... and the winner is YV Reddy, so says Joe Nocera in NYT and Dean Baker! Nocera even describes Dr Reddy as "anti-Greenspan".
Even as Greenspan, endowed with oracular powers by the Wall Street and their trumpet bearers in the financial media, got swept away by the "irrational exuberance" accompanying the real estate and sub-prime mortgage bubble, Dr Reddy went the other way and tightened lending standards, curtailed securitization and derivative products, and increased risk weightings on commercial buildings and shopping mall construction, as a similar real estate bubble took shape in India. As early as December 2007, even before the crisis had erupted, the US Federal Deposit Insurance Corporation (FDIC) reported that 28% of the banks had an exposure to construction lending that exceeded their capital.
But the moot point, as Mark Thoma raises, is not whether Central Bank Governors or Chairmen should have rung the alarm bells and taken away the punch bowl as the party got going. It is the need to put in place rules that move automatically to cool rising asset prices, and thereby avoid having to depend on the discretion of individuals, with the attendant dangers of flawed judgement.
Update 1
Joe Stiglitz approves of YV Reddy's handling of the RBI during the real estate bubble.
Sunday, December 21, 2008
Economics of oil production
I had blogged earlier on the debate surrounding the spectacular increase in petroleum price, which had reached $147 in July 2008, only to fall below $40 recently. Oil Drum now feels that the prospects of prices rebounding are bleak, especially given the weakness of the economy and the massive debt accumulated by households.
There are three popular explanantions for the volatility in oil prices - multiple equilibria, importance of the marginal barrel and Hotelling principle.
First, unlike other commodities, oil is characterized by three factors - it is an exhaustible resource, production is controlled by national governments, and for the major oil exporters oil is the overwhelmingly dominant source of national income. Paul Krugman therefore feels that oil exporters respond to high oil prices in three ways - engage in real investment at home, which is subject to diminishing returns; invest abroad, which carries dangers (or frozen accounts etc) for many Middle Eastern oil producers; or "invest" by cutting oil extraction or leaving more supply under the ground for future extraction, and hence reduce supply.
So there is a definite chance that over some range higher oil prices will lead to lower output, which given highly inelastic demand opens up the possibility of multiple equilibria (as proved by Cremer et al). This is corroborated by the history of yo-yo swings in oil prices. The presence of such multiple equilibria leaves the market vulnerable to being tipped from one equilibrium to another even by small events - small production cuts in a tight market, political events, changes in expectations etc - thereby magnifying the volatility.
Calculated Risk finds another inflexion point in the massive increases in recent years in government spending in the major oil producing nations. It therefore follows that if the oil prices decline, the need to maintain these high expenditures (in grandiose projects and benevolent welfare largesse) will force many of these producers to increase their production, thereby leading to further falls in prices.
Second, the oil market cares about the marginal barrel and the immediate situation. Oil and natural gas are products that are unlike any other product in history that their use is pervasive and they need long lead times to create alternatives and restructure society around more local energy sources and smaller energy footprints. The high futures prices caused by production shortages or excessive financial ingress into commodities will slow economic activity, which will then reduce demand for oil and prices will plummet and overshoot on the downside, only to bounce back (and overshoot on the upside) when the economy rebounds.
Third, Harold Hotelling in 1931 had suggested that any exhaustible mineral resource under the ground has the same significance as a bond, and is in some sense interchangeable with such a financial instrument. Hotelling Rule states that the unit price of an exhaustible resource less the marginal cost of extracting it will change exponentially over time at a rate equal to the return on comparable capital assets, say interest rates or exchange rates.
As the resource is depleted, the price rises and as the price rises the demand, and hence the consumed quantity, falls. This continues until a price, the backstop price, is reached where an alternative technology or a substitute for the resource becomes economically viable. At this point, the resource is said to be economically exhausted, even though there is some amount of the resource remaining in the ground. Since there is always a backstop technology at a sufficiently high price, it follows that no exhaustible resource can ever be completely extracted. That means that in some sense, exhaustible resources aren't exhaustible.
Interestingly, the steeply declining prices may contain within itself the seeds of future increases. The lower prices have already induced many oil companies to postpone or even cancel exploration projects. The high oil prices had given a filip to oil exploration, making even Canadian tar sands or deep sea reserves off the coast of Brazil attractive options. If the lower prices make these marginal barrels unremunerative, firms are likely to increasingly back off even committed investments, leave alone newer ones.
Standard economic theory says that when demand drops and prices fall, companies curb their investments, leading to lower supplies. When demand recovers, prices rise again and companies start to invest in new production, starting another cycle. It is more pronounced with the oil market. Given the time lag between exploration and getting oil to the pumps, future supplies are strongly co-related with investments made now. Lower prices now therefore appear to be a recipe for higher prices in future, especially when after the economic activity rebounds back and supply is not able to keep pace with demand.
There are three popular explanantions for the volatility in oil prices - multiple equilibria, importance of the marginal barrel and Hotelling principle.
First, unlike other commodities, oil is characterized by three factors - it is an exhaustible resource, production is controlled by national governments, and for the major oil exporters oil is the overwhelmingly dominant source of national income. Paul Krugman therefore feels that oil exporters respond to high oil prices in three ways - engage in real investment at home, which is subject to diminishing returns; invest abroad, which carries dangers (or frozen accounts etc) for many Middle Eastern oil producers; or "invest" by cutting oil extraction or leaving more supply under the ground for future extraction, and hence reduce supply.
So there is a definite chance that over some range higher oil prices will lead to lower output, which given highly inelastic demand opens up the possibility of multiple equilibria (as proved by Cremer et al). This is corroborated by the history of yo-yo swings in oil prices. The presence of such multiple equilibria leaves the market vulnerable to being tipped from one equilibrium to another even by small events - small production cuts in a tight market, political events, changes in expectations etc - thereby magnifying the volatility.
Calculated Risk finds another inflexion point in the massive increases in recent years in government spending in the major oil producing nations. It therefore follows that if the oil prices decline, the need to maintain these high expenditures (in grandiose projects and benevolent welfare largesse) will force many of these producers to increase their production, thereby leading to further falls in prices.
Second, the oil market cares about the marginal barrel and the immediate situation. Oil and natural gas are products that are unlike any other product in history that their use is pervasive and they need long lead times to create alternatives and restructure society around more local energy sources and smaller energy footprints. The high futures prices caused by production shortages or excessive financial ingress into commodities will slow economic activity, which will then reduce demand for oil and prices will plummet and overshoot on the downside, only to bounce back (and overshoot on the upside) when the economy rebounds.
Third, Harold Hotelling in 1931 had suggested that any exhaustible mineral resource under the ground has the same significance as a bond, and is in some sense interchangeable with such a financial instrument. Hotelling Rule states that the unit price of an exhaustible resource less the marginal cost of extracting it will change exponentially over time at a rate equal to the return on comparable capital assets, say interest rates or exchange rates.
As the resource is depleted, the price rises and as the price rises the demand, and hence the consumed quantity, falls. This continues until a price, the backstop price, is reached where an alternative technology or a substitute for the resource becomes economically viable. At this point, the resource is said to be economically exhausted, even though there is some amount of the resource remaining in the ground. Since there is always a backstop technology at a sufficiently high price, it follows that no exhaustible resource can ever be completely extracted. That means that in some sense, exhaustible resources aren't exhaustible.
Interestingly, the steeply declining prices may contain within itself the seeds of future increases. The lower prices have already induced many oil companies to postpone or even cancel exploration projects. The high oil prices had given a filip to oil exploration, making even Canadian tar sands or deep sea reserves off the coast of Brazil attractive options. If the lower prices make these marginal barrels unremunerative, firms are likely to increasingly back off even committed investments, leave alone newer ones.
Standard economic theory says that when demand drops and prices fall, companies curb their investments, leading to lower supplies. When demand recovers, prices rise again and companies start to invest in new production, starting another cycle. It is more pronounced with the oil market. Given the time lag between exploration and getting oil to the pumps, future supplies are strongly co-related with investments made now. Lower prices now therefore appear to be a recipe for higher prices in future, especially when after the economic activity rebounds back and supply is not able to keep pace with demand.
More criticism of the Paulson bailout plan
Pietro Veronesi and Luigi Zingales accuses that the revised Paulson bailout plan ($125bn equity infusion in the nine largest U.S. commercial banks, in return for preferred equity with a nominal value equal to the amount invested, and a three year Government, through FDIC, guarantee on all new bank debt issues), with its emphasis on equity injections, creates no value to the banking system, amounts to a massive redistribution from taxpayers to bondholders, and enriches Wall Street cronies!
They write that the plan "increased the value of banks’ financial claims by $109 billion at a taxpayers’ cost of $112 -135 bns, creating no value in the banking sector. The biggest beneficiaries of this massive redistribution were the debtholders of financial institutions, especially those of the three former investment banks and of Citigroup. The equity holders just broke even."
Luigi Zingales suggests that the channel for equity injections should have been different. He feels that a better option would have been for the FDIC to take equity stakes in the borrowing banks, by swapping their debts as equity.
Alan Blinder is equally scathing in his indictment, arguing that the preferred stocks, with no control rights, were puchased often at above-market prices and with no public-purpose strings attached. He writes, "The 5% dividend rate that taxpayers will generally receive is half what Warren Buffett got from Goldman Sachs. Banks receiving capital injections through the front door are generally allowed to pay dividends out the back door. And there are no public-purpose quid pro quos, such as a minimal lending requirement. So banks can just sit on the capital, which is what most of them have done, or use it to make acquisitions, as a few have."
He feels that the crisis cannot be settled without addressing the issue of mounting foreclosures. This would require re-financing home mortgages (so that foreclosures that destroy real estate values and force fire sales of homes are contained) and buying "illiquid and now worthless" troubled assets (so that these assets start getting traded and their valuations get established).
They write that the plan "increased the value of banks’ financial claims by $109 billion at a taxpayers’ cost of $112 -135 bns, creating no value in the banking sector. The biggest beneficiaries of this massive redistribution were the debtholders of financial institutions, especially those of the three former investment banks and of Citigroup. The equity holders just broke even."
Luigi Zingales suggests that the channel for equity injections should have been different. He feels that a better option would have been for the FDIC to take equity stakes in the borrowing banks, by swapping their debts as equity.
Alan Blinder is equally scathing in his indictment, arguing that the preferred stocks, with no control rights, were puchased often at above-market prices and with no public-purpose strings attached. He writes, "The 5% dividend rate that taxpayers will generally receive is half what Warren Buffett got from Goldman Sachs. Banks receiving capital injections through the front door are generally allowed to pay dividends out the back door. And there are no public-purpose quid pro quos, such as a minimal lending requirement. So banks can just sit on the capital, which is what most of them have done, or use it to make acquisitions, as a few have."
He feels that the crisis cannot be settled without addressing the issue of mounting foreclosures. This would require re-financing home mortgages (so that foreclosures that destroy real estate values and force fire sales of homes are contained) and buying "illiquid and now worthless" troubled assets (so that these assets start getting traded and their valuations get established).
Saturday, December 20, 2008
PPP models in advertisement rights
Foot-over-bridges or sky-walks are increasingly becoming commonplace in many metropolitan cities as a means of facilitating pedestrian crossings at busy traffic junctions. Apart from this functional utility, these bridges provide vantage locations to display advertisements, and advertisement agencies naturally find these bridges a good source of raising revenue.
The Mumbai Metropolitan Region Development Authority (MMRDA) proposes to erect 50 sky walks or foot-over-bridges with modern designs to facilitate pedestrian crossings at busy traffic junctions. These bridges will be built with its internal funds, at a cost of over Rs 600 Cr. The MMRDA will then bid out advertisement rights on them.
Cities like Hyderabad have opted to follow another business model to finance such bridges. They have bidded out the construction-cum-maintenance of these structures for a specific period of time (usually the bid parameter) to advertisement agencies who would finance them by raising revenues from advertisements.
The same two models are possible in other similar projects like construction of toilets and bus bays. In the MMRDA model, the construction risk is borne by the Government, while in the Hyderabad model the construction, operation and commercial risks are borne by the private agency.
It has been found from experience across the country that the later (Hyderabad model) is a better option for more mature markets where price discovery mechanisms are in place, while the former (MMRDA) is more suited to emerging and developing markets.
Apart from the strong possibility of not finding suitable bidders (as many cities who have followed it have found out, and Hyderabad itself found out with its failed experiment with bidding out toilets and bus bays), the Hyderabad model leaves the Government vulnerable to being left with a bad deal (both in financial terms and in terms of the concession period) as the private agency hedges its risks in an uncertain market. Given the state of the market, from both supply and demand side, in most Indian cities, the MMRDA model may be a more appropriate model.
The Mumbai Metropolitan Region Development Authority (MMRDA) proposes to erect 50 sky walks or foot-over-bridges with modern designs to facilitate pedestrian crossings at busy traffic junctions. These bridges will be built with its internal funds, at a cost of over Rs 600 Cr. The MMRDA will then bid out advertisement rights on them.
Cities like Hyderabad have opted to follow another business model to finance such bridges. They have bidded out the construction-cum-maintenance of these structures for a specific period of time (usually the bid parameter) to advertisement agencies who would finance them by raising revenues from advertisements.
The same two models are possible in other similar projects like construction of toilets and bus bays. In the MMRDA model, the construction risk is borne by the Government, while in the Hyderabad model the construction, operation and commercial risks are borne by the private agency.
It has been found from experience across the country that the later (Hyderabad model) is a better option for more mature markets where price discovery mechanisms are in place, while the former (MMRDA) is more suited to emerging and developing markets.
Apart from the strong possibility of not finding suitable bidders (as many cities who have followed it have found out, and Hyderabad itself found out with its failed experiment with bidding out toilets and bus bays), the Hyderabad model leaves the Government vulnerable to being left with a bad deal (both in financial terms and in terms of the concession period) as the private agency hedges its risks in an uncertain market. Given the state of the market, from both supply and demand side, in most Indian cities, the MMRDA model may be a more appropriate model.
Causes of conflicts
The Heidelberg Institute for International Conflict Research (HIIK) recently released the latest issue of its Annual Conflict Barometer 2008, which describes recent trends in conflict development, escalations, settlements. The HIIK defines "conflicts as the clashing of interests (positional differences) over national values of some duration and magnitude between at least two parties (organized groups, states, groups of states, organizations) that are determined to pursue their interests and achieve their goals".
The report documents nine wars and almost 130 violent conflicts across the world in 2008 and classifies conflict broadly to include peaceful disputes over politics or borders (low intensity), as well as those involving sporadic or constant violence (medium or high intensity). It finds that though ideological change is both the most common cause of conflict and the root of most wars, but there is rarely only one cause of dispute. The other commonest causes include self-determination, national control, and control of resources and territory.
(HT: The Economist)
The report documents nine wars and almost 130 violent conflicts across the world in 2008 and classifies conflict broadly to include peaceful disputes over politics or borders (low intensity), as well as those involving sporadic or constant violence (medium or high intensity). It finds that though ideological change is both the most common cause of conflict and the root of most wars, but there is rarely only one cause of dispute. The other commonest causes include self-determination, national control, and control of resources and territory.
(HT: The Economist)
Friday, December 19, 2008
Corporate Governance and Ethics in India
Two recent events have focussed attention on the issues of Corporate Governance and Corporate Ethics among private sector firms in India. First, Satyam Computer Services had to beat a hasty retreat from its outrageous decision to acquire Maytas Properties and take a 51% stake in Maytas Infra for $1.6 billion, in the face of strong shareholder opposition.
Second, in another less discussed incident, Rajya Sabha member and Chairman of the Bajaj Auto Ltd, Rahul Bajaj, in an obvious case of conflict of interest, blatantly used the question hour in the Parliament to campaign for sops to the auto industry to tide over the economic slowdown.
In this context comes the Transparency International’s 2008 Bribe Payers Index (BPI), which explores the degree to which companies from 22 of the world’s wealthiest and economically dominant countries are likely to engage in bribery when doing business abroad. And, expectedly, Indian companies comes out as the third most bribery prone. Russian firms leads the pack.
It appears that despite all high-minded talk and wailing about lack of leadership (including by the aforementioned worthy) among the political class in television channels in the aftermath of the recent Mumbai terror attacks, substantial sections of coporate India are in many ways sailing in the same boat as the very politicians they accuse with righteous indignation!
(HT: The Economist)
Update 1
Siemens pays $1.6 bn in fines, the largest such payout, after pleading guilty of corrupt practices involving bribing foreign governments. The company had creatively itemized these expenditures in its balance sheet.
Second, in another less discussed incident, Rajya Sabha member and Chairman of the Bajaj Auto Ltd, Rahul Bajaj, in an obvious case of conflict of interest, blatantly used the question hour in the Parliament to campaign for sops to the auto industry to tide over the economic slowdown.
In this context comes the Transparency International’s 2008 Bribe Payers Index (BPI), which explores the degree to which companies from 22 of the world’s wealthiest and economically dominant countries are likely to engage in bribery when doing business abroad. And, expectedly, Indian companies comes out as the third most bribery prone. Russian firms leads the pack.
It appears that despite all high-minded talk and wailing about lack of leadership (including by the aforementioned worthy) among the political class in television channels in the aftermath of the recent Mumbai terror attacks, substantial sections of coporate India are in many ways sailing in the same boat as the very politicians they accuse with righteous indignation!
(HT: The Economist)
Update 1
Siemens pays $1.6 bn in fines, the largest such payout, after pleading guilty of corrupt practices involving bribing foreign governments. The company had creatively itemized these expenditures in its balance sheet.
State of Indian infrastructure
The Economist puts the Indian Infrastructure sector in perspective. Sample these dismal stats
1. Only 13% of the sewage prduced by the 1.1 billion people is treated, and an estimated 700m Indians have no access to a proper toilet. The result - 1,000 children die of diarrhoeal sickness every day!
2. It takes an average of 21 days to clear import cargo in India; in Singapore it takes three.
3. India’s urban roads are choked: the average speed in Delhi has fallen from 27kph (17mph) in 1997 to 10kph. In 2007, 130,000 people died on India’s roads, 60% more than in China, which has four times as many cars. By the end of 2007 China had some 53,600km of highways with four lanes or more, India had just 8000 km of dual carriageways.
4. Peak power demand outstripped supply by almost 15%, distribution losses are 35%, 9% of potential industrial output in India is lost to power cuts, and some 600m Indians have no mains electricity at all.
5. In the next five years the government plans to increase India’s generating capacity by an annual 14%, or 90,000MW (China added 100,000MW in 2007), but it added only 7000 MW in 2007, itself a record!
6. Though primary school enrolment rate is 96%, the quality of education on offer is abysmal. Half of ten-year-olds cannot read to the basic standard expected of six-year-olds, over 60% could not do simple division, and half the children leave school by the age of 14. One reason is that only half of Indian teachers show up to work.
7. NASSCOM reckons that of the 350,000 engineering graduates who emerge each year, mostly from private colleges, 25% are unemployable without extensive further training, and half are just unemployable!
8. Though the Planning Commission estimates India'a infrastructure investment requirement over the next five years to be $475 billion or about 8% of GDP a year, this year’s investment is likely to be only around 4.6% of GDP!
1. Only 13% of the sewage prduced by the 1.1 billion people is treated, and an estimated 700m Indians have no access to a proper toilet. The result - 1,000 children die of diarrhoeal sickness every day!
2. It takes an average of 21 days to clear import cargo in India; in Singapore it takes three.
3. India’s urban roads are choked: the average speed in Delhi has fallen from 27kph (17mph) in 1997 to 10kph. In 2007, 130,000 people died on India’s roads, 60% more than in China, which has four times as many cars. By the end of 2007 China had some 53,600km of highways with four lanes or more, India had just 8000 km of dual carriageways.
4. Peak power demand outstripped supply by almost 15%, distribution losses are 35%, 9% of potential industrial output in India is lost to power cuts, and some 600m Indians have no mains electricity at all.
5. In the next five years the government plans to increase India’s generating capacity by an annual 14%, or 90,000MW (China added 100,000MW in 2007), but it added only 7000 MW in 2007, itself a record!
6. Though primary school enrolment rate is 96%, the quality of education on offer is abysmal. Half of ten-year-olds cannot read to the basic standard expected of six-year-olds, over 60% could not do simple division, and half the children leave school by the age of 14. One reason is that only half of Indian teachers show up to work.
7. NASSCOM reckons that of the 350,000 engineering graduates who emerge each year, mostly from private colleges, 25% are unemployable without extensive further training, and half are just unemployable!
8. Though the Planning Commission estimates India'a infrastructure investment requirement over the next five years to be $475 billion or about 8% of GDP a year, this year’s investment is likely to be only around 4.6% of GDP!
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