The new government must take an immediate view on revoking bans on futures trading in a number of commodities. We have had bans imposed on eight commodities at different points in time on grounds of them being responsible for higher inflation. A committee was set up which did show that no such conclusion could be drawn, and a lot of independent studies have shown that futures trading and inflation are not related. Yet, the threat of a ban lingers even as the FMC has taken progressive steps to bring back four products last year, and also wheat just recently. Every time prices move up, there is a loud call for a ban on futures trading. Curiously, if the product is not traded on the futures exchanges, like vegetables, moong, urad and tur today, an increase in price does not provoke any response.
Now, futures prices have actually performed a very useful role to provide early warning signals to the market and the government, provided one is willing to open one’s mind and be free from preconceived notions. In 2005, the wheat futures prices showed that there would be a problem, but were dismissed as being an indicator of speculation. The harvest was sub-optimal and we ended up importing large quantities of wheat at an exorbitant cost. In February 2007, wheat futures actually indicated a fall in prices. Yet, a ban was imposed.
In 2006, the tur and urad futures contracts showed that there were problems with production and stocks. These trends were ignored again on the grounds of being a sign of only speculation. Both were banned in January 2007 but that did not help improve supplies, and prices continued to surge.
Now, the irony here is that when futures prices moved upwards based on fundamentals, the products were banned from the futures trading ambit. However, the government on its own has taken steps to increase the prices of these banned products. Between 2006-07 and 2008-09, the government has actually increased the MSP of wheat by 44% from Rs 750 to Rs 1080/quintal, tur and urad by 60% from Rs 1,520 to Rs 2,420/quintal. Jowar and bajra prices were increased by 40%. When the MSP is increased, the floor is set and the market price settles at a higher level. Therefore, it is odd that when prices are consciously raised by the government, the decision is okay. But, when market prices move up based on fundamentals, futures trading have been blamed consistently.
At present, the debate is on sugar. The government’s own estimates have shown that sugarcane production has declined by 20% this year. Overall sugar production is set to fall by over 50%. Sugar prices have hence increased to match consumption requirements as the existing stocks from higher production in the last two years can provide only limited support. Once again, there is a school of thought which believes that futures trading is the sole reason for higher prices. Coincidentally, the same indications were given by the futures prices in late 2008 and early 2009, which could have been accepted and used for appropriate policy responses. As was the case with wheat in 2006, it was a case of too little too late.
There is serious need for all those who hold a distorted view of futures trading to understand that this market captures both the domestic and global mood relating to the product in one shot when price views are taken. Today global factors influence domestic prices, which we cannot avoid even though we may not like it. A swine flu in Mexico will affect the maize prices in the country while crop failure of urad in Myanmar will affect urad imports and prices in India. Further, the FMC and the commodity exchanges have strong surveillance systems in place to ensure that prices are not out of sync with the fundamentals and trading is orderly. More importantly, as highlighted earlier, futures prices give critical signals, which need to be considered with an open mind. But, certainly, as in a hospital, we do not destroy the diagnostic equipment that tells you there is a problem; the same must not be done to futures trading.
Saturday, May 23, 2009
Tuesday, May 12, 2009
Unbalanced Payments: Financial Express: 12th May 2009
As a rule, all of us are obsessed with growth and seek solace in numbers to feel better. GDP forecasts have ranged from a pessimistic 4.5% to an optimistic 6.5%, and everyone has an opinion, even though the year has just begun and there is no model which can predict agricultural harvest, which has a strong bearing on the state of industry and services. However, an important concern this year which may have escaped attention thus far is the external sector. The picture for the year appears to be quite grim judging by the state of the world economy as well as the balance of payments within.
There are three major components in our balance of payments: trade, invisible transactions and capital inflows. Our exports have grown by just 3.4% last year, as they were affected by the global slump. Given that the IMF has projected a decline in world trade by 2.8% in 2009, the picture is not too good for us. And we are quite dependent on the shrinking economies of the OECD nations for our exports. Add to this the fact that imports would continue to increase as they supplement domestic investment and production requirements, and the trade deficit would certainly exceed the $119 billion mark touched last year. In the invisibles account, the most buoyant component of software receipts would be affected by the global downturn as growth of this sector would be contingent on the prospects of the world economy, especially the US, but also Europe and Japan.
Trends in capital flows are largely negative and form a reason for concern. Fresh FDI from the western nations would be affected as they would have less to invest in the emerging economies in times of recession. The IMF has already projected a decrease of around 7.5% in such flows, where past commitments rather than fresh investments would dominate. Further, FII investment had actually declined last year by $9.8 billion as funds were in a withdrawal mode. There is little reason to believe that this mood will change in 2009. At the earliest, a recovery would be in the second half of 2010.
RBI data further shows that in the first three quarters of the year, ECB inflows were down by $10.3 billion compared to last year. The IMF has again warned that it will be progressively difficult for the developing nations to borrow in the overseas markets as the credit crisis has peaked. The Libor spreads have widened to between 400 and 500 bps for the developing nations that seek loans. Therefore, this route will remain difficult to penetrate in the coming year.
Another daunting task in this area in the coming year is the large burden of forex outflow on account of external debt repayments. The ministry of finance had earlier this year indicated that for this calendar year, there would be an outflow of around $90 billion, which is a concern. The major part, of course, is the short-term debt component of $47 billion. Normally this would not have been an issue, as the new inflows would make up for this outflow. However, these loans, which are essentially trade credits, have dried up globally, and the risk of default has also risen sharply. This being the case, the issue of repayment becomes onerous.
The NRI deposits outflow of $32 billion is less of a worry for us as there would be a tendency for renewal or rollover of these deposits. In fact, they have been rather stable in the last three years, which is a comfort. But, the ECB repayment commitments of around $8 billion will put pressure on the balance of payments ultimately.
In fact, last year, our foreign exchange reserves had declined by around 18% from $310 billion to $253 billion on account of a combination of all these factors. Simultaneously, the exchange rate had also declined by around 22% from Rs 41.92/$ to Rs 50.95/$. This was, in fact, more than the appreciation in the dollar vis-à-vis the Euro by 15.3%. It would be extremely fortuitous in case the extent of depreciation is better than what was witnessed last year.
There are three major components in our balance of payments: trade, invisible transactions and capital inflows. Our exports have grown by just 3.4% last year, as they were affected by the global slump. Given that the IMF has projected a decline in world trade by 2.8% in 2009, the picture is not too good for us. And we are quite dependent on the shrinking economies of the OECD nations for our exports. Add to this the fact that imports would continue to increase as they supplement domestic investment and production requirements, and the trade deficit would certainly exceed the $119 billion mark touched last year. In the invisibles account, the most buoyant component of software receipts would be affected by the global downturn as growth of this sector would be contingent on the prospects of the world economy, especially the US, but also Europe and Japan.
Trends in capital flows are largely negative and form a reason for concern. Fresh FDI from the western nations would be affected as they would have less to invest in the emerging economies in times of recession. The IMF has already projected a decrease of around 7.5% in such flows, where past commitments rather than fresh investments would dominate. Further, FII investment had actually declined last year by $9.8 billion as funds were in a withdrawal mode. There is little reason to believe that this mood will change in 2009. At the earliest, a recovery would be in the second half of 2010.
RBI data further shows that in the first three quarters of the year, ECB inflows were down by $10.3 billion compared to last year. The IMF has again warned that it will be progressively difficult for the developing nations to borrow in the overseas markets as the credit crisis has peaked. The Libor spreads have widened to between 400 and 500 bps for the developing nations that seek loans. Therefore, this route will remain difficult to penetrate in the coming year.
Another daunting task in this area in the coming year is the large burden of forex outflow on account of external debt repayments. The ministry of finance had earlier this year indicated that for this calendar year, there would be an outflow of around $90 billion, which is a concern. The major part, of course, is the short-term debt component of $47 billion. Normally this would not have been an issue, as the new inflows would make up for this outflow. However, these loans, which are essentially trade credits, have dried up globally, and the risk of default has also risen sharply. This being the case, the issue of repayment becomes onerous.
The NRI deposits outflow of $32 billion is less of a worry for us as there would be a tendency for renewal or rollover of these deposits. In fact, they have been rather stable in the last three years, which is a comfort. But, the ECB repayment commitments of around $8 billion will put pressure on the balance of payments ultimately.
In fact, last year, our foreign exchange reserves had declined by around 18% from $310 billion to $253 billion on account of a combination of all these factors. Simultaneously, the exchange rate had also declined by around 22% from Rs 41.92/$ to Rs 50.95/$. This was, in fact, more than the appreciation in the dollar vis-à-vis the Euro by 15.3%. It would be extremely fortuitous in case the extent of depreciation is better than what was witnessed last year.
Sunday, May 10, 2009
Can there be an ideal prime lending rate: Economic Times: 6th May 2009
One of the grievances of industry is that banks are not lowering their lending rates even when the reverse repo and repo rates have been reduced.
The Reserve Bank of India (RBI) too has voiced its concern over the banks’ intransigence. Is this view justified? Is it possible to calculate an ideal prime lending rate (PLR)? To do this, we can pose the question as to what is the cost that a bank has to bear for providing a loan of Rs 100. There are five components that have to be taken into account. These are: the cost of deposits, return on assets (which is the profit that has to be earned ultimately), possibility of a non-performing assets (NPA) and operating expenses. To this we need to subtract the return on investments, which would be earned on the deposits over and above the Rs 100 that have to be garnered to be able to lend Rs 100 as 30% of the deposits have to be set aside for cash reserve ratio (CRR) and statutory liquidity ratio (SLR) on which the latter earns this return. Based on the performance of scheduled commercial banks in FY08, certain thumb rules can be ascertained. The first is that to lend Rs 100, a bank will have to pick up deposits of Rs 140, wherein after setting aside SLR and CRR of 30% the balance 100 can be used for credit. The second is that total assets of banks are 1.3 times the size of deposits, which means that the balance sheet size has to be Rs 180. The third is that 1% return on assets to be paid to shareholders. Fourthly, the operating expenses for the system, as a whole, are 1.8% of total assets. Fifthly, in 2007-08, the ratio of incremental gross non-performing assets to incremental bank credit was around 1.2%. Sixthly, term deposits constitute around 65% savings 22% demand and 13% of total deposits. Here, it may be assumed that term deposits cost 8%, while savings deposits cost 3.5%. Lastly, the return on investments of banks would vary between 6-7%, which compensates for the cost of deposits on the SLR component. The table above gives the calculation of the PLR, in terms of the basic cost to be covered on a loan for Rs 100. The important takeaway here is that the PLR would, under the current circumstances work out to 12.5%, which is on the upper end of the present range. Let us now look at the various components of the PLR to see if they can be negotiated. The cost of deposits is actually very low because there is a component which comes free of cost to banks or at a very low rate. The effective cost of the demand and savings deposits component is just 1%. Further, the return of 8% on term deposit is reasonable as the household confronts not the WPI but the CPI which is 9.6-10.8%. Moreover, banks are answerable to the shareholders and have to deliver profits and, hence the 1% ratio to total assets is intractable. The NPA provision is a direct result of the behaviour of borrowers, and their debt-servicing record must improve to lower this number. Recently, Crisil warned that the level of NPAs in banks could increase. If this is so, it is even more essential to make these provisions. Operating expenses of banks at 1.8% of total assets are much lower than that of the manufacturing sector, where the ratio is around 14% and cannot be brought down. Hence, there is really limited scope for reduction in the PLR and even a 100 bps cut in term deposit rates will lower the cost by 65 bps bringing the PLR down to 11.6%, which is at the lower end of the present range. We have heard of banks which are charging single-digit lending rates. Quite clearly, there is need for introspection and further enquiry, for the cost of the last three components of 6.25% is not tractable; and there could just be a drift away from prudence under all-round pressure to reduce rates.
The Reserve Bank of India (RBI) too has voiced its concern over the banks’ intransigence. Is this view justified? Is it possible to calculate an ideal prime lending rate (PLR)? To do this, we can pose the question as to what is the cost that a bank has to bear for providing a loan of Rs 100. There are five components that have to be taken into account. These are: the cost of deposits, return on assets (which is the profit that has to be earned ultimately), possibility of a non-performing assets (NPA) and operating expenses. To this we need to subtract the return on investments, which would be earned on the deposits over and above the Rs 100 that have to be garnered to be able to lend Rs 100 as 30% of the deposits have to be set aside for cash reserve ratio (CRR) and statutory liquidity ratio (SLR) on which the latter earns this return. Based on the performance of scheduled commercial banks in FY08, certain thumb rules can be ascertained. The first is that to lend Rs 100, a bank will have to pick up deposits of Rs 140, wherein after setting aside SLR and CRR of 30% the balance 100 can be used for credit. The second is that total assets of banks are 1.3 times the size of deposits, which means that the balance sheet size has to be Rs 180. The third is that 1% return on assets to be paid to shareholders. Fourthly, the operating expenses for the system, as a whole, are 1.8% of total assets. Fifthly, in 2007-08, the ratio of incremental gross non-performing assets to incremental bank credit was around 1.2%. Sixthly, term deposits constitute around 65% savings 22% demand and 13% of total deposits. Here, it may be assumed that term deposits cost 8%, while savings deposits cost 3.5%. Lastly, the return on investments of banks would vary between 6-7%, which compensates for the cost of deposits on the SLR component. The table above gives the calculation of the PLR, in terms of the basic cost to be covered on a loan for Rs 100. The important takeaway here is that the PLR would, under the current circumstances work out to 12.5%, which is on the upper end of the present range. Let us now look at the various components of the PLR to see if they can be negotiated. The cost of deposits is actually very low because there is a component which comes free of cost to banks or at a very low rate. The effective cost of the demand and savings deposits component is just 1%. Further, the return of 8% on term deposit is reasonable as the household confronts not the WPI but the CPI which is 9.6-10.8%. Moreover, banks are answerable to the shareholders and have to deliver profits and, hence the 1% ratio to total assets is intractable. The NPA provision is a direct result of the behaviour of borrowers, and their debt-servicing record must improve to lower this number. Recently, Crisil warned that the level of NPAs in banks could increase. If this is so, it is even more essential to make these provisions. Operating expenses of banks at 1.8% of total assets are much lower than that of the manufacturing sector, where the ratio is around 14% and cannot be brought down. Hence, there is really limited scope for reduction in the PLR and even a 100 bps cut in term deposit rates will lower the cost by 65 bps bringing the PLR down to 11.6%, which is at the lower end of the present range. We have heard of banks which are charging single-digit lending rates. Quite clearly, there is need for introspection and further enquiry, for the cost of the last three components of 6.25% is not tractable; and there could just be a drift away from prudence under all-round pressure to reduce rates.
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