Reliability of the Most Reliabale

Any research, analysis or even a commentary on the economy draws heavily on the macro-economic data.  When it comes to data, analysts all over the world unanimously agree that the most reliable data source is the Government.  They just accept the data provided by the government without even the slightest doubt on its reliability.  The data released by governments has various roles to play.  (a) It indicates the direction and momentum of the economy, which has great influence on the confidence levels of business enterprises; (b) It acts as guiding tool for attracting both domestic and foreign capital; (c) It influences the decisions of Foreign as well as Domestic Institutional Investors, and (d) It sends signals to the financial markets, taking them to new levels.  Such is the importance of data provided by the government, that many people eagerly wait for the release of the most recent data.  Now let us look at some recent headlines:

(a) Govt Admits Subsidy Math has Gone Awry (Economic Times, 8 Dec)
(b) $9B Goof-up in Export Numbers, Admits Govt (Economic Times, 10 Dec)
(c) Export Nos. Gaffe Adds $7.2B Headache to Govt (Economic Times, 15 Dec)
(d) Rangarajan Spots Sampling Errors in IIP Data (The Hindu, 21 Dec)

The first one is an error of forecasting, where the subsidy bill has overshot the budget estimates by a huge margin.  This is very much possible and does happen at times.  But the last three are calculation/estimation errors.  In the second case, "computer and human errors overstated India's export figures", says the report.  It gives further reasons as "wrong data entry, double counting of certain items and computer malfunction".  The difference was to the tune of $8.8Billion.  Within 5 days of revising the export numbers downwards, the government got the next shock.  The export data compiled by RBI for 2011-12 exceeded the government estimates by $7.2Billion.  The RBI data is considered to be more reliable as it is based on the actual payments received.  Then came the big announcement of IIP's contraction by 5.1% during October 2011.  This sent shock waves among the business fraternity and the financial markets alike.  And today, Dr. Rangarajan, Chairperson of the Prime Minister's Economic Advisory Council spots sampling errors in the IIP numbers for Oct 2011.  He had expressed his shock and disbelief when the IIP numbers were released last week.

If one were to make any conclusion on the conditions of the economy based on the data released by the government, the data needs to be compiled properly and computed scientifically without errors.  With the advent of advanced computing technology, we have increased the frequency of reporting by shrinking the reporting interval.  In some cases, this type of increased frequency in reporting can only create unwanted panic in the market.  It looks like a doctor monitoring the temperature of his patient every 15 minutes and reporting the same to the patient.  It only adds to his panic, especially when the news is not good.  What is worse is that the doctors is using a flawed thermometer! 

Series on Financial Markets - V

Continuing with the discussion on raising capital by business entities, unlike what I mentioned in my earlier post, capital can also be raised directly from the savers.  Small businesses borrow money from the friends/relatives of the promoter directly; whereas large corporate houses raise money from public at large.  (There are various reasons why businesses do not fully depend on banks and financial institutions for capital, which is not explained here).  A business enterprise can raise capital in the form of debt or equity (ownership).  When an enterprise raises capital directly from the public, it is said to be raising the money from the 'Primary Market'.  Unlike many other forms of market, primary market is a notional one, with no specific location or office.  However, this market is regulated by the government through appropriate regulatory bodies.

Since there is no specific location; and savers, who would be interested in supplying capital to the firm are geographically scattered throughout the country, the firm has to put in place a complete system to reach the prospective suppliers of capital.  It resorts to the following processes and depends on the respective intermediaries in the process.
(a) Obtaining regulatory approvals (wherever required)
(b) Releasing advertisement inviting public to subscribe to the bonds/shares
(c) Preparing and printing prospectus containing various details of the issue
(d) Printing application forms
(e) Approaching brokers/sub-brokers to promote the issue
(f) Appointing registrars to manage the issue
(g) Appointing bankers to collect the payment etc.

Thus, as against loan from a bank or financial institution, the process of raising capital directly from the public involves lot of money (spent on the above activities) and it is time consuming.  Then why do businesses raise capital directly from public?

Series on Financial Markets - IV

Let us now understand the role of Financial Institutions in an economy.  These institutions act as intermediaries between the suppliers of capital and those in need of it.  It is always possible for the business enterprises to raise capital directly from the individuals who have surplus money.  But there are few problems:
(a) many individuals may have only small amounts of money as surplus
(b) the individual investors do not have the expertise to analyse the business that the firm is engaged in
(c) the individuals find it difficult to understand and assume the risks involved
(d) there is a question of credibility as the business enterprise may cheat the investors

This is where the role financial institutions becomes relevant.  Lets take commercial banks for example.  Banks collect small as well as large amounts of money from those who are willing to invest their surplus, make a big pool of money, which is then used for lending to business enterprises or individuals placing demand for money.  Thus the surplus money that would have directly flowed from the investors to the firm, now takes a detour through the bank.  This solves most of the above concerns.  Lets see how:
(a) individuals can deposit even small amounts as banks pool the funds
(b) banks have the expertise to analyse the business projects
(c) banks can reduce the risk of lending as they lend to many enterprises and thus diversify the risk
(d) banks are regulated by the government which brings in credibility (though not all banks share the same credibility and risk)

Similarly, the financial institutions like insurance companies, mutual funds, pension funds etc. act as financial intermediaries.  They are all regulated, though the extent of regulation differs.  The process of financial institutions bringing suppliers and users of funds together is known as 'Financial Inter-mediation'.