In response, the president and the independant director

I’m writing this post in response to the comments that readers posted on my last post about how the government is flouting the corporate governance rules. The readers really raised some good points like preventing PSU banks from divestment and clumsy comparison of president of India with the independent directors of the PSU banks.

 

Let’s first discuss the issue of the divestment of PSU banks. A company in public sector is divested only when its performance is shoddy for years unless the people in charge of the industry have some personal benefits from the divestment of the company. Looking at the financial health of all the PSU banks no one in power would think of divesting any of the PSU banks. Even if someone, with a very high political influence wants some PSU bank to be divested, the decision needs a nod from parliament. It wont be easy for any political authority to get a go ahead on this from the parliament for many reasons, chief among them being the expected opposition to the divestment from the left (We can’t forget about the current situation of the ruling party where in it can’t go ahead on anything unless they have a tacit go ahead from left). So divestment of a PSU bank is a far cry in the current situation. If in worse case the government decides to divest, then the bank executives won’t have any say in this decision as they are simply the bureaucrats and not the stakeholders, so the independent director who is going to keep a watch on these executives won’t be of any help in case of divestment against the public will. Rather appointing the party members as independent directors, the government is safeguarding its interests if tomorrow it goes for divestment, by having their own people on the board of the bank.  So a political leader from the ruling party in the chair of the independent director is going to help the divestment of bank rather than preventing the bank from divestment. There is a small legal stint to the issue of the divestment of the public sector companies. The government is a major stake holder in all such companies and if government decides to sell its stakes to some private player then no rule can stop them from doing that, left alone the independent director. So government, at any time can partially divest any of the public sector company and the independent director has no role to play in it.

 

The second comment about the clumsiness of the comparison of the president of India with independent directors of the PSU banks, talks of the power that president of India has. My take on this is that, the comparison is not between the president and the independent directors of the PSU banks but it is between the way government is using its power of majority to push its party members into the system where the common people expect someone with proven abilities to handle the post as well as the system. And though the president of India has almost no rights in anything, we shouldn’t be forgetting that as the first citizen of this country he/she is the face of India for the whole world and we don’t want any bruises on the face of the nation, we don’t want the representative of this nation to be selected based on his loyalty to any particular political party. Even with the restricted rights, the president has the power to make the ministers rethink on any debatable bill presented in the parliament. For this very right, the president’s post should be looked at with great care and respect, both as the citizen and as the voter.

The corporate non-governance

The two most conspicuous things about this year’s presidential elections are the arguments of the opposition to the candidate chosen by the ruling parties and the adamant nature of ruling parties in doling out favors to the loyal members of the party. But this is not the only example where the ruling party has made use of its power of majority to keep happy those party members who have served the party for years. The appointment of political leaders from the ruling party as the independent directors on the board of major PSU banks is another striking example of how the ruling party is misusing its power.

The Indian banking sector is growing by leaps and bounds these days and PSU banks are not left behind in this banking rally. Rather the PSU banks are still most coveted banks in India. The banks and government are investing enough of capital to improve the infrastructure and provide the quality service to its customers. But moral investment is one place where government has failed as far as PSU banks are concerned and if the trend continues then the same would happen in all the public sector industries. Ever since the clause 49 has been introduced in the listing agreement, there has been some relief for the shareholders of the companies as the law now makes it mandatory for the companies to appoint on its board, an independent director, who has no interests in the company or its profit, directly or indirectly and whose major objective of being on the board of the company would be to preserve the shareholders’ interests. But the recent moves by the ruling party, in which they appointed some of the old party members as the independent directors of the PSU banks, have disappointed both the shareholders and the executives of the PSU banks.  For one, these independent directors don’t have any working knowledge of the large banking systems; second, they are not fully aware of the responsibilities and the job of an independent director. Conflict of their opinions with the executives of the bank is slowly getting revealed. One such conflict in the board meetings of Punjab National Bank recently caught the attention of media. One of the most important criterions for being an independent director is that the selected person should be an expert in the business domain of the company, consequently it is expected that he or she should be having good knowledge about the day to day working of the company. These criteria assure that the independent director is a quality addition to the already existing executives on the board of the company and the independent directors would be able to keep a watch on the way business is carried out by the company. But by appointing the politicians with no banking knowledge as the independent director of the PSU banks, the ruling party has not only done an injustice to the executives of the PSU banks but also has tacitly broken a rule.

The job of the independent director is to stop the bad practices followed in the company and not to interfere in the day to day working of the company if the company is not indulging in any wrong things or following all the legal frameworks. I don’t know, what is achieved by the government by appointing non-expert independent directors on the board of PSU banks, who indulge in the altercations with the bank executives for no reasons, but the government has surely made angry the executives of the bank who have loyally been serving the bank for years. Government for a pity political benefit is letting its moral down. They are introducing corporate non-governance when the need of the hours is the clean corporate governance.

The wrong inflation figure

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I also write technical articles here

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Last week the headline inflation fell to a figure below 4.5% and everyone heaved a sigh of relief. But does this really mean a relief to the common man? The answer surprisingly is ‘No’ as the headline inflation doesn’t at all reflect the price changes that the common man deals with. This is so because in India the head line inflation is calculated by tracking the changes in Wholesale Price Index (WPI) and not Consumer Price Index (CPI), which is more relevant to the common man. For this relevance of CPI to the common man, most of the developed nations use CPI data to arrive at the head line inflation.

To understand the difference, let’s try to understand what exactly are CPI and WPI. WPI, Wholesale Price Index, tracks the changes in the wholesale/retail prices of a predefined goods and services. This is the price at which your shopkeeper buys the goods that you buy from him. CPI, Consumer Price Index, tracks the changes in the prices of the goods and services that the common man/consumer buys. This is the price at which you buy the goods from your shopkeeper. So WPI based inflation is more relevant to the retail businessmen and not to the common man. For common man we need an inflation figure based on CPI.

Most of the modern economists don’t buy the strategy of WPI based inflation. There are some more reason to this, than just the one mentioned above. WPI uses ‘wholesale basket’, which is a list of 435 goods and services, whose prices are tracked continuously to calculate WPI. This basket was last defined some 70 years ago and was revised a couple of times later, but still doesn’t fully represents the commodities, goods and services that a common man consumes today. The wholesale basket doesn’t contain most of the goods and services that are widely consumed these days as no government agency took pain to update the list in the recent years. In defending its stance the government says that the headline inflation figure that it releases is for business purpose and not for the common man’s use.

In an interview to Business Standard, C Rangrajan, noted economist, ex-RBI governor and advisor to finance minister, told the reason why government is using WPI based inflation. As he told, in India, the CPI data is not released as frequently as WPI data. WPI data is released almost weekly and sometimes at most biweekly, where as CPI data is released once in a month. There is also a lot of lag in collating all the CPI data. The latest, fully collated CPI data available is for March 2006. There is another problem with the CPI data in India. We don’t have a single CPI data, but four different CPI figures relating to agriculture goods, urban manual labor and non-urban labor etc. There is no discipline in when these different figures are released and with what frequency. So government of India has a genuine reason in not going for CPI based inflation. But then something needs to be done. With advanced computing technologies and prevalence of IT in India in every sector the task of collecting a single CPI figure shouldn’t be a big deal, that too when we have one of the best economist as out prime minister, another one as finance minister and third one as RBI governor.

The GDP or GNP…??

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I also write technical articles here

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We always hear the words GDP and GNP or more precisely the nominal GDP and nominal GNP, but rarely do we understand the exact difference between the two. It would be interesting to dig deep into the difference in GDP and GNP and look at how they affect the overall economy.

 

So, the GDP, standing for Gross Domestic Products, is the monetary value of all the goods and services produced or manufactured within the borders of a country by the industries originating from any country. For example all the goods produced by the Indian unit of General Motors count towards the India’s GDP, though the manufacturer is not Indian.

 

GNP, standing for Gross National Product, on the other hand is the monetary value of all the goods and services produced by the industries of a particular country anywhere in the world. So for example the products of TATA’s unit in South Korea, count towards the GNP of India and the GDP of South Korea.

 

So far so good. Then comes the term Nominal GDP, and the confusion starts increasing. To add to it, there are two terms, nominal GDP and Real GDP, same with GNP. What’s the difference? The difference is the way monetary value of something is affected by another economical phenomena called inflation. We all know that the value of money keeps on changing over the time and so does the monetary value of something. Nominal GDP/GNP is the GDP/GNP calculated based on the prevailing prices of the goods and services produced, so the effect of inflation is included in the final nominal GDP/GNP figure. And when this figure is adjusted for the inflation over time, we get what is called real GDP/GNP.
So if Maruti produced 1000 cars in year 2006 and sold each for Rs 1 lac (For the sake of example only, I know they are not going to sell their car for 1 lac), then their contribution towards GDP is Rs1000 lacs. Now in year 2007, due to inflation the price of the same car goes to 2 lacs (inflation of 50%, a rare case, but again for the sake of example) then their contribution towards the GDP becomes 2000 lacs. This is how it works, no extra goods were produced over the years but the GDP grew at a rate equal to the rate of inflation, again, to be precise, the nominal GDP grew at that rate. Now to calculate the real GDP we subtract the inflation rate from the nominal GDP rate. This figure provides a more true picture to compare year 2007 GDP to that of year 2006 and claim any economical developments.

 

The question still is which one of these is the most dependable indicator of the economy of a country. To me none, none is independently able to provide a clear picture of economy for many reasons. For one, GNP doesn’t give a clear picture as it doesn’t specify how much of the money earned by an Indian corporation outside India, comes back to India, how much does the exchequer earns from such corporations through direct or indirect taxes. For the other the GDP too doesn’t provide any clear picture as it hides the same information about the foreign corporations working on Indian soil. Though for the sake of national pride we admit to one of the two, still we need to choose between the nominal or real figures and none of which is again able to prove anything independently. The nominal figures hide the inflation effect and the real figures totally ignore the inflation effect which is very important.

 

So how does one gauge the health of economy? The answer is obvious, by going beyond GDP and GNP figures, understanding how these figures affect the other economic indicators and how other economic indicators affect these figures.