Markets

The Cobra effect

| Updated on March 01, 2019 Published on March 01, 2019

A cobra effect is when unintended consequences of an action can worsen the situation. The anecdote is about a British offer, which in order to curb the menace of cobras, offered a reward to anyone catching and surrendering them. This worked, initially, until people realised that breeding cobras would give them a steady income. On discovery of this, the scheme was stopped, and the newly-bred cobras were released, as they were not an income source, thus increasing the problem instead of decreasing it.

The recently passed ordinance on collection of deposits has the good intention of aiding victims of Ponzi schemes, and of preventing future ones. Ponzi schemes are a menace and sometimes a conduit to political funding (in return for political protection, which prolongs the suffering of the victims). So, the intention to protect them through the ordinance is a laudable one.

Clarification helped

The drafting could have been better, though, as it gave an impression that personal loans from relatives and friends would be barred. This would have been a cobra effect, inflicting more suffering on the victims, whose life savings have been stolen by the scamsters, and who would be unable to get loans from anyone other than relatives and friends. Belatedly, and thankfully, a clarification was provided that these were not banned, as indeed they ought not to be. Governments cannot intervene in private relationships.

Another recent example of the cobra effect was the government guarantee to Air India for its proposed ₹7,000-crore bond issue. Without such a guarantee, Air India, which is unable to service its debt, would not get any public money. The guarantee enhances its credit rating, and investment banks are falling over each other to take up the issue, which they would have avoided, had it not been for the guarantee.

The cobra effect on private airlines who have not the benefit of a guarantee. Cost of funds for them would be higher, and their rating lower. In essence, the government has penalised their efficiency and rewarded Air India’s inefficiency. This is a bad signal to send by any country that seeks to invite investment with an improved ease-of-doing business rating. All animals must be equal.

Jet Airways, struggling to raise funds, has grounded 28 planes in the past two months and is expected to ground another 12 more in March. Had it got a government guarantee, it, too, could have raised money through bonds. Fewer flights make travel more expensive and comes at a time when the government is seeking to popularise air travel and privatise airports. Cobra effect.

In the NSEL scam, now in its fifth year, SEBI has initiated criminal action against 300 brokers and declared some as ‘not fit and proper’. The scam was perpetrated by the exchange and its management, who are the ones responsible for lending money, ostensibly against commodities (though they never obtained any stocks, whilst issuing receipts for stocks, a clear fraud) to firms that later defaulted. The liability of brokers, should it be a factor, is secondary to the liability of NSEL and the parent, 63 Moons. It is a cobra effect.

The stock market seems to have taken in its stride the escalation in hostilities between India and Pakistan and has not reacted. It presumably assumes that the situation will de-escalate, as Pakistan’s economy is too weak to be able to afford a war.

With the US and China likely to agree to a trade deal, and Fed Chairman Powell not raising interest rates, international risk factors are reduced for the moment.

(The writer is India Head — Finance Asia/Haymarket. The views are personal.)

Published on March 01, 2019
This article is closed for comments.
Please Email the Editor