Anticipating the Unintended

This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com

This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com

Full text here. This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com

The full text is here. This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com

The full text is here. This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com

Read the edition here. This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com

Read the edition here. This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com

Financial Regulation of Private Firms + Emigration of Indian Talent This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com

India Watch #1: Of Protests and Perfect TricksInsights on issues relevant to India— RSJFor nearly a month now, some of India's top wrestlers, who between them have earned over 25 medals in various global competitions, have been protesting against the conduct of the Wrestling Federation of India (WFI) chief and BJP MP Brij Bhushan Singh. This is not an ordinary protest. The allegations in the FIR against Singh are quite serious, including a couple of instances of demanding sexual favours as a quid pro quo for professional assistance, about 15 incidents of sexual harassment and stories of inappropriate touching, and molestation of minor girls. You would imagine this would be some kind of an open-and-shut case. I mean, here are a few women wrestlers who have everything to lose here by taking a stand against their own federation and the government. They aren’t superstar cricketers with financial security and access to media. They don’t have multi-million and multi-year sponsorship deals or lucrative post-retirement commentary gigs waiting for them. Their sport is everything to them, and they are willing to risk that one thing they have loved doing all their lives. These are girls who have come up the hard way in a society that doesn’t prize either women or sports and especially women in sports. They have persevered despite the odds against them because that’s what athletes do. So, the least you would have thought is that while the police investigations and the judicial process is going on, or, as we like to say in India, as the law takes its own course, the government should ask the WFI chief to step down temporarily. Surprisingly though, this doesn't seem to be a priority for the government. Instead, it appears they would rather suppress these voices than address their concerns. So, last week while you had saturation coverage on various channels about the inauguration of the new parliament building, these athletes were being roughed up and assaulted at the site of protest. There was barely any TV media there. As they say, there are always two Indias at work. It is tempting to zoom out a bit and say that this story, in many ways, reflects the current state of Indian politics and society. It is not there yet. But there is a pattern in how we are dealing with protests and dissent that merits a deeper look. Before I go there, let me count the number of ways we have got this thing wrong. Firstly, for decades, we have managed sports and their governing bodies in India in the most unprofessional way possible. These positions have often been given to politicians as small consolation prizes to run their minor fiefdoms. Corruption, nepotism and high-handedness of officials have come along with this. Read any autobiography of an athlete in India and you will be struck by the remarkable apathy and neglect they had to overcome from their own sporting federation to succeed. As major sports events like the Olympics or Asian Games approach, there's often a question of why our sporting performance doesn't reflect our population size and recent prosperity. This story never gets old. While we have seen some improvement in the last decade, we remain an underperforming nation in sports. One fundamental issue to address is improving sports administration by involving experts with experience in either playing the sport, managing large organizations, or possessing a proven visionary track record. Indian tennis is a prime example where one family has presided over its administration for over half a century. We have only gotten worse in tennis, with almost no one ranked anywhere in the top 1000 in the world. Similar fiefdoms exist in other sports like boxing, shooting and even cricket. Despite the efforts of some public-spirited lawyers and a few interventions by the Supreme Court to set things right, things have remained the same. There was some hope when this government came to power that there would be much-needed reforms in sports administration, especially in those early days. However, once you have the keys to the power of the state, it is difficult to resist its benefits. The result is a disheartening situation where politicians with limited understanding or passion for sports lead the federations. We are back to the bad old days now. Secondly, we seem to be undoing all the progress we have made in addressing sexual harassment allegations in the workplace. There are POSH committees that are legally mandated in organisations and a framework that allows for a safe and secure environment for women at work. In India, the foundation for this framework was based on the Vishaka guidelines set nearly 25 years ago. In cases like this, the employer (in this case, the sports ministry) should form a committee with an independent chair who investigate these allegations and arrive at their conclusions. And it is usual that during such an investigation, it would be appropriate for the accused to step aside for a free and fair process. However, none of this process has been followed. Neither the WFI nor the Indian Olympic Association (IOA) have even acknowledged taking up these allegations. In fact, P.T. Usha, the current chief of IOA and a track legend initially dismissed them as false and an attempt to tarnish our nation's image. We are back in the territory of ghar ki izzat, and the patriarchal attitudes where raising such concerns are seen as bringing dishonour to one's family or damaging a country's reputation. It is concerning that even government officials are not adhering to their own established guidelines. The response to the protests by both the sporting fraternity and the general public has been surprising. Despite the police manhandling of these athletes, very few voices have come out in support of them, with notable exceptions like Abhinav Bindra and Sania Mirza. Even their anodyne statements hoping that the athletes are given their due and that proper investigations take place seems like an act of courage. The 1983 cricket World Cup winning team, too, came out with a statement expressing anguish at the treatment of the athletes and hoping for a resolution. I’m not sure what resolution they are expecting in a case that should be picked up by the police and investigated with rigour. Quite disconcertingly, although to the surprise of no one, the usual set of partisans and news anchors have questioned the motives behind these protests. The usual whataboutery season is on in the TV debates, and the WhatsApp universities are busy generating content blaming the victims or distracting us with Rahul Gandhi’s US visit. It is a textbook case of a society losing its moral compass today while romanticising its glorious past and its superiority as a civilisation. In a society where many underprivileged children pursue sports as a means to improve their lives, the exploitation by administrators and coaches within the system should be a matter of great concern. Despite this reality, political affiliations and a belief that our leader can do no wrong is now trumping reason. We now have a situation where there are people questioning the legal process put in place for sexual harassment complaints that apparently favour the woman victims’ rights to fight their case. This mindset risks undoing the progress made towards providing safe working environments for women. We are happy to go down the path of victim blaming and gaslighting than hold men in power accountable. This in a country where crime against women is still among the highest in the world and that has one of the lowest female participation rates in labor worldwide. So, why is the government reluctant to act against Singh? Based on the track record of how it has handled previous protests, there are three possible explanations for this behaviour. One, this administration perceives admitting a mistake as a sign of weakness. They would rather make incorrect decisions than appear weak in any way. We have made this point earlier. This is the basis of its electoral appeal. That it can do no wrong. Accepting that the protesters are right will dent its strong government image. Two, there is the electoral angle to this, given we are less than a year away from the Lok Sabha polls. Brij Bhushan Singh's influence in the Ayodhya-Gonda region cannot be ignored. He or his family members have won elections there for over three decades, regardless of their party affiliation. His ability to switch allegiances while maintaining electoral success suggests a ground network that doesn’t depend on a party for success. While the BJP is on a strong wicket for winning 2024, it doesn’t want to risk failure, especially in U.P. This calculus might still turn if the recent mobilisation of the local Jat communities and Khap panchayats to support the wrestlers becomes stronger. This shift may transform the protest into something more politically relevant, as it happened with the farmer protests. I don’t think I had imagined a day when the Khap panchayats would be seen as advocates of women’s rights. But we are there. The third explanation lies in the ruling party's deeper understanding of social undercurrents, which they believe represent the silent majority's views. This covers issues like women's liberation and how India has imitated Western liberal guidelines that aren’t compatible with our civilisational values. They would like to believe that a sizable portion of Indian society may support a pause on liberal issues especially relating to women’s freedom. I’m not very sure if this is an accurate assessment, but it doesn’t hurt to be politically ambiguous on this. At a broader level, this is also about how we see protest or dissent in these times. It is intriguing how easily people trust the state despite the weight of history against it while distrusting the protesters who have a grouse against the powerful. This is an odd inversion that seems to have arisen because our collective sense of self-worth and pride are now cl

Being Pragmatic about ESG Norms, Lessons for India's Semiconductor Strategy, and Challenging Common Wisdom about India's Constitution-making. This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com

India Policy Watch #1: Silly Season Is Upon UsInsights on issues relevant to India— RSJLate on Friday this week, the RBI issued a circular withdrawing the circulation of ₹2000 denomination banknotes. The RBI clarified that these notes would continue to serve as legal tender, so this isn’t another demonetisation. Here’s the Indian Express reporting:THE RESERVE Bank of India (RBI) Friday announced the withdrawal of its highest value currency note, Rs 2,000, from circulation, adding that the notes will continue to be legal tender. It said the existing Rs 2,000 notes can be deposited or exchanged in banks until September 30, but set a limit of “Rs 20,000 at a time”.“In order to ensure operational convenience and to avoid disruption of regular activities of bank branches, exchange of Rs 2,000 banknotes can be made up to a limit of Rs 20,000 at a time, at any bank starting from May 23,” it said.“To complete the exercise in a time-bound manner and to provide adequate time to the members of the public, all banks shall provide deposit and/ or exchange facility for Rs 2,000 banknotes until September 30, 2023,” the RBI said.The RBI circular and the press note also attempt to make a convincing, logical case for this decision. There appear to be three reasons for doing this.Thanks for reading Anticipating the Unintended! Subscribe for free to receive new posts and support my work.One, the ₹2000 denomination notes seem to have served their useful purpose. They were introduced in November 2016 when the legal tender status of existing ₹500 and ₹1000 banknotes in circulation were withdrawn. Looking back, it appears these were introduced to help re-monetise the economy really quickly, which was under the stress of not having adequate new legal tender banknotes. According to the RBI, after this task of re-monetising was completed, the printing of new ₹2000 banknotes was stopped in 2018-19. Therefore, after 5 years of not printing any new notes, this looks like the right time to take them out of circulation completely.Two, since most of the ₹2000 denomination notes were issued prior to 2017, they have apparently completed the typical lifespan of a banknote which is between 4-5 years. In an ideal system, most of these old notes should have come back to the RBI by now. Further, these notes are not seen to be used for transactions anymore. They seem to be just sitting somewhere out there. So, in pursuance of the ‘clean note policy’, the best course of action is to withdraw them from circulation. Lastly, there was also an allusion to the ₹2000 notes being often found by various investigative agencies in their haul of black money or frauds. So, somewhere there is a view that withdrawing these notes would smoke these fraudsters out, who are sitting on piles of this unaccounted-for cash.Now, as students of public policy, we must assess this measure based on its intended objectives, the likely costs of doing it and the unintended consequences that are likely to arise. The first reason—that the ₹2000 banknotes have served their purpose, so it is time we take them out—can be scrutinised further. I don’t think it was made clear when they were introduced back in November 2016 that the only reason for doing it was to re-monetise the economy quickly. There’s a bit of retrofitting of logic here. Also, the decision to stop printing new ₹2000 notes in 2018-19 has meant the total circulation of these notes has been on a decline. In the last four years, the total value of the ₹2000 notes in circulation has gone down from ₹6.5 trillion (over 30 per cent of notes in circulation by value) to about ₹3.6 trillion (about 10 per cent of total circulation by value). I guess, left to itself, we might have had this number slide to a smaller number, say below, ₹1 trillion in the next 3 years. The same point is relevant for the ‘clean note policy’ since these notes would have eventually come back if they were not being used for transactions and were already at the end of their lifetime. So, the question is, did we need to accelerate something that would have followed a natural path to the policy objective that’s desired? Would another three years of these notes in circulation have been detrimental to some policy objective? It is not clear. What’s clear is there will be another season of ordinary citizens queuing up in front of bank branches that will begin on Monday. It might be argued that there won’t be any panic because the regulator has made it clear that these notes will continue to be legal tender. But who will receive these notes for any transactions starting today? These notes are as good as useless, and for anyone who uses them for transactions or has stored them for any legal purpose, the only way is to get them exchanged for those notes that are both legal and usable. There’s always a sense of schadenfreude among the middle class that it is the rich who will suffer. As was seen during the demonetisation exercise, the poor suffer equally, if not more. The cost of the logistics of sending all ₹2000 notes back from ATMs and branches to the RBI, replacing them with notes of other denominations, the extra hours spent by people exchanging their notes in batches of ₹20,000 and the additional measures to be taken to check for the provenance of the money that will come into the banking system and the risk of frauds during this process are all additional costs to the system. There should be a more compelling upside to these costs except to argue that these notes have served their purpose.Lastly, on high denomination notes abetting corruption and fraud, there’s some data from experiences in other countries that suggest this. However, experience in India has shown after the initial ‘disruption’, the system finds a new equilibrium, and things continue as usual. The idea that demonetisation would aid the digital economy and will bring down cash in circulation was compelling at that time. But as seen, over time, cash in the economy continued to rise despite a significant ramp-up in digital transactions, which might have happened anyway because of UPI. There are more fundamental reasons for corruption that need to be addressed than making a case for smaller denomination notes. Anyway, the corruption argument never gets old in India, where everyone assumes that, barring them, everyone else around is corrupt. So, the usual arguments have started surfacing on social media that this will impact a small minority of people, and they anyway need to answer why they were hoarding these high denomination notes. And, there’s the political masterstroke argument which suggests this will derail the fundraising ability of the opposition in this election year. I’m not sure if that’s supported by data because we had the unusual scenario of almost 100 per cent of the invalidated denomination notes during demonetisation eventually returning to the RBI. Nobody was wiser when that happened. The only upside at the end of this exercise will possibly be with banks that will have a temporary increase in their deposits. The scramble for deposits that was on because of shrinking liquidity will abate for some time. That will possibly help them support loan growth that was dependent on deposit mobilisation. That might not be a bad outcome, but it is a torturous way to get there. But then we like convolutions.In parallel, there was another interesting piece of policy-making going on. The TCS (tax collected at source) on international credit card spending outside of India. Earlier during the week, reports emerged that all such spends will now attract a TCS of 20 per cent which can then be recovered by individuals at the time of filing their annual return. The Indian Express on Tuesday reported:THE CENTRAL Government, in consultation with the Reserve Bank of India, in a late night notification Tuesday amended rules under the Foreign Exchange Management Act, bringing in international credit card spends outside India under the Liberalised Remittance Scheme (LRS). As a consequence, the spending by international credit cards will also attract a higher rate of Tax Collected at Source (TCS) at 20 per cent effective July 1.The notification brings transactions through credit cards outside India under the ambit of the LRS with immediate effect, which enables the higher levy of TCS, as announced in the Budget for 2022-23, from July 1. This is expected to help track high-value overseas transactions and will not apply on the payments for purchase of foreign goods/services from India.Prior to this, the usage of an international credit card to make payments towards meeting expenses during a trip abroad was not covered under the LRS. The spendings through international credit cards were excluded from LRS by way of Rule 7 of the Foreign Exchange Management (Current Account Transaction) Rules, 2000. With the latest notification, Rule 7 has now been omitted, paving way for the inclusion of such spendings under LRS.Now, what could be the reason for this? The Chief Economic Advisor in a column in the Indian Express gave an insight into the thinking:It is a fact that remittances under LRS have increased multi-fold in the last few years, and as per data published by the Reserve Bank of India (RBI), LRS remittances which were Rs 0.9 trillion in FY2019, crossed Rs 2 trillion in FY2023. During FY2023, an interesting trend was noticed in the remittances for deposits, purchase of immovable property, investment in equity/debt, gifts/donations and travel. Remittances under these heads constituted almost 70 per cent of the total, representing a year-on-year growth of 74 per cent. Foreign travel alone was almost Rs 1.1 trillion in FY2023, a three-fold increase from the pre-Covid period. In all of these, payments made through credit cards are not reflected as such payments were not subject to the LRS limit. This is an anomaly that needed to be fixed anyway.We are back to the old Indian argument. There are people who are spendi

Global Policy Watch: Much Ado About De-dollarisationReflections on global policy issues— RSJThis week, Donald Trump urged Republican lawmakers to let the U.S. default on its debt if the Democrats don’t agree on massive budget cuts. Trump likened the people running the U.S. treasury to ‘drunken sailors’, an epithet I can get behind. Default is not something Janet Yellen, the U.S. Treasury Secretary, can even begin to imagine. As CNBC reported, Yellen chose strong words to express her views if the debt ceiling was not raised by the House:“The notion of defaulting on our debt is something that would so badly undermine the U.S. and global economy that I think it should be regarded by everyone as unthinkable,” she told reporters. “America should never default.”When asked about steps the Biden administration could take in the wake of a default, Yellen emphasized that lawmakers must raise the debt ceiling.“There is no good alternative that will save us from catastrophe. I don’t want to get into ranking which bad alternative is better than others, but the only reasonable thing is to raise the debt ceiling and to avoid the dreadful consequences that will come,” she told reporters, noting that defaulting on debt can be prevented.There is more than a grain of truth there in some of her apparent hyperbole. The U.S. hegemony in the global financial system runs on trust that they won’t default on their debt. Take that trust out of the equation, and what have you got left? This is somewhat more salient in these times when there’s a talk of de-dollarisation going around. Russia and China have been keen to trade in their own currencies between themselves and other partners who are amenable to this idea. And they have found some traction in this idea from other countries who aren’t exactly bit players in the global economy. In March this year, the yuan overtook the dollar in being the predominant currency used for cross-border transactions in China. Here’s a quick run-through of what different countries have been doing to reduce their dollar dependence. Russia and Saudi Arabia are using yuan to settle payments for gas and oil trade. Russia offloaded a lot of US dollars in its foreign reserves before the start of the war and replaced it with gold and yuan. It will possibly continue building yuan reserves in future. Brazil is already doing trade settlements in yuan and is also using the CIPS (China’s response to US-dominated SWIFT) for international financial messaging services. Argentina and Thailand seem to be also doing more of their trade with China in yuan. And I’m not including the likes of Pakistan, Bangladesh and other smaller economies that have politically or economically tied themselves up with China and are following suit. And a few weeks back, the French President, Emmanuel Macron, also raised the issue of strategic autonomy of the EU after his visit to Beijing. As Politico reported:Macron also argued that Europe had increased its dependency on the U.S. for weapons and energy and must now focus on boosting European defense industries. He also suggested Europe should reduce its dependence on the “extraterritoriality of the U.S. dollar,” a key policy objective of both Moscow and Beijing. “If the tensions between the two superpowers heat up … we won’t have the time nor the resources to finance our strategic autonomy and we will become vassals,” he said.You get the picture. This idea of de-dollarisation seems to be gaining traction. How real is this possibility? There are possibly three lenses to look at this issue, and we will cover them in this edition.Why the recent hate for the dollar?A useful area to start with is to understand where this desire to find alternatives to the dollar is emerging. I mean, it is obvious why Russia and China are doing it and the way the U.S. used its dominance over the financial system to shut out Russia. Companies were barred from trading with Russia, Russian banks couldn’t access SWIFT and networks like Visa and Mastercard stopped their operations. Russia got the message but so did other large economies that didn’t think of themselves firmly in the U.S. camp. ‘What if’ questions began circulating among policymakers there. What if, in future, a somewhat unpredictable U.S. president decides to do this to us? And once you start building these scenarios, you soon realise the extent of dependence the global financial system has on not just the dollar but, beyond it, to the infrastructure and rules of the game developed by the U.S. corporations. There’s been a measured retreat ever since. In India, a visible example of this has been the push toward Rupay by the regulator and the government in lieu of Visa and Mastercard. But merely looking at the U.S. response to Russia as the reason would be missing the longer-term trend. In his book ‘Bucking the Buck’, Daniel McDowell shows data on the annual number of executive orders that instruct the US Treasury to enforce financial sanctions against specially designated nationals (SDNs). These were rarities in the 70s. By the early 2000s, such annual orders were in their low twenties and in the last few years, they have reached the three-figure mark. It is clear that the U.S. is using its enormous clout as the owner of the global reserve currency and financial infrastructure to punish those who fall out of line. This is war by other means. Interestingly, this ‘sanctions happy’ behaviour in the last decade coincided with a wave of populist leaders coming into power in many countries who would not like to be seen as weak or held to ransom by the U.S. This has meant these states have used strategic autonomy as a plank to pursue their interests to go around the U.S. built system. I don’t see this trend abating any time soon. The future U.S. administrations will continue to use financial coercion as a tool because it appears bloodless, and the larger economies will continue freeing themselves from this hegemony one system at a time. The tough and fortuitous road to becoming a reserve currencyBut does that mean we will eventually end up with de-dollarisation? Well, there are two things to appreciate here. How does a currency become a reserve currency? How did the dollar become one? And once it does, what keeps it there? If you go back a little over a hundred years, most countries in the world pegged their currencies to gold as a means of facilitating cross-border trade and stabilising currencies. But during World War 1, it became difficult for these countries to fund their war expenses without printing paper money and devaluing their currencies. Britain continued adhering to the gold standard, but it was difficult for it to sustain its war efforts too. It had to borrow to run its expenses during and after WWI. Between the two wars, the U.S. became a huge exporter of goods and armament to the rest of the world, and it took the payment in gold. By the time World War 2 was ending, the U.S. had hoarded most of the world’s gold, which made going back to the gold standard impossible because other countries just didn’t have any gold. When the allied nations met at Bretton Woods to discuss the new financial world order after the war, it became quite clear that the only real option of managing a foreign exchange system was one that would have all other currencies pegged to the dollar, which would then be linked to gold. It is important to understand that there was no specific effort made to replace Pound as the international reserve currency. It just became inevitable, given the mix of circumstances. Around the same time and for a decade after, the U.S. led the post-war reconstruction efforts in Western Europe and Japan, which gave it a political clout that was unmatched. This political dominance, along with the remnants of the Bretton Woods agreement, is what runs the global currency system in our times, though, in the 70s, the U.S. delinked the dollar from gold as well. That led to the floating exchange rates system that exists today and the dollarisation of the global economy. Over time countries learnt to accumulate their foreign exchange reserves in dollars by buying U.S. treasury bills. Together with the IMF and WB and the associated ecosystem that got built around the U.S. dollar, it became the force that it is today. Now for any currency to replace the U.S. dollar, it has to have the happy coincidence of being a dominant political and economic force, a lack of alternatives for the countries and an alternative to Bretton Wood (or a modification of the same) which can replace the current system. It is very difficult to imagine how something like this can happen unless there is a global crisis of a magnitude where a rebaselining of everything becomes the only way ahead. That brings us to the other point on what sustains the dollar as a reserve currency. There are multiple factors at play here. There are, of course, the network effects of the dollar being deeply embedded in so many commercial ecosystems that taking it out is rife with friction and pain. Also, the dollar is fully convertible, which makes it convenient for others to use it as a store of value. It has remained stable; its market is deep and liquid, enabling easy conversion of bonds to cash and vice versa; there exists a mature insurance market to cover currency risks and above all, we have an implicit guarantee that the U.S. will not default on its debt. This is a trust that has been built over the last eight decades because the world believes the U.S. will run a rule-based order with a strong legal framework to ensure no single person can override rules or conventions. Yawn when you hear Yuan as the next reserve currency So, how does one see the efforts of China or Russia to wean themselves away from this dollar-dominated system? Will the yuan be able to replace the dollar ever? Apart from the points mentioned above, which led to the dollar being in a unique place in the world in the post-war days a

Global Policy Watch: Chronicle Of A Crisis Foretold Reflections on global policy issues — RSJA major state election (Karnataka) is coming up this week. But there’s hardly anything worth analysing. The Congress seemed to have a slight edge in the early opinion polls, but that’s wearing thin. The BJP, always with its ears to the ground, has cranked up its poll machinery in the last couple of weeks drawing upon the star power of the PM in the urban areas of the state. The friendly media houses have been mobilised to pick up ‘emotive’ issues that would tilt the scale in favour of the party in power. It is not too difficult to figure out what the average voter wants if you go by the opinion polls and surveys. But those substantive issues just don’t feature in the public discourse. If you read the papers or media reports on what’s being debated among parties in Karnataka, it is about who is a Hindu hater, who prostrates more often before deities and how going back to the OPS (old pension scheme) is such a wonderful idea. In the classical model of how representative democracy ought to work, the voters would have a limited view of how the world works, and it is the representative who owes the voters not only his labour but also his judgment on issues (to riff on Burke). That seems to be inverted here. One set of representatives has, over the last few years, instituted all kinds of targeted laws - hijaab ban, anti-conversion laws, scrapping minority quotas and cow slaughter ban - in the hope that they will yield electoral gains. The other set is talking of another set of bans convenient to them and some really bad economic policies. We often say that this newsletter attempts to change the demand side of the political equation by making people more aware of public policies and demanding better from their representatives. What we have here is the public demanding the right kind of things (if opinion polls are to go by), but their representatives are keen on dragging them back to divisive emotive issues. The Karnataka election will be a good test of what prevails eventually. I can almost see the straight line from these polls to the general elections due almost exactly 12 months from now. We will all be debating similar trivial issues than what really should matter to India. For some reason, that doesn’t make for a good topic of debate. It makes any election analysis a waste of time, really. Switching gears, as I finished writing my last week’s edition on what the US Fed refuses to learn from the SVB collapse, another mid-sized US bank, the First Republic Bank (FRB), went down and was sold to J.P. Morgan, the ultimate backstop in the US financial system. No amount of assurance from FDIC to the depositors of the bank nor the combined infusion of capital about a month back from a consortium of big banks into FRB was enough to stanch the outflow of deposits. Soon the bank was insolvent, the shareholders and bondholders lost everything, and J.P. Morgan was given enough of a sweet deal to pick up the pieces. I’m sure the Fed will come out with another report on the FRB collapse where it will blame the management for not hedging its treasury risks and being lax in its risk practices. There will be a light rap to the supervisors and staff from Fed who monitored FRB, and that will be that. I hope there’s some more introspection by the Fed than that. Because as the shares of PacWest and Western Alliance have sunk over the last two days, it is clear that a number of mid-sized banks are going to collapse in slow-motion and end up in the lap of J.P. Morgan or FDIC very soon. The feeble Fed response was a 25 bps hike in rates last week with a strong indication that it will hit the pause button on hikes now. The question is if that’s enough to structurally save many of these banks.I have argued for the past couple of months (just after the SVB collapse) that there are three problems for the Fed to contend with, and there are no real answers for them. It is Hail Mary time. Choose the best among the worst options and brace for the impact. I will lay out the three problems it faces before suggesting what looks like the best of the worst option that the Fed has chosen. First, the Fed continued raising interest rates to fight inflation without thinking through its impact on the banking system. This much is clear now. The surprises that have come up in the shape of SVB, Signature and FRB weren’t anticipated at all. As the interest rates rose, the value of the long-term assets held by banks has fallen while their liabilities, in the form of deposits, which tend to be shorter in term, haven’t fallen as much. The slowdown in the economy has meant there’s not enough demand for credit at elevated rates, which means banks continue to invest in long-term US treasury bills. Every time the rates go up, these held-to-maturity (HTM) assets take a notional mark-to-market loss. A recent report by the Hoover Institution suggests that at this moment, the US Banking system’s market value of assets is about $ 2 trillion below their book value. In an article on Yahoo Finance, Ambrose Evan-Pritchards writes:The second and third biggest bank failures in US history have followed in quick succession. The US Treasury and Federal Reserve would like us to believe that they are “idiosyncratic”. That is a dangerous evasion.Almost half of America’s 4,800 banks are already burning through their capital buffers. They may not have to mark all losses to market under US accounting rules but that does not make them solvent. Somebody will take those losses.“It’s spooky. Thousands of banks are underwater,” said Professor Amit Seru, a banking expert at Stanford University. “Let’s not pretend that this is just about Silicon Valley Bank and First Republic. A lot of the US banking system is potentially insolvent.”The second problem, which kind of starts giving this a contagion feel, is the state of the commercial property market in the US. Interest rates have moved up too fast, the slowdown is real with many large employers laying off people, so there’s no real need for commercial capacity, and the excess liquidity fuelled by the Fed during the pandemic meant additional capacity was built up cheaply, which now has no takers. What’s worse, the rapid increase in rates means that a lot of these loans that will come up for refinancing soon (at higher rates) will face defaults. The mid-sized regional banks have a sizable exposure to commercial real estate, with estimates that about two-thirds of all commercial property borrowing comes from them. From the same Yahoo Finance article:Packages of commercial property loans (CMBS) are typically on short maturities and have to be refinanced every two to three years. Borrowing exploded during the pandemic when the Fed flooded the system with liquidity. That debt comes due in late 2023 and 2024.Could the losses be as bad as the subprime crisis? Probably not. Capital Economics says the investment bubble in US residential property peaked at 6.5pc of GDP in 2007. The comparable figure for commercial property today is 2.6pc.But the threat is not trivial either. US commercial property prices have so far fallen by just 4pc to 5pc. Capital Economics expects a peak to trough decline of 22pc. This will wreak further havoc on the loan portfolios of the regional banks that account for 70pc of all commercial property financing.Estimates vary, but it is likely that even a 10-15 per cent increase in default rates on commercial property when the refinancing chickens come home to roost could mean about $ 100 billion in losses for banks. And these are real losses, not the notional variety sitting on the books. Will the regional banks be able to weather this? And what happens if 4-5 of them catch a cold together in this portfolio? The risk of contagion flowing up the banking food chain is real.Lastly, the Fed, FDIC and the government took the extraordinary step of guaranteeing all deposits after the collapse of SVB to reassure depositors and not have further runs on mid-sized banks. But that didn’t stop the ever-increasing deposit erosion for FRB during April. People can do the math, and they realise there’s no way the government can fill a giant hole in case there’s a real deposit run. The FDIC, after all, has a little over $ 100 billion to act as insurance for such an eventuality. That’s loose change in the broader scheme of things. So, the depositors will flee the more you try and convince them all’s well. Plus, the blanket deposit backstop has meant there’s a moral hazard built right there for the management not to be too worried about the nature of deposits they bring or the risk of serious asset-liability mismatches. At the time of SVB collapse, I wrote in edition # 205:I guess one way to look at this is if you let fiscal dominance become the central canon of how you manage your economic policy, you will eventually reach the same place as other economies (mostly developing) that have indulged in the same for years. The monetary authorities in the U.S. have been accommodating the fiscal profligacy of the treasury for years. This was accentuated during the pandemic. Trillions of dollars were pumped in to save the economy. I’m not sure how much the economy needed saving then. But that bill has come now. First in the shape of inflation, followed by rapid, unprecedented rate hikes and the inevitable accidents that are showing up now. Almost certainly, a recession will follow. Isomorphic mimicry of Latin American monetary policy indeed.Now, back to Evans-Pritchard and his article in Yahoo Finance:The root cause of this bond and banking crisis lies in the erratic behaviour and perverse incentives created by the Fed and the US Treasury over many years, culminating in the violent lurch from ultra-easy money to ultra-tight money now underway. They first created “interest rate risk” on a galactic scale: now they are detonating the delayed timebomb of their own crea

India Policy Watch #1: How Not to Let the Opportunity Slip AwayInsights on issues relevant to India — RSJA strange thing happens when you are away on a break. One week you are sitting and wondering how many different things you can write about because of the flurry of events around you. US banks getting into trouble, Rahul Gandhi being denied bail, more curbs on US companies doing business in China, frenetic moves in semiconductor politics - you get the picture. And then you take a break. And everything slows down. First Republic Bank doesn’t implode in a matter of hours like SVB. Instead, it drags its feet in a slow-motion death spiral. RBI pauses on its rate increases. Janet Yellen pulls back on US hostility towards China while cooing about how the two economies need one another. Things go to a standstill when you stop looking at the world with a weekly columnist’s gaze. It is like the vibe of a still summer day in India takes over everything. Nothing moves. Once back, what does one write about? Well, thematically, there isn’t any one thing that will do right now. So, I guess I will cover a few areas that could be of interest.The big story out of India last week was that we might have overtaken China in the population sweepstakes. This was kind of inevitable, and a million people here or there doesn’t make a difference in the larger scheme of things. Yet, it is as good a moment as any to reflect on that elusive thing called the India opportunity. Now, we have devoted multiple editions to why having more people is a good thing. Somewhat to my relief, a lot of commentary in the last week has echoed this sentiment. There’s the usual comparison of the relatively younger demographics in India with that of China and the advantage of being more aligned geopolitically with the West. And, of course, the governments in India don’t do terribly arbitrary things like China did in the past couple of years to the tech sector. On this last point, I have my views, but we are using a really broad brush here, so I will let it pass. The general tone of these articles is that this is India’s opportunity to lose—a far cry from my school days when the population was seen as a problem. I have three points to make in this context which are a bit different from the usual view of what India should do not to let this opportunity slip.First, there’s the usual prescription that India should industrialise faster to take advantage of this dividend and avoid the middle-income trap. My usual take on this is how well do we know why India couldn’t industrialise faster in the last 20 years when China took off. It is not like this is a fresh insight that wasn’t known to policymakers then. So, what gets in the way of India to industrialise? My short answer will always be the state. Despite all the hype around Make in India and the rising ease of doing business rankings, it is still quite difficult to start and run a business in India. The state is deeply entrenched in controlling capital in India, and it enjoys the arbitrary power that it has over them that it is impossible to change this with just better optics of ‘single window’, tax holidays or investment roadshows. In the last two decades, the state has retreated a bit in some areas, but paradoxically, with greater digitisation, it has more information and, therefore, greater power over industry. My general contention is that the state can continue with its welfarism (or whatever else you may call it) on the social and political front, but for India to industrialise, the state has to retreat on the economic control it wields. This looks very difficult today because the state’s first goal is to perpetuate itself. It will require the PM to go back to some of his campaign promises of pre-2014 with real conviction. All Indian politicians of a certain vintage are instinctively socialist. And as the farm reforms saga showed, even a small vocal minority can derail a progressive reform. The other challenge has been the availability of capital for MSMEs to build their business and compete for global orders. For the most part, since 2009, we have had a twin balance sheet problem, and that has meant banks have been very choosy about whom to lend. Add to that the shallowness of the corporate bond market, and we end up having a manufacturing sector low on its ambitions. On this, we might be on a better footing now. Bank and corporate balance sheets are at their robust best, and the public digital infrastructure and GST network make it possible for better underwriting decisions using informational collateral. This is evident in the robust credit offtake reported in the MSME segment across the banking sector in the past year. My view is we will industrialise a bit faster than in the past, but we are going to fall short of the expectations of the kind of industrialisation that’s expected for us to increase our per capita income from $2000 to $10,000 in the next 15 years. China traversed that exact journey between 2006-20, so it is possible. And it is possible to do it without making the same mistakes as China, where it went back on its decentralised model of growth that made regions and companies compete with one another to an overly centralised model now that will only hurt it further. We need a very specific retreat of the state from the economy with a regulatory framework that acts as an enabler rather than lording over it in a policing role. These seem to be difficult even for a PM and a party that’s hugely popular and has no immediate threat of losing power. We will therefore continue to do a respectable 7 per cent growth over the long run than a tearing 10+ per cent. It is what it is. This growth is good but not good enough to take care of the employment aspirations of the people. So, we will have to contend with high unemployment or underemployment for the foreseeable future. What will compound this is automation and the speed of AI adoption in the industry. One of the things to watch out for is the increasing sophistication of AI tools that could automate the services sector. The short-term evidence of generative AI tools like ChatGPT or Dall-e shows how quickly lower-skilled white-collar jobs could be automated. Also, these tools are now getting ‘consumerised’; that is the AI use cases are no longer restricted to a business-to-business context. This will increase the ability of the end users to use them for their needs directly. And that will reduce opportunities in the services sector, which has been the growth engine of the Indian economy in the post-liberalisation decades. Separately, we have talked about the increasing market concentration among 4-5 corporate groups in India. This trend is only getting stronger, and I have explained in the previous edition how this is different from the ‘national champions’ model of the Asian tigers. Simply put, unlike them, these national champions aren’t using their monopoly to win in global markets. Concentration is a classic market failure that will eventually lead to higher prices and poor allocation of capital. There’s a good argument on this that’s been made, of late, on this by Viral Acharya. But it has gotten drowned in the usual nationalistic noise that any criticism of this government brings these days. The usual caution that would have come up at this stage would be about the social risks of a young and aspirational population being unemployed. As I travel across India, I find this risk to be somewhat overblown. The availability of cheap smartphones, cheaper data and a general increase in prosperity mean the youth is forever busy staring at their screens engaged in low-quality entertainment. We will continue to generate low-end services jobs to take care of the top tier of Indian society like the ‘home delivery of everything’ model has already shown us. This ‘yajman’ system of one rich Indian supporting ten others will be a feature of our economy.Lastly, we must realise that the surplus labour and surplus savings (we are already getting there) that we will have will need to find their use outside of India. We will be one of the few countries in the world to have these together and almost no one will have our scale of surplus labour and savings. Free trade and open borders will therefore play to our advantage. It will be counterproductive to champion protectionism or any kind of swadeshi brand of politics. It will just be bad economics and blunt our edge in the global economy. There is no shortage of things to solve if we want to make use of the demographic dividend. I have read the usual lament on how we must improve the quality of our labour pool, upgrade our education system, improve infrastructure and bring women into the workforce - the list is long. I think these are downstream factors that will mostly get taken care of if the state makes it easier for the enterprises to do business. That retreat when the state has enjoyed having capital under its thumb for decades is mighty difficult. India will do well because there is an overlap of trends that favour it uniquely. The giant leap it so desires will need more than just this happy coincidence to come its way.  Course Advertisement: Admissions for the May 2023 cohort of Takshashila’s Graduate Certificate in Public Policy programme are now open! Visit this link to apply.PolicWTF: Tariff ki Taareef Mein This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?— Pranay KotasthaneWe’ve cried ourselves hoarse that India’s position on international trade in electronics is self-defeating. The consensus in India is that high tariffs, heavy customs duties, and other such barriers are a crucial pre-condition for creating world-beating Indian electronics companies. Another edition of this series titled “Tariff ki Tareef Mein” played out last week. On April 17, the World Trade Organisation (WTO) dispute settlement panel ruled that India’s imposition of tariffs o

India Policy Watch #1: Don’t Concentrate Insights on issues relevant to India— RSJIn one of the recent editions on the Hindenburg short-selling saga, I had written about how easily the Adani group had spread itself into a diverse range of sectors. The group was highly leveraged because it was so keen on getting into newer sectors and then winning bids in them with metronomic efficiency. Generally speaking, it is difficult to run a conglomerate of different businesses. You might argue that each business can be handled by a competent management team who will use the brand name and deep pockets of the parent group to build a solid business. But it is easier said than done. Capital allocation decisions, which lie at the heart of executing a business strategy, are difficult within a single line of business. They become hugely complicated within a conglomerate of businesses. Misallocation of capital, lack of focus and inability to stay competitive against smaller, nimbler players eventually follow. Soon, the businesses need to be hived off, and you find companies convincing would-be investors on how they are doing fewer things and doing them well instead of spreading themselves too thin. This is the usual cycle. Yet, you see conglomerates appearing on the business landscape across countries. In some cases, these are businesses integrating vertically or finding interesting adjacencies in their business. This kind of makes sense in the Coase-ian “Nature of Firm” way. I mean, if the transaction costs of finding someone to do a particular work are higher than you doing it yourself, sure, go ahead and do it yourself. But beyond that, there should be no economic reason for having conglomerates. Unless you have one of these conditions in the economy: a) Cost of capital is high, and access to it is difficult. Newer players find it difficult to access capital to start new businesses while older, established players with free cash flow can muscle their way into unrelated but lucrative new sectors only because they have access to capital at a lower rate. b) The playing field isn’t level for newer players to make a dent. Through a mix of friendly regulations, ‘working’ the networks and M&A activities, the bigger players continue to have an advantage going into a new sector over smaller players who might have expertise in cracking those sectors open.c) There’s relatively little ease of doing business in those sectors or in the evening overall. The established conglomerates with an army of people, lawyers and consultants can get started relatively faster and capture the market than new entrants. You don’t have to be a genius to see where the Indian policy-making framework is on the above conditions. There’s common and easy access to capital through a large number of PEs and VC funds but only for a particular kind of ‘flavour of the season’ variety. This also is getting difficult to access. The market for other forms of capital isn’t deep enough. In the same vein, long-term capital for greenfield projects where the credit risk has to be borne by the issuer isn’t available. There is always a whiff of regulatory capture especially in sectors where the government is closely involved bin decision making. Lastly, we might have moved up in the ‘ease of doing business’ rankings, but it isn’t clear yet how this has changed things on the ground. New businesses still find going tough for them. All of the above means that in the past five years, we are reversing a trend seen since the ‘91 reforms. That of increasing salience of conglomerates in India. You don’t have to research too hard. Just take a look at any sector - already big or one that is emerging - you will have the same spectacle of a few large corporate groups getting themselves into all sorts of businesses, from defence to semiconductors or from airlines to carbonated soft drinks only because they believe they can take advantage of market distortions.As if to illustrate this point further, here's news that’s only a day old. Here’s Moneycontrol  reporting:“The shares of Mukesh Ambani-led Reliance Industries Ltd (RIL) rallied 3.5 percent in the morning trade on March 31 after the company said secured creditors, unsecured creditors and shareholders would meet on May 2 to approve the proposed demerger of Reliance Strategic Ventures.After the approval, the unit, which is the financial services subsidiary of the oil-to-telecom conglomerate, would be renamed Jio Financial Services.Benefits that shall accrue on the demerger of the financial services business will be the creation of an independent company focusing exclusively on financial services and exploring opportunities in the sector, the independent company can attract different sets of investors, strategic partners, lenders and other stakeholders having a specific interest in the financial services business, a financial services company can have a higher leverage (as compared to the Demerged Company) for its growth and, unlocking the value of the demerged undertaking for the shareholders of the demerged company, the conglomerate said in an exchange filing.”This isn’t out of the ordinary. If you search for similar news items from the last five years, you will notice the same pattern of large conglomerates (usually the big 5) muscling into other or newer sectors because they think they have the capital and they will be able to manage the sector well. While one cannot blame these conglomerates for their ambitions, this trend suggests we might have tipped over from being pro-markets to pro-business. Coincidentally, as I was writing this, we had a paper authored by Viral Acharya (former Deputy Governor, RBI) on the opportunities and challenges for the Indian economy published by the Brookings Institution and being discussed in the media. Acharya has highlighted the concentration of power in Indian industry as a particularly worrying trend. He writes (I have paraphrased a bit):“A striking feature of this rise in industrial concentration by private companies is that it is in part due to the growing footprint of “Big-5” industrial conglomerates, based on the overall share of assets in non-financial sectors in 2021. Data shows the following patterns.First, until 2010, the Big-5 increased their footprint in more and more industrial sectors, broadening their reach to 40 NIC-2-digit non-financial sectors. After this breadth first strategy came the depth-next strategy. Starting in 2015, the Big-5 started acquiring larger and larger share within the sectors where they were present. In particular, their share in total assets of the non-financial sectors rose from 10% in 1991 to nearly 18% in 2021, whereas the share of the next big five (Big 6-10) business groups fell from 18% in 1992 to less than 9%. In other words, Big-5 grew not just at the expense of the smallest firms, but also of the next largest firms.Next, this growth of Big-5 appears to be driven in part by their growing share of overall Mergers & Acquisitions (M&A) activity. Even though the aggregate number of M&A deals has dropped since 2011, the share of M&A deals by the Big-5 has doubled from under 3% in 2015 to 6% in 2021, without such an increase being seen in the next five biggest groups. Arguably, this growth has also been supported by a conscious industrial policy of creating “national champions” via preferential allocation of projects and in some cases regulatory agencies turning a blind eye to predatory pricing. Equally importantly, given the high tariffs, Big-5 groups do not have to compete with international peers in many sectors where they are present and derive most of their revenues domestically.”Acharya then goes on to list the usual downstream problems of such an increase in market power concentration - inefficient allocation of capital, favouritism in project allocation, regulatory interference, related party transactions, over-leveraging while becoming too big to fail and crowding out new players. But he also makes an important claim that this concentration of market power is one of the reasons for persistent core inflation. He concludes:“In summary, creating national champions, which is considered by many as the industrial policy of “new India”, appears to be feeding directly into keeping prices at a high level, with the possibility that it is feeding “core” inflation’s persistent high level.”I won’t go as far as Acharya yet on this thesis. As he admits, there’s more work that needs to be done here, but his conclusion on pricing remaining high because of industry concentration does pass the smell test. And it should concern policy makers. I know there are many who will ask what’s wrong in creating ‘national champions’ like the tiger economies did between the 70s-90s. But there are a few differences in our case. Firstly, the focus on creating national champions elsewhere was to choose specific sectors where they might have a comparative advantage, invest in them, especially on technology and then win in global markets through an export-oriented strategy. It is a somewhat flawed approach, but it still makes sense for a low-income economy to do this. But we aren’t really doing this in India. Our so-called national champions are focused on domestic markets where there’s no particular need to have them. In fact, there is only a monopoly risk here with the attendant problems of price cartelisation and poor customer service. Also, the limited focus on exports that these big five domestic players have as of now is largely linked to natural resources and not large-scale, job-creating manufacturing setups. It is unclear how the broader economy is benefitting from this apparent design. Secondly, the successful national champion model in other economies didn’t need high import tariffs to support their ambitions like it is now the case in India. We have written about this many times in the past. Higher tariffs will reduce the competitiveness of the domestic players in those sect