The RBI has taken serious efforts to increase liquidity and lower interest rates in the last 4 months. Recognising that the industry was under pressure, the CRR was reduced by 250 bps, which meant an injection of around Rs 100,000 crore. Further, the repo rate was reduced swiftly in quick steps from 9% to 5.5%. While credit advance has been satisfactory with growth being 12.6% up to January 2 this year as against 11.0% last year, the pace of growth has not really accelerated.
In fact this number would also be higher on account of adjustments made every quarter. Further, lending rates (PLRs) have come down from an average of 12.75-13.25% last year to 12-12.5% this year. But, the average reduction of just 75 bps in PLR is very low when juxtaposed against the 350 bps reduction in repo rate. The issue is why is it that things have not gone quite according to the RBI’s plans considering that liquidity is in abundance today given the flow of bank funds into the reverse repo market?
Theoretically, we appear to be somewhere close to what Keynes had called the liquidity trap wherein the demand for money becomes flat meaning thereby that lower rates do not stimulate demand. This sounds okay under the present circumstances when there is an industrial slowdown with excess capacities in various industries. The slower pace of growth in infrastructure and housing has depressed overall demand. This is the macro picture. Maybe the government has recognised the same and invoked quite a few fiscal steps to resuscitate the economy.
Now, if we look at banks, their deposit rates have not really come down and the average rate on a 1 year deposit is at 8.25-10% as against 8.25-9% last year. What this means is that banks are vying for deposits and are willing to pay higher rates to attract deposits. Growth in deposits has been slower during the financial year so far at 13.2% (14.3%) as on January 2, 2009. There is evidently a shortage of savings, which is an enigma because we have a situation where people are not spending nor investing in the share market. Banks are hence, offering higher rates on longer maturities which mean that there is also a mismatch in assets-liabilities since they are betting on paying higher rates for longer tenures too. The focus of banks on infrastructure and housing, where the loans are for a period of 15 years, could be the explanation.
Now, quite a few industries have claimed that funds are not forthcoming from banks or are coming at a high cost.
Wednesday, January 28, 2009
Liquid Enough: Financial Express: 28th January 2009
RBI’s credit policy is pragmatic even though it has done nothing. Perhaps, this is what Mint Street should be doing when all its policy measures fail to do what it wanted to achieve in the first place i.e. lower interest rates for borrowes. Lending rates haven’t fallen at nearly the same pace as the repo rate over the last few months. Still, RBI’s overall policy approach provokes some debate.
The first issue really is its stance on interest rates. RBI has been exhorting banks to lower interest rates which should, in a decentralised set up, be the prerogative of the banks. The fact that the public sector banks have responded more appropriately than the foreign and private banks does not speak of much autonomy for these banks.
Now, the ideological question is whether the regulator should be commenting on the direction of movement of the price which it regulates i.e. the interest rate here. Sebi does not tell NSE or BSE to keep share prices up nor does the FMC ask exchanges to ensure that prices move down. The price should be determined by the market, and while RBI can influence the supply of funds through the CRR and other infusions, it should desist from forcing banks to lower their rates. Banks have to take a commercial decision on rates, which should not be influenced unduly by RBI.
Secondly, for the first time, RBI has spoken of total funds available rather than just bank funds that are available to the commercial sector. The reason is that bank disbursements to the commercial sector have been higher than last year by nearly Rs 68,000 crore on an incremental basis. This means that credit is flowing to this sector contrary to the perception that banks are not lending money. In fact, the non-oil industrial credit was higher by around Rs 43,000 crore.
Flows such as FDI, capital markets, NBFCs and ECBs are lower with a decline of around Rs 83,000 crore. Evidently, the problem is more the lack of demand from industry rather than a problem of supply from banks. RBI, in the last 5 months, has infused around Rs 388,000 crore into the system but if supply isn’t the problem, then the additional liquidity would not have the necessary impact. RBI’s own survey has indicated, “weak demand conditions and decline in sentiment for production, order books, capacity utilisation and exports”. If this is indeed the case and there is a big demand squeeze taking place, then the question of supply and cost of credit are not that pertinent.
What about inflation? The RBI’s take on inflation is that it would be down to 3% by March-end. This number needs to be put in the right perspective. The RBI recognises that inflation by the CPI will be higher as consumer prices come down with a lag. It also acknowledges the base year effect on inflation, which is why a 3% number looks achievable. But, which inflation number should we look at? Ideally, what matters is the average inflation rate which is the rate calculated by dividing the sum of the 52 WPI indices for this year over that of last year. Now, if we assume that the rate would be 3% on a point-to-point basis for the next two months, and calculate this number, we still arrive at a figure of 8.4% for the year. Hence, the 3% number could be sending the wrong signals as it is affected by a high base number and ignores all that has happened during the year when purchasing power has been eroded.
The RBI has hence concluded that growth will be lower, but still impressive considering that we are going to do better than the rest of the world; inflation has been successfully controlled through monetary policy measures as well as softening of oil prices. While it has done nothing for the time being, it has assured us that it would make sure that funds would be available in the next two months, meaning thereby that more CRR and repo rates cuts are possible if warranted—especially if government borrowing will crowd out private demand for funds.
The first issue really is its stance on interest rates. RBI has been exhorting banks to lower interest rates which should, in a decentralised set up, be the prerogative of the banks. The fact that the public sector banks have responded more appropriately than the foreign and private banks does not speak of much autonomy for these banks.
Now, the ideological question is whether the regulator should be commenting on the direction of movement of the price which it regulates i.e. the interest rate here. Sebi does not tell NSE or BSE to keep share prices up nor does the FMC ask exchanges to ensure that prices move down. The price should be determined by the market, and while RBI can influence the supply of funds through the CRR and other infusions, it should desist from forcing banks to lower their rates. Banks have to take a commercial decision on rates, which should not be influenced unduly by RBI.
Secondly, for the first time, RBI has spoken of total funds available rather than just bank funds that are available to the commercial sector. The reason is that bank disbursements to the commercial sector have been higher than last year by nearly Rs 68,000 crore on an incremental basis. This means that credit is flowing to this sector contrary to the perception that banks are not lending money. In fact, the non-oil industrial credit was higher by around Rs 43,000 crore.
Flows such as FDI, capital markets, NBFCs and ECBs are lower with a decline of around Rs 83,000 crore. Evidently, the problem is more the lack of demand from industry rather than a problem of supply from banks. RBI, in the last 5 months, has infused around Rs 388,000 crore into the system but if supply isn’t the problem, then the additional liquidity would not have the necessary impact. RBI’s own survey has indicated, “weak demand conditions and decline in sentiment for production, order books, capacity utilisation and exports”. If this is indeed the case and there is a big demand squeeze taking place, then the question of supply and cost of credit are not that pertinent.
What about inflation? The RBI’s take on inflation is that it would be down to 3% by March-end. This number needs to be put in the right perspective. The RBI recognises that inflation by the CPI will be higher as consumer prices come down with a lag. It also acknowledges the base year effect on inflation, which is why a 3% number looks achievable. But, which inflation number should we look at? Ideally, what matters is the average inflation rate which is the rate calculated by dividing the sum of the 52 WPI indices for this year over that of last year. Now, if we assume that the rate would be 3% on a point-to-point basis for the next two months, and calculate this number, we still arrive at a figure of 8.4% for the year. Hence, the 3% number could be sending the wrong signals as it is affected by a high base number and ignores all that has happened during the year when purchasing power has been eroded.
The RBI has hence concluded that growth will be lower, but still impressive considering that we are going to do better than the rest of the world; inflation has been successfully controlled through monetary policy measures as well as softening of oil prices. While it has done nothing for the time being, it has assured us that it would make sure that funds would be available in the next two months, meaning thereby that more CRR and repo rates cuts are possible if warranted—especially if government borrowing will crowd out private demand for funds.
Thursday, January 22, 2009
Currency futures: The best is yet to come: Economic Times: 21st January 2009
The growth in traded volumes in currency futures
has increased substantially in the last month, with the total volumes traded on the two exchanges around Rs 2,500 crore (around $0.5 billion) a day. There is talk of two or maybe three more exchanges joining the fray and the question is whether or not there is room for more players. Currency futures today are offered only for rupee-dollar contracts for longer periods (12 contracts) than the existing forward contracts (3 contracts). The futures markets were to get in the speculators and investors who would help to deepen the market. It was also assumed that there would be little cannibalisation of the markets given that the main players, i.e. the banks, would be in both of them. Given that volumes have sort of stabilised in the futures market, one can firm up an initial opinion. The first is on the forwards market involving merchant and inter-bank transactions. Overall volumes traded were lower at around $4.6 billion a day in December and January relative to around $6 billion in September and October, though higher than the volumes of around $4.3-4.9 billion a day in June-August. But, it is difficult to say whether there has been any substitution considering that the volumes in the futures markets are only $0.5 billion a day. Given that the forex market has been volatile in the past three months — it was around 18% in December — one would have expected a higher number. On the other hand, lower volumes of foreign trade would have lowered the merchant transactions. The inter-bank transactions have been roughly steady along these periods. The second is that the forward market in dollars (merchant and inter-bank) is a very small part of the overall foreign exchange market today. The forward market in dollars would prima facie have a counterpart in the futures market. The other segment in 'other foreign currency' would technically not have a counterpart. With an average daily turnover of $50 billion, the transactions in forwards in USD accounts for around 21% while inter-bank forwards in dollars account for another 4%.
Hence, the current currency futures actually maps around 25% of transactions in the forwards market. The inter-bank market on the other hand is more in spot and swaps, which account for around 30% each of the overall market. The balance is accounted for by the spot and forward cancellations on the merchant account. The third aspect, the participants on the futures exchanges are quite different from those in the forward market. This can be conjectured based on the implicit futures rates based on the data presented by RBI and NSE. The forward rates appear to be much higher than the futures rates for the same tenure with the difference being almost 200 bps. For example, on January 1, 2009, the one-month forward rate was annualised at 4.43% while the futures market had a rate of 2%. The three-month forward rate was 3.28% as against 2.2% on the futures exchange (only a small part of the difference could be attributed for by the differences in the days involved). In fact, at times, the futures rate was trading at a discount to the RBI reference price. It is likely that it is the speculative money that has been coming into the futures market as against the merchant transactions in the forward market which would be based on physical transactions. Two conclusions can now be drawn form this data. First: the two markets are not integrated and there is scope for arbitrage which will bring about convergence in the markets, as we cannot have two prices in two markets for the same product — one is notional and the other is based on real transactions. Second: given the size of the forward market of around $50 billion and the current size of $0.5 billion in futures, there is enormous scope and opportunity for the existence of more exchanges in the country which will enable back-to-back hedging opportunities for all market participants.
has increased substantially in the last month, with the total volumes traded on the two exchanges around Rs 2,500 crore (around $0.5 billion) a day. There is talk of two or maybe three more exchanges joining the fray and the question is whether or not there is room for more players. Currency futures today are offered only for rupee-dollar contracts for longer periods (12 contracts) than the existing forward contracts (3 contracts). The futures markets were to get in the speculators and investors who would help to deepen the market. It was also assumed that there would be little cannibalisation of the markets given that the main players, i.e. the banks, would be in both of them. Given that volumes have sort of stabilised in the futures market, one can firm up an initial opinion. The first is on the forwards market involving merchant and inter-bank transactions. Overall volumes traded were lower at around $4.6 billion a day in December and January relative to around $6 billion in September and October, though higher than the volumes of around $4.3-4.9 billion a day in June-August. But, it is difficult to say whether there has been any substitution considering that the volumes in the futures markets are only $0.5 billion a day. Given that the forex market has been volatile in the past three months — it was around 18% in December — one would have expected a higher number. On the other hand, lower volumes of foreign trade would have lowered the merchant transactions. The inter-bank transactions have been roughly steady along these periods. The second is that the forward market in dollars (merchant and inter-bank) is a very small part of the overall foreign exchange market today. The forward market in dollars would prima facie have a counterpart in the futures market. The other segment in 'other foreign currency' would technically not have a counterpart. With an average daily turnover of $50 billion, the transactions in forwards in USD accounts for around 21% while inter-bank forwards in dollars account for another 4%.
Hence, the current currency futures actually maps around 25% of transactions in the forwards market. The inter-bank market on the other hand is more in spot and swaps, which account for around 30% each of the overall market. The balance is accounted for by the spot and forward cancellations on the merchant account. The third aspect, the participants on the futures exchanges are quite different from those in the forward market. This can be conjectured based on the implicit futures rates based on the data presented by RBI and NSE. The forward rates appear to be much higher than the futures rates for the same tenure with the difference being almost 200 bps. For example, on January 1, 2009, the one-month forward rate was annualised at 4.43% while the futures market had a rate of 2%. The three-month forward rate was 3.28% as against 2.2% on the futures exchange (only a small part of the difference could be attributed for by the differences in the days involved). In fact, at times, the futures rate was trading at a discount to the RBI reference price. It is likely that it is the speculative money that has been coming into the futures market as against the merchant transactions in the forward market which would be based on physical transactions. Two conclusions can now be drawn form this data. First: the two markets are not integrated and there is scope for arbitrage which will bring about convergence in the markets, as we cannot have two prices in two markets for the same product — one is notional and the other is based on real transactions. Second: given the size of the forward market of around $50 billion and the current size of $0.5 billion in futures, there is enormous scope and opportunity for the existence of more exchanges in the country which will enable back-to-back hedging opportunities for all market participants.
Tuesday, January 20, 2009
Ten Truths from Satyam: Financial Express: 20th January 2009
Against Enron’s backdrop, one need not really be embarrassed about something like Satyam happening in India. Globalisation means that everything is possible everywhere, and the fact that Satyam was listed overseas supports this point.
That no one knew about this scam until the protagonist himself revealed all speaks volumes about institutional failure. In fact, if he had not been honest about his dishonesty, this story would not have come out. If we look deeper, there are at least ten institutional shibboleths that have been shattered.
The first is that all individual CEOs who become celebrities need to be looked at with suspicion, especially those who are aggressively hyped. Second, organisations that are flashy and dynamic are more prone to mischief than the staid ones, and this holds more for new generation companies. Third, when mischief is done, the entire management needs to be investigated. After all, the mischief in professionally run organisations is a joint effort as all work towards the same goal of self-enrichment.
Fourth, auditors are no longer a credible lot, or rather are credible only until such time that the truth on untruth is out. The entire fraternity gets a bad name, as it will now be generalised that they have also colluded with the company to get their fees. Either they did not ask the hard questions or they did not attend to the distasteful things around them, before submitting the certifications on which they stake their reputation. Fifth, investment banks and so-called advisors to public issues are not above board as they too work for a fee and their own profits; and on grounds of confidentiality may tread the road of apparent ignorance. This cannot be escaped in a capitalist society.
The sixth institution that has taken a beating is the concept of a Board of Directors, which it now appears can be kept in the dark most of the time. In this case, they spent not more than 15 hours in a year with the company and could not have had a hold on what was happening. What then should be their stance and as a corollary, what is its relevance? The seventh hit has been taken by the credit rating agencies that give ratings based on audited information, which is subject to manipulation. In fact, in Satyam’s case, the accounts were there to be seen even at the SEC. Therefore, there was no reason to suspect the numbers. But, does this really help the investor?
The eighth blow is to the usual punching bag, the regulator, who is always found napping when such things happen. We can all ask what the regulator was doing. The regulator in such instances always appears to be swift to spot the small miscreant, but cannot see big mischief. But, to be fair to the regulators all across the world, they take a lot of flak for scams, when it is impossible to really stop crime from taking place. Stringent regulation only reduces the incidence. Besides, this is nothing compared to the so called collapse of Citi Bank, where no one saw the accounts disappear for a whole year despite all the talk of Basel II and stern regulation.
Ninth, corporate governance has been exposed as a sham. From now on, no one will pay much attention to what the annual report says, as eloquent words and lofty thoughts are rarely followed in actual practice. Lastly, there is going to be even more cynicism concerning the entire business of corporate awards. Satyam had, after all, bagged many such awards.
Amidst all this ado, how do we stand as individuals? Employees will continue to feel jittery but then the law of markets dictates that risk goes along with their pay packets. Shareholders should not really be our concern because when the prices of these stocks increased to dizzy heights, no one asked why they were rewarded. This is part of the game. And for the common man, this is just another subject for discussion after the financial crisis and terrorist attacks. Umbrage and incessant banter, which is typical of the middle class, will continue till the next big episode comes on air.
That no one knew about this scam until the protagonist himself revealed all speaks volumes about institutional failure. In fact, if he had not been honest about his dishonesty, this story would not have come out. If we look deeper, there are at least ten institutional shibboleths that have been shattered.
The first is that all individual CEOs who become celebrities need to be looked at with suspicion, especially those who are aggressively hyped. Second, organisations that are flashy and dynamic are more prone to mischief than the staid ones, and this holds more for new generation companies. Third, when mischief is done, the entire management needs to be investigated. After all, the mischief in professionally run organisations is a joint effort as all work towards the same goal of self-enrichment.
Fourth, auditors are no longer a credible lot, or rather are credible only until such time that the truth on untruth is out. The entire fraternity gets a bad name, as it will now be generalised that they have also colluded with the company to get their fees. Either they did not ask the hard questions or they did not attend to the distasteful things around them, before submitting the certifications on which they stake their reputation. Fifth, investment banks and so-called advisors to public issues are not above board as they too work for a fee and their own profits; and on grounds of confidentiality may tread the road of apparent ignorance. This cannot be escaped in a capitalist society.
The sixth institution that has taken a beating is the concept of a Board of Directors, which it now appears can be kept in the dark most of the time. In this case, they spent not more than 15 hours in a year with the company and could not have had a hold on what was happening. What then should be their stance and as a corollary, what is its relevance? The seventh hit has been taken by the credit rating agencies that give ratings based on audited information, which is subject to manipulation. In fact, in Satyam’s case, the accounts were there to be seen even at the SEC. Therefore, there was no reason to suspect the numbers. But, does this really help the investor?
The eighth blow is to the usual punching bag, the regulator, who is always found napping when such things happen. We can all ask what the regulator was doing. The regulator in such instances always appears to be swift to spot the small miscreant, but cannot see big mischief. But, to be fair to the regulators all across the world, they take a lot of flak for scams, when it is impossible to really stop crime from taking place. Stringent regulation only reduces the incidence. Besides, this is nothing compared to the so called collapse of Citi Bank, where no one saw the accounts disappear for a whole year despite all the talk of Basel II and stern regulation.
Ninth, corporate governance has been exposed as a sham. From now on, no one will pay much attention to what the annual report says, as eloquent words and lofty thoughts are rarely followed in actual practice. Lastly, there is going to be even more cynicism concerning the entire business of corporate awards. Satyam had, after all, bagged many such awards.
Amidst all this ado, how do we stand as individuals? Employees will continue to feel jittery but then the law of markets dictates that risk goes along with their pay packets. Shareholders should not really be our concern because when the prices of these stocks increased to dizzy heights, no one asked why they were rewarded. This is part of the game. And for the common man, this is just another subject for discussion after the financial crisis and terrorist attacks. Umbrage and incessant banter, which is typical of the middle class, will continue till the next big episode comes on air.
Tuesday, January 6, 2009
Economic Futures: Financial Express, 6th January 2009
The year gone by was a difficult one for all economists and policy makers. Everything that could go wrong went wrong, and existing shibboleths of capitalism were shattered and the concept of governments became more relevant. Terms like governance, moral hazard and inefficiency dominated our jargon as the financial crisis revealed more victims than an earthquake. Internally too, we transcended from irrational optimism (remember the double digit growth we bragged about) to a cautious 7% growth rate and stood helpless as inflation soared and the desperate monetary measures turned out to be impotent. Industry is down and so is the service sector, and with the rupee falling and foreign reserves declining, the story, though not too bad, is not one for the pulpits. What lies ahead?
2009 has to be better than 2008 for India as we have actually been through a low from where things can only get better. While agriculture will be directed by the weather conditions, the global slowdown will have an impact on our exports, and hence industrial growth. The absence of wide-scale loss of jobs will help in maintaining demand and moderate industrial growth in the range of 7-8% looks possible on a lower base. The government will have a tough time reining in the fiscal deficit, which has gone awry due to lower growth and higher expenditure. The fiscal stimulus programme coupled with Pay Commission payments and oil subsidies and loan waivers will actually call for a FRBM holiday in the face of an election. RBI also would per force be looking at further easing the credit reserve ratio and interest rates to prop up the economy and we could be looking at lending rates moving towards the 10% mark.
The capital market, which has been providing a booster shot for consumption especially in the areas of housing and high living, would be subdued given the high dependence on the foreign investment flows, which are unlikely to be too buoyant in the first half of the year. But, given that the worst is over, a recovery could be expected in the second half of the year, as the lower rates of the Fed, ECB and BOE take effect. This also means that investment opportunities would be limited and banks, insurance and government papers would continue to be attractive.
Inflation should be less of a concern though an upward pressure can be expected towards the second half, as the world economy recovers and the price of oil starts inching northwards. A number of 5% on an average should be okay enough to provide a stimulus for industry without hurting the consumer too harshly. Moderate inflation and stable global prices would also mean normal conditions in the commodity markets, which have in the past swayed in accordance with the growth prospects of the world economy (especially China) and agricultural production (remember the diversion of land to growing soybean and corn away from wheat for production of bio-fuels).
The year may not be too bright for the external sector and the surpluses which were seen in 2007 are unlikely to be replicated as there would be fewer inflows through FII funds even as the pressure on current account deficit should ease as the oil import bill declines due to lower prices. The rupee would tend to depreciate rather than appreciate on a mid-term basis (good news for the currency futures markets).
Globally too, the focus of growth will shift back to the developed nations. Developing countries’ fortunes would get coupled again as the China boom phase would have gotten moderated. The new US President would show the way and as the growth path meanders upwards towards the third quarter of the year, it would mean good news for us too in this continent.
2009 has to be better than 2008 for India as we have actually been through a low from where things can only get better. While agriculture will be directed by the weather conditions, the global slowdown will have an impact on our exports, and hence industrial growth. The absence of wide-scale loss of jobs will help in maintaining demand and moderate industrial growth in the range of 7-8% looks possible on a lower base. The government will have a tough time reining in the fiscal deficit, which has gone awry due to lower growth and higher expenditure. The fiscal stimulus programme coupled with Pay Commission payments and oil subsidies and loan waivers will actually call for a FRBM holiday in the face of an election. RBI also would per force be looking at further easing the credit reserve ratio and interest rates to prop up the economy and we could be looking at lending rates moving towards the 10% mark.
The capital market, which has been providing a booster shot for consumption especially in the areas of housing and high living, would be subdued given the high dependence on the foreign investment flows, which are unlikely to be too buoyant in the first half of the year. But, given that the worst is over, a recovery could be expected in the second half of the year, as the lower rates of the Fed, ECB and BOE take effect. This also means that investment opportunities would be limited and banks, insurance and government papers would continue to be attractive.
Inflation should be less of a concern though an upward pressure can be expected towards the second half, as the world economy recovers and the price of oil starts inching northwards. A number of 5% on an average should be okay enough to provide a stimulus for industry without hurting the consumer too harshly. Moderate inflation and stable global prices would also mean normal conditions in the commodity markets, which have in the past swayed in accordance with the growth prospects of the world economy (especially China) and agricultural production (remember the diversion of land to growing soybean and corn away from wheat for production of bio-fuels).
The year may not be too bright for the external sector and the surpluses which were seen in 2007 are unlikely to be replicated as there would be fewer inflows through FII funds even as the pressure on current account deficit should ease as the oil import bill declines due to lower prices. The rupee would tend to depreciate rather than appreciate on a mid-term basis (good news for the currency futures markets).
Globally too, the focus of growth will shift back to the developed nations. Developing countries’ fortunes would get coupled again as the China boom phase would have gotten moderated. The new US President would show the way and as the growth path meanders upwards towards the third quarter of the year, it would mean good news for us too in this continent.
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