Friday, March 6, 2015

Bloodshed in the finance ministry

[I sat on the Prime Minister's Economic Advisory Council for a couple of years and adivsed Atal Bihari Vajpayee; then I resigned when I went to Stanford. After coming back, I used my freedom to criticize the government's economic policy. This column was published in Business Standard of 14 November 2000.]

The Premier’s dilemma

Early this month the government transferred 14 secretaries. It was thoroughly and deservedly excoriated by the press. In the damage control exercise, a Deep Throat put out the story that the Prime Minister is concerned over the poor performance of the economy and perplexed by disagreements amongst government economists, and that he decided to replace the team in the finance ministry to get some cohesiveness in policy.
It is a pretty lame story; and for that reason it is substantially true. The Prime Minister’s Economic Council is now two years old. Every once in a while the PM calls it together, its members give him sage advice, in return for which he gives them cashew nuts and tea. Much has been said, much paper has been expended; but at the end of it, the PM remains as bemused as ever. Now he has asked the members of the Council to speak to him with one voice, and give him the consensus of their advice. The story of the meeting between finance ministry officials and the Governor of Reserve Bank in his presence has also been leaked to the press; apparently there were sharp differences between them and the Governor on policy, and the PM was even more deeply bemused.
Having been conveniently removed from the Prime Minister’s Economic Council, I have no knowledge of the precise points of difference. But the cause of the dispute between Bimal Jalan and the sacked finance ministry officials is pretty easy to imagine. It relates to four issues:
1.    Balance of payments: Reserve Bank makes projections of the balance of payments; they are apparently alarming. Just why would not be clear to mere mortals, but the reserve bureaucrats know something that we do not. For one thing, they know how much military hardware from Russia and France is going to cost; apparently it runs into billions. For another, Resurgent India Bonds come up for repayment in 2003. But there is apparently something more. It probably has something to do with foreign capital inflows. The defaults of Essar and Spic have turned foreign lenders off Indian companies; and if Indians themselves are not buying into Indian companies, other than software companies, foreigners are hardly likely to do so. If they join Bajoria and Dalmia and take over cheap Indian companies, the xenophobes will raise a racket. Both the government’s swadeshi connections and the industrial slowdown are bad for foreign investment. Whatever their precise elements, the forecasts look bad.
What can be done about it? The only thing RBI and finance ministry could agree on is borrowing – in the form of India Millennium Deposits. These borrowings are a racket. They are only for NRIs, so others have to pay NRIs a commission for getting in (which is why the US has banned us from collecting the deposits there). They are at an appreciably higher interest rate than the rate at which NRIs can borrow, so NRIs can earn a nice little margin. Some of that margin can be given back to those who conceive and collect these Deposits. So they are popular amongst politicians and state bankers too. And RBI gets an accretion to its reserves. Everyone is happy. But this is not enough in RBI’s view; more needs to be done.
2.    Exchange rate: What could be done? Devaluation? That would raise the price of oil. The government could not even pass on the price increase that has occurred; it made a messy compromise. A further price increase would mean a bigger deficit on Oil Price Equalization Account, more trouble with more Mamtas.
3.    Interest rates: After dipping briefly in 1997 and 1998, interest rates on government borrowings are pretty close to what they were in the early 1990s. Their cost pinches more because in the meanwhile, the government has added a couple of trillion Rupees to its debt. Government’s borrowing rates push up the rates at which banks and FIs lend to industry, so industry is complaining. The finance ministry would like RBI to reduce interest rates. Now that the central government does not borrow on the SLR, the banks cannot be forced to take its loans. RBI finds it difficult to place the increasing volume of loans even at the current interest rates; how can it force the banks to take the bonds at even lower rates? The finance ministry thinks it can; the governor thinks it cannot. Besides, he is aware that although he has strangled the foreign exchange market, leads and lags in payments for exports and imports can cause a run on his exchange reserves; he needs to keep domestic interest rates high to persuade traders to keep their money in India.
4.    The budget: The Governor must have told the finance ministry that the solution lay in its lap: it must borrow less. Then he could bring down interest rates. He would have pointed out that revenues had been buoyant this year despite the slowdown, but that the government had managed to blow them up by spending on arms and what else. In the circumstances, it should reduce expenditure, raise taxes or both in the next budget.

These are the controversies to settle which the Prime Minister sacked the top brass in the finance ministry. Will he have settled them thereby? Will the next lot agree with the Governor and bite the bullet? I doubt it. What I am sure of is that it will fully display its inexperience and opportunism in the next budget. It will not touch government expenditure, whence politicians derive their sustenance. It will raise import duties; from the Swadeshi xenophobes to the FICCI-CII types, every lobby loves this, whatever its effect on exports. It will raid the cash reserves of public enterprises to fill its borrowing requirements. But to cure the economic slowdown that the PM brought it in to do? It would not even know where to start.

A gambler in a jute suit

[Arun Bajoria owned one-sixth of the jute industries in the 1990s, and was making obscene profits; then he lost his way. He tried to wrest control of Bombay Dyeing from Nasli Wadia and failed. After his only son died, he too died at the relatively early age of 63 in 2008. This columns was written in Business Standard of 24 December 2000.]

Who is afraid of Bajoria?

Ashok V Desai

Arun Bajoria has been making news. He has taken substantial positions in the share capital of Bombay Dyeing and Ballarpur Industries, and is wondering what to do with them. The promoters of the two companies are not prepared to take him on the board of directors. He could sell his holdings to the promoters’ ill-wishers. But unless the holdings were large enough to help in unseating the promoters, their value would not much exceed their market value; and if they were unloaded in the market their value would be much less. Bombay Dyeing has also apparently referred Bajoria’s acquisition of its shares to SEBI, for it is large enough to attract SEBI’s requirement of an open offer.
An open offer would cost Bajoria much more money; and it would not be worth making unless he had a good chance of taking over the companies. Which he does not have seeing the holdings of the promoters and the financial institutions. So why has he been playing this futile game?
It is unwise to try and look inside a rich man’s mind. But an obvious reason is that he had money. It seems that he made it running jute mills in Calcutta. He has run them with great profit, and used his earnings to buy up 15 per cent of jute capacity. Here is a declining industry. The government keeps it alive by forcing various producers to pack their goods in gunny. Carpet backing seemed to be the hope twenty years ago; but its stimulus proved short-lived. Travel goods, curtains and such offbeat items offer niche markets but absorb very little volume. But the fact is, that there is a market, and money can be made in it if someone knows how to cut costs. It is difficult in Calcutta, since the CPM government would beat up anyone who threw his workers out of job. But Bajoria somehow did it. He also tightened up management. And he made money.
He is not the first one who has more money than he knows what to do with. In the early 1990s, the Jains of Jain Irrigation were making a lot of it. They were pioneers in drip irrigation equipment, and money was pouring out of their ears. They looked well set for the next 20 years. I recommended their shares to a friend, and she lost almost all her money. The Jains issued a public apology, but it did not earn my friend anything. They had used their profits unwisely and lost it.
There are other Indians who have made a lot of money. Look at all the infant millionaires in Silicon Valley – Kanwal Rekhi, Sabeer Bhatia, Chandra Shekhar and others. They got rich before they got old enough to need massage. What did they do with their wealth? Of them, I know only Kanwal Rekhi well. He decided that he had made enough to last his lifetime, and so gave up making money. He spends his time teaching other Indians how to succeed, collecting money for Indian Institutes of Technology, funding a libertarian institute, and so on. He is playing venture capitalist to both entrepreneurs and ideologically fired people. I know less about the others, but a number of them are known to be setting up new businesses in information technology. In other words, they are doing more of what they have been proved to be good at.
What would that be for Bajoria? More jute mills are an obvious answer. There is still another 85 per cent of capacity to buy. There is all of Bangladeshi industry. There are possibilities downstream – fashion garments, for instance. But then Bajoria would have thought of these things first, and rejected them for some good reason. Maybe there are no more jute mills on sale; maybe he, like the rest of the world, has come to regard this industry as a hopeless one.
In which case I would have thought first of similar industries: polythene and polystyrene packing, cardboard, wood. That is where his specialist knowledge of jute might be useful. I would have thought of cotton weaving: that is where his knowledge of weaving might help. Or of jute cultivation and preparation. Jute accounts for three-quarters of the cost of gunny; a one per cent fall in its cost is worth three times a one per cent fall in the downstream costs.
Or I would have thought of other half-dead Calcutta industries. Printing, for instance. Calcutta at one time had the best printers in India: their work was clean, accurate, and if properly supervised, beautiful. Right into the 1990s, the Oxford University Press was using certain Calcutta printers for high-value printing. Today that industry is in its death throes; computers and related printers have made typesetting redundant.
In these circumstances, the communists try to halt historical forces: they try to protect the jobs of letterpress printers. That is silly. They will still be competed out of existence by computer operators elsewhere in India. Jyoti Basu well realizes this, and after thirty years of bleeding, his CPM rank and file in West Bengal too must find it impossible to miss reality. The 1990s have been particularly sobering for West Bengal; despite its best efforts to adapt itself to liberalization and open up to outside investment, it has fallen behind.
Meanwhile, Calcutta’s work force, although it is aging, still retains its old skills; and its wages have fallen far behind wages in the west or the north. It has potential as low-cost producer of things that require its old skills. So why do not Bajorias spring up to use the opportunity? Because it is much easier to invest your money in the stock market than in physical production. The latter is for the young and hungry. But once you’ve made your millions out of jute, life is much easier twisting the tail of Nusli Wadia.

Thursday, February 26, 2015

Design of well-intentioned subsidies

[Government subsidies to education and medical care have become religious beliefs in the modern world. They are widely given, with little thought and plan, and consequently are often very inefficient. In this column in Business Standard of 10 October 2000, I speculate about how they may be designed better.]

Investing in humans

Ashok V Desai

While holidaying in London, I recently got talking to an Indian doctor from Manchester. He was one of the thousands of doctors who left socialist India  and joined Britain’s National Health Service. He was well settled, but was sad about one thing – that patients sometimes abused him.
I put it down to British racism. But then, while I was in America, a child shot dead his teacher. Other children have been less selective; they killed their fellow students, or simply sprayed bullets into a class, killing whoever was available. One teacher told me that he tolerated misbehaviour in class because disciplining a student was too troublesome: the parents might protest, approach his superiors, or file a case.
I have myself wanted sometimes to beat up the linesman who had helped some crook misuse my electric power line, or the Egyptian customs officer who went through every inch of my suitcase because he had nothing else to do, or a man called Chandhok who stole half the things I had stored with him and broke the rest. But I did not. I guess there are customers who beat up sellers and customers who do not; and a supplier tries to attract the better class of customer.
Some businesses are peculiarly susceptible to customer misbehaviour. Obviously, giving credit is a hazardous operation. It has made many a supplier go bankrupt. Some of them adopt suitable strong-arm tactics. After the last car boom in 1996, many who had bought cars on hire purchase stopped paying. It was reported that Citibank employed or commissioned strongmen who had some pretty ungentle ways of recovering the vehicle. Evidently in such circumstances, a businessman would try to choose customers who would give him least trouble.
Now suppose the government offers a free service – say, schools or health care or police. Then it could not choose the customer; everyone who came along would have to be treated, or educated, or protected. Even unsatisfactory customers who beat up their teachers or doctors. No case has been reported of complainants beating up policemen. That is clearly because policemen would beat the pulp out of them. But doctors in NOIDA are taking Karate lessons. No wonder.
But instead of admitting a killer for treatment and then trying hamhandedly to overpower him, it would be better not to take him up at all. Instead of avoiding difficult customers, doctors reduce the chances of meeting them by settling in middle-class areas full of docile middle-class middle-agers.
Where schooling is free, the students as well as teachers are deprived of choice. Children who go to government schools have to attend the one closest to them. It is a principle of modern conservatism that this choice should be restored – for instance, by allowing people to choose which health maintenance organization (HMOs) to join as in the US, or by giving children vouchers which they can use to join any school as in New Zealand.
The results are predictable. HMOs refuse to insure people with prior maladies who pose greater health risks; US Congress has had to pass complicated laws to prevent HMOs from rejecting applicants for policies. Good schools cream off the best students, leaving the stupidest to government schools and making them even worse; so New Zealand has forced good schools to take outside students by lottery.
Are these the correct policy moves? They are solutions typical of politicians – based on minimum analysis, maximum political mileage and hence maximum cost.
In the case of medical insurance, what is being consumed by potential patients is the chance of contracting different illnesses. The probability varies enormously, being from, say, four times a year for a cold to once in a lifetime by a twentieth of the population for a heart attack. It depends on the person’s age and medical history: the chances of arthritis grow in old age, and chances of a diabetic getting hypertension are much higher than average. Hence there must be a premium to insure a person against a particular ailment, which will vary with the person’s age, sex, medical history, lifestyle and environment. An insurance company can thus work out a price list for each person for every ailment. It would be stupid for the government to pay the sum of all the prices for all the people; that is the way to bankrupt the state, and to set the stage for uncontrollable paring of quality of treatment. The thing to do is to give every person a single fixed lifetime subsidy on her health premia, and to let her buy insurance against whichever ailments she wishes at a time of her choice. That way people will be encouraged to live a healthy life so that their subsidy goes further, to treat themselves to save cost, and to use more of the subsidy in old age when they get more debilitating diseases.

Education is more complicated because children are too young and because their family has considerable influence on their aptitude. There are inherent differences in children’s capabilities: some are more intelligent than others. Children’s educability also declines with age: if they do not learn to speak by the age of five, they never will; other skills too are more easily acquired early. Here, the subsidy should go to a child, not to its school. It should vary with the child’s capability: higher subsidies should be given to the more intelligent and the more stupid. But above all, children should be given the choice of more environments: if their families are dysfunctional, they should have the choice of going elsewhere. It may be to stay with relatives, in children’s homes, or in hostels. Institutions should be created for children from families which cannot realize their potential; the children’s subsidy should go to finance the institutions as much as the schools; and the subsidy should be higher for children living away from their families.

India as a home for enterprise

[Mukesh Ambani does not speak much in public; this column, in Business Standard of 26 September 2000 was provoked by one of his speeches.]

A rival your size

Ashok V Desai

It was a curious forum to choose: a conclave organized by the Civil Service Officers’ Institute, Department of Administrative Reforms and Public Grievances and the Andhra Pradesh government. And the proposition was one that would have made waves in any management school, but scarcely caused a ripple in that forum. For Mukesh Ambani told this gathering of miscellaneous bureaucrats that he did not believe in core competence. Who is right? C K Prahalad or Mukesh Ambani?
It is said that those who can, do; those who can’t, teach. Mukesh might say that he does it, whereas Prahalad teaches it. And there is no gainsaying that Ambanis do it extremely well: they are by far the most successful entrepreneurs in India. But that would not settle the argument. Prahalad may well argue that on the average, companies that stick to their core competence do better. If he were in a more catty mood, he might say, the story has not ended - just wait till the Ambanis fail.
But the issue cannot be settled by anecdotes or figures. Obviously there are businesses that have done extremely well by sticking to their knitting. But they are not the only ones to have done well; some have done well precisely by going on to something different – or “reinventing the future”, as a management guru would say it. Any business has an advantage in an area in which it has competence. and would be well advised to exploit the advantage to the full. But the value of that advantage depends on how lucrative that market is, and how fast it can be made to grow. If the market itself is declining, core competence is not going to be enough: the company would have to go and become competent at something else if it was to maintain its growth.
That is precisely what Reliance did. Mukesh referred to the migration of the company from its original field of synthetic fibres to oil, and on in the future to telecommunications. In each it had started at the grassroots and built up competence. In this transformation, however, Reliance was helped by two factors. One was mentioned by Mukesh; he said that almost two-fifths of the labour force in Reliance was hired from the public sector. For this, there had to be a public sector – to be more precise, there had to be an Indian public sector. In no other country could Reliance have had this honeycomb full of skilled, little-used and less paid labour available. Nehru made the mistake of building the temples of modern India without the idol of Lakshmi in them; the numerous priests they recruited were lured away by the Lakshmi of the Ambanis. Nor has it been only the Ambanis; public enterprises have been the favoured raiding grounds of many private businesses. The only difference is that the Ambanis have built up an awesome database to track and evaluate the baboos, and have consequently taken away the best.
The other factor is the market: Reliance has largely relied on the protected Indian market, whether in fibres, fabrics, oil or telecommunications. Mukesh talked of being competitive; but being competitive with Modis and Singhanias is somewhat easier than with Du Pont and GE. It is rumoured that the Ambanis put spikes in the wheel fn Du Pont’s efforts to ride into India. It may or may not be true. What is true is that Reliance has chosen its competitors with care, and made sure they were not too difficult to vanquish.
In these circumstances, it is not surprising that Reliance has been able to build up competence in completely unrelated areas. And there is at least one area in which it has not been able to do so. When D V Kapoor left the public sector, Reliance employed him with the obvious intention of making an entry into the power sector. To this end it has bought up shares of BSES. It also bought its way into L&T. L&T has built quite a few power plants, and at one point, contemplated going to power generation itself. But it did not; it is rumoured that the Reliance members of the L&T board vetoed the move.
So does the example of Reliance prove that core competence is irrelevant? Is Mukesh right to assert “We believe in building competence around people and processes to create value”? Or has the success of Reliance been due to special circumstances and has little international relevance?
I think that the managerial model of Reliance would succeed in many countries and circumstances. But it would have faced tougher competition elsewhere. In particular, the governments’ xenophobia gravely truncated the market for businesses. In effect, Indian companies could be sold only to other Indians. They were all pretty short of cash; so takeovers would have required the say-so of the government financial institutions, which were always unwilling to give it. So there was virtually no market for companies in India; that is why Reliance found it easy to vanquish them. If India had opened up to foreign investment, the competitors of Reliance would have been taken over by stronger foreign companies, and Reliance would have had to work harder to achieve the same competitive success.
If it had had to do so, it would not have gone so readily into unrelated grassroots projects, where the risks as well as capital costs are higher. If it had had to face competition from BP or Exxon, it would have thought twice before going into refining without any experience at all.

By the same token, it would have had a larger market for companies to buy from, and would not have needed to go into grassroots projects. And if India had been more open, Reliance would have commanded a larger market, and its managerial competence would have brought it greater returns. In other words, core competence pays off better in larger, more integrated, less protected markets.