Author: Manasi Phadke

Silicon Valley is thrilled to bits and bytes. The Draft Encryption Policy by the Department of Electronics and Information Technology (DEITY) has been nothing less than a godsend for GOD, the Gathering of Developers. Even as the Indian PM goes into the valley to charm the IT honchos, the Deity has already got their attention fully.

Store all electronic communication, unencrypted, no matter how private, for 90 days? How exciting! Mark Zuckerberg was moved to tears on spying this huge opportunity. What! Save the FB status updates for 90 days! The Indian government is really making me feel special. Given that there are some 5 million status updates done in a day on FB in India, 90 days storage means a database of 450 million status updates! That is not a cloud computing opportunity, folks, its a crowd computing one. This itself would create billions of dollars in wealth and add another 2000 people to the FB employee base.

He is now thinking of launching the FB Utsav, along Star Utsav lines. FB will only show the new updates while the older data will automatically go into the FB Utsav memory. FB Utsav will also have an automatic tie-up to the regular FB; when you open your regular FB account, the Utsav account will tell you “You had received 326 likes 3 months ago” making you feel instantly wanted and desired and maybe also a bit wistful.

This’ll enhance the emotional connect between FB and the user. There’ll be more scope for emoticon development as well, as newer shades of wistfulness and jealousy get identified by the user. Pixar is looking animatedly happy about this and Disney stocks have been rising ever since the Deity announced their grand storage plans last weekend.

FB Utsav will also host a real- time webcam option to capture the emotions on the user’s face when she sees her slim image from 3 months ago. This, together with the speed with which the user surfs away from the page, will give rise to a new fitness-panic index, say psychologists. Higher the speed, more is the speed with which dieticians and gyms will advertise on your FB account. This should give a total business boost of $5 billion, say Ad Gurus and fitness professionals.

FB Utsav will further carry an add-on option of telling you “This guy has not liked you in 3 months now, the bugger” and will immediately flash “Remove inactive friends” button at you. Optionally, the Utsav platform will automatically “unfriend” people who are not that fond of you, helping you to manage your life better.

Once the FB Utsav steadies as a product in India, its global counterpart FB Nostalgia would be launched. Howard Schultz, the CEO of Starbucks, has already started bidding to get FB Nostalgia launched exclusively at Starbucks Cafes, since nothing helps nostalgia along like the aroma of coffee. CCD has urged the PM to make nostalgia in India and to secure exclusive rights for Utsav and Nostalgia only for the Indian chain.

Tim Cook has decided to come out with a special iPhone for India. Only, it’ll be called “we-phone 90”; 256 GB local storage, at ₹90,000.

IMF has heralded the move by the Deity to be a supreme move by India to make sure that the global recessionary winds do not persist. Even though the draft Encryption Policy has been withdrawn, there is now pressure that it be re-instated with immediate effect in global interests. New ideas, apps and platforms are in line. All that is needed is the policy. Make it in India.

It’s status quo. She has not changed the rates.

With a growth rate of around 3.5% and better and brighter jobs data, the general expectation in early August was that the Federal Funds rate would be hiked in this policy meeting. However, as China devalued the yuan, global markets went into a major turbulence episode. Further, reduction in the Chinese interest rates caused uncontrolled outflows from all asset classes in EMs and showed markets moving to the dollar, like they always do in troubled times.

A hike in US interest rates, at such a time, could cause further disruptions in an already volatile environment; it is with this view in mind that the Fed has not changed the interest rates in this policy review.

However, this keeps us in a tentative state of mind and markets till December, which is when the next guidance is scheduled.

What I attempt in this blog is to try and see where the rates are headed in a medium term outlook, as we move into 2016.

The Taylor Rule and the Fed Funds Rate

The Taylor’s Rule is a rule that prescribes the nominal interest rate charged by the Fed be dependent on output gap, divergence of actual inflation from the target and on the equilibrium interest rate in the following fashion.

i_t = π_t + 0.5 (π_t – π_t*) + 0.5 (GDP_t –GDP_t*) + r_t*;

where i_t is the is the nominal Fed funds rate, π_t and π_t* are the actual and targeted inflation rates, GDP* is potential output and r_t*is the equilibrium real interest rate.

Is the rule really used by the Fed to set interest rates? As Ben Bernanke said recently, Fed fund rates should be set systematically, not automatically. Using the Taylor’s rule to determine Fed funds rate is too simplistic, given that economic conditions keep changing all the time. Thus, the Fed does not actually set its rates by the Taylor’s rule; however, studies do show correlations between the rate as determined by the rule and the actual Fed fund rates.

If the Achilles heel of the rule is its simplicity, that perhaps is also its biggest strength. The rule connects movements in economic fundamentals to interest rates, giving us an analytical tool to create a baseline understanding of how rates will move in the future.

Higher is the inflation as compared to the target inflation (about 2% for the past 4-5 years in the US) and more is the GDP as compared to the potential GDP (that level of GDP at which all labor and capital resources are fully employed), more is the nominal funds rate that the Fed ought to set in order to cool down economic activity. The Fed Funds rate also depends on r_t*, the equilibrium real interest rates in the economy. Equilibrium real interest rates are those at which the output and inflation are absolutely at target and monetary policy is said to be neutral. In a recession and low asset prices, the equilibrium real rate required to get the system to a higher growth level would have to be very low. Easier said than computed.

The following table shows the output gap (OECD data) and core inflation (Bureau of Labor Statistics) for the US from 2009 to 2015. Core inflation was chosen rather than CPI due to the high volatility that oil and food prices have shown in the time period. Under the very simple assumption that the Fed fund rate corresponds closely to the Taylor rate computation, we realize that the equilibrium real interest rates in the US for the said period have been extremely low, in fact negative at times, as many analysts have suggested.

Year	Core inflation (Fed data)	Output gap (OECD data)	Fed Funds Rate	Equilibrium real rate
2009	1.7	-4.535	0.25	0.97
2010	1.0	-3.786	0.25	1.64
2011	1.7	-3.913	0.25	0.66
2012	2.1	-3.428	0.25	-0.19
2013	1.8	-3.016	0.25	0.06
2014	1.7	-2.476	0.25	-0.06
2015	1.7	-2.363	0.25	-0.12
2016 (forecast)	1.8	-1.631	0.750.88 1.38	-0.120.00 0.50

Taylor’s Rule to forecast interest rates

It may be fruitful to attempt understanding the movement of Fed Funds rate in the next one year using this analysis.

There are plenty of signs of strengthening in the US. As per OECD forecasts, the output gap will reduce in 2016, indicating better utilization of resources. Unemployment rate is already at around 5.2%, which is lesser than 5.5%, the natural rate of unemployment for the US, at which we assume that labor is almost fully employed. Since January, personal consumption expenditure index has been growing at an average of 2.2%. Real interest rates are bound to rise in the immediate future.

Even if we assume the same low negative real interest rates for 2016, the Taylor rule calculation tells us that the Fed Funds rate will jump up by 50 bps in the immediate future (Graph shown below). More realistically, if we assume the real interest rates to be 0% or 0.5% in 2016, the corresponding funds rate would jump to 0.88% and 1.38% respectively.

Ceteris Paribus, the way the fundamentals are evolving right now, a rate hike over the next one year seems imminent. This is not only because the fundamentals are strengthening; it is also because keeping interest rates unnaturally low beyond the required time-frame can have heavy costs in terms of asset bubble formations. To presume that the Fed will delay internal adjustment to allow a smoother glide path to EMs is just too naive for words.

Even if the hike has been postponed as of now, directionally the markets will have to get poised for a higher Fed funds rate between 1 to 1.5% in the next one year.

September 8, 2015. There was a flurry of activity at 7, Race Course Road. After all, PM Modi had decided to host the Big Boss show in his own house. The who’s who of industry, banks, industry associations, ministries, mutual funds and the RBI would be called in as inmates. The event was bound to be full of masala and histrionics.

Inmate selection had been a nightmare. Cyrus Mistry had been extremely ruffled by the huge outlays that Big Boss had promised on roads and infrastructure in the last budget. “After all the pain we took to create a toy car which can navigate all the potholes! This guy is going to kill my small car business!” Even after 10 phone calls from the PMO, the man refused to attend. It was only after FM Arun Jaitley cleverly pointed out that there is a difference in outlay on roads and laying out the road that Mistry came to the House.

Sunil Mittal pooh-poohed the whole idea of having a physical meeting in digital India and offered 5G connections to ModiG. “What an absurd idea!” remarked Kumar Mangalam Birla, deciding to nominate the Airtel candidate for eviction immediately.

“Hehehe. Do what you will, guys, but end of the day, there’ll be only one winner. RIL.” That was Mukesh Ambani, the one inmate who had immediately accepted the Big Boss’ invite. He had already won several Big Boss seasons. Mallya did not have dates in his calendar and was not invited.

Culinary conundrum

There was a big issue over who would cook. Chief Economic Advisor Arvind Subramanian, having established himself firmly in the culinary department with the introduction of JAM (Jan Dhan, Aadhar and Mobile scheme) in the Economic Survey, was called in to cook up some steam in the stale economy. Pancake would be cooked by Panagariya, the other Arvind. Minister Goyal, the “power” factor, was jealous of Minister Dharmendra Pradhan, whose job of supplying oil at low prices was being undertaken by the Saudi Prince himself.

The Governor of the People’s Bank of China Zhou Xiaochuan was invited as the firang guest. However, he cleverly declined seeing that the mutual fund inmates had donned “khali” looks at the mere mention of yuan devaluation. It is a nice game of thrones, thought Big Boss, with the policy team at loggerheads with implementation. “Take risks!” he boomed and the game began.

The games begin

RIL wanted all taxes to go; no I-T, no MAT, and certainly no GST. It also demanded no SIA and no ecological assessment when it acquired land. FM Jaitley, startled at such extreme demands, remarked that Mukesh needs to be the next FM. Mutual funds wanted bears out of the house. The bears said volatility needs to be evicted. The industry pointed fingers at banks for keeping rates so high. SBI chief Ms Bhattacharya bristled visibly and asked why the inmates had taken loans they couldn’t repay.

“But why don’t you reduce interest rates?” There was a sudden silence as Big Boss spoke. Ms Chanda Kochhar delicately looked at her empty glass. “No liquidity, Big Boss.” RBI Governor Raghuram Rajan, who was brought in to keep “interest” on the show high, started uncomfortably. No matter how slowly the government moves on critical infrastructure, he knew that eventually his interest rate policy would be blamed for the slow pace of investments. “The weak transmission,” he began but was shouted down by the other inmates. The show had begun.

Big Boss smiled. He could see his TRPs going up.

Dear Reader,

The Chinese Yuan was devalued so suddenly, it was almost filmy in its implementation. Here’s my filmy take on a “Bahubali of a Devaluation” that appeared in the Hindu Business Line today under my column “Tweakonomics.” You can also read the column directly at http://www.thehindubusinessline.com/opinion/yuan-a-lens-eye-view/article7583325.ece

Enjoy!

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It’s official. So impressed is the film fraternity with the filmi way in which the Chinese Yuan was suddenly devalued, that film makers all over the world now want to re-create famous movies in China.

Cast of the sci-fi movie “Honey, I shrunk the kids” was found in China last week, trying to create “Honey, I devalued the Yuan.” Instead of a mad scientist, the movie will show a mad economist, trying to gain entry into the IMF inner circle. The mad economist makes a desperate appeal to the IMF to let the Yuan be one of the 4 currencies that can be part of the Special Drawing Rights. But the IMF refuses to consider it and then the mad economist goes back to China and creates a machine that can shrink the Yuan to miniscule sizes.

In the meanwhile, disavowed IMF agent Raghuram Rajan comes to India on Mission Impossible. His mission, if he is to accept it, is to prevent the Chinese devaluation from affecting Indian markets. He is given a team of the best to assist him in this mission. An FM who can make statements to calm the markets and Sundar Pichai as IT support. The services of Amma or Didi can also be availed to create the charm of the femme fatale, but he correctly refuses. As he fights with the havoc created by the Rogue Nation, he uses the FOREX to control the Rupee from going into free fall. Indian FOREX reserves fall a bit, but he says in style “Desperate times, desperate measures.”

Karan Johar has also reached China to re-make “Kabhi Renminbi Kabhi Yuan”. In Johar’s film, Shah Rukh Khan, who is Bachchan’s son and lives in a palace that looks suspiciously like the NY Federal Reserve, is called Dollar. In the meanwhile, there’s Renminbi, played by Kajol, who lives in abject poverty off the Great Wall of China. Dollar and Remnimbi exchange rate their vows and enter parity. The marriage enters troubled waters. Reason? Kajol has become fat and has slowed down. Bas! Aur nahiiii! Renminbi decides to devalue and break parity. Kajol, wearing a 10-feet long black pallu depresses currency, derivative and stock markets through the globe. But she emerges looking leaner and meaner and with re-newed fundamentals, re-enters a new, more flexible relationship vis-a-vis Dollar. Shava shava!

Karan Johar also wanted to re-make “Currency of the Year” in China; but the Chinese Government expressed serious reservations about allowing Alia Bhat to play a central role in any movie made on Yuan dynamics.

Finally, much to the consternation of the Chinese, the entire star cast of Bahubali reached Shanghai, the new Mahishmati. Chinese economists were rounded up for a compulsory viewing of the first part. The poor economists could only watch in stunned silence as the towering matriarch with the curled lip gave crazy orders holding two babies in one hand, while Orcs from another movie suddenly entered the scene to pass lewd comments. Her spite and command reminded many of the good old Mao days. After the ordeal was over, wiping tears of disbelief and relief, the Chinese Premier asked the only question, which has been ticking in the mind of crores of Indians. “WHY, oh WHY did Katappa cut-uppa Bahubali? Tell me the answer and I’ll do anything you want. I’ll stop the Yuan from devaluing further.” Bahubali Junior removed his helmet. It was PM Modi. “Place a call to Dr. Rajan and tell him it’s all over. Mission Accomplished. There’s no need for competitive depreciations and FOREX reductions. All it needed was a Hindi movie.”

 

Today morning, the RBI gave in-principle approvals for payment bank licenses to 11 out of 41 applicants. While there are some big names there such as Reliance Industries, Aditya Birla Nuvo, Vodafone and Airtel, the most humble name in the list was the one with maximum connect to the objective of financial inclusion. Indian Postal Service.

Big numbers in small accounts

I went back to browse through the Annual Reports of the Department of Posts and found some interesting snippets on how the post supports the economic structure in India. As on 31st March 2013, there were 1,54,856 Post offices, of which 89.87% were in the rural areas of India. That is 1,39,164 branches in rural India, folks! The Post Office also operates several small savings schemes floated by the Government of India. The Post Office Savings Bank (POSB) handles 12.53 crore small savers’ accounts with an outstanding balance of nearly Rs.378 billion. And if we add the total balances outstanding under different savings accounts, recurring deposits, fixed deposits, PPFs, MNREGA accounts, etc., we are looking at a total outstanding balance of Rs. 6031.7 billion! Most of these deposits have been collected from the poor, unbanked areas, hence offering inclusivity to the chunk of our populace which finds it difficult to approach a bank, for whatever reason.

It would be interesting to compare this number to the rural branches of a big nationalized bank, say, SBI, I thought. And voila! Here’s what I find.

In 2013, SBI boasted  having 16,000 total branches, of which 9851 (around 66%) were in the rural areas. No bank comes even close in the actual number of villages/ rural areas that are covered by the Post Office. Interestingly, I found it exceedingly difficult to get data on savings deposits mobilized by the SBI in the rural areas. One rather oblique number that I found claimed that the rural deposits are roughly around 38% of the total deposits. This amounts to Rs.3600 billion. Thus, one comparison point that comes across is that the Postal Offices, which are not really banks, mobilize a tenth of the deposits mobilized by the SBI, whereas the number of branches of the Postal Services is 10 times that of SBI.

Is that small comparison telling us a deeper story? Perhaps, yes. Perhaps it is hinting at the tremendous potential of the post offices to offer financial inclusion to that section of the population that shies from commercial banking, for whatever reason.

The physical reach of the humble Post Office is definitely enviable; the next question is whether the Post Office has in it the wherewithal to function as a payment bank. It is fruitful to stop for a minute and reflect what a payment bank really does. It basically collects small deposits (to the tune of Rs. 1 lakh), invests in Government paper, disburses payments done through Government of India schemes, cannot really offer a loan, but would definitely offer the facility of a debit card or an ATM card. If you discount the last feature there, what you have is a full fledged description of the Indian Postal Services.

Postal Services and interaction with the Government

Since 2008, the Post Office was chosen by the Government to be an official agency to disburse MNREGA wages; in the year 2013, 57.4 million beneficiaries of the scheme were disbursed payments worth Rs.120 billion through the Post. The Department of Posts enjoys a seamless kind of an interface when it comes to networking with the Government of India. The pilot programme of the Direct Benefits Transfer (DBT) in Andhra Pradesh for disbursement of MNREGA wages and other benefits is being handled by the Post. Disbursal of pensions for several Government schemes is facilitated by the Post. The Aadhaar letters were booked and delivered under the Speed Post facility offered by the Department.

Very very interestingly, the Post Department helps the Ministry of Statistics and Programme Implementation (MoSPI) gather data in 1181 villages which feeds into preparing the CPI data for rural India! Thinking about it, it makes sense, doesn’t it? Who else, than the dak ghar, with a reach to the smallest of houses in the remotest of villages, to offer a sneak peek into how the prices of the basket of goods and services consumed by the rural folk are changing!

Since 2012, a computerization scheme of the postal network has started. The objective of this computerization program is not only to connect the postal network across the country to help track parcels and postal delivery instruments, but to also allow a platform for the Post Offices to get financially integrated into the overall payments system. Once this financial integration is completed, we may well be looking at one of the biggest potentials in Indian financial history to truly offer inclusivity to India.

Stories from elsewhere in the world

A quick look at some other postal case studies from other countries offers some lessons. The World Bank has published financial inclusion data after interviewing 65,000 participants from across 60 developing and developed countries. And there are some very interesting findings.

1. The data suggests that those people in the 60 countries who tend to have an account with a post office are likely to be older, poorer, less educated and not employed.
2. Most poor people who tend to hold a postal account also tend to hold an account in a commercial bank! Only 3% of the respondents were those who exclusively owned only a post account.
3. The success of post banks as a vehicle of financial inclusion depends on the business model followed. There are countries where the post office acts like an unlicensed savings bank (POSB, the kind of model we have in India currently), others where the post office has a tie-up with some established commercial bank, and yet others, where the post offices get a formal license to operate as a Financial Institution or a payment bank (this is the model we are now getting into).
4. Whenever there are partnership models between commercial banks and post offices, it has been observed that postal deposits do not actually increase; but this model does lead to an overall increase in the total number of accounts held by the poor.
5. More importantly, whenever the post office acts as a “cash merchant” for transactional financial services, such as electronic government and remittance payments, the number of accounts held by the poor is likely to increase significantly.

What does this mean for India?

To begin with, post office payment banks have a chance to make it real big in terms of the financial inclusion vision of the Government of India. If they could aggressively market the strength they have in terms of being the preferred institution through which the Government benefits are disbursed, it’ll give them the numbers to become a viable force in the initial few years. Over a period of time, these banks may have to explore the possibility of tying up with another Financial Institution to sustain the momentum of the earlier years.

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As I came in from my walk yesterday, I saw some little girls playing their usual, chirrupy games…

Ring-a Ring-a Roses

Pocket full of posies

Atishoo! Atishoo!

They all fall DOWWWWWNNNNNN!!!

There was a great amount of scuffling and giggling to make sure that one sits down before the others. A competitive, let-me-fall-before-you-do game. The person to fall last gets a penalty, of course. I sat down on a bench to watch them play, and Econ Mom took over. Obviously.

The day’s news were playing on my mind. It’s almost similar, I found myself thinking. The ring-a-roses on the currency markets today. The yuan sneezes…Atishoo! And they all fall down in a competitive depreciation. The Rupee and the Yen and the Ringitt. The question is: WHY did the Yuan sneeze? Here are some quick Q&As.

#1. I hear that the Yuan devaluation has to do with Special Drawing Rights? What are SDRs?

Simply put, the SDR is an international reserve asset created by the IMF, which can be used to supplement or augment the member countries’ official reserves. Now this reserve asset comprises of 4 currencies; the dollar, the euro, the pound and the yen. 2015 is the year in which the IMF will review whether new currencies should be included in the pool of currencies that comprise the SDR.

There are 2 basic features that a currency has to posses to make it to the highly dignified SDR category. It has to have a significant role in world trade and it has to be “freely usable”.

That the Chinese have a significant role in world trade is undisputed. Their current contribution to 11% of the world’s exports means that they gain automatic entry into the IMF review this year, though of course, their chief stumbling block would be that the Yuan is not perceived to be “freely usable.”

The Articles of Agreement of the IMF define a “freely usable” currency as that which is widely used to make payments for international transactions and is widely traded in the principal exchange markets. Thus, a freely usable currency is technically NOT a freely floating currency. In fact, it has very little to do with the underlying exchange rate regime. You could have a situation where in a currency was fixed but was freely usable in markets across the globe.

So the next question is: Is the Yuan freely usable? Increasingly so. More and more FOREX reserves are being held in Yuan terms, more and more export payments are being made in Yuan terms. The Economist has shown that even though Yuan payments/ holdings may not be high in absolute terms, its been showing a growth rate that allows it to come very close to the “freely usable” terminology. At least, “The Economist” thinks so.

The People’s Bank of China (PBC) is now in a mood to make sure that the IMF thinks so too. One of the chief reasons why the Yuan was devalued is because the PBC is anxious to prove to the world that the Yuan increasingly is market determined, rather than determined in a fixed parity by the Bank.

#2 Hold on. I thought the Yuan was always undervalued. If the market is to determine it, it should have risen, right?

Wrong. There are 2 factors here. First, that the yuan has been typically held undervalued is a correct perception. However, in the last one year, with the US showing robust fundamentals, the dollar has undoubtedly strengthened. The robust fundamentals and increasing sentiment has also increased the possibility of a rate hike and FIIs hence have been making a beeline towards the dollar, strengthening it further. Since the Yuan, at whatever undervalued level, was held fixed vis-a-vis the dollar, it has implied that the Yuan has de-facto strengthened against most currencies in the globe. So even if the yuan was undervalued, the extent of its undervaluation has lessened. This is one of the reasons that sparked off the devaluation.

Second, the Chinese fundamentals have definitely deteriorated in the last one year, when the US strength has increased. Here is my earlier blog on what plagues their banking structure and why excess capacities got built in China. A deterioration in the fundamentals calls for a devaluation from the present value, whether that value is correct or otherwise to begin with becomes immaterial.

# 3. Does the Yuan devaluation help China? If every Emerging Market goes into competitive depreciation, there’ll be no relative change at the end of the game.

The argument given above is largely a financial argument. As currencies across the globe get hit, relatively we may find in the medium term that the Yuan is not really cheaper compared to the other emerging currencies and hence, Chinese exports may not really get the boost that they want vis-a-vis other emerging markets. But that the yuan stands cheaper vis-a-vis the dollar, is undeniable.

Second, the current movement in the yuan is not so much about devaluation as it is about sending a signal of more flexibility. While the IMF has now said that the same 4 currencies will comprise the SDR till September 2016, there is increasing reason to believe that the Yuan would find a place in the SDRs after 2016. This would make the Yuan more acceptable, more traded and would create a different positioning for China in the global markets.

Epilogue:

As every News Channel was analyzing yesterday, the currency market movements are because of the SDR issue. Never in my life do I remember the humble, modest SDRs occupying such a special place in a common man’s life and discussions. To have news analysts yelling about Sensex and currencies was okay, but to have them yelling on composition of SDR, the IMF’s virtual currency, the role of which IMF itself says has been “insignificant”, was surprising beyond measure.

As I got up from the bench with a sigh to head back home, I heard the girls start on their game…

Who stole the cookies from the cookies pot? Who me? Yes, you. Couldn’t be. Then who? Mr. Yuan stole the cookies from the cookies pot.