How They Saved The India Story

On the second anniversary of the crisis,in September 2010,basic assumptions about how our money is governed seem boring. But that time two years ago,those assumptions were under threat. Today,the Sensex coming close to 20,000 again seems unremarkable. Then,the Sensex falling below 10,000 was not even the worst of problems for the economy’s managers; there were things far worse. India’s quick recovery and its high growth rates now owe a lot to how the crisis was handled then.

Never before had government decision-making been so unorthodox as it was in those four weeks. And seldom had it been so effective. One of the things all the players remember is how many phone calls they made,and how few files were opened. There was no time for files. There was no time for bureaucratic rules.

Prime Minister Manmohan Singh,his then finance minister,P Chidambaram,and Montek Singh Ahluwalia,then and now,deputy chairman,Planning Commission,were at the top of the informal command structure managing the crisis. Ahluwalia was the one keeping the PM informed most regularly. Chidambaram was the one who sought out good advice from everywhere,including young,sharp economists.

Ahluwalia doesn’t remember how frequently he spoke to the Prime Minister over those four weeks. “It seemed so often,” is all that he can recall today. A conservative Reserve Bank of India (RBI) that had got a new governor in Duvvuri Subbarao ended up releasing an ocean of money —

Rs 4,60,000 crore — into the system. But the RBI staff put up a stiff fight. Chidambaram was the government’s main battler to get the RBI to embrace unorthodoxy. And while many fierce proponents of the free market in the private sector were clamouring for market restrictions,it was the sarkari types,from Securities and Exchange Board of India (Sebi) and the finance ministry,who kept faith in the Indian markets.

Sebi was quick to react. Not only did India’s stock market regulators work till midnight and beyond on many days of that crisis period,they asked the stock exchanges,BSE and NSE,to settle all Lehman accounts in India the moment news broke that the investment bank had collapsed in the US. Lehman India managers were asked on Monday morning,September 15,to call up their bosses in the US,where it was night. They were reluctant to call their bosses that late,recall Sebi officials. But the regulator was taking no chances.

This fascinating story of all the players and all the moves that ensured there were no panic runs in India has two broad lessons. One,stakeholders must cooperate and do so by forgetting precedents when money is at risk. As the latter part of the story shows,this wasn’t the case at the start. There was a group within policy-making circles who didn’t take the crisis seriously enough. How that group lost its argument is a fascinating part of how India avoided a full-blown crisis. The second lesson is that it all boils down to the government in the end. Bankers,businessmen and regulators are crucial. But it is the political appointees who are finally accountable for keeping India’s money safe.

This absorbing story is also inevitably complex,given the nature of the crisis. We tell the story via three crisis points that best capture the drama and the dilemma — the ICICI bank,speculators and mutual funds. We wrap up the story with an account of the big picture,as recalled by those who handled the crisis.

Point to note: India’s chief financial bureaucrat,the Union finance secretary,Arun Ramanathan,had been appointed a week after Lehman died in the US. The Union economic affairs secretary,Ashok Chawla,had been appointed on the day news of Lehman’s collapse hit the headlines,September 15,2008. And India’s new central bank governor,Subbarao,had been appointed 11 days before the Lehman collapse. For them it was trial by fire. But it was a trial by fire for everyone — ministers,secretaries and CEOs.

The ICICI ‘scare’

The most outlandish rumours two years ago this time were about ICICI. The bank was made the symbol of the Indian version of the crisis. Here’s the real story of what happened and why.

On the weekend of October 11-12,2008,Chidambaram offered the then ICICI Bank CEO,KV Kamath,some blunt advice. There were fears of a run on ICICI’s deposits. Chidambaram told Kamath,talk to your customers. “ICICI was passing through tough times. And I asked Kamath to personally assure his customers,” Chidambaram recalls. Monday,October 13,2008,first thing in the morning,Kamath was on business TV. “Hand on my heart,the deposits are safe,” he said with utmost sincerity. For the CEO of the country’s largest private bank,whose aggressive banking style was already renowned in the financial sector,this was a big change. But it was a change the markets believed in. ICICI’s shares surged 25 per cent intra-day,helped also by Chidambaram himself backing ICICI and the entire banking sector. “No Indian depositor need be apprehensive,” he said.

But only a few days before,it was very different. When Chanda Kochhar,then ICICI’s joint managing director and now CEO,made similar assurances on Friday,October 10,few were convinced,rightly or wrongly. ICICI was the focal point of one of the dimensions of the crisis — a big bank going down — precisely because it was big and successful.

Roughly,$50 billion annual liquidity from foreign sources is required by India’s big corporate players. The India growth story can’t survive without this liquidity. When Western finance went into meltdown mode,dollars rushed out of all emerging markets,including India. For those betting on big names going under in such situations,the biggest private bank in India was a good target. The ICICI-will-go-down bet seemed a low-cost-high-return wager.

It looked even more so because ICICI’s position in the complex financial sector transactions looked somewhat vulnerable. Banks borrow and lend in the inter-bank market routinely to meet their short-term cash management needs. But ICICI was borrowing at a scary 20 per cent in this market. This,to many,signalled trouble.

They got more support for their thesis from Singapore. Credit default swaps (CDS) are financial instruments used to speculate on a company’s ability to repay debt. In Singapore,trading on ICICI’s CDS showed what the markets were thinking. The measure of risk increased by four times in four weeks. If ICICI took a $10 million debt,the market earlier thought $400,000 a year was enough to make that debt safe. But in the four weeks starting September 2008,that amount went up to $1,600,000 — a shocking rise in the market’s scepticism.

And here was the bigger problem: CDS markets are thin and can be influenced by a few hedge funds. It’s a cosy club,with only a few institutional players determining the opinion of the market. Some hedge funds can plan an attack.

The CDS message,the research reports of some analysts,ICICI’s reputation as an aggressive financial player and rumours,most importantly the rumours,were all making a bet against ICICI look like a money spinner for some speculators — and a disaster for Indian finance. For your money. Imagine your confidence level in 2008,if ICICI was taken down by speculators. Imagine what today would have been. Today would have been very different. That’s when and that’s why the government had to step in.

Chidambaram spoke to Kamath,and Kamath spoke to the markets. The markets listened and believed.

To Ban or not to Ban

This is the strangest part of the story,and also the part that’s least known. Private sector biggies wanted to curtail commercial freedom. Ministers and babus defended commercial freedom — and prevailed. This is a story of why India avoided taking regressive decisions that Western capitalist countries were guilty of.

The provocation was,again,ICICI,whose shares went into free fall after the financial crisis hit the West. ICICI was going at Rs1,231 per share when 2008 began. The share was trading at Rs 364 on October 10,at the height of the crisis. Kamath blamed manipulation and rumour mongering. The hedge funds did nothing to make him or anyone else feel more secure. The opinion of a few — that ICICI was a blowout case – was threatening to become the opinion of many — the market at large.

It was then that Kamath called up Sebi chief CB Bhave and several officials in the North Block,including KP Krishnan,the then joint secretary in the capital markets division. Kamath was pushing for restrictive action against market speculators,at least those betting on financial sector companies. Big names from India’s private sector joined in. That’s when the unlikely champion of the markets stepped in — sarkari babus.

Krishnan was summoned by Chidambaram in the second half of October. “Why shouldn’t we implement the ban?” was Chidambaram’s question. Krishnan and other officials tried to explain to Chidambaram at his North Block office why this was a bad idea. First,the babus gave the technical answer. Then,they gave the answer in plain English; the answer that won the argument. Krishnan told the FM: “You have very high fever. There are two options. One,take a paracetamol and sleep it through. Two,break the thermometer,and do not acknowledge you have fever.”

That was plain English. Krishnan was telling the FM that banning speculation wouldn’t cure the problem. How the FM might have responded to that metaphor would never be known because as Krishnan and others finished their pitch,the FM’s phone rang. It was the Prime Minister’s Office,calling Chidambaram over for a discussion on banning speculation.

Chidambaram had also received inputs from the Sebi chief,Bhave,who made the same argument,much more technically. So,here were India’s senior bureaucrats,defending trading freedom to their political masters,while the latter were being lobbied to take the opposite decision by big names of India Inc.

Krishnan had another problem — was he dressed right to meet the PM? Krishnan and two finance ministry officials were going to brief the PM. The joint secretary had dressed down — it being a weekend — and was wearing a collar-less white T-shirt. His sartorial worries were dismissed by Chidambaram,who told Krishnan (in Tamil): The PM isn’t calling you to see a prospective bride.

Chidambaram took the three officials to the PMO,where he started by cracking a joke. You (the three babus) can use all the mumbo-jumbo of finance with the PM; he understands,Chidambaram said. The capital markets division had done its homework well. Among the telling arguments they presented was this: many of those shouting for a ban on speculation today had been critical of timid official efforts on financial liberalisation earlier. “We shared those comments with the PM,” said an official who attended that meeting but did not wish to be quoted. The PM laughed,and remarked,“It is a sad day that I have to learn economics this way.”

Chidambaram backed his officials. The PM agreed. India didn’t impose blanket restrictions on trading freedom. It was a rare victory for market freedom at a time when markets were in very bad odour.

A Pack of Cards

Mutual funds,middle-class Indians’ preferred route to the world of finance. They were a great success story — and as the crisis hit India,they seemed like the biggest domino that could fall. Officials say those four weeks were the scariest when they looked at the mutual fund industry. It looked like a pack of cards. Strange,very strange things were happening. Like this:

Wednesday,October 29,2008. Ajay Bagga,CEO,and Rajiv Shastri,head,business development and strategic initiatives,both of Lotus India,a modest-sized mutual fund,were incommunicado. Their mobile phones were switched off. Their friends in the mutual fund industry say they were “pretty frustrated”. Why? Because Lotus India’s foreign sponsors essentially ditched their Indian partners and sold off the company to another Indian finance firm,Religare,promoted by Malvinder and Shivender Singh of Ranbaxy fame.

The sale happened over a weekend. Bagga and Shastri told their foreign sponsors they were managing their (the sponsors’) brand. The argument mattered little. The sponsors wanted safety,they wanted it quickly,they were willing to pay money for someone to take over the fund. The sponsors put in Rs 100 crore in an escrow account so that Religare could take over Lotus’s assets! This was all new and strange stuff in the Indian mutual fund sector. And Lotus was hardly the only one.

At least six other funds,including the biggies,the Reliance Mutual Fund and the HDFC Mutual Fund,were under severe stress. “Every fund was under siege,” says Dhirendra Kumar of Value Research,a firm that closely tracks the sector.

And then there was the taxman. “The advance tax payments was like taking blood out of a patient who is already bleeding,” Nilesh Shah,joint managing director,ICICI Prudential,recalls. The dates of Lehman’s collapse — September 14/15,2008 — coincided with advance tax payment date in India. This is when companies shell out 30 per cent of their full year’s tax liability.

This tax payment sucked out Rs 48,000 crore. Companies,who park their short-term funds with mutual funds,started taking the cash out to pay taxes. Simultaneously,the crisis-induced shortage of cash in the system was hitting them.

Stories were told then and believed till now that mutual funds were in trouble because they had betted badly. This wasn’t the case at all. The problem was shortage of confidence and cash. “The mutual fund crisis had nothing to do with the quality of their assets. Contrary to perception,real estate exposure was only a very small portion of their assets,” says UK Sinha,chairman and managing director,UTI Mutual Funds.

October 2 was a holiday,as it is every year. That the situation was extremely critical sunk in amongst all players on October 3. Beginning October 6,telephones started working between the ministry of finance,the RBI and Sebi.

Mutual funds were gasping. Everyone wanted their money out — that’s what we were hearing,finance ministry officials recall. Investors took out Rs 60,000 crore in a month. Some key figures involved in the crisis management team say the mutual fund problem should have been tackled earlier,and they trace the delay to a general misjudgment in the early part of the crisis. But that misjudgment was quickly reversed. To understand what happened,we need to turn to the big crisis story — the committees and the people who were tasked to save your money.

We Are OK,No We Aren’t

At the very beginning,senior figures involved in crisis management now say,there was a gap in comprehension. The same complaint is made by some leading figures of India Inc,who wouldn’t like to go on record. A prominent captain of industry puts it like this,talking about crisis management in the first few days after Lehman: “The tail was on fire,but decisions were not taken”. One reason for this disjunction in private-government assessment was that some players in the private sector were getting scary reminders of what could happen during their workdays.

For example,from something as obvious and innocuous as suppliers’ credit. This is the credit that suppliers extend to companies whom they do business with. This is a basic kit of private business and it seldom breaks down across companies and sectors.

But even blue-chip companies were being shut out. Shah of ICICI Prudential recalls getting one such nasty reminder: “Even a company such as Sterlite Industries that imports copper was denied credit by its suppliers. It was upon a chance meeting with Tarun Jain (CFO,Sterlite) that I got to know India Inc was going to face a big problem. Sterlite had started using its own cash for working capital needs. This was impossible to detect,no statistical model could have predicted this.”

In the government,though,the prediction was still not dire. That Subbarao,Ramanathan and Chawla,even though experienced economic administrators,were all new to their jobs was perhaps a factor. But there was something more that was at work. A key member of the crisis management team has this explanation: “It was almost sadistic… the pleasure that many in the decision-making hierarchy derived… There was an overwhelming feeling in India that the crisis did not quite affect us while it was really hurting the rich West. This thought was relished by some seniors in the bureaucracy. Many in the government severely underestimated the openness that India had achieved since 1991.”

That underestimation could have proved very costly. For the first two weeks of the crisis,serious crisis management wasn’t the norm in official action. But serious action followed,most players acknowledged the need for serious action,and voices that were gloating over the West’s problem faded away.

Everyone knows serious intervention was done by the Liquidity Assessment Committee,the nodal crisis management body set up by Chidambaram on October 11,2008. But what’s not known is how tough it was to get all players to agree.

The list of officials/government experts who argued right from the beginning that something could go seriously wrong was very short when the crisis broke. UTI’s Sinha,Sebi’s Bhave,Jahangir Aziz,now a private bank economist who had then just quit being a sarkari economist — that was about it. Initially,both the finance ministry and the RBI were convinced that India needed to do only a few relatively small things,like relax the monetary policy a bit.

This initial attitude was best summed up by a note to the Cabinet Committee of Economic Affairs. That note,senior officials recall,said that India would face no crisis,that India’s financial sector could be ring-fenced. The note was e-mailed to the RBI

as well.

Who gets the most credit for changing that opinion? All senior crisis managers say: Chidambaram. “It is true Chidambaram is pushy. He can be seen as interfering in the affairs of regulators by some. But full credit goes to him for being hands-on during times like these,” says the top functionary in a regulatory body,who did not wish to be quoted. Chidambaram,senior crisis managers recall,doesn’t mind dealing even with the most junior official to get work done. He looked everywhere and listened to everyone worth listening to,says a senior bureaucrat.

Chidambaram’s toughest job was convincing the RBI,recall crisis managers and members of the Liquidity Assessment Committee. The central bank’s first moves,in the first week of October,were conservative,as were its statements. When the financial system was looking at adjustments in the order of Rs 90,000 crore,recall senior crisis managers,RBI’s first move released only Rs 20,000 crore. We were pretty aghast,a senior official said.

That changed,thankfully. But what was the sticking point? All senior officials we spoke to framed the issue in this fashion: Subbarao was new to the job,RBI’s senior staff were and are very cautious,which is good in normal times,but a problem when times are not normal. The RBI governor had to be convinced,he had to convince his staff. That had become the key point in crisis management in the first two weeks of October.

Subbarao was flying to Washington DC as the leader of an Indian delegation to an IMF meeting,scheduled for October 11,2008. Even before he could reach Washington,Ahluwalia called him up with a clear official signal that it was imperative that RBI ratchet up its response. The message was promptly conveyed to the governor’s deputies in Mumbai. On October 10,the RBI ratcheted up its response — injecting a substantial amount of cash in the system.

A day after the RBI’s big response,on October 11,a Saturday,the Liquidity Assessment Committee was set up. But Chidambaram,in a departure from all government precedents,didn’t wait for the committee’s report to take more action. One of the decisions taken in the next two days was that no single mutual fund would be allowed to collapse. The finance ministry was by then a firm believer that one fall could trigger several more.

So,on Monday evening,October 13,Chidambaram asked Bhave and Sinha to reach RBI’s headquarters on Mint Street,Mumbai,early on Tuesday morning. Bhave and Sinha were in by 8 am. The two officials met the RBI brass — the governor was still in Washington — and the central bank announced a special funding facility for mutual funds before the stock markets opened that day. That announcement had a calming effect,as is clear in hindsight. Mutual funds were off the hook from that time on. Just as ICICI was not in danger once Kamath had successfully calmed nerves.

But it wasn’t easy getting there. And there were other fights among crisis managers. Should non-banking finance companies —your friendly neighbourhood fund,for example — get direct RBI help or via banks? North Block wanted direct RBI financing,as in the US,but didn’t get its way.

“Honestly,things were getting done in days and hours… There was a time lag,but only very small,” says Ahluwalia. Chidambaram has a slightly different take: “In times of overwhelming crisis such as this,everybody,all regulators including,must defer to the government,” he says.

In the end,they all did. In the end,the government itself revised its complacent view. In the end,ICICI kept standing,as did all mutual funds. In the end,the financial system didn’t suffer a major breakdown. But,as one senior official now recalls,it

was close,very close,sometimes it felt touch and go.

But in the end,your money was kept safe. l