Overreach in name of common good?

The rhetoric around the demonetisation drive has been to flush black money out of the system. The politically charged mission to root corruption out of the system (undoubtedly a noble goal) has obviously gone well with the masses. At least in popular media, many see their troubles as short term sacrifices in pursuit of the long-term goal of corruption free India. In my opinion, Modi has given the common man a sense of purpose in hardship and is getting great political mileage out of it.

However, Jean Dreze elaborates on an important point which was also noted on Ajay Shah's blog - 

Crooks know better than to keep their illegal income in suitcases of cash. Instead, they spend, invest, launder or convert it in one way or another. They use it to buy property, fund lavish weddings, shop in Dubai or oblige politicians. Of course, at any point of time some black money is likely to be lying in jars or pillow-cases. But going after that residual liquidity is like mopping the floor under the shower. Thinking of it as a decisive strike on the black economy is a severe delusion. This point has already been made by many eminent economists, but the government seems to prefer its own echo chamber.

Without a quantifiable cost-benefit analysis, the argument that grabbing such low hanging fruit is futile will be speculative. Lack of data will only allow the government to blow its own trumpet. 

Besides voluntary disclosures of black money before the Dec 30 deadline, could there be any other proxies to arrive at an approximate figure of black money hoarded in cash prior to the demonetisation announcement? Would it be fair to assume that the quantity of cash not returned in 500/1000 (but the government obviously knows how many notes were printed over time) is the black money which will be eliminated from the system in terms of cash?

Also, I am largely ignorant of the estimated size of total black money. A simple Wiki search puts it in a wide range between 2 billion and 1 trillion dollars. When the size of the pie itself is unknown and if the chunk represented by cash also remains unknown, it will be extremely hard in hindsight to say anything with certainty. 

This makes me wonder whether the Govt. was shrewd enough to understand this and let it play out because it knew it could not be questioned with facts. Could this be a precursor to more arbitrary decisions from the government? Although I was pretty enthusiastic about repercussions regarding black money in the beginning, I now find the government's actions very unsettling.

Balcony

Soft winter sunshine on my feet.

Tepid tiles under, I stretch

In my balcony, to watch

Drama of life unfold.

Mother Nature in all its anarchy,

Pesky creepers spare none.

Onward they climb in rebellion.

To bring down the tallest ones.

Mango, Gulmohar and Cashew -

Them trees all are brooding.

Heavy foliage they carry,

With their shoulders drooping.

Only old Major by the side,

Gazes at carnage below.

Green wig, he is tall and slender,

Wise to have no branches low.

Further down, the mighty bay

All the way to Vasco.

Enthralled by the lovely scene,

Round and round coucals disco.

Calm and placid, the sea

Shows a steely resolve.

With not a ripple to unfeather,

Her silvery gray sheen.

Fickle they know her to be,

And now that there’s a chance,

Cruelly slash her across

Fishermen and speed boats.

Weather is out of favour,

And she cannot remonstrate.

Just small thunders on the beach

With every breaking wave.

Tide will pass they know,

Rocks that peekaboo,

And man will know the fury

Of Oceanus’ wrath.

Case for PSU Disinvestment through Exchangeable Debt

Introduction

The hullabaloo surrounding PSU(public sector undertaking) disinvestment has been in the news again lately following the budget announcement of disinvestment targets in 2014-15. Meeting the fiscal deficit target through disinvestment is a key priority for the new government. Although analysts are positive about the resurgence of the primary capital market in the short term and the beginning of a new investment cycle, the government continues to encounter questions with regard to pricing, market timing and offer mechanisms. Readings from popular press indicate how investor confidence fluctuates around the announcement of these piecemeal public offerings and how regulatory provisions have been made to sweeten the deal. In light of such market uncertainty and haphazard regulatory interventions, whether a more structured and phased disinvestment process independent of market timing is possible begs the question.

Historical Trends

Let's look back at disinvestment targets and realized proceeds in previous years.

Figure 1. Disinvestment targets and actual receipts (2010 - 14)

Disinvestment targets have not been met in the past few years and this was expected. It would have been foolhardy to expect the government to sell its equity holding using the traditional methods of equity sale (including IPO/FPO and OFS) in this period of poor market sentiment. A more nuanced approach, however, might help the government solve its optimization problem in the future.

What are the ultimate goals?

The Department of Disinvestment, MoF has the following mission statement:

1. To promote people's ownership in PSUs.
2. To ensure better corporate governance in PSUs.
3. To unlock true value of PSUs for investors, employees, company and government.

Furthermore, the disinvestment policy states that 

"Public sector undertakings are the wealth of the nation and this wealth should rest in the hands of the people."

Are these goals being met?

Vibrant domestic market - 

1. Investment in equities by households remain abysmally small (around 3% during the recent financial crisis) despite a high savings rate. Traditionally, households have invested in fixed income debt instruments although they posted negative absolute returns over the last decade. While stock market scams in the last two decades may have been responsible for the sour experience, some firms in the past - notably Reliance - had large retail shareholding due to compelling incentives which were provided for investors. How did Reliance succeed in creating investor confidence? Can the government take a leaf out of its book and align risk-return incentives to further its goal of distributing gains from public goods for the public?
2. With the view of providing investment protection, capital controls on public finance institutions including pension and insurance funds limit their exposure to equities. Sub-optimal returns hamper the growth of these institutions. What provisions can be made to improve this?

Corporate governance - 

Corporate governance in PSUs remains weak despite regulations in Companies Act, 2013 and SEBI listing requirement.

It seems that the government is more focused on unlocking the true value of its strategic sales at the expense of the other stated goals. 

What can be done?

The requirement of timing the market during periods of economic upheaval leads to only short-term success e.g. meeting fiscal deficit targets. Furthermore, true value remains elusive due to price reactions around the disinvestment period and the government is constantly on its tenterhooks. No wonder it has no foresight to pursue long term goals!

A paradigm shift in moving away for direct equity sale can be the answer. How can this be done?

What are exchangeable bonds?

Exchangeable bond is: 

"a type of hybrid security consisting of a straight bond and an embedded option to exchange the bond for the stock of a company other than the issuer (usually a subsidiary or company in which the issuer owns a stake) at some future date and under prescribed conditions."

For example, the GoI may issue an exchangeable bond of Rs 1,00,000 with the option to buy say, 350 shares of ONGC at a price of say, Rs 286 per share in the future. 

In terms of pricing, exchangeable bonds are similar to convertible bonds. The figure below shows the market value of convertible bonds with respect to the value of the underlying equity share.

Figure 2. Convertible value against underlying equity value

Exchangeable bonds have the advantage of providing investment characteristics of both fixed-income securities and equity. An investor, therefore, can participate when the equity market rises with limited downside exposure and potentially greater return on capital. It has a lower bond yield than a sovereign bond and gives lesser returns than the underlying equity.

Embedded options can be also be added to the exchangeable bond to cater for certain provisions favouring the issuer or the investors e.g. callable options. 

Why exchangeable bonds?

Exchangeable bonds have a number of incentives for different entities:

1. Government -

• The government issues securities worth Rs. 5 trillion every year. By issuing exchangeable bonds instead of some of the sovereign bonds, the government can reduce its debt burden.
• Market timing becomes redundant and the government can disinvest in a phased manner and meet its disinvestment targets.

2. Individuals and public institutions -  

• They have the option of risk free return and capital protection with the potential upside of equity ownership.
• Improves exposure to equity and better returns.

Results

1. Since the government retains control of the PSUs in the interim, it will push them to comply with corporate governance requirements - which most have been evading. Additionally changes in the management of PSUs will improve their performance. 
2. Public finance institutions like pension and insurance funds will have greater exposure to equities in their investments. Potentially large return over the long term will improve their finances. 
3. Potentially large long term returns for individuals after conversion to shares will improve their experience and lead to greater participation in the future.
4. Government can issue exchangeable bonds in a phased manner at predefined intervals of time. This will reduce information asymmetry and lead to better price discovery.

Conclusion

The current disinvestment policy is plagued with short-sighted vision for immediate results instead of long term gains. Introduction of exchangeable bonds with reservations for retail investors and public finance institutions will bring vibrancy in the domestic market without the need for the government to take any additional debt burden. Furthermore, matched incentives will put pressure on PSUs to improve their performance and better growth figures will translate to higher returns for investors. This 'win-win' situation will be achieved without sacrificing on the primary goal of getting fair price for the equity of the PSUs. 

An overhaul of the PSU disinvestment process is an important reform which requires immediate attention from the government if it is committed to improving growth of the macro economy. 

Croaking Frogs Leap

It finally rained in Goa today - and cats and dogs too! We'd seen it coming for some time now. Over the past few days, the sky was often cloudy and there were some pre monsoon showers. Initially we were all gay about it, but the Rain Gods are cruel and they know how to make you beg. If there's something worse than the sun's heat, it's humidity. And although the clouds might make it less sunny, all that humidity in the air makes you feel really stuffy and uncomfortable.

But there was something different in the air today. It was rather pleasant. There was a cool wind as I watered my plants in the afternoon and by the evening there were huge rain clouds in the sky - all around, as far as you could see them. And the strange thing about rain clouds is that you can't see them separately. They are like a genie in the sky - dark and strong, dangerous and not merciful.

The winds howl through cracks in your house and there's thunderous applause from the heavens above. The dead leaves outside rise again and dance around in circles - joyous to see the spectacle unfold before them. And the sweet smell of the parched earth which spreads around you adds a solemn feeling to the whole ceremony. Oh welcome our mighty saviour - the Monsoons are here!

Humans are not the only species which enjoy the arrival of the monsoons. There are a lot of others too. I'm hoping to see some peacocks around my house soon. :)

But this post is about the frogs. On my drive back home, I saw a lot of frogs leaping all over the place - in the veranda, in the garden, on the road, all over. Must be a happy moment in their lives too I thought. Unlike the peacocks, since they have little to show off by the way of dancing, they like singing. Well, they croak really. You can't expect much more from such ugly looking creatures :P

Male frogs generally croak during the rainy season to attract female frogs or to mark thier territory against other male frogs. I'm sure some of them got lucky today and went leaping around to tell their friends. :D

Down and Humbled

When you're at home on vacation, you'll do anything to kill time. And I think I've been lucky to find things to do this time. A unique opportunity presented itself when one of my dad's friends suggested I go for sailing at the Naval Sailing Club.

I don't know if you've seen anybody sailing before, but I'm sure you'd like to check it out if you saw it. It's a lot of fun. Typically you start with enterprise(dinghy) sailing. A dinghy is a light boat with two sails which are controlled independently by two persons. Before you set sail, it's really important that you know about all the parts of the boat, so you know what to do and how to communicate with each other.

The person who sits in front and controls the fore sail is called the crew. Apart from that, he's also supposed to make sure that the boat doesn't (which can happen sometimes when there are strong winds or if you have a noob at the helm - like me). The person at the helm of affairs, and rightly called the helmsman, controls the main sail and the rudder simultaneously. He's solely responsible for changing directions and steering the boat. Slight error on his part can cause the boat to capsize. And righting the boat is a daunting task in itself.

So as long as I'm giving teaching you the basics of sailing, I'll tell you what happened yesterday. Although I've tried helming before (read once), I committed some rookie mistakes. Firstly, the boat was already hall full with sea water because was a small leakage in the boat. Also I suspect, there was some water in the bouyany tanks (which are supposed to be empty to make the boat lighter in water and keep it afloat). Secondly, I committed the stupid mistake of taking a rookie with me who didn't know a thing about sailing. And being a rookie myself, things were bound to go wrong.

Having gone far enough into the sea, I thought it would be safer to come back. And turning your boat around is a tricky thing to do. If you're at the helm, you have to duck under the boom (the metallic rod which fastens the main sail to the mast), go and sit on the other side while controlling the main sail with one hand and turning the rudder with the other. So you're obviously bound to make mistakes if you aren't confident about what you're doing or if you're too slow. And I think I was too slow. I turned the rudder but couldn't pull the sail fast enough. Mother Nature played her part and we were soon in water.

And when the boat is capsizing, it doesn't really happen just like that. First you commit the stupid crime of tempting Mother Nature. Then there's a brief interval in which you see what's happening and you try to rectify things. And that requires a reflex action. In those few seconds, your mind goes over half a dozen things and if you don't have enough experience, you're bound to go down...slowly but surely. And no matter how many times you revise it on land, you can't learn without actually being there. It's all about mind over matter.

There's nothing to be proud about capsizing your boat. It's dangerous and if you don't know the capsize drill properly, you can be in a lot of trouble. But on the other hand, you can't learn the capsize drill without actually capsizing. And neither can you learn how to sail properly without making a few mistakes. So I guess all in all, you just have to take it as a stepping stone and not try and make the same mistakes again. Also never be overconfident about these things - take a trained professional who can quickly react to mistakes you make and teach you tricks properly.

Driving through Goa

Roads in Goa can be pretty confusing, probably not so much like some other places in India, but still. And it's not the highways I am talking about - like those from Margao to Panjim or Vasco but all the lanes and by-lanes which join these highways from all the villages scattered all over the place.

Typically only a single narrow road passes through an entire village before joining some other road from some other village and that finally joins the highway. And it's not the scenery around which I am complaining about. Mind you, that is always a pretty sight. Roads usually pass through the forest, or by a church (when you're passing through a village) or by large water bodies - by which of course I mean ponds. rivers or the sea.

So if you are a simple man, you'd love to drive through Goa. But what I was really trying to tell you was that since these simple narrow village roads typically all look the same, it's very easy to get lost and end up in some other village with a very similar sounding name. Your best bet then is to retrace your path back to the highway and find the right turn to the village you intended to go to. Highways on the other hand are pretty neat, long and wide (unless they are forced to go through some village) with signboards at regular intervals. So they help you cover the greater part of your journey with considerable ease.

By now you must have some idea that if you were to get lost in some village in Goa, you'd take a lot more time finding your way through the village to the right place than you did on the highway. And if you're wondering why I am taking so much effort to educate you about the roads of Goa, it's because I learnt a very valuable lesson yesterday on my way to my friend's house for his birthday party.

I bet you're thinking that all that I'm saying telling you is gibberish and that I must be a terrible driver with no sense of direction whatsoever. Sure it can't be that tough. But that's exactly what I thought. So take my advice and always consult Google Maps before you go around in Goa, especially if you haven't been to the place a couple of times already. :)

Epilogue

How does it feel?
To be back home...
With all that gold.
And no school to go.

School's out. Finally. Life's not very different from how it used to be when we used to come back home for vacations. But some things have changed forever...

Final year was a lot different from what I had expected it to be. It was very liberating...

The only thing on everybody's mind when we entered final year was getting a job. And the first few months in final year were pure madness. Everyday somebody was getting placed. For some, jobs were available on a platter. And the exultation after getting placed... was like popping a champagne bottle, with all that fizz ready to pour out and fill our empty hearts with happiness and joy.

Some had many dress rehearsals. The diligent ones would iron their shirts and polish their shoes the night before. We, on the other hand, used to beg and borrow whenever the situation called for it... take shoes from the guy next door and put a lot of deodorant on a shirt worn already... once, twice or whatever... :)

And even though we all had different experiences (and let's not forget about how frustrated we used to get when there were rumours that somebody 'screwed' the interview), I guess we all felt the same when we had landed jobs... ecstatic as we'd probably never been in our lives.

Second semester was the best. Always found a reason to celebrate. And even if all those we knew were placed already, we'd go out on a binge - and that was really a lot, every other day. It really seemed like nothing could ever stop us again...

Sail on into that horizon,
With joy in your heart,
And a smile on your face.
Nothing's going to stop you now.

And final year was a lot about things we'd never done before - poker, binge drinking, riding like crazy on highways, or just getting drunk and crying on each others shoulder or just getting drunk and dancing like crazy... any occasion we had always called for a round of drinks - the only way we knew how to pour our hearts out to each other and mean every word we say...