FLSRC: Government’s writ on monetary policy is suicidal

The sweeping recommendations of the Financial Sector Legislative Reforms Commission (FSLRC) headed by Justice B N Srikrishna has stirred a hornet’s nest. Prima facie, the report gives an impression that it is aimed at clipping the wings of the Reserve Bank of India (RBI) Governor and seeks greater role for the government in financial regulation, especially in monetary policy affairs.

The Finance Ministry and the RBI Governor have always been at loggerheads. Current Finance Minister P Chidambaram’s run-ins with past Governor YV Reddy and his predecessor and current Governor D Subbarao is now part of financial folklore.

POLICY RATES OF COUNTRIES The proposals that have generated much noise are setting up of a unified financial regulator by subsuming current sectoral heads like Sebi, Irda, PFRDA and FMC. Regulators will no doubt be fuming, as they will be jobless once FSLRC proposals are implemented. It is debatable if multiple regulators have stifled growth in the financial sector or lack of innovative financial products.

But the over-arching proposals concerning greater accountability of the RBI and the government setting monetary policy goals for the central bank will have wide ramifications.

According to FSLRC, policy rates will be determined by a MPC (monetary policy committee) comprising of two members from the RBI and five members appointed by the government, thereby giving the government greater say over policy. This means, effectively, the RBI governor will no longer have the final word on monetary policy.

There is logic in this view, since in a democracy, an elected government must helm policy affairs. The objective that the central bank must pursue should be defined by the government. But vesting powers with the centre can be dangerous as politically-elected governments tend to favour cheap money policy, while economically sound central banks generally are far more conservative and look for macro-economic stability and not merely growth. Also, it is debatable if the government possesses the necessary expertise and domain knowledge to carry out monetary policy functions considering that they are not elected through merit.

TREND IN POLICY RATES

 

The unified financial regulatory model has been prevalent in global financial system. But with global economy ravaged by one crisis after another, it is foolhardy to borrow a failed model. Rather, the Indian financial system, with its multiple regulators and stiff norms, had come in for immense praise after the global financial crisis in 2008. Isn’t it practical to stick to a model that has withstood the tough times?

The report said that there will be a quantifiable numerical target set by the government that must be met. In the Indian context, it is doubtful if it is feasible to set an inflation or growth target.

STRUCTURE OF FINANCIAL SUPERVISION

The committee has also suggested that the government will frame rules with respect to capital inflows like FDI, FII and NRI deposits against the present system of RBI. Four members of the panel have expressed their opposition to dilution of RBI’s powers on this front.

One area where unanimity seems to exist is the creation of a debt management office (DMO) for raising resources for the government which, at present, is managed by the RBI.

Many experts have warned of conflict of interest saying RBI’s role in monetary policy and managing the centre’s borrowing calendar may give the central bank a bias in keeping interest rates low. Creation of a separate agency will eliminate this loophole.

While FSLRC talks about accountability of the RBI, it is silent on seeking more answers from the government on fiscal policies. The government’s track record of fiscal deficit is there for all to see. The RBI, currently, enjoys the highest levels of credibility in the eyes of the public.

BAD GROWTH MIX

If the government, in its current form and public perception, takes control of monetary policy, the credibility and legitimacy of the entire process will be seen as suspect. Already, the government’s writ runs over financial regulators since almost all the current sectoral watchdogs are appointed by the government. Should we reward the government’s ineptitude with more responsibility? I think not!

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Thoughts on Inertia

It’s always easier to do nothing (new).

Change is difficult to start.

Fear of making a decision > Benefit of making a decision.

The strong desire to keep things the same.

Listening to the same advice from the same people telling you the same things.

 

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On why passive investing is a risky strategy

If you are buying an investment fund, there are two main strategies you’ll encounter – active management and passive management. Passive investing is essentially the replication of an index or benchmark. For example, buying the NIFTYBEES ETF that replicates the Nifty 50 index. The aim of active investing is to deliver returns that are superior to the stock market that the companies sit within. An actively managed fund can offer you the potential for much higher returns than what a particular market is already providing. The debate as to which of these strategies is better has been raging on for the better part of the last 20 years. Whenever stock-market indices recover from a crash, the debate re-emerges.

The problem with passive investment is that passive management is only theoretically possible.

any evaluation of passive investment funds to be complete should include withdrawal activity during draw-downs, something that can be viewed as active management by the part of the investor imposed on the passive fund.

Also, most funds that call themselves “active” are actually “passive.”

the representation of closet index funds and traditional index funds have risen to the point where they now represent approximately 40% of the active universe—making the exercise of differentiating them from true active managers more important than ever.

Traditional passive investing, using indices weighted according to market capitalisation, works best in the kind of long bull markets that ignore fundamentals, because at the end of the day, you effectively end up buying high and selling low.

Investors should be careful of simplistic arguments and biased data while allocating capital. While I remain a fan of ETFs to get broad-market exposure, it is by no means the be-all-end-all of investment choices.

Sources:
Passive Investing in Stock Indices Involves Substantial Risks
Re-thinking the Active vs. Passive Debate

 

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52-Week High Investing

Investing in stocks that have hit 52-week highs is a form of momentum investing. The rationale is that traders are slow to react, or overreact, to good news. A stock whose price is at or near its 52-week high is a stock for which good news has recently arrived. This may be the time when biases in how traders react to news, and hence profits to momentum investing, are at their peaks. The psychological underpinning is traders’ reluctance to revise their reference point is price-level dependent.

Unlike straight-up momentum investing that looks at the top decile of stocks in terms of 200-day performance, the 52-week high model only gets activated when there are stocks hitting 52-week highs. In that sense, momentum investing is a continuous model whereas the 52-week high model is sporadic.

52-week high

How does this sporadic model compare during volatile markets? If you look at the Feb 2013 returns (above) that was picked right before volatility hit and the broad indices tanked, the model outperformed the CNX 100 by over 7 points. The out-performance is largely due to the immunity that these stocks enjoy in terms of positive news flow. It follows that this model is ideal for short- to medium-term investors who like to time their entry into the market. The image below is the performance of the portfolio picked on Feb 2012 to give you a longer-term perspective.

52-week high feb 2012

Check out our 52-Week High Theme and give us a call. Investing without emotions was never simpler.

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Turning coding coolies into solution architects

It hasn’t been easy for the Indian IT outsourcing sector since the global meltdown in 2008. Even as the recession abated and markets began improving, unemployment and economic instability in US and Europe compelled governments to create more favorable conditions for domestic markets. But that’s just the tip of the problematic iceberg that’s denting IT outsourcing growth in India.

IT outsourcing has contributed significantly to the Indian economy. In the initial years, outsourcing came easy – Indian IT professionals were cheaper, work could be done faster with more people on less pay, and the Indian Rupee was not as strong. IT companies made huge profits while keeping 20-30 percent of their workforce on bench at a time. Today, the situation is quite different.

Challenges galore

The demand for IT services from US and Europe (accountable for three quarters of the work and revenue that came India’s way) has dwindled on account of their recovering economies. Furthermore, the popularity of cloud solutions has enabled more SMBs and large enterprises to manage well with a smaller workforce. Businesses no longer need bulk IT labor from India. If they have expectations, they are for experienced professionals who will add measurable value to their business.

Research firm Ovum reveals that the total contract value (TCV) of outsourcing deals in India fell by 30 percent during the last 2012 quarter. That’s a record low in 9 years.

Indian IT companies are seeing much slower growth; lesser attrition and higher productivity owing to enterprise mobility, automation and cloud implementations. Consequently, recruitment have frozen. IT freshers who were recruited on-campus in 2011 are waiting for appointment letters as their employers (like HCL Tech) try to cut costs and maintain profits. The golden dream of joining an IT company for a 6 or 7 figure annual package has just gotten tougher for college graduates.

Another challenge for Indian IT outsourcing companies is the emergence of countries like the Philippines as alternative IT/ITeS destinations.

Opportunities

NASSCOM has forecasted a reduced growth rate of 11-14 percent in IT outsourcing exports in 2013-14. However, the good news is that of the top IT outsourcing providers in India – Infosys, Wipro and Tata Consultancy Services (TCS) – only Wipro fell short of the guidance predicted for the quarter ending December 2012.

Indian outsourcers like Infosys are promoting “mini CEOs” to tap their intellectual property to the maximum rather than hiring new people. The demand for experienced personnel who can adapt to changing environments and stay productive is growing and companies are taking steps to retain such talent. As Tech Mahindra HR, Sujitha Karnad, points out – coding coolies are passé, the demand now is for solution architects. That’s where the new outsourcing opportunities lie.

IT companies are also diversifying their service offerings to stay profitable. Infosys has signed a 5 year agreement with RWE Supply and Trading (RWEST), a leading European energy trading house to provide technology services based on ‘gain-share’ – Infosys gets paid when RWEST makes a transaction on the platform.

NASSCOM predicts that the Indian IT industry will generate $225 billion by 2020 by leveraging on emerging technologies, mobile and cloud platforms, social collaboration, SMB outreach, and the integration of core business applications. It’s not an unbelievable target as India is well placed to address new opportunities and emerging markets. For all you know, this shakeup could be the re-making of Indian IT outsourcing as it matures in value as well as viability.

[stockquote]INFY[/stockquote] [stockquote]WIPRO[/stockquote] [stockquote]TCS[/stockquote] [stockquote]HCLTECH[/stockquote] [stockquote]TECHM[/stockquote]

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