The evolution of microfinance in India can be put in a theoretical context. There is a case of the existence of 'asymmetric information' where the lender has little in his armory to know that the borrower will repay the loan. In the absence of a clear credit evaluation process, this asymmetry will continue to exist. When there is such asymmetry in availability of information, we run the risk of 'adverse selection'. As long as we are dealing with communities that are known to perform, it will work. But, as we scale up this trust model, then we run the risk of selecting the wrong people.
This triggers default and the reason attributed can be high rates being charged in the face of adverse economic conditions for the borrowers. This has a backward linkage with the MFI and lending bank creating financial chaos. The MFIs cannot use strong-arm techniques to recover money. Borrowers now know that if they borrow, they do not have to repay as there is a constituency which will speak for them when the time comes. This raises the issue of 'moral hazard'.
The MFI's Yunus model appeared to be a panacea for the so-called unbankable people and the rate of 30% charged did not raise a stink as these poor people were anyway borrowing from the moneylender at a higher rate. As they had no collateral to offer except peer pressure, banks did not find this social collateral acceptable. With an increase in suicides on account of strong-arm tactics used by the MFIs for non-repayment of loans, regulatory action is being taken to bring this system back on the rails. Is there any alternative way out?
There are some interesting models being experimented with to make MFI credit work. Some of the names that come to mind are Rangde and Milaap - both are startups that have pursued some innovative techniques. The model here aims at targeting investors who are willing to put in money with no expectation of a return on capital or a minimal of 2%. Funds gathered are then lent to MFIs or NGOs that have been carefully screened on the basis of past performance.
The final cost to the borrower varies from 8% (for Rangde) to 12-18% (Milaap). Basically, these startups cover their costs with zero profit. The MFIs add their cost to this and are able to lend money at a substantially lower rate than other MFIs. This model has worked with virtually negligible NPAs and is able to deliver credit at a cost comparable with what, say an SME, gets funds from a bank.
In the earlier system, MFIs had a genuine point of paying substantially high cost for credit from banks, which actually pushed up costs. The lower cost of final credit here is evidently due to sourcing of cheaper funds from investors. Prima facie, there is nothing amiss in this model as the organisations are registered with the RBI and their activities are known. But the issue is whether this model is scalable. Tackling communities within specific geographies is easier to accomplish than widening the canvas.
Where does one get such philanthropic funds from to scale up operations? And further, while the model has worked well so far, it still does not tackle the problems of asymmetric information, adverse selection and the moral hazard. Banks with their superior credit evaluation skill-sets still encounter problems of NPAs in the organised sector where information is relatively more transparent. Logically, it appears that the system has to crack at some point of time, either in flow of funds or NPAs.
The thought which comes here is to address the two issues together: cost of funds and adverse selection. A way out is to first make relatively large sets of funds available for this purpose. The government is evidently the entity that can make these sources available as philanthropy has its limits. Corporates would prefer to create trusts with their names embossed rather than donate anonymously to these organisations.
While there will be some noise on the fiscal front, central and state governments can actually proportionately keep aside these funds for this purpose. Besides, the government is already subsidising agriculture by keeping rates at 7% and taking on the interest rate differential burden of banks. In fact, given the success of entities like Rangde and Milaap, these could be one-time allocations for specific geographies as it may be assumed that the money would largely return to the lending institution.
These funds could be given to either banks or panchayats or organisations like Milaap and Rangde. Banks have the skill-sets of evaluation and are located in rural areas. With funds coming in at zero cost, they could actually lend to MFIs or directly to the borrowers at a low cost.
Panchayats would be another option, given that they actually have knowledge of their people and hence the issues of asymmetric information and adverse selections are simultaneously addressed here. For governments, these are capital expenditures and hence will be analogous to the project expenditures incurred by them. For society, the basic lending cost of say 8-18% charged by banks to the MFIs actually comes down substantially, which can make a difference.
Quite clearly, the MFI space is one of interest and challenge as it offers better living standards to the poor people. Solutions need to be found within the contours of retaining the sanctity of the financial system in which they operate. Organisations like Rangde and Milaap need to be complimented for showing the way and we need to embellish their operational models with strong financial support to ensure that they are sustainable and scalable.
Wednesday, August 24, 2011
Comforting if the ‘ifs’ hold: Financial Express 6th August 2011
One issue which has been a matter of conjecture even more than whether or not Lady Gaga performs in Mumbai is the true state of the economy. There are a plethora of estimates from various agencies, which, though useful, are utterly confusing, given the wide ranges. Therefore, it is only appropriate that the Prime Minister’s Economic Advisory Council (PMEAC) has come up its forecasts. Coming from the PMO, it appears to be relatively more authentic as the government certainly knows more than others on the data as well as its own finances and policies.
Let us see how we should read between the numbers presented by the PMEAC. Bringing down the GDP growth rate to 8.2% from 9% assumed in the Budget is realistic, but what is important is as to how this number would affect other variables. In particular, the fiscal numbers deserve scrutiny at a time when the fiscal deficit ratio has been increased marginally from 4.6% to 4.7% of GDP. Is this possible? There are two parts to this ratio, the numerator and denominator. The denominator has been assumed to remain unchanged with growth of 14% in nominal terms for GDP at market prices, which can be broken up into 8.2% real GDP growth and 5.8% inflation. But, by the government’s own admission, the inflation rate will remain at 9% till October and come down to 6.5% by March 2012. If this is so, then the average for the year has to be higher at around 8%, which will mean growth of around 16% in nominal GDP.
The slippage in fiscal deficit has been assumed to be just 0.1%, which amounts to around R9,000 crore; this is difficult because of three reasons. The first is that the government has given away around R50,000 crore in taxes on oil products. Second, lower GDP growth will mean lower production too. In particular, industry is to grow by 7.2% now, which will lower excise and corporate tax collections. Third, the Budget talks of R40,000 crore of disinvestment, which may not happen as the market so far has been at best stagnant. Therefore, the fiscal deficit ratio has to be higher than 4.7% if ceteris paribus conditions prevail.
The only way to meet this mark is for further expenditure cuts, which cannot be ruled out as this was also done in FY11. If this happens, then we can see infrastructure growth taking a back seat, as this is normally the area where allocations are reduced to meet fiscal targets. But, based on the GDP sectoral projections made by the PMEAC, the sector, community and personal services, is to actually grow at a higher rate of 8.5%. Therefore, we have the curious case of one part of the trinity—fiscal deficit, government expenditure or GDP (nominal) actually moving out of the loop as internal consistency is difficult.
The growth rates for agriculture and industry appear to be realistic. However, the projection for services is aggressive at 10% as the services sector may not grow at such a high rate when the sectors that it supports, i.e., agriculture and industry, are growing slowly. Intuitively, it may be seen that any slippage here will get reflected quite sharply in the GDP number.
The other interesting projection made is that the investment rate is to increase, albeit marginally, from 36.4% to 36.7% in FY12. This is significant because in a rising interest rate environment, one would have expected investment to take a knock. The resilience of investment to interest rates is a major take away. Further, it also means that the higher interest rate policy followed by RBI is expected to affect consumption more than investment. Therefore, growth of consumer goods including automobiles backed by finance would be affected more by higher interest rates than investment, which, in a way, is comforting as future growth prospects are addressed.
The external sector is to be the flag bearer at a time when the global economy is in a state of flux. Exports are to grow by 32%, which will be awesome as it will come over a high base year number while the deficit will widen. Given that the current account deficit is going to rise only marginally, to 2.7%, there is quite a bit of elbow room here. But the high point will be foreign investment where capital flows through FDI (gross of $35 billion and net of $18 billion), FIIs (muted at $14 billion) and borrowings ($35 billion). This is not bad news except for the higher external commercial borrowings, which will exert pressure on the external debt situation.
So, what are we to make of these numbers? Growth will be subdued and could take a dip if the assumptions made are violated. The interest rate hikes and their impact appear to be factored though the optimism on investment is still significant. The external sector will provide strength, which, prima facie, appears feasible. India will remain a fast growing economy in depressed global world, though periodic review of the fiscal picture will be essential to gauge the progress.
Let us see how we should read between the numbers presented by the PMEAC. Bringing down the GDP growth rate to 8.2% from 9% assumed in the Budget is realistic, but what is important is as to how this number would affect other variables. In particular, the fiscal numbers deserve scrutiny at a time when the fiscal deficit ratio has been increased marginally from 4.6% to 4.7% of GDP. Is this possible? There are two parts to this ratio, the numerator and denominator. The denominator has been assumed to remain unchanged with growth of 14% in nominal terms for GDP at market prices, which can be broken up into 8.2% real GDP growth and 5.8% inflation. But, by the government’s own admission, the inflation rate will remain at 9% till October and come down to 6.5% by March 2012. If this is so, then the average for the year has to be higher at around 8%, which will mean growth of around 16% in nominal GDP.
The slippage in fiscal deficit has been assumed to be just 0.1%, which amounts to around R9,000 crore; this is difficult because of three reasons. The first is that the government has given away around R50,000 crore in taxes on oil products. Second, lower GDP growth will mean lower production too. In particular, industry is to grow by 7.2% now, which will lower excise and corporate tax collections. Third, the Budget talks of R40,000 crore of disinvestment, which may not happen as the market so far has been at best stagnant. Therefore, the fiscal deficit ratio has to be higher than 4.7% if ceteris paribus conditions prevail.
The only way to meet this mark is for further expenditure cuts, which cannot be ruled out as this was also done in FY11. If this happens, then we can see infrastructure growth taking a back seat, as this is normally the area where allocations are reduced to meet fiscal targets. But, based on the GDP sectoral projections made by the PMEAC, the sector, community and personal services, is to actually grow at a higher rate of 8.5%. Therefore, we have the curious case of one part of the trinity—fiscal deficit, government expenditure or GDP (nominal) actually moving out of the loop as internal consistency is difficult.
The growth rates for agriculture and industry appear to be realistic. However, the projection for services is aggressive at 10% as the services sector may not grow at such a high rate when the sectors that it supports, i.e., agriculture and industry, are growing slowly. Intuitively, it may be seen that any slippage here will get reflected quite sharply in the GDP number.
The other interesting projection made is that the investment rate is to increase, albeit marginally, from 36.4% to 36.7% in FY12. This is significant because in a rising interest rate environment, one would have expected investment to take a knock. The resilience of investment to interest rates is a major take away. Further, it also means that the higher interest rate policy followed by RBI is expected to affect consumption more than investment. Therefore, growth of consumer goods including automobiles backed by finance would be affected more by higher interest rates than investment, which, in a way, is comforting as future growth prospects are addressed.
The external sector is to be the flag bearer at a time when the global economy is in a state of flux. Exports are to grow by 32%, which will be awesome as it will come over a high base year number while the deficit will widen. Given that the current account deficit is going to rise only marginally, to 2.7%, there is quite a bit of elbow room here. But the high point will be foreign investment where capital flows through FDI (gross of $35 billion and net of $18 billion), FIIs (muted at $14 billion) and borrowings ($35 billion). This is not bad news except for the higher external commercial borrowings, which will exert pressure on the external debt situation.
So, what are we to make of these numbers? Growth will be subdued and could take a dip if the assumptions made are violated. The interest rate hikes and their impact appear to be factored though the optimism on investment is still significant. The external sector will provide strength, which, prima facie, appears feasible. India will remain a fast growing economy in depressed global world, though periodic review of the fiscal picture will be essential to gauge the progress.
What's wrong with our statistics? Business Standard JUly 25, 2011
Irony by definition is laced with dark humour, but it would be more like black humour when one views data systems in India. Less than a week after the Reserve Bank of India (RBI) expressed concern over the quality of data, the Central Statistics Office drastically reduced the Index of Industrial Production (IIP) growth number for capital goods for April to 7.3 per cent from 14.5 per cent when it was initially announced. Such revisions are quite bizarre and have a deeper implication because such high-frequency data is used for high-frequency monetary policy stances. The RBI’s frustration is palpable because the April number would have provided the justification for increasing interest rates based on robust investment growth. But, now it turns out that capital goods production was, at best, stable.
One may recollect that for a long time we had spoken about our base years being anachronistic at 1993-94, and bringing forward the base year to 2004-05 was pragmatic. For some reason, the GDP, IIP and Wholesale Price Index (WPI) indices were changed sequentially. A statement often made was that there was high volatility in the growth numbers that would be addressed by the new series. Though having a new series is necessary, the larger issue is whether it addresses the question of volatility. Volatility in the jargon of financial markets economics means the standard deviation of the growth rates. Now, the annualised volatility for the IIP old series was 16.4 per cent and it has increased to 22.6 per cent in the new series. For the WPI series, the annualised volatility was 11.5 per cent and 10.2 per cent respectively. So there has been improvement in the WPI, but not the IIP. Curiously, when the same volatility is reckoned on annual data, then the IIP volatility changes from 2.96 per cent to 4.76 per cent and 1.67 per cent to 2.42 per cent for WPI, meaning that the older series fares better!
Three conclusions can be drawn here. First, the volatility argument does not hold. Second, the fluctuations in growth rates will vary based on seasonal trends as well as base year effects. Third, the problem is with our data collections systems and processes.
What are the problems with our data? There are basically two areas that need to be addressed. The first concerns farm prices. Today prices come from the mandis, where both transactions and prices are opaque. Agricultural Marketing Research & Information Network (AGMARKNET), the official source of data shows prices within a rather wide range that is not helpful. Further, the single numbers that are displayed vary significantly from what commodity exchanges like NCDEX collect from the ground level. In fact, the volatility of prices is much higher for exchange prices compared with the WPI because the latter are based on modal values that do not vary very often. Further, since farm products are seasonal, they do not enter the mandis every month but are traded widely all the same, which moderates the WPI numbers because they are dependent on the quotes received from mandis. The solution is to have electronic mandis where all transactions are recorded so that we have actual prices that can be weighted by the trades that take place.
The other pertains to manufactured goods. If one looks at metals, our WPI shows that prices are increasing when globally prices are falling based on World Bank data. India is a price taker in all metals except iron and steel. Therefore, there should not be such differences in price changes. The problem in manufacturing is exacerbated by the fact that one-third of total manufacturing comes from the unorganised sector where it is difficult to get timely information. Even for the organised sector, the WPI index for a particular product often does not change for weeks because of non-availability of data after which there is a sudden spike in prices. One way out is to make it mandatory for all firms to record every transaction at the factory gate. By linking this to tax filing, firms will be compelled to report accurately the true picture. Admittedly, this is a challenge considering that even unaudited results of firms are not always filed on time.
This being the case, what should be our approach? First, we need to move away from providing high-frequency data if we are unable to vouch for its sanctity. While revisions happen everywhere, changing growth rates by 50 per cent is dangerous for policymakers.
Second, we need to electronically connect all the mandis and have a database in which all firms registered with the Registrar of Companies have to mandatorily enter their production and price numbers.
Third, we need to look at other leading indicators when taking policy decisions based on monetary data that is generally more accurate because it comes from a smaller universe of commercial banks.
Fourth, whenever we interpret data, we should never look at single month data points to eschew the trap of base year and seasonal influences. It would be better to look at cumulative numbers, especially for the real sector. When we look at annual IIP growth rates, we do not look at March over March, but the average of 12 months over the same of the previous year. This automatically factors in the so-called volatility due to inaccuracies or seasons.
Finally, the RBI should seriously think of going back to two policies with need-based Keynesian intervention. While adopting global practices like the Federal Reserve is progressive, other authorities do not have distorted images in the form of inaccurate data like we do. We will have to wait some more time to reach these levels.
One may recollect that for a long time we had spoken about our base years being anachronistic at 1993-94, and bringing forward the base year to 2004-05 was pragmatic. For some reason, the GDP, IIP and Wholesale Price Index (WPI) indices were changed sequentially. A statement often made was that there was high volatility in the growth numbers that would be addressed by the new series. Though having a new series is necessary, the larger issue is whether it addresses the question of volatility. Volatility in the jargon of financial markets economics means the standard deviation of the growth rates. Now, the annualised volatility for the IIP old series was 16.4 per cent and it has increased to 22.6 per cent in the new series. For the WPI series, the annualised volatility was 11.5 per cent and 10.2 per cent respectively. So there has been improvement in the WPI, but not the IIP. Curiously, when the same volatility is reckoned on annual data, then the IIP volatility changes from 2.96 per cent to 4.76 per cent and 1.67 per cent to 2.42 per cent for WPI, meaning that the older series fares better!
Three conclusions can be drawn here. First, the volatility argument does not hold. Second, the fluctuations in growth rates will vary based on seasonal trends as well as base year effects. Third, the problem is with our data collections systems and processes.
What are the problems with our data? There are basically two areas that need to be addressed. The first concerns farm prices. Today prices come from the mandis, where both transactions and prices are opaque. Agricultural Marketing Research & Information Network (AGMARKNET), the official source of data shows prices within a rather wide range that is not helpful. Further, the single numbers that are displayed vary significantly from what commodity exchanges like NCDEX collect from the ground level. In fact, the volatility of prices is much higher for exchange prices compared with the WPI because the latter are based on modal values that do not vary very often. Further, since farm products are seasonal, they do not enter the mandis every month but are traded widely all the same, which moderates the WPI numbers because they are dependent on the quotes received from mandis. The solution is to have electronic mandis where all transactions are recorded so that we have actual prices that can be weighted by the trades that take place.
The other pertains to manufactured goods. If one looks at metals, our WPI shows that prices are increasing when globally prices are falling based on World Bank data. India is a price taker in all metals except iron and steel. Therefore, there should not be such differences in price changes. The problem in manufacturing is exacerbated by the fact that one-third of total manufacturing comes from the unorganised sector where it is difficult to get timely information. Even for the organised sector, the WPI index for a particular product often does not change for weeks because of non-availability of data after which there is a sudden spike in prices. One way out is to make it mandatory for all firms to record every transaction at the factory gate. By linking this to tax filing, firms will be compelled to report accurately the true picture. Admittedly, this is a challenge considering that even unaudited results of firms are not always filed on time.
This being the case, what should be our approach? First, we need to move away from providing high-frequency data if we are unable to vouch for its sanctity. While revisions happen everywhere, changing growth rates by 50 per cent is dangerous for policymakers.
Second, we need to electronically connect all the mandis and have a database in which all firms registered with the Registrar of Companies have to mandatorily enter their production and price numbers.
Third, we need to look at other leading indicators when taking policy decisions based on monetary data that is generally more accurate because it comes from a smaller universe of commercial banks.
Fourth, whenever we interpret data, we should never look at single month data points to eschew the trap of base year and seasonal influences. It would be better to look at cumulative numbers, especially for the real sector. When we look at annual IIP growth rates, we do not look at March over March, but the average of 12 months over the same of the previous year. This automatically factors in the so-called volatility due to inaccuracies or seasons.
Finally, the RBI should seriously think of going back to two policies with need-based Keynesian intervention. While adopting global practices like the Federal Reserve is progressive, other authorities do not have distorted images in the form of inaccurate data like we do. We will have to wait some more time to reach these levels.
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