Thingalaya, Moodithaya and Shetty examine various aspects of financial inclusion and the challenges and progress of the movement in India in their comprehensive book
Today, in almost all seminars on banking, talking about inclusive banking has become axiomatic if not a fad. Maybe after a decade of competitive banking, where banks have focused on return on capital and return on assets, somewhere inside is a feeling of guilt that the poor have been left out. It is not surprising that bankers spend a lot of time talking on how it is necessary to bring about inclusion and policy makers go a step ahead and relate the same to inclusive growth.
But what exactly does this financial inclusion mean? Have we really made any strides here? Thingalaya, Moodithaya and Shetty attempt to address these issues in their book, Financial Inclusion and Beyond. Thingalaya, a banker-academic obviously has the advantage of personal experience on the subject.
Inclusion basically means having access to a bank account, bank facilities such as remittance, credit, financial advice and probably insurance. The authors look at demand and supply side factors in this context. On the demand side, they point out that awareness, interest rates, need for collateral, social status and information asymmetry (where some get to know more and some less about defining issues) may actually be keeping potential borrowers out of this framework. The supply factors that make banks reluctant to lend are almost mirror images such as insistence on collateral, limited access to all villages, procedures, language and staff attitude.
Then they examine different parameters to gauge inclusion, which is a bit cumbersome given the limited availability of data. Population per branch or accounts per population size are the ones normally referred to, while there are extensions such as loans given based on occupation, status, etc. Of late, the concept of no-frills accounts has caught on, which helps the un-bankable people to access banks. A lot of data from the National Sample Survey is used here, which, unfortunately, tends to be dated in the current context.
The authors have carried out a survey on financial inclusion in four districts—Anantpur (Andhra Pradesh), Madurai (Tamil Nadu), Udupi (Karnataka) and Kasaragod (Kerala). The survey throws up some results and there is reason to believe that Tamil Nadu is a kind of laggard in terms of inclusion. Some of the thoughts that emanate from the study are that men are covered relatively more than women; religion, perhaps, does not matter; education plays a role in all states except Andhra Pradesh, while ownership of land has a positive correlation with access to banks. There is, however, no clear relation with occupation. Further, some of the reasons for exclusion are awareness or low comfort. An interesting finding is that around half the respondents were left out voluntarily, meaning they were not really interested.
Looking ahead, the authors suggest that to improve financial inclusion there should be more points of contact to begin with. Second, the concept of a financial supermarket, Gramin Vikas Soudha, should come up, where a villager gets not just finance, but also other farm inputs and daily-use items. Third, credit should be a part of any development plan undertaken by the government right to the panchayat level. Lastly, there should be a lead district manager who should be in charge of such an initiative.
The book does not make suggestions much different from what we read in the speeches of bankers. But it is always good to have everything in one place. As one of the authors was a banker, the book should have touched on other banker’s perspectives such as banks’ reluctance to experiment, administrative hassles in lending, creation of non-performing loans, impact of such lending on profit margins, etc. Given the problems that microfinance institutions face today, this would have added value. A survey of bankers would have helped in this context, as it would have provided the other view on why inclusion is still a mirage in our society.
After all, banks are commercial units. They have to deliver profits and cannot be run on philanthropic grounds. Covering these aspects would have added some zing to the otherwise matter-of-fact approach taken in this book.
The Academic Foundation, which provides a channel for such research projects, should encourage authors to make their books argumentative and represent both sides, or else such books would have a restricted academic audience, which should not be the case.
Tuesday, November 22, 2011
Will savings rate deregulation help banks? Business Standard 9th November 2011
Debate page
Free pricing helps banks manage their costs more efficiently because they can fine-tune them depending on their requirements
Deregulation of interest rates on savings deposits is probably the last mile in interest rate reforms in India. Though the timing may be debated, banks will surely see something good in this move. For the system as a whole these deposits constitute a little less than a quarter of overall funds — they have increased from around 21 per cent in FY00 to 25 per cent in FY06 and moved down to 23 per cent in FY10. There are four reasons for banks to cheer.
First, the freedom to price around a quarter of available funds gives them better control over an important section of their funds. Second, free pricing helps banks manage their costs more efficiently because they can fine-tune them depending on their own requirements and market conditions. The fact that these deposits are almost constant can give most banks flexibility in pricing, although ironically the mirror image would offer scope for competition to dip into them. Third, banks can increase or decrease this reservoir of funds to the extent that is possible based on their own requirements. This will foster competition between banks and enable them to compete with liquid mutual funds, which are the direct alternative. Also by changing terms of transactions like minimum balance, charges for services and so on, they can encourage or discourage such deposits. Finally, as a consequence of these three factors, asset-liability management becomes easier since banks can factor movement in these deposits to match maturity of assets.
Though it is true that these deposits have been an almost constant factor for the banking system, these dynamics may change gradually once customers see differential interest rates. One cannot conjecture whether this proportion of 23 per cent will move up or down when rates change. This was also observed when banks started very short-term deposits of 15 days and above — a move to get customers to roll over these deposits at a rate that was higher than the savings account rate. Customers did move funds to banks offering higher rates on these deposits. By offering higher rates on savings accounts, there could be migration to these deposits not just within the bank, but also across banks. This will cut administrative costs. Therefore, at the micro level, banks will have scope to play with their balance sheet more effectively.
Individuals usually hold cash at home for liquidity, savings deposits for security and convenience, and term deposits for income. While funds may be swapped between banks or across deposits, the overall amount of deposits may not change if rates are increased, given the profile of customers who are already exposed to various alternatives. Therefore, at the macro level the impact may be minimal since it should be recognised that liquid debt funds tend to give higher post-tax yields. Similarly, if the rates come down, customers may not actually withdraw substantially from this account.
We have already seen disparate reactions from banks. The large ones have been silent, while some smaller ones have increased these rates. This will really be the challenge for banks at the micro level where the share of savings accounts is lower, as in the case of foreign banks (about 15 per cent) and old private banks (around 19 per cent). Those that are already at 23-24 per cent may not really have scope to do so, based on past trends in terms of garnering deposits. The onus will be on banks to actually manage this portion of funds.
So, is it good for the banking system? Certainly yes, since it gives banks the freedom to manage their funds more adroitly. The consequences of the impact on the amount of deposits may not change but as long as it is market-determined, the system will be efficient. The real challenge is for the Reserve Bank of India when interest rates come down substantially — as they did in 2002-2005 when term deposits gave returns of around five per cent. Logically, the savings rate should have also come down proportionately to close to nil in case a spread of, say, 400-500 basis points is to be maintained as is the case today.
This may be tough to accept.
Free pricing helps banks manage their costs more efficiently because they can fine-tune them depending on their requirements
Deregulation of interest rates on savings deposits is probably the last mile in interest rate reforms in India. Though the timing may be debated, banks will surely see something good in this move. For the system as a whole these deposits constitute a little less than a quarter of overall funds — they have increased from around 21 per cent in FY00 to 25 per cent in FY06 and moved down to 23 per cent in FY10. There are four reasons for banks to cheer.
First, the freedom to price around a quarter of available funds gives them better control over an important section of their funds. Second, free pricing helps banks manage their costs more efficiently because they can fine-tune them depending on their own requirements and market conditions. The fact that these deposits are almost constant can give most banks flexibility in pricing, although ironically the mirror image would offer scope for competition to dip into them. Third, banks can increase or decrease this reservoir of funds to the extent that is possible based on their own requirements. This will foster competition between banks and enable them to compete with liquid mutual funds, which are the direct alternative. Also by changing terms of transactions like minimum balance, charges for services and so on, they can encourage or discourage such deposits. Finally, as a consequence of these three factors, asset-liability management becomes easier since banks can factor movement in these deposits to match maturity of assets.
Though it is true that these deposits have been an almost constant factor for the banking system, these dynamics may change gradually once customers see differential interest rates. One cannot conjecture whether this proportion of 23 per cent will move up or down when rates change. This was also observed when banks started very short-term deposits of 15 days and above — a move to get customers to roll over these deposits at a rate that was higher than the savings account rate. Customers did move funds to banks offering higher rates on these deposits. By offering higher rates on savings accounts, there could be migration to these deposits not just within the bank, but also across banks. This will cut administrative costs. Therefore, at the micro level, banks will have scope to play with their balance sheet more effectively.
Individuals usually hold cash at home for liquidity, savings deposits for security and convenience, and term deposits for income. While funds may be swapped between banks or across deposits, the overall amount of deposits may not change if rates are increased, given the profile of customers who are already exposed to various alternatives. Therefore, at the macro level the impact may be minimal since it should be recognised that liquid debt funds tend to give higher post-tax yields. Similarly, if the rates come down, customers may not actually withdraw substantially from this account.
We have already seen disparate reactions from banks. The large ones have been silent, while some smaller ones have increased these rates. This will really be the challenge for banks at the micro level where the share of savings accounts is lower, as in the case of foreign banks (about 15 per cent) and old private banks (around 19 per cent). Those that are already at 23-24 per cent may not really have scope to do so, based on past trends in terms of garnering deposits. The onus will be on banks to actually manage this portion of funds.
So, is it good for the banking system? Certainly yes, since it gives banks the freedom to manage their funds more adroitly. The consequences of the impact on the amount of deposits may not change but as long as it is market-determined, the system will be efficient. The real challenge is for the Reserve Bank of India when interest rates come down substantially — as they did in 2002-2005 when term deposits gave returns of around five per cent. Logically, the savings rate should have also come down proportionately to close to nil in case a spread of, say, 400-500 basis points is to be maintained as is the case today.
This may be tough to accept.
Small Towns, Big Problems: Business World 22nd October 2011 (Book Review)
Paromita Shastri's books addresses the issues regarding the pace of urbanisation in small town cities and the urgent need to reform municipal financial practices and policy making
In the federal governance structure that we follow, the last layer — or rather the last mile — is always a challenge as it gets the least attention both in terms of resources as well as discussion. This is the point that is brought out clearly by Paromita Shastri in her book How India’s Small Towns Live or Die. We are all aware that the pace of urbanisation in India, though less than that in other emerging markets, is still impressive enough to be a brownie point for the nation. But Shastri says this achievement is more for the metropolitan cities rather than the 4,500 smaller towns struggling to maintain a semblance of respectability.
The problem is twofold. First, there are few resources available to these cities, and that is poorly administered. As a result, the entire story of urbanisation is besmirched. In fact, most of the migration is to larger cities — mainly metros, as the other towns do not fare better than their rural counterparts in terms of amenities or opportunities.
Shastri studies 29 such towns, across spread eight states, each of which actually had an inherent competitive advantage in terms of being a centre for handicrafts and small-scale industry or agriculture markets or status of pilgrimage centre, and so on. Yet, almost universally, their administration was sub-optimal, and they had problems of raising financial resources. India’s Constitution has left it to the states to address this issue, which, in turn, set up state finance commissions. Invariably, these towns are dependent on transfers from states and have a limited radius within which they can operate in terms of raising their own revenue. Hence, municipal finances vary across states as there are varying rules, unlike for states which have a single formula for devolving funds from the Centre.
It is not surprising that the ratio of municipal funds to total state domestic product was just 0.63 per cent in 2002 — the latest date for which information is available. The major problem here is the availability of data. Most of these town bodies do not maintain basic accounts, and concepts of double entry book-keeping are missing. The author puts it nicely when she says municipal bodies are handicapped by birth — that is aggrandised by weak finances and fiscal over-dependence. That they are dependent on state governments is a kind of subversion of the process of democratic decentralisation.
Shastri paints a dismal picture, though the extent varies. Haryana is better off than, say, Himachal or Rajasthan, while the southern states do relatively better. As these bodies cannot raise resources by borrowing, they work within the contours. The problem is compounded as most of the funds available through ‘own collection’ or grants from states are spent in salaries and maintenance. Consequently, there is hardly any money left for development purposes.
We have had the Jawaharlal Nehru National Urban Renewal Mission (JNNURM) project, which tried to address the issue of urban development, but the author considers it to be a non-starter. While a lot of emphasis was put on e-governance, accounting practices, tax reforms, user charges and provision of basic services, the non-metro towns have not really made too much progress, which makes the scheme a bit of a disappointment.
The author suggests there is an urgent need to reform the finances and bring in the best practices, especially when politics is not a major issue. Public-private partnership would be a way out. However, she does warn that the constant bickering within the body — between councilors and executives are major roadblocks.
How would one rate this book? It is academic in nature, and is a good project considering that besides a study by the Researve Bank of India, there is not much literature on the subject. Even though much of the data used in this book is about a decade old, the author surmounts this by her own studies. Surely, the book has enough that our policymakers should study and address
In the federal governance structure that we follow, the last layer — or rather the last mile — is always a challenge as it gets the least attention both in terms of resources as well as discussion. This is the point that is brought out clearly by Paromita Shastri in her book How India’s Small Towns Live or Die. We are all aware that the pace of urbanisation in India, though less than that in other emerging markets, is still impressive enough to be a brownie point for the nation. But Shastri says this achievement is more for the metropolitan cities rather than the 4,500 smaller towns struggling to maintain a semblance of respectability.
The problem is twofold. First, there are few resources available to these cities, and that is poorly administered. As a result, the entire story of urbanisation is besmirched. In fact, most of the migration is to larger cities — mainly metros, as the other towns do not fare better than their rural counterparts in terms of amenities or opportunities.
Shastri studies 29 such towns, across spread eight states, each of which actually had an inherent competitive advantage in terms of being a centre for handicrafts and small-scale industry or agriculture markets or status of pilgrimage centre, and so on. Yet, almost universally, their administration was sub-optimal, and they had problems of raising financial resources. India’s Constitution has left it to the states to address this issue, which, in turn, set up state finance commissions. Invariably, these towns are dependent on transfers from states and have a limited radius within which they can operate in terms of raising their own revenue. Hence, municipal finances vary across states as there are varying rules, unlike for states which have a single formula for devolving funds from the Centre.
It is not surprising that the ratio of municipal funds to total state domestic product was just 0.63 per cent in 2002 — the latest date for which information is available. The major problem here is the availability of data. Most of these town bodies do not maintain basic accounts, and concepts of double entry book-keeping are missing. The author puts it nicely when she says municipal bodies are handicapped by birth — that is aggrandised by weak finances and fiscal over-dependence. That they are dependent on state governments is a kind of subversion of the process of democratic decentralisation.
Shastri paints a dismal picture, though the extent varies. Haryana is better off than, say, Himachal or Rajasthan, while the southern states do relatively better. As these bodies cannot raise resources by borrowing, they work within the contours. The problem is compounded as most of the funds available through ‘own collection’ or grants from states are spent in salaries and maintenance. Consequently, there is hardly any money left for development purposes.
We have had the Jawaharlal Nehru National Urban Renewal Mission (JNNURM) project, which tried to address the issue of urban development, but the author considers it to be a non-starter. While a lot of emphasis was put on e-governance, accounting practices, tax reforms, user charges and provision of basic services, the non-metro towns have not really made too much progress, which makes the scheme a bit of a disappointment.
The author suggests there is an urgent need to reform the finances and bring in the best practices, especially when politics is not a major issue. Public-private partnership would be a way out. However, she does warn that the constant bickering within the body — between councilors and executives are major roadblocks.
How would one rate this book? It is academic in nature, and is a good project considering that besides a study by the Researve Bank of India, there is not much literature on the subject. Even though much of the data used in this book is about a decade old, the author surmounts this by her own studies. Surely, the book has enough that our policymakers should study and address
Getting out of low-growth trap: Economic Times, 15th October 2011
If one were a student of Economics in the last five decades or so, there would definitely be some inclination towards either John Maynard Keynes or Milton Friedman. Acrimonious debates have typified discussions by these schools with each one often claiming that the other is only a special case of their own line of thought. But today, ironically, we have a situation where governments and monetary authorities are asking the other to take affirmative action as they do not have a solution.
The world economy is in a fragile state now. The quick recovery from the financial crisis through monetary easing and Keynesian spending was assumed to be the beginning of a new era of prosperity, but the euro region crisis has elevated the crisis from the financial system to sovereign failures. Let us look at the US first. The Fed took it upon itself to resuscitate the economy after the financial crisis and what followed were rounds of quantitative easing: QE1 and QE2. The basic idea was to provide liquidity to the system at a time when banks did not trust one another. Interest rates were lowered to almost zero to encourage spending. Yet, growth is sluggish and could be around 1.4% this year with unemployment rate closer to the double-digit mark.
This is what Keynes would have called the liquidity trap where interest rates reach a plateau and don't matter. The solution is for the government to spend. But the government cannot spend as debt levels are too high and it has just gotten away from a possible theoretical default and raked up controversy over the downgrade . Fiscal solutions are weak. The euro region has a different set of problems as it is a combination of 17 countries. Fiscal deficits in the rogue nations have spoilt the party, and the ECB, Germany and European Financial Stability Fund (EFSF) have pooled in resources and support along with IMF to help them out.
The problem here is the high ratio of debt-to-GDP . Greece tops with over 140%, followed by Italy with 120%, and Ireland and Portugal with over 90%. Governments are being asked to follow austerity as they have built up large levels of debt that will be hard to service. This has meant that governments have to cut expenditure and raise taxes , which is deflationary as the countries slip into a recession that will exacerbate the deficit. The ECB has to risk inflation by lowering rates, as this is the only way in which it can lower the cost of borrowing in a region where there is general 'trust deficit' . But lower rates will help to lower credit default swap rates for governments as well as private bond rates. Keynes will not work here and the ECB has to look closer at the inflation tradeoff.
Amid such a scenario, there is a new brand of Economics that has come to fore, Regulatory Economics, which will further impede the growth process . Following the financial crisis, Basel-III is on the anvil, which though will be implemented over a period of time (spread during 2013-19 ). It will tighten the requirements for capital (tier I) and liquidity, both of which were the main issues at the time of the financial crisis. This means that banks today are even more reluctant to lend as they shore up their capital and liquidity. This has been the issue in the US where low interest rates do not inspire lending as banks have to attend to these requirements. The western nations are, hence, definitely in a difficult state where policy application is a challenge .
How about the developing countries ? Here, the issues are different. While growth in countries like India and China is still strong, the problem of inflation remains with central banks furiously pursuing aggressive monetary policies. This has, in a way, put brakes on the demand for credit that is expected to slow down the pace of overall growth. Therefore, once again, there is a downward thrust on growth as central banks counter consumer inflation rates of 5.4% in China, 8.6% in India, 9% in Russia, 6.9% in Brazil and 5.3% in South Africa.
These governments have embarked on a policy of fiscal stimulus rollback and can look in only one direction: reduction of deficits. Hence, if no affirmative action is taken , then the slowdown can degenerate into a recession that will be slow and painful. Presently, no one wants to appear playing truant as Trust Economics has come into vogue. The solution is really for every entity to give in a bit and accept a tradeoff. US should continue to spend to provide demand notwithstanding its debt - sounds heretical after all the ado about the downgrade - as we need some benign neglect to revive the global economy.
ECB must lower rates for whatever it is worth. China should be more responsible and help foster global trade through exchange rate adjustments and other emerging markets must spend to keep business up. In short, both Keynesianism and monetarism should be pursued as 'deviant fiscal behaviour' , and inflation is better than prolonged stagnation.
The world economy is in a fragile state now. The quick recovery from the financial crisis through monetary easing and Keynesian spending was assumed to be the beginning of a new era of prosperity, but the euro region crisis has elevated the crisis from the financial system to sovereign failures. Let us look at the US first. The Fed took it upon itself to resuscitate the economy after the financial crisis and what followed were rounds of quantitative easing: QE1 and QE2. The basic idea was to provide liquidity to the system at a time when banks did not trust one another. Interest rates were lowered to almost zero to encourage spending. Yet, growth is sluggish and could be around 1.4% this year with unemployment rate closer to the double-digit mark.
This is what Keynes would have called the liquidity trap where interest rates reach a plateau and don't matter. The solution is for the government to spend. But the government cannot spend as debt levels are too high and it has just gotten away from a possible theoretical default and raked up controversy over the downgrade . Fiscal solutions are weak. The euro region has a different set of problems as it is a combination of 17 countries. Fiscal deficits in the rogue nations have spoilt the party, and the ECB, Germany and European Financial Stability Fund (EFSF) have pooled in resources and support along with IMF to help them out.
The problem here is the high ratio of debt-to-GDP . Greece tops with over 140%, followed by Italy with 120%, and Ireland and Portugal with over 90%. Governments are being asked to follow austerity as they have built up large levels of debt that will be hard to service. This has meant that governments have to cut expenditure and raise taxes , which is deflationary as the countries slip into a recession that will exacerbate the deficit. The ECB has to risk inflation by lowering rates, as this is the only way in which it can lower the cost of borrowing in a region where there is general 'trust deficit' . But lower rates will help to lower credit default swap rates for governments as well as private bond rates. Keynes will not work here and the ECB has to look closer at the inflation tradeoff.
Amid such a scenario, there is a new brand of Economics that has come to fore, Regulatory Economics, which will further impede the growth process . Following the financial crisis, Basel-III is on the anvil, which though will be implemented over a period of time (spread during 2013-19 ). It will tighten the requirements for capital (tier I) and liquidity, both of which were the main issues at the time of the financial crisis. This means that banks today are even more reluctant to lend as they shore up their capital and liquidity. This has been the issue in the US where low interest rates do not inspire lending as banks have to attend to these requirements. The western nations are, hence, definitely in a difficult state where policy application is a challenge .
How about the developing countries ? Here, the issues are different. While growth in countries like India and China is still strong, the problem of inflation remains with central banks furiously pursuing aggressive monetary policies. This has, in a way, put brakes on the demand for credit that is expected to slow down the pace of overall growth. Therefore, once again, there is a downward thrust on growth as central banks counter consumer inflation rates of 5.4% in China, 8.6% in India, 9% in Russia, 6.9% in Brazil and 5.3% in South Africa.
These governments have embarked on a policy of fiscal stimulus rollback and can look in only one direction: reduction of deficits. Hence, if no affirmative action is taken , then the slowdown can degenerate into a recession that will be slow and painful. Presently, no one wants to appear playing truant as Trust Economics has come into vogue. The solution is really for every entity to give in a bit and accept a tradeoff. US should continue to spend to provide demand notwithstanding its debt - sounds heretical after all the ado about the downgrade - as we need some benign neglect to revive the global economy.
ECB must lower rates for whatever it is worth. China should be more responsible and help foster global trade through exchange rate adjustments and other emerging markets must spend to keep business up. In short, both Keynesianism and monetarism should be pursued as 'deviant fiscal behaviour' , and inflation is better than prolonged stagnation.
Don’t rubbish the poverty criterion, Financial Express 22nd October 2011
Government bashing is easy because every action of it can be questioned as there are multiple ways of looking at issues. The Budget and monetary policies are two statements that always have critiques, depending on how we want them to be structured. The latest controversy for the government is the poverty line. Who is poor in India? This is relevant from the point of view of coverage under various government schemes as well as economic surveys of the government where we get to know how the country has progressed.
The definition of people who are poor is nebulous. In India, we follow the nutrition criteria and the cut-off of R32 a day in urban areas has come under sharp criticism. There is a World Bank definition of $1 a day or $1.25 a day at PPP (purchasing power parity). Based on these numbers, everyone has their own estimate of the number of poor. The Indian definition has less poor as the national poverty line is 28.6% compared with 41.5% for the World Bank (Economic Survey 2010-11). Then there is the Tendulkar Committee Report and the one from the Planning Commission that arrive at different cut-offs—poverty levels based on the Tendulkar committee (from where the R32 cut-off comes) are 37.2% in 2004-05. Finally, there was the Arjun Sengupta Report that created a stir as it spoke of 77% being poor based on a R20 cut-off, which included some basic services, too (2004-05).
The important thing is what we take into account when calculating who is poor. Should it be only food intake or even other amenities like housing, clothing, education etc? Hence, it becomes a challenge for the evaluator. It is, thus, necessary to upfront define what we mean by a poverty line. Once we move away from basic food, then it becomes difficult to work out costs on shelter or clothing, as they vary substantially across the country depending on the region or state. To take this issue sequentially, let us look at what is required for an individual family to just about live with no luxury of any sort to remain at the fringe of survival. The accompanying Table calculates the cost of various items that are necessary going by prices in Delhi for September 2011 as provided by the ministry of consumer affairs. A family of four is considered here.
The Table shows that at current prices, a family earning R3,800 a month is the basic amount that is required for survival in terms of food. This allows for the concept of tea being consumed regularly for the family and limited variety as well as quantity of vegetables in the form of potatoes and absence of any meat/fish. This amount can rise to, say, R4,000 in case of price aberrations. The cut-off of R32 a day comes close to this amount, because for a family of four, total expenditure is R3,840. Here again, we are assuming that all four are working. Therefore, an evaluator should be asking a question to a household of four members whether or not they earn R3,800 a month. If they do, then this will address the issue of basic food consumption and nothing more.
Thus, there is some merit in the cut-off of R32 a day in case we are talking of only food, with the assumption that facilities like water supply, education and health are taken care of by public systems. This leaves the issue of certain capital costs such as clothing, shelter, transport and maybe a minimum amount of utensils and cosmetics like soap/toothpaste that are required. Here one can impute a rental value of R1,000 in a distant suburb in an urban area and another R300 for electricity, and R700 for transport and other miscellaneous expenditure. Adding the two, a sum of R6,000 a month can be the cut-off for one on the precipice for absolute deprivation. This amount comes within the range of $1-1.25 a day, which works out to R6,000-7,500 per annum. The present amount of R3,800 a month would hold for a just about basic existence with support from public systems that may not exist.
So, how do we look at these numbers? First, let us not just condemn the government’s number of R32 a day per person. There is some sense in it and it is a good cut-off for the government to consider for BPL (below poverty line) supply of foodgrains or any other anti-poverty programme. In fact, the MGNREGA also assures a minimum wage of R100 a day, which covers one member of a family for a fixed number of days, and which assumes that the person’s other requirements are being addressed by the existing systems. Second, the criteria for defining poor should be made broader. It would be transparent to have two poverty lines—one of ‘absolute deprivation’ and the other defining the ‘margin of respectability’. As can be seen, even with R7,500 per month or $1.25 a day, the standard of living is still sub-optimal when compared with the level of living of the poor in other countries. The Centre’s aim must be to tackle deprivation while the state should look for means to improve the respectability of the community through effective supply programmes of health, education, clothing and affordable shelter.
Therefore, while one may still be critical of whether these numbers are adequate to keep a family actually alive, given that the poor in, say, a developed country like the US (family income of R22,350 per annum) is affluent compared to the Indian counterpart, let us not just criticise the government for such an estimate. Alternatives can be worked out and we can reach a consensus.
The definition of people who are poor is nebulous. In India, we follow the nutrition criteria and the cut-off of R32 a day in urban areas has come under sharp criticism. There is a World Bank definition of $1 a day or $1.25 a day at PPP (purchasing power parity). Based on these numbers, everyone has their own estimate of the number of poor. The Indian definition has less poor as the national poverty line is 28.6% compared with 41.5% for the World Bank (Economic Survey 2010-11). Then there is the Tendulkar Committee Report and the one from the Planning Commission that arrive at different cut-offs—poverty levels based on the Tendulkar committee (from where the R32 cut-off comes) are 37.2% in 2004-05. Finally, there was the Arjun Sengupta Report that created a stir as it spoke of 77% being poor based on a R20 cut-off, which included some basic services, too (2004-05).
The important thing is what we take into account when calculating who is poor. Should it be only food intake or even other amenities like housing, clothing, education etc? Hence, it becomes a challenge for the evaluator. It is, thus, necessary to upfront define what we mean by a poverty line. Once we move away from basic food, then it becomes difficult to work out costs on shelter or clothing, as they vary substantially across the country depending on the region or state. To take this issue sequentially, let us look at what is required for an individual family to just about live with no luxury of any sort to remain at the fringe of survival. The accompanying Table calculates the cost of various items that are necessary going by prices in Delhi for September 2011 as provided by the ministry of consumer affairs. A family of four is considered here.
The Table shows that at current prices, a family earning R3,800 a month is the basic amount that is required for survival in terms of food. This allows for the concept of tea being consumed regularly for the family and limited variety as well as quantity of vegetables in the form of potatoes and absence of any meat/fish. This amount can rise to, say, R4,000 in case of price aberrations. The cut-off of R32 a day comes close to this amount, because for a family of four, total expenditure is R3,840. Here again, we are assuming that all four are working. Therefore, an evaluator should be asking a question to a household of four members whether or not they earn R3,800 a month. If they do, then this will address the issue of basic food consumption and nothing more.
Thus, there is some merit in the cut-off of R32 a day in case we are talking of only food, with the assumption that facilities like water supply, education and health are taken care of by public systems. This leaves the issue of certain capital costs such as clothing, shelter, transport and maybe a minimum amount of utensils and cosmetics like soap/toothpaste that are required. Here one can impute a rental value of R1,000 in a distant suburb in an urban area and another R300 for electricity, and R700 for transport and other miscellaneous expenditure. Adding the two, a sum of R6,000 a month can be the cut-off for one on the precipice for absolute deprivation. This amount comes within the range of $1-1.25 a day, which works out to R6,000-7,500 per annum. The present amount of R3,800 a month would hold for a just about basic existence with support from public systems that may not exist.
So, how do we look at these numbers? First, let us not just condemn the government’s number of R32 a day per person. There is some sense in it and it is a good cut-off for the government to consider for BPL (below poverty line) supply of foodgrains or any other anti-poverty programme. In fact, the MGNREGA also assures a minimum wage of R100 a day, which covers one member of a family for a fixed number of days, and which assumes that the person’s other requirements are being addressed by the existing systems. Second, the criteria for defining poor should be made broader. It would be transparent to have two poverty lines—one of ‘absolute deprivation’ and the other defining the ‘margin of respectability’. As can be seen, even with R7,500 per month or $1.25 a day, the standard of living is still sub-optimal when compared with the level of living of the poor in other countries. The Centre’s aim must be to tackle deprivation while the state should look for means to improve the respectability of the community through effective supply programmes of health, education, clothing and affordable shelter.
Therefore, while one may still be critical of whether these numbers are adequate to keep a family actually alive, given that the poor in, say, a developed country like the US (family income of R22,350 per annum) is affluent compared to the Indian counterpart, let us not just criticise the government for such an estimate. Alternatives can be worked out and we can reach a consensus.
Sargent, Sims and RBI Financial Express, 12th October 2011
It has become almost a fashion that the Nobel Prize winners get their reward long after they have made their contribution. It is said in a wry manner that seldom do the winners actually get to enjoy this recognition in their prime and end up ruminating over the same in their twilight years. Also, some of the winners become famous after the award while being in the shadow for most of their careers. However, the field of economics has been different, as it does recognise economists in their prime and for very relevant reasons. This holds especially for Thomas Sargent and Christopher Sims, who are just too relevant in this uncertain world of financial and country crises. Their theories have added method to the madness around us, thus signalling to policymakers as to what should be done.
Their relevance today is for all central banks and governments as they seem to be quite unsure of what should be done given the low level of credibility in a situation of economic downturn. How do we go around framing policies when there is a two-way symbiotic relation between economic variables and policies? For example, central banks base their policies on what they expect economic agents to do, while these agents base their decisions on the basis of what they expect the central bank to do. Therefore, every step taken in this game is based on expectations of the behaviour of the other. One is not sure of whether one or both will get it right. How then does one reach equilibrium, considering that each of the participants is one step ahead of the other all the time?
This is where Thomas Sargent took off on the efficacy of policy changes that are expected and unexpected in the now famous theory of Rational Expectations, along with Robert Lucas, way back in the 1970s. Let us suppose that all of us now expect RBI to increase interest rates later this month. We, as rational economic beings, adjust our decisions based on this rate hike. Now when this rate hike takes place, we see that it is ineffective as it no longer matters as decisions have already factored in these changes. Therefore, Sargent would say that for policy to have its effect, it must be unexpected. In simple language, this means that RBI should, say, raise rates by 50 bps instead of an expected 25 bps if the market is expecting the latter. Intuitively, we can see that when we expect a 25 bps increase in interest rates, we may increase our demand for credit beforehand and hence dent RBI’s move when it happens, which is aimed at controlling growth in credit.
The same holds for tax policies of the government. Sims talks of shocks while Sargent stresses on systemic policy shifts that matter. Both ways, there is a challenge for policymakers, especially when they target, say, inflation. Should we lower tax rates? The crude oil customs rate was lowered by the government around three months ago, but that did not help as prices continued to be rigid. Similarly, RBI has increased interest rates to curb inflation, but the impact has not been satisfactory and this is where we have another theory of efficient markets that comes in the way. If markets are efficient, then they take into account all factors that move it automatically so that the price discovered imbibes the same, which, in the context of expected policy responses, is already subsumed. Therefore, we do need systemic policies to counter the same and not just single shots at rate hikes. Maybe this is what RBI has been pursuing for the last 18 months or so with sustained increases in rates.
The quandary for policymakers is quite interesting. By raising rates, we can impact inflation with a lag of two years (based on their studies). However, the impact on GDP is immediate, as spending stops immediately and hence this is the starting point of the problems as it takes a substantially longer time period for this reversal to upswing.
But the question for, say, RBI, or even the Fed, is whether or not the market is really efficient. If it is, in the theoretical sense, then it may not matter. But in the current context, where there is asymmetric information and varied expectations based on numerous conjectures, an optimal solution will still not be forthcoming, thus opening up the scope for systemic policy steps, which, though not unexpected, are still effective.
These economists have used a lot of econometric modelling to prove their theories and, given the nebulous and symbiotic relation between the two sets of factors, RBI should probably build a strong theoretical basis for its policy actions based on empirical evidence. This will explain, if not resolve, the ongoing debate of the tenuous relationship between interest rates and inflation, where the majority view is gravitating towards the school that given the lags involved, we may just about be shooting in the dark.
Also, to address the issue of providing shock therapy to the markets to be more effective, maybe there should be no official communication on the central bank’s view of interest rates as we have an official statement coming in every 45 days. This may just make the statements more powerful in terms of effect, which is what monetary policy is all about.
Therefore, a combination of systemic policies with shock elements could be the prescription.
Their relevance today is for all central banks and governments as they seem to be quite unsure of what should be done given the low level of credibility in a situation of economic downturn. How do we go around framing policies when there is a two-way symbiotic relation between economic variables and policies? For example, central banks base their policies on what they expect economic agents to do, while these agents base their decisions on the basis of what they expect the central bank to do. Therefore, every step taken in this game is based on expectations of the behaviour of the other. One is not sure of whether one or both will get it right. How then does one reach equilibrium, considering that each of the participants is one step ahead of the other all the time?
This is where Thomas Sargent took off on the efficacy of policy changes that are expected and unexpected in the now famous theory of Rational Expectations, along with Robert Lucas, way back in the 1970s. Let us suppose that all of us now expect RBI to increase interest rates later this month. We, as rational economic beings, adjust our decisions based on this rate hike. Now when this rate hike takes place, we see that it is ineffective as it no longer matters as decisions have already factored in these changes. Therefore, Sargent would say that for policy to have its effect, it must be unexpected. In simple language, this means that RBI should, say, raise rates by 50 bps instead of an expected 25 bps if the market is expecting the latter. Intuitively, we can see that when we expect a 25 bps increase in interest rates, we may increase our demand for credit beforehand and hence dent RBI’s move when it happens, which is aimed at controlling growth in credit.
The same holds for tax policies of the government. Sims talks of shocks while Sargent stresses on systemic policy shifts that matter. Both ways, there is a challenge for policymakers, especially when they target, say, inflation. Should we lower tax rates? The crude oil customs rate was lowered by the government around three months ago, but that did not help as prices continued to be rigid. Similarly, RBI has increased interest rates to curb inflation, but the impact has not been satisfactory and this is where we have another theory of efficient markets that comes in the way. If markets are efficient, then they take into account all factors that move it automatically so that the price discovered imbibes the same, which, in the context of expected policy responses, is already subsumed. Therefore, we do need systemic policies to counter the same and not just single shots at rate hikes. Maybe this is what RBI has been pursuing for the last 18 months or so with sustained increases in rates.
The quandary for policymakers is quite interesting. By raising rates, we can impact inflation with a lag of two years (based on their studies). However, the impact on GDP is immediate, as spending stops immediately and hence this is the starting point of the problems as it takes a substantially longer time period for this reversal to upswing.
But the question for, say, RBI, or even the Fed, is whether or not the market is really efficient. If it is, in the theoretical sense, then it may not matter. But in the current context, where there is asymmetric information and varied expectations based on numerous conjectures, an optimal solution will still not be forthcoming, thus opening up the scope for systemic policy steps, which, though not unexpected, are still effective.
These economists have used a lot of econometric modelling to prove their theories and, given the nebulous and symbiotic relation between the two sets of factors, RBI should probably build a strong theoretical basis for its policy actions based on empirical evidence. This will explain, if not resolve, the ongoing debate of the tenuous relationship between interest rates and inflation, where the majority view is gravitating towards the school that given the lags involved, we may just about be shooting in the dark.
Also, to address the issue of providing shock therapy to the markets to be more effective, maybe there should be no official communication on the central bank’s view of interest rates as we have an official statement coming in every 45 days. This may just make the statements more powerful in terms of effect, which is what monetary policy is all about.
Therefore, a combination of systemic policies with shock elements could be the prescription.
Let’s not be overawed : 5th October 2011 Financial Express
That the fiscal deficit was going to be exceeded was a foregone inevitability once the government reduced duties on oil products a few months ago, which would result in a fall of around R50,000 crore in tax revenue. The slowdown in growth in industry is indicative of excise collections getting under pressure while other collections like corporate tax and customs would be in the fuzzy zone for some time. The only way the situation could have been saved is by the denominator increasing to maintain the ratio at around 4.6% for the year. With the government/RBI now announcing a calendar for government borrowing of an additional R53,000 crore, the markets have been spooked. How serious is the issue?
The fiscal deficit ratio is the one which is under the control of the government to a large extent as it has the power to monitor the expenditure towards the end of the year, depending on how the revenue collections fare. Often in the past, project expenditure is scaled down to ensure that the ratio is maintained while the sluggish nature of approval of projects in the normal course adds to the comfort level. Admittedly, this will be a challenge, considering that some part of the NREGA allocation would have been spent by now. Therefore, there is a strong possibility of the budget still being manageable notwithstanding these slippages.
The fiscal deficit ratio of 4.6% was budgeted on the assumption that GDP at current market prices would grow by 14% in FY12. In real terms, GDP was projected to increase by 9%, consistent with 5% inflation. The way things have turned out, real GDP will grow by possibly 8% now, while inflation would average 9% for the year, thus bringing the nominal growth rate to 16%. The higher inflation rate will hence be quite fortuitous for the budget. This higher base will cushion the higher numerator, which will be higher by around R50,000 crore. The fiscal deficit ratio hence will be around 5% of GDP for the year under these conditions.
The only joker in the pack, so to say, would be the disinvestment programme, where the government started off with hopes of raising R40,000 crore and little progress has been made so far. While the market may not be exciting for raising money at this point of time when global markets are also gloomy, given the uncertain conditions in the euro area, any action of the government by itself can propel investors at a time when there is a drought in the market. But, certainly, this can upset calculations further, which could take the ratio to 5.5%, depending on the revenue shortfall on this score.
How about the money markets? Bond prices have been quick to respond, which is but natural, given that there will be an excess supply of paper, which, in turn, will depress bond prices and increase yields. But yields may not really soar to substantially higher levels if one looks at past trends. During June-August 2008, 10-year yields scaled the 9% mark and touched 9.32%, but this was not a year when borrowings were excessive. It was caused by tight monetary conditions, in terms of both liquidity and interest rates, at a time when there was a global financial crisis and RBI too had been aggressive in the market. Interest rates surely are high today given high inflation (which was subdued at that time). But liquidity is relatively easy, which is comforting in this situation. Also, traditionally, bond yields react more to liquidity conditions than the policy stance on interest rates.
RBI has already scaled down its projection for credit growth by 1 percentage point, which intuitively means that, on a base of R35 lakh crore as of March 2011, there would be a potential release of R35,000 crore for banks, assuming that deposits continue to grow smartly. In fact, the picture up to the first week of September shows that there is a large gap between incremental deposits and credit by around R1,30,000 crore, which is indicative of a twin phenomenon of growing deposits and subdued credit conditions. Therefore, liquidity should not really be an issue, though banks will not be too comfortable with declining bond prices as it would mean a hit on their mark-to-market valuation of their investment portfolio at the end of the year. Hence, their concern would be of a different kind, given that liquidity could be positive as long as growth in credit does not accelerate—which is anyway RBI’s goal, given its aggressive monetary policy stance.
All this means that while there will be a fiscal slippage, and our dream of moving towards the 3% fiscal deficit mark is still far away, conditions will not be too bad. Globally, too, deficits are high, with governments struggling to keep it under control. In fact, the new way of thinking everywhere is that higher deficits are useful to keep economies afloat. There is no reason why things should be different here in India.
The fiscal deficit ratio is the one which is under the control of the government to a large extent as it has the power to monitor the expenditure towards the end of the year, depending on how the revenue collections fare. Often in the past, project expenditure is scaled down to ensure that the ratio is maintained while the sluggish nature of approval of projects in the normal course adds to the comfort level. Admittedly, this will be a challenge, considering that some part of the NREGA allocation would have been spent by now. Therefore, there is a strong possibility of the budget still being manageable notwithstanding these slippages.
The fiscal deficit ratio of 4.6% was budgeted on the assumption that GDP at current market prices would grow by 14% in FY12. In real terms, GDP was projected to increase by 9%, consistent with 5% inflation. The way things have turned out, real GDP will grow by possibly 8% now, while inflation would average 9% for the year, thus bringing the nominal growth rate to 16%. The higher inflation rate will hence be quite fortuitous for the budget. This higher base will cushion the higher numerator, which will be higher by around R50,000 crore. The fiscal deficit ratio hence will be around 5% of GDP for the year under these conditions.
The only joker in the pack, so to say, would be the disinvestment programme, where the government started off with hopes of raising R40,000 crore and little progress has been made so far. While the market may not be exciting for raising money at this point of time when global markets are also gloomy, given the uncertain conditions in the euro area, any action of the government by itself can propel investors at a time when there is a drought in the market. But, certainly, this can upset calculations further, which could take the ratio to 5.5%, depending on the revenue shortfall on this score.
How about the money markets? Bond prices have been quick to respond, which is but natural, given that there will be an excess supply of paper, which, in turn, will depress bond prices and increase yields. But yields may not really soar to substantially higher levels if one looks at past trends. During June-August 2008, 10-year yields scaled the 9% mark and touched 9.32%, but this was not a year when borrowings were excessive. It was caused by tight monetary conditions, in terms of both liquidity and interest rates, at a time when there was a global financial crisis and RBI too had been aggressive in the market. Interest rates surely are high today given high inflation (which was subdued at that time). But liquidity is relatively easy, which is comforting in this situation. Also, traditionally, bond yields react more to liquidity conditions than the policy stance on interest rates.
RBI has already scaled down its projection for credit growth by 1 percentage point, which intuitively means that, on a base of R35 lakh crore as of March 2011, there would be a potential release of R35,000 crore for banks, assuming that deposits continue to grow smartly. In fact, the picture up to the first week of September shows that there is a large gap between incremental deposits and credit by around R1,30,000 crore, which is indicative of a twin phenomenon of growing deposits and subdued credit conditions. Therefore, liquidity should not really be an issue, though banks will not be too comfortable with declining bond prices as it would mean a hit on their mark-to-market valuation of their investment portfolio at the end of the year. Hence, their concern would be of a different kind, given that liquidity could be positive as long as growth in credit does not accelerate—which is anyway RBI’s goal, given its aggressive monetary policy stance.
All this means that while there will be a fiscal slippage, and our dream of moving towards the 3% fiscal deficit mark is still far away, conditions will not be too bad. Globally, too, deficits are high, with governments struggling to keep it under control. In fact, the new way of thinking everywhere is that higher deficits are useful to keep economies afloat. There is no reason why things should be different here in India.
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