Tag Archives: rupees

Liquidity

In economic theory, outside of capital markets, “liquidity” is a topic that isn’t spoken about as much as it should. While I’m no academician to set this right in theoretical circles, I’ll make an attempt to help my readers what the fuss is all about.

Well past midnight, when you exit a mall after having just watched the “second show” of a movie, you will find a bunch of auto rickshaw drivers who accost you. Without exception, each of them is likely to quote an exorbitant price to take you home. As the night goes on, there is a reasonable chance that some of these drivers will have to move away from the mall, unable to have found a customer for the night.

Two months back, I was looking to purchase a high end laptop. I walked the high streets of Bangalore, going to every big and small computer store I came across. Each brand had a maximum of one laptop that fit my requirements. I ended up purchasing the laptop I’m typing this post on in the US (got a cousin to bring it in for me).

In London in 2005, a sandwich at Subway cost less than two pounds, while a Masala Dosa at a half-decent restaurant cost at least seven or eight pounds. In Bangalore today, a first rate Masala dosa won’t set you back by more than thirty rupees, while a standard unexceptional “sub of the day” at a subway costs over twice that amount.

All the above cases of pricing anomalies or market failures can be ascribed to “lack of liquidity”. In financial literature, liquidity is defined as an asset‘s ability to be sold without causing a significant movement in the price and with minimum loss of value (source: Wikipedia). From a practitioner’s standpoint, liquidity is positively correlated with the amount of activity that is happening in the market – the more the buyers and sellers for a particular security, the less the “transaction cost” you incur in selling it.

Auto rickshaws in the middle of the night, dosas in London, subs in Bangalore and high end laptops in India – they are all examples of markets that (by the above definition) are highly illiquid. In each of the above markets, the number of buyers and sellers at any point of time is low (relative to other comparable markets – such as auto rickshaws in the evening or dosas in Bangalore). Thanks to that, the “bid ask spread” (my apologies for continuing to use financial jargon. Bid ask spread refers to the price between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept) is high, and consequently, buyers end up paying a high price, or in some cases, sellers end up not realizing a high enough price for their good.

Now, why should this happen? Doesn’t it sound counterintuitive if I say that “there isn’t much demand for subs in Bangalore, hence the price is high”? The fact is that when I say that “there isn’t much demand” I omit saying that there isn’t much supply also. This calls for further explanation.

Let us imagine a world where it is impossible for a buyer and a seller to interact directly to conduct a sale (this sounds like dystopia, but let us imagine a situation like that). In this world, there are a bunch of “specialists” called “market makers”, whose only job is to buy and sell goods. So if you are the seller of a particular good, instead of finding a buyer, you sell it to a market maker, who takes the risk of holding on to your good (carrying cost, possible damage, risk of sudden fall in value of that class of goods, etc.) until he has found a seller. Similarly, if you want to buy something, you only contact a market maker.

When there are a large number of buyers and a large number of sellers for a particular good, the costs of making markets is low. Due to the number of buyers, the average length of time a market maker has to hold on to the good is low, which automatically reduces the risk of making markets in this particular good. Since the cost of making markets in this good is low, more market makers will want to make markets for this particular good. Their competition lowers the bid-ask spread (refer to definition above), and thus both buyers and sellers will realize a price that is close to the true market clearing price.

Now what happens when there are few buyers and sellers for a good? Very few market makers will want to trade in this good, since the risk of holding on to these goods is significantly higher. Consequently, there is less competition among market makers and the bid ask spread remains high (while it is a fact that the cost of market making is also high for these goods, the lack of competition in market makers further pushes up the spread). As a seller, you now have much less choice in terms of buyers for your good, so you end up accepting a rate much lower than true market clearing price. Similarly, as a buyer, you end up paying exorbitant prices.

Now let us get back to the real world where buyers and sellers can actually interact. It can be seen as being similar to the above world, but with the change that buyers and sellers are their own market makers! The cost of making markets comes into play here. As a seller of auto rickshaw services outside a mall past midnight, you know there is a risk of not finding a buyer for your services. You try and price in this risk in the price you quote, and you end up asking for more than the market clearing rate, and there is a good chance there will be no takers for that rate, until you get desperate about finding a customer and quote something below the clearing rate. If you are looking to hail a rickshaw outside a mall past midnight, you are wary of being stranded there without a ride home, so you end up paying much more than the true clearing price.

Several examples of this nature abound. Like how real estate prices are “sticky”, and builders refuse to drop prices in the face of falling demand (note there that real estate brokers are not market makers – they don’t take on the risk of holding on to the asset). Like how I get suboptimal rent for the house that I own in Kathriguppe in Bangalore, only because there aren’t too many people who want to rent a 3BHK independent house. And how apple products are almost a fourth more expensive in India than in the US.

Moving briefly from micro to macro economics, GDP grows when there is more economic activity, or when there is more trade. One way of increasing GDP is to foster trade. However, a large number of goods and services that people need, or that people want to provide, are “illiquid” (that includes Quant consulting –  which is what I do. There aren’t too many of my ilk around, and no too many organizations interested in buying these services). One way of fostering internal trade, and thus economic growth, is to reduce the cost of market making. When it comes to goods, VAT, in that sense is a step in the right direction since at each step it is charged only on the marginal value added – and thus the presence of an intermediary doesn’t increase the total cost by too much. Stamp duty on real estate, however, is a bad idea. By charging a full tax on every transaction, it dissuades market makers in the sector, and thus keeps markets illiquid and opaque. The worst of all, though, is Agricultural Marketing, where by law the APMCs have monopoly in making markets in agriculture. Now you know why the farmer continues to suffer even though retail prices of agricultural products have been going through the roof.

Ok I end this post with that digression into macroeconomics. However, I do hope that I’ve been able to explain to you why illiquid products are costlier (if you’re a buyer that is)! Let me know in case you have any questions.

Update

This post came about as a result of a twitter conversation earlier today with Dhiren and Pavan. Giving credit where it’s due

Missing the Obvious

It was a year and a half back that I bought this desktop that I’m writing this post on. Given that the desktop was to be placed in my study, and the modem is in the drawing room, the most intuitive thing for me to connect up this desktop was to buy a USB wi-fi adapter, which cost me in excess of a thousand rupees. While it worked well in general, it gave problems once in a while, requiring reinstallation of the software and setting some random settings.

Last week, when I got some data from a client, I realized that my computer was wholly unsuited for big data operations, and I needed to upgrade, big time. I’ve now got myself a badass Intel I7 processor, with 8GB RAM and a 64 bit OS which will hopefully enable me to run my business successfully. The downside of this is that my old USB Adapter doesn’t work on a 64bit processor (it can be made to work, but the process is long and tedious). After getting my wife to dirty her hands on this (she is the in-house hands-on engineer), I realized that it wasn’t possible to get the USB Adapter to work, and thought of complicated options such as using this computer purely for analysis and using my laptop and a Pen Drive for the networking. Half a day of working thus told me it was way too inefficient. Then I thought of shifting the entire modem to the room, drawing a line from the telephone jack in the drawing room all around the house,  a process that is not painless.

Finally, for two hundred and sixty rupees (less than a fourth of what I had paid for the USB Adapter) I got myself a 20 meter long LAN cable, and have simply connected my computer with that. Beautiful, intuitive, simple. The question, though, is about why I had never thought of this beautiful, simple, intuitive solution for so long! It turns out that I had never really taken this option into consideration at all, for had I done it there would have been no grounds to reject it at any point in time.

I have recently embarked on a career in consulting, and I believe that a significant proportion of my insights are going to be beautiful, intuitive, simple solutions which for whatever reason the client hadn’t particularly thought of. Why do such low hanging fruit exist at all?

What is it about our thinking that we get so tied up in complications and completely miss out the obvious? Is it a fallout of our spending large amounts of time trying to solve complicated (and in the larger context inconsequential) problems? Or is it that these simple obvious solutions have to “hit us” sometime (in the form of an insight) and when we sometimes approach the problem in too structured a manner we tend to miss out on these insights? What do you think?

While I’m happy that I’m connected again, and in such simple a manner, I’m cross with myself that a simple soluti0n as this didn’t strike for such an extended period of time.

Free float and rupee volatility

Following a brief discussion on twitter with @deepakshenoy I’m wondering what’s preventing the RBI from making the rupee fully convertible. The usual argument for full convertibility is that it will make the exchange rates volatile. My argument is that exchange rates are already so volatile that the additional volatility that could stem out of a free float is marginal, and a small price to pay.

The wise men at RBI, though, might argue the precise opposite. They will claim that in terms of already high volatility they wouldn’t want to do anything that might add to volatility, however marginally. This is a constant battle I faced in my last job, of delta improvements. I would frequently argued that when something was already high, making it delta higher was not so bad. I would argue in terms of making systemic changes that would reduce drastically the already high number, rather than focusing on the deltas.

Coming back to the rupee, you can also imagine the wise men talking about some stuff about black money and hawala money and all that. The thing with making the rupee fully convertible would be that hawala would be fully legal now, and the illegal practice would cease to exist. And when something becomes legalized it comes back to the mainstream rather than remaining on the margins, and that is always a good thing.

Then you can expect some strategic affairs experts to bring some national sovereignty and national security argument there. There will be people who will talk about the increase in counterfeit money (since it’ll become easier to “smuggle” rupees into India then), and about how foreign governments might pose a threat to India’s security by manipulating the rupee (who says that threat doesn’t already exist?)!

I don’t know. I don’t find any of these anti-full-convertibility arguments compelling. If we do adopt full convertibility, though, we can at least pay Iran for the oil we get from them, and that might for all you know help tackle inflation. I don’t, however, expect the RBI to act on this.

The Second Hand Goods Market

Every time we clean up our house, which is quite frequent I must say, there is a bunch of stuff that we want to throw or give away. Being rational beings, each time we look to maximize the returns we get out of whatever we don’t need, and hence go around looking for people who will buy them. The problem here, though, is that the second hand market doesn’t really exist, and even if it does it’s so illiquid that it’s not worth the effort to locate them and sell our goods there.

For example, for a long time we’ve been wanting to get rid of our dining table. The question is how do we dispose of it in order to maximize returns. I don’t know of any shops that buy used furniture, and there are search costs involved there. And then there is the cost of actually transporting the dining table (you realize it can’t be done by my car, right?) to the location of sale. And then haggling over the price. Given that it’s not made of particularly good wood (we know where to sell stuff made out of “good wood”) I don’t even know if what get by selling even covers the cost of selling it!

Worse, we got a bunch of new electric appliances (microwave, mixie, gas stove) as wedding gifts. The “normal” way of getting rid of old mixies or gas stoves is to give it “in exchange” so that we get a small discount for the new appliance we’re buying. When we get appliances as a gift, though, this avenue is lost. The old mixie and stove (and a couple of ancient table fans) decorated our attics and bred rats until we sold all of them for a grand total of five hundred rupees while buying a new saucepan! (I’d located that store and carried the stuff there with such great difficulty that I was willing to sell at any price).

Now there’s this ancient vacuum cleaner and old RO water filter out for disposal (the latter was disposed due to exorbitant maintenance costs). There’s a good chance that we’ll dispose of them by just dumping them on the road somewhere. Seriously. The selling costs are way too high. I know that in New York there’s this whole “industry”, where people leave old furniture and appliances on the roads in the middle of the night, and some other people take them away and salvage whatever profit they can get.

I thought of a business plan that gets unnecessary appliances and furniture from people (for a nominal fee; and by paying transport costs) and then sells it on to people who are actually willing to buy these things. The problem is that a lot of people actually dispose stuff as part of “exchange offers” so I don’t know how much volume this new business can get. But if someone manages to pull it off, I promise to donate all my useless stuff to them. Else, you’ll soon start finding unnecessary furniture and appliances scattered along KR Road in Bangalore.

The problem with private provisioning of public goods

… is that private players who are providing those goods have an incentive in blocking attempts by the public sector to provide those goods. For the purpose of analysis, let us take the example of Gurgaon, both because I’m reasonably familiar with it and because it has been in the news in the international media thanks to a recent profile of the city by the New York Times.

Now, Gurgaon has a major problem with power supply. It is said that (I don’t have first hand info for reasons you’ll soon understand) the “city” faces about four to six hours of regular power cuts every day. I don’t know the exact reasons for it (surprisingly, Haryana sells power to other states so it appears there is no power deficit per se in the state), but it could be a pricing issue, with free power for farmers and all that. Anyway, the reason for the power cuts doesn’t matter so much.

In reaction to this, apartment societies have taken it upon themselves to provide “power backup” to the residents (for a fee of course). Even in that, there are three grades. I used to live in a DLF complex that had “one hundred per cent power backup”, which meant that I was assured of 24/7 power supply. Every time there was a power cut, the generators would start in a matter of a few seconds, and with “one hundred percent backup”, I could run just about any device on the “backup” power supply. In return, I would pay the apartment association six rupees per unit (as opposed to 3 rupees I pay here for sarkari power in Bangalore).

Then, there as “eighty percent backup”, in which you could use the generator-power supply to run all appliances except air-conditioners and geysers (both extremely important in Gurgaon given the weather). Then, there was another level with fifty percent backup, though I didn’t particularly understand it. The individual houses in the city, though, had no backup, and people living there had to make do with inverters.

Now, suppose that magically Haryana were to become a power surplus state, would the state government be able to provide uninterrupted three phase power supply to Gurgaon? I would think not, for there are several “private players” in that city whose source of profits and wealth is derived from the fact that they provide backup power supply. Think of all those people who invested in DLF flats because they had “one hundred percent power backup”. Now, with power backup not being a distinguishing factor, these flats will lose in value since they cannot command the same kind of premium as they used to (rather, the supply of “apartments with assured power supply” goes up, thus reducing demand for the only ones that offered this luxury earlier). Then, there are scores of generator and inverter dealers in Gurgaon, who again depend on the power shortage for their livelihood. And so forth.

It doesn’t appear as if Haryana has power shortage any more (recently, Karnataka bought power from that state to tide over its power crisis). However, there are enough powerful lobbies in Gurgaon who depend on power cuts (!! ) for their income and wealth, and it appears they have managed to lobby the government there (officially or unofficially) to block the provision of assured power supply. The moral of this story is that once “public goods” start being provided by private players, it is hard to displace them, and this results in a lifetime of inefficiency.

When will my courier reach?

Earlier today, I had to urgently send a package to Mumbai. I was recommended that I use Bleudart since they guarantee next day delivery, and off I went to the Bluedart collection centre near my house. There, I learnt that there were 3 options.

For two hundred and eighty rupees (what I ultimately picked) I was guaranteed that the package would be delivered tomorrow. However, there were two premium offerings – promising 1030 am delivery, and 12 noon delivery. Given my payoffs I settled for the “normal” next day package. Now, I wonder when my package will reach.

What are the odds that the package would reach before noon? I would say the odds are very slim, for if my “normal” package were to reach before noon, there would be no reason for me in the future for me to pick the 1030 delivery or 12 delivery package. Even if the package would have reached close to the destination tomorrow morning (I expect that it’ll be sent on a late evening flight today or early morning flight tomorrow), the delivery person would be instructed to wait till after noon before delivering, I think.

What do you think? If you think it’ll reach before noon, you can bet on it. Leave a comment and we can discuss odds. I’ll give you the airwaybill number so we know when exactly it got delivered.

Update

I win the non-existent bet.

Pickup Date 12 October 2011
From Bangalore
To Mumbai
Status SHIPMENT DELIVERED 
Date of Delivery 13 October 2011
Time of Delivery 12:15


Vegetable shopping – It’s not about percentages

Some habits are hard to change. One that is especially hard to change is bargaining for vegetables. I was trained well, I must say, in the bazaars of Jayanagar 4th Block Shopping Complex. I was taught that one needs to do a full round of the market before making any purchase, in order to understand the “market price”. I was taught  techniques that would make the shopkeepers give the goods for the price I offered, I was told what demographics to approach for what kind of vegetables, and over time I must say I became an excellent vegetable shopper, when sent to Jayanagar 4th Block that is.

Another thing that is hard to change is willingness to pay, and this is where I see some irrationality. For example, I’ve just returned from the fruit and vegetable shop close to my house, having refused to buy a cucumber because the shopkeeper asked for Rs. 10 for it, a 100% markup on the not-so-longterm average price of Rs. 5. And that is precisely the problem – looking at it as percentages.

We don’t usually consume too much cucumber. If I’d bought that cucumber it would’ve lasted about a week. So by refusing to pay the “100% premium” for it, I’ve essentially saved my family a maximum of five rupees over the course of a week (and this is in the best case – conditional on my being able to procure cucumber at the “normal rate” soon. Else the loss is larger). And given our not-so-inconsiderable weekly expenses, and the fact that our “discretionary spend” is an order of magnitude larger than the five rupees I’ve saved on the cucumber, this just doesn’t make sense.

The mistake we make here is to look at the percentage increase in weekly budget of the particular item, and base our decision on that. Instead, if we were to look at the increase in the “total weekly budget” (across all items), that could help us get a more realistic figure for our willingness to pay for certain things.

Of course, the big problem here is that even if my rational mind says this, there’s a behavioural issue in paying much more than the price we’ve been “anchored” to. I don’t know how we need to get over this.