Standard Chartered might do an Indian Depository Receipt

George Smith Alexander has a story in Economic Times about a possible `Indian Depository Receipt' issue by Standard Chartered.

If this works out, it would be a major achievement for the impending internationalisation of Indian finance. In an IDR issue, the Indian primary market process obtains an international customer (and revenues for financial firms operating in India). After that, the secondary market ecosystem kicks into play. A wide variety of domestic and international players could send orders into NSE and BSE for trading the IDR, thus delivering revenues for financial firms operating in India. Analyst reports about Standard Chartered would get written and consumed in India, and I'm sure that the reports written in India would be good by world standards so that a person trading the stock anywhere in the world would have an incentive to look at these reports.

There are policy impediments that come in the way of this coming about properly. FIIs can now participate in trading of IDRs. I think NRIs are still prohibited from doing so. I hope trading in futures and options on IDR also commences.

IDRs would also help improve the Sharpe's ratio of domestic portfolios by reducing home bias, that is either rooted in mistakes on the part of fund managers or in capital controls. You might like to see this.

Crisis watch, 31 October

TED spread	2.82
S&P 500 returns	+2.5%
VIX	62.9
Nikkei 225 (11:09 AM IST)	-0.97%
US Financials index	+1.55%
ICICI Bank ADR	+13.64%
Call rate (31st, 11 AM	18.53%
Currency futures (11:10 AM IST)	49.68

• This morning, Financial Express had an editorial which strongly criticises RBI's handling of the money market. Things have worsened sharply on the money market. See this article from Business Standard and Prabhakar Sinha in Times of India yesterday. This morning, CCIL shows a `high price' of as much as 21% on the call money market. We're back to very tight liquidity conditions. Infusing rupee liquidity is imperative.
• Anto Antony has an article in Economic Times talking about a paper by Economists-Who-Must-Not-Be-Named.
• Avinash Persaud in Financial Express.
• Paul Kattuman writes in Financial Express about the importance, in a downturn, of having a financial system that is well functioning. Also see the APS 2008 paper on this.
• A few weeks ago I had commented on the liquidity crunch that had afflicted Unitech. Yesterday, there is a report where Unitech has obtained Rs.6,120 crore by selling their ownership of Unitech Wireless. This emphasises the links between different aspects of economic reform. Addressing the liquidity crunch at Unitech critically required easing capital controls against foreigners buying shares of unlisted telecom companies.
• Are we sure this will not work out as bad as the Great Depression? by Anders Aslund.
• Percy Mistry on the Brown package.
• The US Fed has extended lines of credit of dollar funds to Brazil, Mexico, Korea and Singapore.
• Sri Lanka has run a pegged exchange rate (LKR 108 to the USD) from November 2007 onwards. Their reserves have dropped to $2.6 billion. They have budged and done a small depreciation. I don't see how a small depreciation solves the problem.

Crisis watch, 29 October

TED spread	2.71
S&P 500 returns	+10.79%
VIX	66.96
Nikkei 225 (9:10 AM IST)	+6.39%
US Financials index	+12.16%
ICICI Bank ADR	+18.96%
Call rate on 27th	9.3422%
Currency futures (9:10 AM IST)	50.27

• Akash Joshi on systemic risk on the equity market.
• Joel Rebello and Raj Nambisan in DNA on dollar liquidity.
• An editorial in Financial Express on the stock market decline.
• An editorial in Indian Express on monetary policy.
• An interview in Economic Times with Ashok Chawla, the new Secretary of DEA.
• Jayanth Varma on the Aziz, Patnaik, Shah paper.
• Jayanth Varma on devaluations in Asia
• A great piece by Brad DeLong on central banks.
• An article in The Economist on the unsung hero of the crisis: the US FDIC

Crisis watch, 27 October

TED spread	2.67
S&P 500 returns	-3.45%
VIX	79.13
Nikkei 225 (9:17 AM IST)	+0.40%
US Financials index	-3.65%
ICICI Bank ADR	-13.55%
Call rate on 24rd	8.55%
Currency futures (9:17 AM IST)	50.9125

• What not to do in the crisis
• Countries going bust by Anatole Kaletsky in The Times of London.
• Rajeev Deshpande in Times of India on the policy debate taking place within government today.
• Tamal Bandyopadhyay says the credit policy document wasn't so bright.

A few currency crises coming together?

So far, the global financial crisis was largely about financial firms and markets in the first world. This was a novel experience; it had never happened before. Now it might morph into a few currency crises hitting pegged exchange rates. This is an old movie; we have seen this many times before and we know a lot about it.

Speculative attacks on pegged exchange rates appear to be in the offing. The market is carefully analysing all countries with pegged exchange rates, looking at the possibility of large devaluations when the central bank runs out of reserves. Countries which have interfered with exchange rate devaluation are in focus now. Thankfully, by and large, India is not one of these.

A key mistake that is being made in thinking about these problems is that many countries hold reserves that are "large enough". As an example, writing in Financial Times, Charles Clover reports:

After two months of crisis, meanwhile, Russias currency reserves have dropped from $597bn in August to $515bn on October 17, partly as a result of defending the rouble. Capital flight is running at $12bn-$16bn a week. The Moscow interbank lending rate hit 22 per cent last week before settling back to 17 per cent, by far its highest level this decade, reflecting the scale of the stress in the banking system. Domestic banks are seeing depositors confidence evaporate four retail banks have experienced runs and been sold off in a hurry.

This month, the central bank instituted the first measures designed to prevent a speculative attack on the rouble when it banned currency swaps. But analysts are starting to ask how long the authorities can stand as substitute for the cut-off foreign investment and seized-up credit markets. They have enough reserves to last a year at this rate, maybe 18 months, says an economist at a Moscow bank.

This `economist at a Moscow bank' is not reckoning with the incredibly nonlinear behaviour of the system when a speculative attack comes together. Once a speculative attack starts, reserves can essentially vanish in no time. Linear extrapolation is a poor guide to the outlook for reserves.

Exchange rate flexibility is now highly desirable. If countries try to hang on to exchange rate targets (e.g. RBI was a bit squeamish about breaching INR 50 per dollar) then this could cause a lot of damage. In this environment, it's easy to get into a speculative attack. In contrast, exchange rate flexibility has a lot to offer. Countries that allow bad news to result in a sharp depreciation of the currency (and a sharp drop in asset prices) benefit from the lack of a perception of a one-way bet. A currency that has dropped in response to market forces (without interference by a government) has a good chance of going up the next day: there is no one-way bet in taking capital out of the country.

Holding "large" reserves is not a very good deal. In peacetime, they are not required, and in wartime, they are useless.

From an Indian point of view, as the Aziz, Patnaik, Shah paper has emphasised, there is a case for RBI using dollars to solve the dollar liquidity problems of Indian firms. The outer limit for the quantity of dollars that might get used in this fashion is $50 billion (partly because the London money market is showing some halting signs of life). There is no case for RBI to have any kind of exchange rate target. If RBI embarks on trading on the market in order to influence the exchange rate, this would be imprudent.

From a trader's point of view, the consequences of this are simple. Look for countries where there is exchange rate rigidity, where the central bank has sold reserves in doing market manipulation, and short those currencies / stock market indexes. In doing this, be careful to not mis-interpret a decline in reserves expressed in USD.

If a clutch of countries experiences speculative attacks, and then large devaluations take place, this would add to the negative outlook for the world economy, for we know that in the aftermath of a currency crisis, it takes a year or three for the country to put itself together. Hopefully, these countries will come back to life with better monetary policy frameworks, so in the long run, this will turn out to have been for the better. But in the short run, this could be quite painful.

Why ban short selling?

I have an article in Financial Express on this subject.

When will I stop writing a Crisis Watch blog post each morning?

When the VIX drops below 40. Last night the intra-day high was 89 and it closed at 79.

Crisis watch, 25 October

The credit policy announcement

RBI's credit policy statement was a disappointment. Read the editorial in Indian Express and Rajeev Malik in Mint. It felt like the forward-looking policy activism that we saw at RBI in the last month had mysteriously been switched off. The editorial in Financial Express encourages us to not read too much in this since RBI reacts on a day to day basis anyway, so credit policy documents do not matter that much.

The prose in the credit policy on inflation and credit growth felt sharply out of touch with current conditions. Consider the following text:

114. Based on the above overall assessment of the macroeconomic of monetary policy for the rest of 2008-09 will be as follows : - Ensure a monetary and interest rate environment that optimally balances the objectives of financial stability, price stability and well-anchored inflation expectations, and growth; - Continue with the policy of active demand management of liquidity through appropriate use of all instruments including the CRR, open market operations (OMO), the MSS and the LAF to maintain orderly conditions in financial markets; - In the context of the uncertain and unsettled global situation and its indirect impact on the domestic economy in general and the financial markets in particular, closely and continuously monitor the situation and respond swiftly and effectively to developments, employing both conventional and unconventional measures; - Emphasise credit quality and credit delivery, in particular, for employmentintensive sectors, while pursuing financial inclusion.

All you have to do is to change the year and this text is timeless. A special time like this called for a thoughtful hand-crafted statement; instead all we got was traditional RBIspeak. This links up to the problems of RBI transparency. An essential part of RBI's opacity is this release of bulky and badly written documents. Central bank transparency requires sharp, analytically clear, well written, brief documents. Bulky, badly written documents communicate nothing and effectively hide the thought process and policy intent.

Real estate companies

Earlier this month, I had blogged about the credit crunch at real estate companies such as Unitech. Now Unitech is showing stock market returns over the latest 12 months of -91%. Shabana Hussain reports on the sharp drop of the Unitech stock price yesterday.

Nifty option strikes

In Economic Times, Shakti Shankar Patra continues to rightly complain about NSE's rules on options strikes.

Sri Lanka

In June 2008, Deane J and I had an exchange on the difficulties in Sri Lanka on running a pegged exchange rate while local inflation was much higher than that in the US. The situation seems to have gotten a bit worse.

Lack of leverage = larger mispricings

James Saft has one of the most insightful pieces on what is happening to the configuration of asset prices worldwide, on Reuters. I was thinking of similar things but he beat me to it.

Crisis watch, 24 October

TED spread	2.57
S&P 500 returns	+1.26%
VIX	67.8
Nikkei 225 (9:10 AM IST)	-4.89%
US Financials index	-1.01%
ICICI Bank ADR	+1.91%
Call rate on 23rd	6.1
Currency futures (9:13 AM IST)	49.98

• An editorial in Financial Express on what RBI should do by way of trading on the rupee-dollar market.
• Using data for 23 October, there are 8 banks which have a double digit P/E ratio. The overall industry index has a P/E of 9.35 and a P/B of 1.3. There are 21 banks which are available at a price below book value.
• Writing in Economic Times, Shakti Shankar Patra says NSE needs new rules on option strikes in this time of elevated vol.
• Jahangir Aziz in The Times of India on the key ideas of this paper. Jahangir is next up on Ila's "Policy with Patnaik" show on NDTV Profit, discussing these same issues.
• Subhomoy Bhattacharjee in Financial Express.
• Tamal Bandhyopadhyay in Mint on RBI's credit policy announcement.
• Arvind Subramanian in Business Standard.

Crisis watch, 23 October

TED spread	2.54
S&P 500 returns	-6.1%
VIX	69.65
Nikkei 225 (9:54 AM IST)	-6.82%
US Financials index	-6.74%
ICICI Bank ADR	-15.2%
Call rate on 22nd	6.11%
Currency futures (9:55 AM IST)	49.94

• Liberalisation of ECB rules by RBI.
• Government will shore up the equity capital of seven public sector banks
• Editorial in Indian Express

Two milestones in Indian finance

• At NSE, the currency futures turnover exceeded Rs.1000 crore today. The other two interesting numbers for currency futures trading today were: 4,904 trades and an open interest of $176 million (176,323 contracts).
• Liquidity seems to be coming about for some exchange traded funds. A useful way to think about this is to look at the rank of two ETFs produced by Benchmark in the list of products traded on the NSE spot market, sorted by rupee turnover:

  Date	Nifty ETF	Liquid BeES
  20 October	88th	45th
  21 October	114th	115th
  22 October	127th	112th

With these, we have two new elements of liquidity emerging in Indian financial markets: ETFs and currency futures.

Crisis watch, 22 October

TED spread	2.77
S&P 500 returns	-3.08%
VIX	53.11
Nikkei 225 (7:30 AM IST)	-3.01%
US Financials index	-1.99%
ICICI Bank ADR	-4.58%

• Jayanth Varma engages in some aggregation.
• Rahul K. Bhonsle in Mint on the situation in Pakistan.
• Tamal Bandyopadhyay on dollar liquidity in Mint.
• L. Gordon Crovitz in Mint on short selling.

Crisis watch, 21 October

TED spread	2.83
S&P 500 returns	+4.77%
VIX	52.97
Nikkei 225 (9:30 AM IST)	+2.01%
US Financials index	+2.57%
ICICI Bank ADR	+8.32%
Call rate on 17th	6.78%
Currency futures (9:30 AM IST)	49.03

• The Indian response to the global crisis, my column in Financial Express today.
• Editorial in Indian Express, and Ila Patnaik's column today there.
• An editorial in Mint on short selling.
• Markets offer early warning signals by Mobis Philipose in Mint.
• Sebi's disapproval means nothing by Mobis Philipose and Sanat Vallikappen in Mint.
• Statement by Manmohan Singh in Parliament.
• Christopher Cox of the US SEC talks about how to make the Credit Default Swaps market work.
• Think the Bailout Is Radical? Just Wait. in Washington Post.
• Countries that risk occasional credit crises enjoy higher long-run growth, by Romain Ranciere, Aaron Tornell and Frank Westermann, which reports on the results of: Romain Ranciere, Aaron Tornell and Frank Westermann, 2008. Systemic Crises and Growth The Quarterly Journal of Economics, MIT Press, vol. 123(1), pages 359-406.
• The case for forcibly breaking up banks to make them small enough to fail, by Rob Cox.
• South Korea infuses dollar liquidity into its firms.
• The G-4 that matters: ECB, BoE, Swiss National Bank and Bank of Japan. These are the four central banks that have access to unlimited dollar liquidity.

Crisis watch, 20 October

TED spread	3.63
S&P 500 returns	-0.62%
VIX	70.33
Nikkei 225 (9:40 AM IST)	+1.49%
US Financials index	-1.88%
ICICI Bank ADR	-5.79%
Call rate on 17th	4.16
Currency futures (9:40 AM IST)	48.96

• RBI cut the repo rate to 8% (1 PM).
• Paper on India's policy response to the global financial crisis, by Jahangir Aziz, Ila Patnaik and myself.
• SEBI circular on valuation by debt funds
• Needed now: Dr. Singh's Manmohan moment by Shekhar Gupta on the front page of Indian Express.
• Interview with Arun Shourie in Indian Express.
• Two editorials in Financial Express: link, link

How the global financial crisis affects India, and what we can do about it

See this paper by Jahangir Aziz, Ila Patnaik and myself.

Mythbusting: Reserves edition

Myth: When FIIs sell shares and capital leaves India, RBI's reserves go down

An FII sells shares, realises rupees, and then takes those rupees to the currency market. Under ordinary circumstances RBI's reserves are not affected. The currency market is a vast ocean and there are many buyers and sellers. The FII is just one seller of rupees on this market. Buyers and sellers make the price - RBI needn't be in the picture. E.g. an FII buying dollars might have his currency trade match against an exporter selling dollars.

Conversely, if Apple India buys $500 million on the currency market in order to import a million iPhones, this is no different from an FII buying $500 million because he sold shares. All buyers/sellers of rupees or dollars come together in the currency market. Reserves do not go down when Apple India buys $500 million of foreign exchange in order to import iPhones, just as reserves do not go down when an FII buys $500 million of foreign exchange by liquidating shares or bonds.

It is only in a fixed exchange rate system, with every currency transaction going through the central bank, that every decision by a private party to either import goods or take capital out of the country leads to a dimunition of foreign exchange reserves. The people who assume that sale of shares by FIIs yields a reduction in reserves are perhaps instinctively operating on the intellectual toolkit of a fixed exchange rate regime - something that India shed many decades ago.

RBI is a player on the currency market. When they sell dollars on this vast market, reserves go down. But there is no tight link between RBI's decision to sell dollars with the decision by an FII to take money out. RBI's trading on the currency market is designed to manipulate the price. Their motivation for trading is price based. As with any market manipulator, RBI buys when they want to drive up the price and sells when they want to drive down the price. A trade by RBI might match against anyone - e.g. RBI might buy dollars or sell dollars from importers or exporters. It's a vast market out there; it is impossible to pinpoint who in the market "sold dollars to RBI", and it is certainly not true that sales by FIIs somehow selectively pickup RBI as the counterparty. On a currency market which does $10-$30 billion a day, FII purchases/sales of about $250 million a day are not particularly important in influencing the exchange rate and thus triggering off trading by RBI.

While I'm on this subject, I must mention a report that RBI regularly puts out named `sources of reserves accumulation'. When you think seriously about it, that report is conceptually confused. It would be best to discontinue the production and release of this report.

Myth: When reserves drop, RBI was selling

The level of reserves changes for three reasons: interest income on the securities held in the reserves portfolio, valuation changes, and transactions.

All of us tend to track reserves measured in USD. RBI holds other currencies in the reserves portfolio also. E.g. suppose they have Euros. When the Euro loses ground, it looks like the reserves (measured in dollars) declined.

Here's an example, where I use the `US Major Currencies Index' produced by the US Federal Reserve as a measure of fluctuations of the USD. It is an index of the USD against all the floating exchange rates of the world, weighted by their trade with the US. I abbreviate this as `USM'.

Month	USM	Delta Reserves	RBI purchase
April 2008	70.91	4.99	4.32
May 2008	70.69	0.65	0.15
June 2008	70.96	-2.54	-5.23
July 2008	71.73	-6.42	-6.32
August 2008	75.06	-9.80	1.21

In a month like April or July, RBI's purchases are similar to the change in reserves. But this is not always the case. August is a striking example. The market widely commented on the decline in reserves of $9.80 billion. But with a long lag, when data for RBI purchases was released, we find that in that month, RBI was a net buyer of dollars. They bought $1.21 billion. What happened?

In August, the USD gained strongly - the global flight to safety involved selling assets in other countries and buying assets in the US. As a consquence, the USD strengthened from an index level of 71.73 to 75.06 - a change of 4.6%. Suppose RBI had $150 billion in non-USD assets and suppose these assets took a hit of 4.6% (i.e., that RBI's weights are the same as US trade weights). This yields a loss of $6.9 billion.

Apart from valuation effects, some money gets added to reserves regularly, on account of the interest income on the fixed income securities held in the reserves portfolio. So even in a month when there was no trading by RBI on the market, and there were no currency fluctuations, the reserves would rise owing to interest income.

It might be useful to look at the weekly changes in reserves (which come out with a small delay) even though they're not the same as weekly data for RBI trading

The lack of transparency by RBI on their currency trading can have some interesting consequences:

1. Suppose economic agents treat purchases by RBI as evidence that the INR will appreciate at future dates and vice versa.
2. When you see RBI buying dollars, it's efficient to bring capital into the country, for you profit from the coming INR appreciation. Conversely, when you see RBI selling dollars, it's efficient to sell assets in India and take money out of the country, for you avoid the coming INR depreciation.
3. The trouble is, you don't observe RBI's trading, except with a long lag, and all that is then given out is monthly aggregates.
4. What's the closest proxy to what RBI might be doing? Delta reserves.
5. So while Delta reserves is not an accurate measure of the extent to which the exchange rate is distorted by RBI, it's the only one you have.
6. It might be efficient for you to use Delta reserves as a tool for forecasting the exchange rate, even though it's not a sound measure.
7. Weekly data for delta reserves might influence capital flows.

The main argument here is that by using such a heuristic, people might often do the wrong thing because delta reserves does not quite predict the direction and magnitude of distortion of the exchange rate. E.g. in August, reserves fell quite a bit, and you might have thought that the rupee was overvalued, but actually RBI was pushing the rupee towards depreciation. But given RBI's opacity, this is the best that the private sector can do and it might be efficient to use this noisy data for gauging currency distortions.

Crisis watch, 17 October

TED spread	4.08
S&P 500 returns	+4.25%
VIX	67.61
Nikkei 225 (9:50 AM IST)	2.38%
US Financials index	+2.11%
ICICI Bank ADR	+11.76%
Call rate on 15th	6.9374
Currency futures (9:50 AM IST)	48.80

• Editorial in Financial Express.
• Unhappy situation with mutual funds, as reported in Economic Times.
• Jaimini Bhagwati in Business Standard
• Nirvikar Singh in Mint.

Crisis watch, 16 October

Call rate on 15th	10.04%
S&P 500 returns	-9.03%
VIX	69.25
Nikkei 225 (9:20 AM IST)	-9.55%
US Financials index	-9.37%
ICICI Bank ADR	-14.2%
Currency futures (9:20 AM IST)	49.14

• RBI works further to strengthen rupee and dollar liquidity.
• SEBI raised margins for exchange-traded equity derivatives.
• A few other moves: MOF releases resources to banks, pulls up the weakest banks to 12% capital adequacy, and (most interesting) doubles the FII limit on corporate bonds to $6 billion.
• Jayanth Varma in Financial Express on problems of home loans in India.
• Shashi Tharoor says we shouldn't squander the opportunities from economic reform.
• Early signs of a thaw in the global credit market.
• US retail sales slowed down in September.
• What happened in the world markets yesterday, reportage in Financial Times by Chris Giles, Javier Blas and Krishna Guha. Also see this by Chris Flood in FT.

The PSU bank debate

Willem Buiter reminds us that when you nationalise banks, it is important to undo this as quickly as possible.

Crisis watch, 15 October

Call rate on 14th	9.95%
S&P 500 returns	-0.53%
VIX	55.13
Nikkei 225 (9:33 AM IST)	-0.70%
US Financials index	+4.55%
ICICI Bank ADR	-0.94%
Currency futures (9:33 AM IST)	48.67

• RBI liquidity support of Rs.20,000 crore for mutual funds facing redemptions, but see this and this also.
• Ben Bernanke speaks, in Wall Street Journal.
• Gordon Brown will will be in the history books for having put UK financial and monetary policy on a sound footing, and having played a key role in solving the Panic of 2008.
• Some firms in India are booming in this time of distress in the US.
• Creative destruction in hedge funds.
• David Brooks is pessimistic about how US economic policy will shape up in an Obama presidency.
• Buying gold is a vote of no confidence in civilisation in general, and fiat money in particular. As the current joke goes, one man says to another: "The global financial crisis is making me really pessimistic. I'm starting to buy gold". The other replies "You're an optimist; I'm stocking up on rice".

Crisis watch, 14 October

Call rate on 13th	9.92
S&P 500 returns	+11.58%
VIX	54.99
Nikkei 225 (6:50 AM IST)	+12.32%
US Financials index	+9.79%
ICICI Bank ADR	+29.96%

• Ila Patnaik on the front page of Indian Express
• Avinash Persaud in Financial Express.
• Developments in the US, as reported by Mark Landler in New York Times.

Crisis watch, 13 October

• Tamal Bandyopadhyay in Mint
• Ila Patnaik on the front page of Indian Express
• Manas Chakravarty in Mint
• Ila Patnaik on the exchange rate regime in Indian Express
• Abheek Barua in Business Standard
• Editorials in Indian Express, Financial Express, and Business Standard.

Outlook for the currency futures

I have been very interested in the evolution of exchange-traded currency derivatives in India. Some prominent people in the field do not share this sense of possibility and importance. As an example, on 19 September, Jamal Mecklai wrote in Business Standard on this subject:

Indeed, the volume of trading in the first few days -- although quite impressive as compared to start-up futures contracts anywhere in the world -- has barely crossed $50 million on a single day, a drop in the ocean compared to even our own OTC market. Of course, futures volumes are unlikely to ever be much more than a bucket in the ocean in the global market, for instance, currency futures trades constitute just about 2-3 per cent of the OTC market. So, while I applaud the move, it is important that we don't get carried away with great expectations -- we need to understand what is the real role that currency futures can play in an economy, and as a step towards greater deregulation of financial markets.

First of all, for the economy at large, the impact will likely be relatively minor and at a second order. Contrary to the belief apparently held by the regulators, the government and the ever-eager exchanges, I can't see currency futures having any value as a hedging tool. They are not used as such anywhere in the world and there are several reasons for this.

I disagree with this pessimism. First, let's get a numerical grip of the OTC INR/USD forward market. The latest RBI WSS shows FCY/INR merchant forward business as being roughly $2 billion a day, and the interbank as being another $1 billion a day. (They show these numbers twice, once as `purchase' and once as `sales', and I suspect the correct turnover number is to only count it once). Putting these together, we're probably talking OTC business on INR/USD forwards of roughly $3 billion a day. 3% of this would be $90 million a day or Rs.400 crore a day.

I have an article titled Where are we on the currency futures in Financial Express today where I take stock of what has been happening on the currency futures market. The picture you see there is much unlike what Jamal is painting. But that article used data till 7th October, and I'm already running behind the events! Here's the full daily time-series of turnover and open interest:

Date	Open interest	Turnover
	(Contracts)	(Rs. crore)
29/08	16387	291
01/09	24078	107
02/09	33667	187
04/09	30268	178
05/09	30311	168
08/09	30632	240
09/09	28744	244
10/09	41570	198
11/09	51050	235
12/09	55733	186
15/09	60272	232
16/09	86559	456
17/09	90731	338
18/09	86494	378
19/09	78973	307
22/09	71156	259
23/09	78025	363
24/09	89343	377
25/09	92526	223
26/09	74470	200
29/09	69005	290
30/09	88426	297
01/10	96958	418
03/10	122942	429
06/10	132866	406
07/10	148552	590
08/10	151484	614
10/10	143526	936

As we see, the turnover on the currency futures market has exceeded 3% of the OTC forward market (i.e. a threshold of Rs.400 crore) from October 1 onwards. On Friday the 10th, the turnover at Rs.936 crore was more than double of this threshold. Looking into the future, I think the story has only begun; it would not be prudent to bet that at the latest level of Rs.936 crore a day, growth will cease. So I think we have to start questioning the pessimistic view that exchange-traded currency futures can't exceed 2-3% of the OTC forward business.

In parallel, also note that there is some international evidence that private players are shifting away from OTC contracting to the safety of the exchange. So it's time to question our pessimistic assumptions about what can be done on exchange.

I also disagree with the claims about hedging. Cash settled derivatives as a risk management overlay on top of a physical position is a standard technique taught in the textbooks. There is absolutely no reason why the currency futures cannot be used for hedging - except when RBI's limit that no one person can hold over 6% of the market wide open interest comes in the way.

There also, things are getting better with the growing open interest of the market. On Friday, with open interest of 143,526 contracts, the limit of 6% gives a per-client limit of 8611 contracts or $8.6 million or Rs.40 crore.

There are tens of thousands of firms in India who have currency hedging needs (owing to economic exposure) which can be adequately met within this position limit. NSE members have their work cut out for them, scouting the countryside, identifying firms with currency exposure where the position limit is not a show stopper, and getting them going on doing hedging using currency futures.

Financial sector development in emerging markets

Erik Berglöf and Raghuram Rajan worry that recent events are doing damage to economic reform in emerging markets.

Why the crisis got worse

I have an article in Financial Express on why the crisis got worse after the Paulson plan was approved.

The last word on the Nano leaving West Bengal

"What West Bengal does today, the rest of India holds in utter contempt." [source]

SEBI's move on PNs

I have an opinion piece in today's Financial Express on this.

Solving the funding problems of the Employee Pension Scheme (EPS)

Vikas Dhoot has an important article in Financial Express today on changes being made to the Employee Pension Scheme (EPS). This is a fairly underfunded defined-benefit pension scheme created in 1995. The scheme was broke to start with. From 1995 onwards, interest rates have dropped, and mortality has gone down. These factors have worsened the funding status of the scheme. For more details on EPS, see this paper.

EPS is broke, and the only way to make ends meet is to increase contributions and/or decrease benefits. It is to the credit of the UPA that they are doing these politically unpopular things. However, this illustrates the three pathologies of defined benefit schemes. First, they are prone to get into funding trouble owing to elongation of mortality. Second, bringing the schemes back into balance is politically unpopular, and in the meantime, this induces costs on the taxpayer. Third, bringing them back into sound territory often involves reducing benefits. To this extent, they are actually not as `defined' a benefit as is often claimed.

The four stages of the global financial crisis

As this crisis has evolved over the years, I find my set of tabs in firefox has changed. The evolution of this set of things-to-watch is mildly interesting.

1. The first place to focus on was US housing construction. US housing was clearly in stratospheric territory. Once the US Fed started raising rates, and Mortgage Equity Withdrawal became less important, trouble was going to come about in US home construction. In this period, I watched the DJ US Home Construction Index.

2. By mid 2006, it was clear that big damage had taken place in this industry index. (E.g. see this article in Business Standard in September 2006). The next shoe to drop was the firms that had financed homes. Hence, my focus then shifted to US housing finance companies. By mid 2007, it was clear that big damage had taken place in this industry index.

3. Now the question became: where in the world of financial firms does the damage go? My focus then shifted to the DJ US Financial Services Index. And, by this time, it was clear that there were deep problems in the money market, so I started watching the TED spread. At first, after the death of Bear Stearns in March, US Financials bounced back and it looked like the trouble would subside.

4. And then, after the death of Lehman, the real question became: what would this do to the broad US economy. Now we're all down to watching the S&P 500 and VIX.

With VIX at 58, isn't it time to be shorting VIX? (You might like to see this slideshow on the global financial crisis, from a few weeks ago).

Indian growth outlook for 2008-09

See this slideshow by Mahesh Vyas at ICRIER, Sunil Jain's article in Business Standard about this, and the CMIE Monthly Review for September 2008.

Cash crunch at real estate companies

I am anxiously scanning the money market looking for dislocations. The closest that seems to be found is the funding crisis of real estate companies who appear to be facing a cash crunch. I have heard of interest rates going all the way to 36%. These are really attractive returns, but then there is the possibility of default.

I looked up accounting information about one such firm, Unitech, as an example. A glance at the liabilities shows a lot of leverage: net worth of Rs.2143 crore is supporting a balance sheet of Rs.17,327 crore. Current liabilities are Rs.7,069 crore, so there must be a lot of stress rolling these over. At the same time, the market value of equity is Rs.18,000 crore. From this perspective, the leverage is not particularly high (Jayanth Varma had made a similar point recently) even though the stock price has lost 67% in the latest 12 months. In a KMV/Merton model world, you wouldn't think this firm was particularly likely to go bust.

There is one problem in the measurement of accounting `equity' capital for some of these firms which needs to be borne in mind. India has capital controls against debt flows. There are many mechanisms for getting around these restrictions, for equity and debt are ultimately intimately intertwined [link, link]. One mechanism is for founders (`promoters') to sell shares to a foreign investor and have a private contract to buy these shares back at a future date. I have heard that quite a few small Indian promoters have done such deals with private equity funds and other funding sources. These transactions are really debt transactions, being disguised to look like equity transactions.

While such transactions are in flight, the accounting data for `equity' capital is overstated. And, given the drop in stock prices in recent terms, the cost of this borrowing for the promoter will prove to be very high. Such promoters must be in a tough spot looking for personal money to do the buyback, at a stock price well above the market price.

None of these particularly attenuates the stock price, though, once there is adequate stock market liquidity, for speculators on the market know all these things. So I would still maintain that by market value measures, there is a lot of equity in Unitech. If you have insights to offer on the funding crunch of real estate companies, and why they're paying as much as 36%, do tell.

What is at stake in Afghanistan

Read Robert Kaplan in the New York Times.

What restrains authoritarianism 2.0

Authoritarianism 2.0 is the mixture of a degree of economic freedom without political freedom that is in force in parts of Latin America, Russia, the Middle East, and China. The new conventional wisdom is that Milton Friedman was wrong, that capitalism does not generate a lot of pressure in favour of movement towards democracy. Russia, China, UAE, etc. have found the recipe to harness globalisation and free markets for obtaining high growth, but at the same time not permitting freedom. This is an important phenomenon that merits exploration. More importantly, it poses a challenge to prosperity and freedom in the world today.

In China, one sees the phenomenon of urban intelligensia - who should have ordinarily been a fertile ground for subversive ideas - being quite comfortable with the deal that the State offers them, and settling into the roles of consumers, workers and entrepreneurs without hankering for the role of citizens. In this case, the domestic channel through which capitalism can help induce freedom is blunted.

I feel that while this domestic channel is weaker than expected, an external channel does operate. Authoritarianism 2.0 does involve embracing globalisation, of engaging with trade and capital flows with the world. As an example, Russia and all the autocracies of the Middle East have full capital account convertibility, and China has a very large current account. This induces some checks and balances. Consider the Russian stock market index:

The recent experience with Russia is interesting. In recent months, considerable economic pain has come about, as a consequence of decisions of the State. This suggests that there are external economic constraints upon Authoritarianism 2.0. See this excellent article by Charles Clover and Catherine Belton in the FT. The key events in tracing the loss of confidence on the part of private capital seem to be as follows. (I'm quoting from this article):

Late May

"BPs 50 per cent stake in the TNK-BP oil venture, came under pressure from Russian shareholders and the government seemed powerless or unwilling to intervene. As the dispute escalated Robert Dudley, the BP-backed chief executive, left the country in July blaming official harassment."

The same day

"At a meeting of metals industry chieftains in Siberia, Mr Putin lashed out at Igor Zyuzin, the owner of Mechel, the Russian steel and coal producer, for price-gouging. With trademark gallows humour, he threatened to send a doctor to cure Mr Zyuzin, who was absent from the meeting claiming illness. Markets sank and half the value of Mechel, which is listed on the New York Stock Exchange, was erased amid fears that the company was finished."

After that

"Then the anti-monopoly service began to investigate other big metals companies for price-gouging as part of a battle to fight rampant inflation, later extending the probe to price fixing in fertilisers and cement. Investors began to fear the government could start imposing price caps on some of Russias biggest blue chips, limiting their earnings capacity."

6 August

War in Georgia. "Fear of a capricious and arbitrary Kremlin put flight to foreign investors, with analysts estimating that $21bn left the country in the weeks that followed Russias military intervention. Adding to the pressure was the weakness in global stock markets and the falling price of oil, on which Russia is dependent for its fiscal health."

These events give us a useful framework to think about the evolution of stock prices in Russia. Stock prices are down to the levels of 2006. Some of this is owing to global events, that have impacted upon all emerging markets. As a control, consider India.

This is an unfair comparison because Russia is an oil exporter while India is an oil importer. This suggests that roughly speaking, the Russian stock market has suffered a 20-30% loss over and above that suffered by India.

If Putin had chosen to not engage in global economic integration, he would have had the autonomy to pursue political actions much like Stalin did under Authoritarianism 1.0: there would have been essentially no checks and balances. But under Authoritarianism 2.0, he does face external constraints.

Evolution of the web browser

By one measure, Microsoft's market share in browsers dropped below 50% in September 2008. They are now at 48.6%. I suspect that this measure (w3schools.com) understates the importance of mobile phones, so this probably overstates the importance of Microsoft.