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Polymer rupee notes: Slow or no progress?

As per the finance ministry, 5.21 lakh pieces of fake currency were detected in 2011-12, up from 4.35 lakh units in 2010-11 with the majority of them in Rs500 notes. When will the RBI take a call on polymer notes?
 
Recently we carried a story on the history of the pioneering effect by Australia in bringing out polymer currency notes couple of decades ago. (See: What about polymer rupee notes?)
 
Several countries followed suit including our neighbours such as Bangladesh, Nepal, and Sri Lanka besides a host of other countries like Singapore, Chile, Indonesia, Kuwait, Malaysia, New Zealand Mexico and Brunei.  It is not yet announced, but it appears some others are contemplating such a switchover from the Australian experience, which is only expected.
 
India has faced the problem of fake or counterfeit currency notes, mostly emanating from Pakistan, which is presumably used for terrorist activities and also to undermine the rupee for political reasons. After all, the Indian economy is strong and has a growing influence in international trade.
 
According to the information given by minister of state for finance, Namo Narayan Meena, as against the 4.35 lakh units of fake currency detected in 2010-11, for the period ending March 2012, counterfeit notes had increased to 5.21 lakh pieces, with the majority of them being found in Rs500 notes.  Even bankers, it was reported in the press, had failed to distinguish between the real and the fake ones, as the counterfeiters had almost reached the point of perfection in fooling people with their reproduction!
 
In fact, in order to counter this menace, a couple of months ago, it was reported that in a pilot scheme to introduce polymer rupee notes, an unannounced entry into the market was made in selected cities like Bhubaneswar, Jaipur, Kochi, Mysore and Sheila, to test the market or public reaction.
 
So far, however, the Reserve Bank of India (RBI) has not yet made its findings public on this score.  Nor do we know the quantum of such currency or the unit or face value.
 
But the crucial point is what is delaying the actual introduction of polymer rupee notes at least in the higher denomination of Rs500 or Rs1,000 as a start, as the majority of the counterfeit notes detected were in Rs500?
 
The government must take serious steps to implement the change. First is to establish a time frame to introduce the polymer notes and set a target date by which the entire paper currency system will be replaced. It must also target the date by which time the old paper currency will be totally withdrawn or even ‘demonetised’.
 
Second to gear up the production machinery that will have to be imported, most possibly from Note Printing Australia, a subsidiary of the Reserve Bank of Australia, so that indigenous supply can also be established. We must also investigate if other western or European countries are planning such a switch?
 
It may be recalled that Australia introduced the polymer notes in 1988 and completely switched over by 1996. The population and currency in circulation in Australia, during this period, have no bearing in size comparison with India, and it would probably take 10 to 15 years for such a switchover.
 
During this period, it will also give the opportunity for India to eliminate smaller coins, and replace the present Re1, 2, 5, 10 and 20 with coins, provided minting capacity is available, and possibly introduce a Rs25 polymer notes and maintaining a Rs10 polymer as well.
 
The third step is to ensure that we have the adequate supply of the required type of polymer from indigenous sources, machinery and technical know-how to make the required type of polymer sheets and obtain the technology to print them.
 
Fourth, by obtaining the collaboration from technical partner like Note Printing Australia, we must also be able to enter into long-term contract with them for continuous supply of our polymer currency notes to supplement our indigenous production efforts. It is a tall order but this can be achieved given the methodical way the RBI functions as an independent statutory body.
 
If and when these are done, the polymer rupee can become a totally convertible currency. These notes will have four times longer shelf life than the paper currency after which they can be recycled also.
 
It is time the RBI made some announcements in the progress of making the polymer rupee.

(AK Ramdas has worked with the Engineering Export Promotion Council of the ministry of commerce and was associated with various committees of the Council. His international career took him to places like Beirut, Kuwait and Dubai at a time when these were small trading outposts; and later to the US. He can be contacted at [email protected].)

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High Frequency Trading: Do machines make fewer mistakes than humans?

High frequency trading (HFT) has been cited as the cause for increased volatility and systemic risk. However, HFT firms counter that it has brought down the cost of trading for retail and institutional investors
 
High frequency trading (HFT), or trading by machines based on complex algorithms, has increased exponentially over the past few years. According to a recent analysis only 16% of the buying and 13% of the selling on US exchanges is actually done by people. Ten years ago it was 35% and 25%, respectively. High frequency trading used to occur in milliseconds (it takes you 300-400 of these to blink), but the new hardware has increased that to microseconds, or millionths of a second. These trades are not only fast, they are also short. The holding period for a particular position if there is one is for only a few moments. This type of trading is supposed to be good for the markets. Academic research shows that since HFT has been introduced, there has been increased liquidity as measured by shrinking bid-ask spreads. So this wonderful technology really works. Except when it doesn’t.

Last year Knight Capital, the largest independent wholesale market maker in the US, was showered with awards for its pre-eminence in high-speed trading systems. This all changed in a mere 45 minutes. The company had developed a new piece of software. But it didn’t work. It sent out numerous orders for stocks and then buying them almost instantaneously, guaranteeing a loss based on the difference in price. The machine went on a buying spree that no trophy wife could even imagine. It purchased $7 billion worth of securities, an amount way beyond the limits allowed by the regulators. When the mistake was discovered, Knight’s traders stepped in and started selling. By the end of the day they were able to reduce the total to a mere $4.6 billion, but it was still too much. Fortunately for the firm, it had a saviour. Goldman Sachs kindly stepped in and bought the remaining shares for a discount of 5% to market value. Between the losses from the sales and the discount to Goldman, Knight had lost a total of $440 million. The only thing that enabled Knight to open the next day was a rescue package from six financial firms in exchange for securities that can be converted into 73% of the firm.

The story of Knight Capital would be bad enough except that it might have had greater repercussions. Knight Capital executes trades for some very large retail trading firms including Etrade, Fidelity, Scottrade, TD Ameritrade, and Vanguard. They use Knight Capital because it is cheaper than sending the trade directly to the New York Stock Exchange. A panic among retail investors could have been disastrous. It would demolish any remaining trust Americans have in their markets.

The other problem with the so called ‘Knightmare’ is that it is not a unique event. Most investors remember the Flash Crash on 6 May 2010 when the American equity markets dropped 10% in a few minutes. Technical glitches put a damper on the much-hyped debut of Facebook and dropped the shares of exchange operator BATS Global Markets to a fraction of the offering price within seconds of its IPO. According to one technology expert miniature flash crashes happen all the time.

Naturally as with any new technology there have been criticisms. HFT has been cited as the cause for increased volatility and systemic risk. Institutional investors are concerned with front running. Other problems include manipulative practices with rather esoteric names such as ‘spoofing’ and “quote stuffing”. There is the problem that when it is really needed, the liquidity dries up. The HFT firms counter that it has brought the cost of a trade for a retail investor down from $20 to $8 and a penny a share for institutional investors. But the central question is whether the present system is worse than what went before? Do the machines make fewer mistakes than humans? Of course with the controversy and the problems have come the regulators and the United States Congress, who are all in the process of investigating and, hopefully, creating solutions.

But a major meltdown on developed markets is not what worries me. Markets in the US are generally well regulated, transparent and liquid. The problem is that the vogue for high-speed trading has spread to emerging markets. Rapid electronic trading is now taking place in Brazil, Thailand, Turkey, Hong Kong, India and now China. Some are trying to protect their exchanges. The local regulators in India require approval of all algorithms before they are used. Hong Kong mandates that they be tested annually. Still these are small markets with inexperienced underfunded regulators. They are often dominated by a few players, who routinely engage in corrupt practices. These exchanges are not only subject to technical glitches, but outright fraud. When the debacle occurs it will affect far more that just one company.

You may also want to read: SEBI unveils norms to check systemic risk of algo trading

(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages. Mr Gamble can be contacted at [email protected] or [email protected].)

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COMMENTS

Ashith Kampani

4 years ago

Dear William,

Quoting a para from your article

"Rapid electronic trading is now taking place in Brazil, Thailand, Turkey, Hong Kong, India and now China. Some are trying to protect their exchanges. The local regulators in India require approval of all algorithms before they are used. Hong Kong mandates that they be tested annually. Still these are small markets with inexperienced underfunded regulators. They are often dominated by a few players, who routinely engage in corrupt practices. These exchanges are not only subject to technical glitches, but outright fraud. When the debacle occurs it will affect far more that just one company."

Need to get some clarity on a specific comment from the above para "They are often dominated by a few players, who routinely engage in corrupt practices."

In my view the emerging markets are evolving and within EM India seems to be doing its bit as regulator is pro-active but the above comment does not seem to fit in the Indian context as I am unable to comment on other EM's

Appreciate your response ..... Ashith Kampani

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