth in terms of laying more lines, better freight handling, infrastructure facilities and train wagons. The Railways after independence already had a network of around 53,600 route kms. Today, it stands at 65,000 route kms. An increase of just roughly 12,000 route kms of network in 60 years! It is indeed very shocking that the Railways not taken up any major expansion initiatives. This lack of initiative cuts across many government agencies.

Another major negative has been the cross-subsidisation fare policy of the Railways. Under this policy, the revenue collected from freight charges is used to cross subsidize the losses from the passenger fares collection. Passenger fares have always been kept low as a populist measure, but the ever-rising oil (fuel) prices have been causing massive losses to the Railways. The PM’s Office has even suggested that this system be abandoned in favour of something more relevant and effective. It had suggested passenger fares be indexed to oil prices. But, even this was not accepted in this year’s budget. And so by keeping fares low this year as well, we can again expect it to incur huge losses.
It seems the Railways, like few of its fellow PSU brethren is on a journey with no destination.
Also, a problem characteristic to all PSU is evident here as well. There is no clear roadmap for public-private partnerships. In natural monopolies like the railways it is essential to bring external technology and competition into the system, so as to give consumers a better return for their money. Private players will bring with them funds and expertise, which is vital to revamp the existing Indian Railways.

Like a sail..keep drifting
The railways has to bring its act together, and the process should start from the top. In the current budget, announcements of setting up medical colleges and sports academies are unnecessary money laundering excuses. There was no mention of the ‘world class’ stations, a promise made last year. No mention about modernisation of the machinery and facilities. No more faster trains. No vision, no serious number crunching. It seems the Railways, like few of its fellow PSU brethren is on a journey with no destination.