Bust: Greece, The Euro, And The Sovereign Debt Crisis
By Matthew Lynn
For history buffs, the Acropolis is the bastion of western civilisation. For music aficionados, it is a reminder of the famous music concert of Yanni. On 4 May 2010, as a financial crisis unfolded in Greece, the structure witnessed an important turn in history. Multitudes of people climbed its portals to hoist banners featuring the hammer and sickle, which was antithetical to what the European nation stood for. Syntagma Square in central Athens became a riot square of opposition. Journalist Matthew Lynn tracks the story of Greece’s meltdown in Bust and unveils the fault lines that were evident but ignored as the crisis was fomenting. There were several rogues in the kitchen, but the bond players started the mess, and played out the acts in vivid technicolour.
Lynn says the problem was basically with the concept of the euro, which was more a political convenience rather than an economic solution. The seed idea dates back to Napoleon Bonaparte, Victor Hugo and John Stuart Mill, and its ultimate creation under the aegis of Brussels and Frankfurt was a victory of the implausible over the rational and, hence, had to be short lived. The irony was not lost when European Central Bank president Jean-Claude Trichet had been revelling in the glory of the euro just about a month before the drama was staged. A decade was a long time for such episodes to be played, as Greece, not known for its honesty, kept fudging its numbers and promised to be a good boy when entering the euro. The community was only too keen to have as many members under it, and closed its eyes. The drachma, which no one would touch, was alchemised into the euro as the country gained acceptance.
Lynn feels that there was always a difference between Europe’s north and south, and two variants of the euro could be a solution to the current crisis. Germany is the proverbial conservative player, which set the rules and followed them assiduously. While it was known that the rich would pay for the poor, Spain and Ireland misused the largesse available through the common low interest rate policy on buildings, which was not sustainable.
As the crisis exploded, there was acrimony as Germans felt they should not be helping cheats, while the Greeks went back to Nazi history to say continuance of support was reparation. Bringing in the IMF to play the bad cop helped the German cause and the Euro ego as the possible collapse of the currency was more a threat to the concept, than the Euro economy.
Lynn takes us through the events as if in fiction without being judgemental. He explains the complexities of the fiasco where French banks held Spanish, German and Italian debt. So, no one could be allowed to fail, else all would go down. Devaluation could not happen because of a single currency and neither could one inflate to lower the value of debt as Zimbabwe did.
Lynn poses some interesting queries on brea-king up the euro. If Greece was kicked out, it would go bankrupt and its creditors could suffer. So, restructuring was necessary. The other option is to have Germany exit as its Deutsche Mark is stronger than the euro. The mark will appreciate, but Germany’s exports will not suffer as quality is a distinguishing factor anyway. But the euro will collapse as it will be dominated by the French and Italians who the Dutch or Austrians do not trust. That is the rub.
Lynn concludes by leaving us ruminating on three lessons. First, do not put politics before economics. Second, let markets decide the outcome (means: let Greece go bust). Last, be suspicious of all grand schemes such as the euro, which do not leave room for error. He ends by saying that the West’s intellectual dominance started in ancient Athens also died, probably, here. That is the touch of a journalist, which leaves you thinking.
Sunday, October 2, 2011
Lag effect of rate rise worries apex bank: Economic Times 28th September 2011
Every time the Reserve Bank of India (RBI) increases interest rates, a plethora of voices are heard. Industry laments that their profits get squeezed affecting growth. Bankers aver that their interest margins come under pressure and non-performing assets (NPAs) get perversely affected. The RBI is concerned more on the transmission mechanism as credit growth continues with only the GSec market being responsive.
At times, bankers openly state that they will not alter rates. What has been the past experience? The increase in repo rate affects banks as they borrow from RBI which affects the call and CBLO markets where the repo rate is the benchmark. Today banks are borrowing around Rs 20,000-50 ,000 crore, while the daily trade volume in the call, CBLO and repo is around Rs 70,000-80 ,000 crore.
The transmission process is quite direct here. Deposits are slow to react to rate hikes, and it is only the incremental deposits which are affected as rates are increased in those tenure buckets where funds are required. Further, a large proportion of deposits (35-40 %) are CASA which buffers the overall cost impact. Now, between FY06 and mid-FY 09 the RBI raised the repo rate by 300 bps, yet the cost of deposits of a set of 71 banks increased from 4.52% to 6.22% with a lag of over a year. Subsequently in FY09, the RBI scaled down the repo rate by 275 bps and later increased the same by 200 bps in the next two years.
Yet, the cost of deposits has been declining continuously from 6.22% in FY09 to 5.54% in FY10 and 5.07% in FY11. Quite clearly, the higher deposit rates of last year have not yet shown in the cost of deposits as there is a lag of 1 year in actual transmission. The return on advances reacts almost instantaneously and the 300-bps increase was reflected in an increase of 230 bps to 10.51% up to FY09. But it declined subsequently even as the RBI raised rates in FY10 and FY11 to 9.28% and 9.24%, respectively.
This really means that banks have not increased their return to retain business. Therefore , a lot depends on the lag effect in FY12 when cost of deposits and return on advances would increase. Net interest margin declined continuously from 3.01% in FY06 to 2.48% in FY10, before increasing to 2.90% in FY11, which means that in net terms, borrowers have started bearing the higher interest cost.
Profitability too has been stable with return on assets vacillating between 0.98% and1.07%. The RBI has maintained that the transmission mechanism of interest rates is sluggish and has, therefore, been aggressive. The return on advances for FY12 would witness an upward thrust with the lag effect of 200-bps increase in rates in the last two years striking harder and faster than that in deposits, especially as the latter slowed down in FY11.
The impact on corporate profits can be gauged by the results of a set of 1,401 non-financial companies. Growth in both PBT and PBIT had accelerated in FY07 (36-38 %) when the RBI increased rates and stabilised at around 27% in FY08 when rates remained unchanged.
Profits declined in FY09 and were robust in FY10 with the base year effect kicking in. However in FY11, growth slowed down to 16-17 %. On asset quality, additions to gross NPAs increased sharply in FY09 (47.8%) and FY10 (33.1%) and moderated subsequently. These were also the years when industrial production slowed down to 2.5% and 5.3%, respectively. The financial crisis had its impact in FY09 when overall GDP growth was impacted.
Therefore, there may be a tendency for NPAs to increase when conditions are challenging and would indirectly be related to interest rates. GSec rates have moved in consonance with the repo rate though with less than unitary elasticity. The yield on 10-years GSec rose by around 50 bps when the repo rate was changed by 125 bps in FY07. The decline in yield by almost 90 bps in FY09 was less than commensurate with the net decrease of 150 bps invoked by the RBI, while the increase in the last two years has again been around half the increase in the repo rate.
Clearly, there are other factors at work affecting the yields. Four conclusions may be drawn. First, the impact on cost of deposits comes with a lag while the cost for borrowers increases immediately. Second, corporate profits have shown some signs of stress last year and will face challenging times in FY12 as fresh investment will be impacted as we have reached the inflexion point.
Third, bank profitability will be under pressure depending on the impact on interest margins and, more importantly, provisions for NPAs. Lastly, the GSec market is the most responsive one and the rates respond , though not commensurately. The story of interest rate impact may just change this year compared with the earlier ones when resilience was shown at all ends.
At times, bankers openly state that they will not alter rates. What has been the past experience? The increase in repo rate affects banks as they borrow from RBI which affects the call and CBLO markets where the repo rate is the benchmark. Today banks are borrowing around Rs 20,000-50 ,000 crore, while the daily trade volume in the call, CBLO and repo is around Rs 70,000-80 ,000 crore.
The transmission process is quite direct here. Deposits are slow to react to rate hikes, and it is only the incremental deposits which are affected as rates are increased in those tenure buckets where funds are required. Further, a large proportion of deposits (35-40 %) are CASA which buffers the overall cost impact. Now, between FY06 and mid-FY 09 the RBI raised the repo rate by 300 bps, yet the cost of deposits of a set of 71 banks increased from 4.52% to 6.22% with a lag of over a year. Subsequently in FY09, the RBI scaled down the repo rate by 275 bps and later increased the same by 200 bps in the next two years.
Yet, the cost of deposits has been declining continuously from 6.22% in FY09 to 5.54% in FY10 and 5.07% in FY11. Quite clearly, the higher deposit rates of last year have not yet shown in the cost of deposits as there is a lag of 1 year in actual transmission. The return on advances reacts almost instantaneously and the 300-bps increase was reflected in an increase of 230 bps to 10.51% up to FY09. But it declined subsequently even as the RBI raised rates in FY10 and FY11 to 9.28% and 9.24%, respectively.
This really means that banks have not increased their return to retain business. Therefore , a lot depends on the lag effect in FY12 when cost of deposits and return on advances would increase. Net interest margin declined continuously from 3.01% in FY06 to 2.48% in FY10, before increasing to 2.90% in FY11, which means that in net terms, borrowers have started bearing the higher interest cost.
Profitability too has been stable with return on assets vacillating between 0.98% and1.07%. The RBI has maintained that the transmission mechanism of interest rates is sluggish and has, therefore, been aggressive. The return on advances for FY12 would witness an upward thrust with the lag effect of 200-bps increase in rates in the last two years striking harder and faster than that in deposits, especially as the latter slowed down in FY11.
The impact on corporate profits can be gauged by the results of a set of 1,401 non-financial companies. Growth in both PBT and PBIT had accelerated in FY07 (36-38 %) when the RBI increased rates and stabilised at around 27% in FY08 when rates remained unchanged.
Profits declined in FY09 and were robust in FY10 with the base year effect kicking in. However in FY11, growth slowed down to 16-17 %. On asset quality, additions to gross NPAs increased sharply in FY09 (47.8%) and FY10 (33.1%) and moderated subsequently. These were also the years when industrial production slowed down to 2.5% and 5.3%, respectively. The financial crisis had its impact in FY09 when overall GDP growth was impacted.
Therefore, there may be a tendency for NPAs to increase when conditions are challenging and would indirectly be related to interest rates. GSec rates have moved in consonance with the repo rate though with less than unitary elasticity. The yield on 10-years GSec rose by around 50 bps when the repo rate was changed by 125 bps in FY07. The decline in yield by almost 90 bps in FY09 was less than commensurate with the net decrease of 150 bps invoked by the RBI, while the increase in the last two years has again been around half the increase in the repo rate.
Clearly, there are other factors at work affecting the yields. Four conclusions may be drawn. First, the impact on cost of deposits comes with a lag while the cost for borrowers increases immediately. Second, corporate profits have shown some signs of stress last year and will face challenging times in FY12 as fresh investment will be impacted as we have reached the inflexion point.
Third, bank profitability will be under pressure depending on the impact on interest margins and, more importantly, provisions for NPAs. Lastly, the GSec market is the most responsive one and the rates respond , though not commensurately. The story of interest rate impact may just change this year compared with the earlier ones when resilience was shown at all ends.
RBI must intervene: Financial Express 27th September 2011
The stock market is known for its inherent volatility and, since July 1, has shown annualised volatility of 22% as against 8% in the forex market. In September, however, this difference has narrowed down, with stock market volatility being 26% and forex 12%. Clearly, the forex market has become a more interesting market with various forces at work that have made an otherwise staid market into one which has provoked concern and discussion.
The spot merchant forex market has a turnover of around R3,000 crore a day while the OTC forward registers trades of R5,000 crore. The inter-bank spot and forward markets clock around R15,000 crore each while the F&O turnover on the exchanges is another R70,000 crore. The price discovery process is robust, as the market knows best.
Given the volumes traded and wide-scale participation, there can be no case of manipulation. Therefore, in a free market economy, ideally a sharp depreciation in the currency should be allowed to prevail.
However, if you were the central bank, this stance may not be possible. Theoretically, two sets of factors drive the exchange rate. The first is the physical demand and supply for dollars, and the other is the fallout of the euro-dollar relationship. Both the components are fuzzy today. The demand is not unusual as while the trade deficit has widened, it is still under control. Besides, this cannot affect the rate on a daily basis. On the supply side, the FII flows matter as there is a one-to-one correspondence here. These flows have been fairly erratic on a daily basis, but more stable when aggregated over months.
The euro-dollar relation is more complex. Global uncertainly pervades this relation on a real time basis. The Eurozone is in all kinds of trouble. The rogue nations are on the precipice of default and the trust deficit between nations is at an all-time high. Any news on the default of any nation or the discovery of high debts on their balance sheets is driving the euro down vis-à-vis the dollar, even though nothing much happens on the dollar end. Further, any announcement of a possible stimulus in the US or the absence of one could drive the dollar up or down. In this situation, the rupee takes a hit as part of the transmission mechanism.
A regression analysis of the rupee movement with the euro-dollar movement (with lags) and absolute FII flows on a daily basis since June shows that around 30% of the variation in the rupee-dollar rate since June can be explained by these two factors. The euro-dollar rate, with current and two-day lags, has an influence of around 0.40%, thereby meaning that three days of dollar strengthening by 1% can lead to a 0.4% fall in the rupee. In the month of September, the dollar strengthened by around 5.4% (until September 22), which can explain just over 2% of this variation. The impact of FIIs, on the other hand, is quite marginal at 0.00037 (i.e. $1,000 million net inflows will cause rupee appreciation of 0.37%). The important point is that around 70% of the variation cannot be statistically explained and is attributable to ‘sentiment’. This is why RBI intervention is called for.
RBI’s concern as a regulator is to intervene in any market when there is too much volatility. Bond price volatility is addressed through some large banks while stock prices are addressed by the insurance companies. For the forex market, when sentiment is quite adverse, direct intervention could be justified. The depreciation that we are witnessing has some important implications that can justify intervention if RBI is convinced that it is not being driven by only fundamentals.
First, the boost to exports that depreciation provides is unlikely to materialise since the global markets and world trade have slowed down. Therefore, halting this depreciation will not have an adverse impact.
Second, the chance of imported inflation is there, as imports would continue to flow at a higher cost. Rupee depreciation has already negated the phenomenon of declining global commodity prices. RBI is trying hard to control inflation through repo rate hikes. Letting in imported inflation will be contradictory to its own stance. In fact, imported inflation will not be just through higher cost of imports but also derived inflation where commodity prices are based on a global price discovery process. Third, rupee depreciation will hit our external debt servicing quite hard. This year, there are around $25 billion of outflows, which already mean an additional burden of R10,000 crore for the economy. Fourth, in the first four months of the year, there have been $12.3 billion of ECB approvals compared with $23 billion of inflows last year. A depreciating rupee adds to the future burden. Fifth, companies now wishing to borrow will have to pay a higher risk premium in the euro market.
Under these conditions, there is a strong case for intervention by RBI to control the falling rupee. While India is better placed than other nations in terms of growth, there are still concerns on inflation. Unchecked rupee depreciation, which is not driven by fundamentals, is not a good sign, as it upsets the wobbly apple cart. Sustained intervention with guidance on a target range will help to assuage the market greatly.
The spot merchant forex market has a turnover of around R3,000 crore a day while the OTC forward registers trades of R5,000 crore. The inter-bank spot and forward markets clock around R15,000 crore each while the F&O turnover on the exchanges is another R70,000 crore. The price discovery process is robust, as the market knows best.
Given the volumes traded and wide-scale participation, there can be no case of manipulation. Therefore, in a free market economy, ideally a sharp depreciation in the currency should be allowed to prevail.
However, if you were the central bank, this stance may not be possible. Theoretically, two sets of factors drive the exchange rate. The first is the physical demand and supply for dollars, and the other is the fallout of the euro-dollar relationship. Both the components are fuzzy today. The demand is not unusual as while the trade deficit has widened, it is still under control. Besides, this cannot affect the rate on a daily basis. On the supply side, the FII flows matter as there is a one-to-one correspondence here. These flows have been fairly erratic on a daily basis, but more stable when aggregated over months.
The euro-dollar relation is more complex. Global uncertainly pervades this relation on a real time basis. The Eurozone is in all kinds of trouble. The rogue nations are on the precipice of default and the trust deficit between nations is at an all-time high. Any news on the default of any nation or the discovery of high debts on their balance sheets is driving the euro down vis-à-vis the dollar, even though nothing much happens on the dollar end. Further, any announcement of a possible stimulus in the US or the absence of one could drive the dollar up or down. In this situation, the rupee takes a hit as part of the transmission mechanism.
A regression analysis of the rupee movement with the euro-dollar movement (with lags) and absolute FII flows on a daily basis since June shows that around 30% of the variation in the rupee-dollar rate since June can be explained by these two factors. The euro-dollar rate, with current and two-day lags, has an influence of around 0.40%, thereby meaning that three days of dollar strengthening by 1% can lead to a 0.4% fall in the rupee. In the month of September, the dollar strengthened by around 5.4% (until September 22), which can explain just over 2% of this variation. The impact of FIIs, on the other hand, is quite marginal at 0.00037 (i.e. $1,000 million net inflows will cause rupee appreciation of 0.37%). The important point is that around 70% of the variation cannot be statistically explained and is attributable to ‘sentiment’. This is why RBI intervention is called for.
RBI’s concern as a regulator is to intervene in any market when there is too much volatility. Bond price volatility is addressed through some large banks while stock prices are addressed by the insurance companies. For the forex market, when sentiment is quite adverse, direct intervention could be justified. The depreciation that we are witnessing has some important implications that can justify intervention if RBI is convinced that it is not being driven by only fundamentals.
First, the boost to exports that depreciation provides is unlikely to materialise since the global markets and world trade have slowed down. Therefore, halting this depreciation will not have an adverse impact.
Second, the chance of imported inflation is there, as imports would continue to flow at a higher cost. Rupee depreciation has already negated the phenomenon of declining global commodity prices. RBI is trying hard to control inflation through repo rate hikes. Letting in imported inflation will be contradictory to its own stance. In fact, imported inflation will not be just through higher cost of imports but also derived inflation where commodity prices are based on a global price discovery process. Third, rupee depreciation will hit our external debt servicing quite hard. This year, there are around $25 billion of outflows, which already mean an additional burden of R10,000 crore for the economy. Fourth, in the first four months of the year, there have been $12.3 billion of ECB approvals compared with $23 billion of inflows last year. A depreciating rupee adds to the future burden. Fifth, companies now wishing to borrow will have to pay a higher risk premium in the euro market.
Under these conditions, there is a strong case for intervention by RBI to control the falling rupee. While India is better placed than other nations in terms of growth, there are still concerns on inflation. Unchecked rupee depreciation, which is not driven by fundamentals, is not a good sign, as it upsets the wobbly apple cart. Sustained intervention with guidance on a target range will help to assuage the market greatly.
The lay of the land: Financial Express 15th September 2011
Conventional economic theory talks of four factors of production—land, labour, capital and enterprise—that are required for growth. To this has been added technology, while the more fertile minds have appended others, like human capital. However, theories have been floated for all factors except land, which was exogenously given. And, ironically, land has been one of the most controversial issues when discussing economic progress in the country. The land laws date to 1894 and evidently are anachronistic and controversial as it transcends into a social issue that is quite characteristically captured by realpolitik.
The problem with land is that there are an equal number of interested and antagonistic parties. The Sardar Sarovar Dam is an evergreen story, while the escapades of Tata Motors or Sterlite are more recent. There are companies that want to buy land and use the same for mineral exploration or setting up their units. The owners are either landlords or poor people with marginal but contiguous units of land who would sell, though they do not quite know what it best for them. Then there are the ubiquitous environmentalists who will always find a reason to block such deals. Add to this the group of activists who are anti-industry about everything and the battlefield gets dense.
At another level, there are various levels of government that come in the way of land ownership, with the laws being nebulous on the extent to which the Centre has the power to overrule the state and local bodies. Given that the
governments are from different parties across these governing units, there will be conflict.
The current Land Acquisition Bill, if enacted, will provide guidelines for future land deals. To touch on the major contours, this is how the new proposed rules look. The Bill talks of resettlement and rehabilitation of the affected people. There are rules governing the acquiescence of 80% of the owners, while multi-cropped areas are now on the shopping displays. Separate rules apply for rural and urban land and state governments can have their own rules. However, government purchase is out of the ambit and can be done for public purpose. Compensation has been fixed at four times or twice the market value in rural and urban areas, respectively. The creation of a land bank would address the issue of land being purchased and not used for 10 years.
The country is in the midst of taking off on a high growth trajectory and the current use or rather restricted access to land has led to overcrowding and other accompanying disadvantages that go with rapid urbanisation and industrialisation. While factors such as capital, enterprise, technology and capital are available either within the nation or
outside, the same does not hold for land. Indian companies have looked towards the outside world to buy land with the minerals or setting up business as the current antiquated laws are inhibitive. Quite evidently, we need to have land laws in place that offer enterprise the factor of production which is intrinsic for growth. The current Bill is therefore welcome.
It is true that greater use of land does lead to environment degradation and displaces the owners who could be illiterate and at a disadvantage. But, this is a tradeoff to accept because any form of development will have to be at the expense of the environment as one cannot generate power, or bring about consumerism without investment in factories or offices that have to be located on land. To counter the environment issues, the concerned governments should lay down the rules of the game in parallel so as to mitigate these effects.
Could there be problems along the way? Definitely yes, as the current rules lay down the ground rules and will have to address the issue of valuation, which is important in any market. Also getting 80% of the people to agree to sell will be a challenge and, to begin with, there would be a lot of suasion, which may not always be ethical, especially where the projects are large. The government would have to further look at this issue as land prices are always opaque as the official and market rates vary considerably even in metropolitan cities.
The current content of the laws can be debated as being pro-industry or anti-poor, but a start has to be made. The current guidelines make it easier to acquire land though the cost of this factor is bound to increase, which can be accepted as being the price that is discovered in the market. In fact, having the ground rules set helps in creating a market for land, which can, at some later point of time, also lead to a vibrant secondary market with the proliferation of financial derivative products. Currently, it is expected that the cost of production would increase with the fixed cost component moving up, which will get reflected in the price of the product—be it housing or factory output. But then, if it is the true reflection of the price of this vital commodity, i.e. land, so be it.
The problem with land is that there are an equal number of interested and antagonistic parties. The Sardar Sarovar Dam is an evergreen story, while the escapades of Tata Motors or Sterlite are more recent. There are companies that want to buy land and use the same for mineral exploration or setting up their units. The owners are either landlords or poor people with marginal but contiguous units of land who would sell, though they do not quite know what it best for them. Then there are the ubiquitous environmentalists who will always find a reason to block such deals. Add to this the group of activists who are anti-industry about everything and the battlefield gets dense.
At another level, there are various levels of government that come in the way of land ownership, with the laws being nebulous on the extent to which the Centre has the power to overrule the state and local bodies. Given that the
governments are from different parties across these governing units, there will be conflict.
The current Land Acquisition Bill, if enacted, will provide guidelines for future land deals. To touch on the major contours, this is how the new proposed rules look. The Bill talks of resettlement and rehabilitation of the affected people. There are rules governing the acquiescence of 80% of the owners, while multi-cropped areas are now on the shopping displays. Separate rules apply for rural and urban land and state governments can have their own rules. However, government purchase is out of the ambit and can be done for public purpose. Compensation has been fixed at four times or twice the market value in rural and urban areas, respectively. The creation of a land bank would address the issue of land being purchased and not used for 10 years.
The country is in the midst of taking off on a high growth trajectory and the current use or rather restricted access to land has led to overcrowding and other accompanying disadvantages that go with rapid urbanisation and industrialisation. While factors such as capital, enterprise, technology and capital are available either within the nation or
outside, the same does not hold for land. Indian companies have looked towards the outside world to buy land with the minerals or setting up business as the current antiquated laws are inhibitive. Quite evidently, we need to have land laws in place that offer enterprise the factor of production which is intrinsic for growth. The current Bill is therefore welcome.
It is true that greater use of land does lead to environment degradation and displaces the owners who could be illiterate and at a disadvantage. But, this is a tradeoff to accept because any form of development will have to be at the expense of the environment as one cannot generate power, or bring about consumerism without investment in factories or offices that have to be located on land. To counter the environment issues, the concerned governments should lay down the rules of the game in parallel so as to mitigate these effects.
Could there be problems along the way? Definitely yes, as the current rules lay down the ground rules and will have to address the issue of valuation, which is important in any market. Also getting 80% of the people to agree to sell will be a challenge and, to begin with, there would be a lot of suasion, which may not always be ethical, especially where the projects are large. The government would have to further look at this issue as land prices are always opaque as the official and market rates vary considerably even in metropolitan cities.
The current content of the laws can be debated as being pro-industry or anti-poor, but a start has to be made. The current guidelines make it easier to acquire land though the cost of this factor is bound to increase, which can be accepted as being the price that is discovered in the market. In fact, having the ground rules set helps in creating a market for land, which can, at some later point of time, also lead to a vibrant secondary market with the proliferation of financial derivative products. Currently, it is expected that the cost of production would increase with the fixed cost component moving up, which will get reflected in the price of the product—be it housing or factory output. But then, if it is the true reflection of the price of this vital commodity, i.e. land, so be it.
Why do we want more banks? 31st August 2011: Financial Express
RBI’s revised draft guidelines for new banks are a step towards the latter’s final fructification though there is a rider that the Banking Regulation Act has to be amended for the same. We will have to wait beyond October. Having new banks in the arena will be refreshing just as it was when the Narasimham Committee Report’s recommendations were adopted in the nineties. The success of new banks was mixed with the institution-backed ones along with a group-backed bank emerging ahead while several others got absorbed through acquisitions due to non-viability.
RBI has focused a lot on regulation to ensure that the ownership of these banks is in the right hands and that there is little exposure to the sensitive sectors such as real estate and capital markets. By insisting on R500 crore of capital, it does keep out the smaller players, but then that is understandable because we need banks with deep pockets which can meet other aspirations of domestic banking. Besides, from the point of view of monitoring banks, a smaller set of large banks is more convenient. Also, there are strict guidelines on the exposure norms which will ensure that there is no cronyism. How will the landscape of banking change assuming that we have some big players coming in?
On the positive side, having new banks will help to spread banking to the masses. We can see large corporate houses and NBFCs qualifying for the same, which will really help to expand the overall banking structure with the requisite technology. There was a sea change in the way in which banking was conducted in the nineties and the new set will increase competition and improve efficiency. By RBI insisting on 25% of the branches being in rural unbanked areas, these banks will support the drive towards financial inclusion.
NBFCs, in particular, should find this route useful as they already have strength in specific niche segments and by adhering to the compliance standards laid down by RBI they can actually reach out for the deposit base, which today is a high-cost one. They have their own distribution networks, which can be harnessed to take a firmer hold on this turf. It must be pointed out that banks have the advantage of accessing current and savings deposits, which are stable in terms of rollovers.
There are, however, some challenges for the new banks. They have to compete with well-established banks and bringing in incremental innovation is a task. Further, they could be pressurised by the norms for inclusive banking. We already have around 87,000 bank branches in the country.
Rural branches clock around R14 crore of deposits per branch while urban/metropolitan ones do R116 crore. Similarly, rural branches bring in an average credit ticket of R8.5 crore per branch while urban/metropolitan branches get in R96 crore. Clearly, there will be pressure on profit margins for these new players, especially so as they are beginning their business on this slippery note. Also, the priority sector adherence will be a tough one for new entrants unless allowed in a phased manner. It may be advisable to treat the priority sector commitments on line with those for foreign banks and include export credit as an option.
An issue to be debated is why we want more banks in the country. If it is to bring in more capital and foster competition, then we are on the right track. Large business houses with deep pockets are just the panacea that we are looking for given that if we are talking of credit growing at 20% per annum in the next 5 years, we are looking at incremental funds of almost R40 lakh crore which has to be supported by 10% CAGR.
The existing banks can certainly provide support given that they are well-capitalised, but with prudential regulation becoming stiffer, new banks are the answer.
However, bringing in the inclusive banking compulsion can be inhibiting. If we want to target the un-bankable class, then the approach should be different. We already have a large banking network in the rural areas which can bring about financial inclusion; it is not necessary to create fresh infrastructure. Instead, this would have been an appropriate time to actually bring in a new category of banks which would be dedicated to this niche group with different minimum capital requirements. This could have provided an opportunity for either existing players in the NBFC or the cooperative banking system to transform into a niche bank for this purpose. A thought that can be pursued is to see if these new entrants can acquire existing banks so that financial strength is delivered without recreating the infrastructure.
It must be reiterated that the Indian banking system is regulated quite closely through the SLR (25%) and priority sector compulsions (40%), with restrictions on sectoral lending. While these are prudential measures, at some point they can conflict with commercial considerations. So, a dualistic approach that separates inclusive banking from general banking may be a suggestion to consider.
RBI has focused a lot on regulation to ensure that the ownership of these banks is in the right hands and that there is little exposure to the sensitive sectors such as real estate and capital markets. By insisting on R500 crore of capital, it does keep out the smaller players, but then that is understandable because we need banks with deep pockets which can meet other aspirations of domestic banking. Besides, from the point of view of monitoring banks, a smaller set of large banks is more convenient. Also, there are strict guidelines on the exposure norms which will ensure that there is no cronyism. How will the landscape of banking change assuming that we have some big players coming in?
On the positive side, having new banks will help to spread banking to the masses. We can see large corporate houses and NBFCs qualifying for the same, which will really help to expand the overall banking structure with the requisite technology. There was a sea change in the way in which banking was conducted in the nineties and the new set will increase competition and improve efficiency. By RBI insisting on 25% of the branches being in rural unbanked areas, these banks will support the drive towards financial inclusion.
NBFCs, in particular, should find this route useful as they already have strength in specific niche segments and by adhering to the compliance standards laid down by RBI they can actually reach out for the deposit base, which today is a high-cost one. They have their own distribution networks, which can be harnessed to take a firmer hold on this turf. It must be pointed out that banks have the advantage of accessing current and savings deposits, which are stable in terms of rollovers.
There are, however, some challenges for the new banks. They have to compete with well-established banks and bringing in incremental innovation is a task. Further, they could be pressurised by the norms for inclusive banking. We already have around 87,000 bank branches in the country.
Rural branches clock around R14 crore of deposits per branch while urban/metropolitan ones do R116 crore. Similarly, rural branches bring in an average credit ticket of R8.5 crore per branch while urban/metropolitan branches get in R96 crore. Clearly, there will be pressure on profit margins for these new players, especially so as they are beginning their business on this slippery note. Also, the priority sector adherence will be a tough one for new entrants unless allowed in a phased manner. It may be advisable to treat the priority sector commitments on line with those for foreign banks and include export credit as an option.
An issue to be debated is why we want more banks in the country. If it is to bring in more capital and foster competition, then we are on the right track. Large business houses with deep pockets are just the panacea that we are looking for given that if we are talking of credit growing at 20% per annum in the next 5 years, we are looking at incremental funds of almost R40 lakh crore which has to be supported by 10% CAGR.
The existing banks can certainly provide support given that they are well-capitalised, but with prudential regulation becoming stiffer, new banks are the answer.
However, bringing in the inclusive banking compulsion can be inhibiting. If we want to target the un-bankable class, then the approach should be different. We already have a large banking network in the rural areas which can bring about financial inclusion; it is not necessary to create fresh infrastructure. Instead, this would have been an appropriate time to actually bring in a new category of banks which would be dedicated to this niche group with different minimum capital requirements. This could have provided an opportunity for either existing players in the NBFC or the cooperative banking system to transform into a niche bank for this purpose. A thought that can be pursued is to see if these new entrants can acquire existing banks so that financial strength is delivered without recreating the infrastructure.
It must be reiterated that the Indian banking system is regulated quite closely through the SLR (25%) and priority sector compulsions (40%), with restrictions on sectoral lending. While these are prudential measures, at some point they can conflict with commercial considerations. So, a dualistic approach that separates inclusive banking from general banking may be a suggestion to consider.
American crisis, Asian concerns: 24th August Financial Express
The protests by Anna Hazare come at a time when the world economy is also battling a credibility issue, with a global slowdown being conjectured for the current year. One thought that hits us is whether or not these protests will have any wider ramifications for our economy. The global slowdown has evoked a mixed response with arguments being on both sides, with a distinct tilt towards a neutral situation for us. How about the current political and social unrest? Will it upset the clichéd apple cart?
There are two aspects to this protest. The first is whether or not foreign investment will be affected, and the other is whether the domestic economy will witness a backlash. The protests so far are more political in nature, which, at its exaggerated best, has probably some traces of the scent of the jasmine backlash in Tunisia, Egypt and the rest. Hopefully, it does appear that it will remain confined to demonstrations with the more affluent sections of society also using this opportunity to be seen with the rest. The interesting conjecture here is its implications for the economy.
Growth in the economy is driven by three sectors: agriculture, industry and services. Agricultural output is impervious to what happens in Delhi as long as the pricing policy is correct and the FCI is in action. Therefore, there should be no concern from this quarter. Industry is more worried about interest rates, demand and policies. Currently, the concern is that interest rates will drive back consumerism and investment, which is not good news. RBI is evidently looking at inflation to consider interest rate decisions. Therefore, there should be no impact of such demonstrations. Policies are of course important for industry and this is where there can be concern because important discussion time is being used up on the governance issue rather than economic affairs. There are important policies on pension reforms, insurance, FDI in retail, and so on, which will obviously miss the bus as Parliament time is diverted to Ramlila grounds.
There are two ways of looking at it. A more cynical view is that these policies have been on the agenda anyway for long without really derailing growth and hence should not matter. While this is true to the extent that immediate prospects may not be affected, further deferment of such issues will come in the way of future progress. This is so because once Bills are held back, it takes a long time to get them back on the discussion table. One can recollect the infamous FCRA amendment, which has been pending since 2003 and has not seriously been discussed as sessions close and the papers have
to be reintroduced. Therefore, definitely in the medium run, growth will be held back as long as there is a status quo on the policy approach, which is not desirable.
The services sector is a dominant one, with around 45% of its output coming from the unorganised segment, which is largely insulated from any such thought-based revolution. The rest of the sector will be driven by the normal course unless there are any disruptions physically, which, though not expected, cannot be ruled out. We have seen that events like strikes or blockages of transport take their impact on the movement of goods and people, which eventually affects certain sectors like transportation or tourism. But, assuming that the movements will be largely peaceful, as this is the core of the ideology here, disruptions should be minimal.
This then turns attention to foreign investors. Here, again, there is a pragmatic way of looking at things. India has not really been anywhere close to high on the World Bank’s chart of doing business and remains in a static state—notwithstanding economic reforms—when it comes to other morality and governance indices used globally. This, in a way, is a comfort because a peaceful relentless move against such issues should not stop foreign investment from coming in. Portfolio investors will still prefer to look at the future growth convictions in the Indian economy, which is strong even today in a world that is sliding down the grease pole. With strong growth numbers still expected in such adversity from India, it remains an attractive market for all purposes.
Foreign direct investment, on the other hand, has been coming in good numbers this year, and evidently the
opportunities that exist are an ex post vindication of the economy’s prospects. Gross inflows have been $13.4bn in the first quarter as against $5.7bn last year. Therefore, foreign perception of Indian markets should remain unaltered here. In fact, governance standards would definitely improve in the aftermath of what is happening today.
Hence, it may be concluded that it should be business as usual except for some further delays in discussing Bills that anyway do not solicit broad consensus. Our economy is fairly mature and resilient to such occurrences and there is an inherent strength that has been displayed in the working of the economy. Our policymakers have been pursuing policies quite independently with a single-minded focus—be it RBI, finance ministry or Planning Commission. We have seen that even a change of government with different ideologies has not derailed the broader vision or growth path. Quite clearly, Ramlila or any other venue should not come in the way.
There are two aspects to this protest. The first is whether or not foreign investment will be affected, and the other is whether the domestic economy will witness a backlash. The protests so far are more political in nature, which, at its exaggerated best, has probably some traces of the scent of the jasmine backlash in Tunisia, Egypt and the rest. Hopefully, it does appear that it will remain confined to demonstrations with the more affluent sections of society also using this opportunity to be seen with the rest. The interesting conjecture here is its implications for the economy.
Growth in the economy is driven by three sectors: agriculture, industry and services. Agricultural output is impervious to what happens in Delhi as long as the pricing policy is correct and the FCI is in action. Therefore, there should be no concern from this quarter. Industry is more worried about interest rates, demand and policies. Currently, the concern is that interest rates will drive back consumerism and investment, which is not good news. RBI is evidently looking at inflation to consider interest rate decisions. Therefore, there should be no impact of such demonstrations. Policies are of course important for industry and this is where there can be concern because important discussion time is being used up on the governance issue rather than economic affairs. There are important policies on pension reforms, insurance, FDI in retail, and so on, which will obviously miss the bus as Parliament time is diverted to Ramlila grounds.
There are two ways of looking at it. A more cynical view is that these policies have been on the agenda anyway for long without really derailing growth and hence should not matter. While this is true to the extent that immediate prospects may not be affected, further deferment of such issues will come in the way of future progress. This is so because once Bills are held back, it takes a long time to get them back on the discussion table. One can recollect the infamous FCRA amendment, which has been pending since 2003 and has not seriously been discussed as sessions close and the papers have
to be reintroduced. Therefore, definitely in the medium run, growth will be held back as long as there is a status quo on the policy approach, which is not desirable.
The services sector is a dominant one, with around 45% of its output coming from the unorganised segment, which is largely insulated from any such thought-based revolution. The rest of the sector will be driven by the normal course unless there are any disruptions physically, which, though not expected, cannot be ruled out. We have seen that events like strikes or blockages of transport take their impact on the movement of goods and people, which eventually affects certain sectors like transportation or tourism. But, assuming that the movements will be largely peaceful, as this is the core of the ideology here, disruptions should be minimal.
This then turns attention to foreign investors. Here, again, there is a pragmatic way of looking at things. India has not really been anywhere close to high on the World Bank’s chart of doing business and remains in a static state—notwithstanding economic reforms—when it comes to other morality and governance indices used globally. This, in a way, is a comfort because a peaceful relentless move against such issues should not stop foreign investment from coming in. Portfolio investors will still prefer to look at the future growth convictions in the Indian economy, which is strong even today in a world that is sliding down the grease pole. With strong growth numbers still expected in such adversity from India, it remains an attractive market for all purposes.
Foreign direct investment, on the other hand, has been coming in good numbers this year, and evidently the
opportunities that exist are an ex post vindication of the economy’s prospects. Gross inflows have been $13.4bn in the first quarter as against $5.7bn last year. Therefore, foreign perception of Indian markets should remain unaltered here. In fact, governance standards would definitely improve in the aftermath of what is happening today.
Hence, it may be concluded that it should be business as usual except for some further delays in discussing Bills that anyway do not solicit broad consensus. Our economy is fairly mature and resilient to such occurrences and there is an inherent strength that has been displayed in the working of the economy. Our policymakers have been pursuing policies quite independently with a single-minded focus—be it RBI, finance ministry or Planning Commission. We have seen that even a change of government with different ideologies has not derailed the broader vision or growth path. Quite clearly, Ramlila or any other venue should not come in the way.
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