Interesting time for banks, if only...Financial Express 13th December 2012

The banking space is always full of activity, with RBI in particular being under the lens not just for the decision on interest rates but the financial environment as well. It is not surprising that the Banking Law Amendment Bill has raised interest once again for not being passed.

The Bill, when viewed along with the passage of changes in the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, reads well for the banking sector as it addresses the issues of both capital and asset quality (subsumed under prudential banking) in a limited manner. We all know that for sustaining growth of 8% per annum in the future, bank credit has to increase by over 20% per annum. This requires capital for banks, which will progressively pose a challenge given that we are moving over to Basel III, where the capital and liquidity requirements are more pressing. Therefore, having new banks makes a lot of sense as this will bring in the capital that is required. The next stop would be for RBI to work out the game-plan and set the ground rules. There are a number of corporate houses like Tata, L&T, Birla, etc, that are prepared to start such outfits or have their own NBFCs converted to a bank.
The second area where the Bill has focused on is the voting rights privilege. Increasing it to 10% for public sector banks (PSBs) and 26% in private banks is pragmatic as it provides more incentives to involve shareholders in the running of the bank, which improves transparency as well as governance and efficiency. This could be a useful step in moving further towards disinvestment of public sector banks as we get used to more private participation in the affairs of the bank. Third, RBI will have more powers to regulate acquisitions in this space. This does not really matter much as RBI is already quite powerful and we may not be seeing such activity concerning large banks. More likely, this would be for weaker or smaller banks, where there would not be any serious issue.
Fourth, the question of banks and ARCs being allowed to convert outstanding debt owed to them to equity or bidding for immoveable property that has been put for auction is useful for them as it means that they will address the critical part of NPAs. Banks should be pleased with this move as they are offered more options at a time when their NPAs have increased and they have been saddled with progressively increasing restructured assets. Discussions on these issues have, by and large, been more or less according to the script, which over months has managed to garner a reasonable level of acceptance. However, the issue that has become controversial pertains to allowing banks to enter the commodity futures market. This would have probably been one of the most revolutionary decisions taken by the government because given the pro-cyclical nature of growth of NPAs with agricultural production and industrial growth, there is a pressing need for a cover to be procured by banks. At present, agriculture has crop and weather insurance, which provides cover to the farmers, though not to the bank as recovery would still be its job.
As bank lending is predominantly against the existence of a commodity somewhere in the input-output matrix for a company or directly for farmers, there is a commodity price risk that is carried on its books. At the pre-harvest stage, the farmer carries a price and volumetric risk, of which the latter is covered by the insurance company. The bank lends to the farmer for inputs and the latter’s ability to repay the loan depends on the price at the time of harvest. Intuitively, it can be seen that the bank is better off in case the farmer hedges his price risk on a commodity exchange. However, today, farmers cannot access this market due to the absence of knowledge as well as their trading lot size, which is too small. A solution is for banks to act as aggregators for farmers as it pays them to hedge their risk in the eventuality of the crop failing. The banker only needs to convey the quantity of crop involved to the central treasury which puts in the order. This is what RBI had recommended in the draft report on warehouse receipt finance in 2005.
The same analogy can be carried for non-farm products, where often banks are impacted by volatility in prices of specific commodities like oilseeds, sugarcane, steel, aluminium, wheat, crude oil, etc. Here, banks can provide cover for themselves in case they take a corresponding position in the commodity derivative market with active trading in farm products on exchanges like NCDEX and energy products on MCX. Most of these products are offered on these exchanges or have proxy products that may be used. In fact, banks would be better off in case ‘options’ were permitted in this market as futures protects against downside risks while options lets one exit when conditions are better at the time of settlement of contract. But this needs the Forward Contract Regulation Act (FCRA) to be changed, which is another Bill pending in Parliament.
The FCRA Amendment Bill seeks to give autonomy to the Forward Markets Commission (FMC), which, in turn, would give it power to introduce new products which will include options and indices (intangibles). Therefore, for banks to be allowed into the commodity market, it would also be necessary to amend this Bill so that options are permitted as in the capital market. An interesting corollary here is that banks could also take proprietary trading positions in this segment, just like they do in the capital market. RBI would, however, have to set the regulatory processes to ensure that there is controlled trading that does not distort their own business models. This may still be a long way off.
The impasse in Parliament is ostensibly on account of futures trading by banks. Logically, the other elements that have been agreed upon should be passed immediately so that work can begin, especially on the issue of new banks being permitted, while the issue of futures trading can be separately debated. Or else we will have to wait again for a longer time period, which is not desirable for the banking system as we always seem to be returning to the starting line of a race that never seems to begin.

Need to rethink priority sector lending: Financial Express November 8th 2012

Inclusive banking is desirable, but by forcing it on financial institutions, we could be making it tough for banks

A major issue confronting our financial system is the quality of assets. This has been exacerbated by the economic downturn, which is typically when loans stop performing. While restructuring is a way out for some cases, it poses conundrums for the lending institution as well as the regulator. An issue that comes up here is asset quality and priority sector lending. So far, with all the talk of inclusive growth, there are fixed norms for lending to vulnerable sectors. But, if one looks beyond the conventional commercial banking system, this problem is even scarier.
Within commercial banks, a little less than half of the non-performing assets (NPAs) originate in the priority sector (whose share in total credit is around 31-33%), and given that this sector is held sacrosanct, seldom do bankers raise objections and instead defend the concept as being necessary. In FY12, 4.4% of outstanding priority sector advances were classified as non-performing, while the same for non-priority sector was 2.4%. Further, growth in these NPAs was much higher than that in loans to this sector. Clearly, there are problems associated with such finance.
The accompanying table provides the picture of NPAs for various cooperative banks that are seldom analysed, which provide support to the rural economy and the small & medium enterprise (SME) segment.
The table shows that we have a large network of cooperative banks in the urban and rural spaces that offer various credit facilities to agriculture and SMEs. These banks have assets equivalent to around 12-15% of the commercial banking system, which is quite significant given that they address sections that would not qualify with commercial banks. Further, while the urban cooperative banks are profitable, the same does not hold at the rural level.
The significant aspect is the high levels of NPAs, which, at the level of rural development banks, is quite disastrous. Clearly, the business model does not work well at this level. The recovery ratios are also quite low and vary between 39.4% for PACs to 91.8% for SCBs. Given that these loans are directed mainly to farm-based borrowers, the problem is actually with the sector rather than the banks.
Two questions may be posed here. The first is whether the concept of priority sector lending is anachronistic in a regime where banks are answerable to their shareholders and adhere to prudential norms relating to bad assets and capital. Forcing banks to lend in areas where the probability of assets turning bad is higher may not be right. One reason why foreign banks do better is that they have less exposure to this segment.
The second relates to reforms in cooperative banking. Having NPA levels of 41.7% for PACs, 34.3% for SCARDBs, and 11.6% for DCCBs is definitely not viable. While there is a committee that has spoken about revamping them and providing more capital, the question to be answered is whether or not there are ways in which such lending is addressed. At the level of cooperative banks, the skill sets for evaluation of loans may be missing. But for commercial banks it is more the compulsion than the absence of skill sets that engenders such quality of assets.
Four solutions could be looked at, which should probably progress simultaneously. If banking has to be profitable and viable at the same time, the concept of priority sector should not be forced on banks and this level has to be brought down. In fact, it was suggested by the Narasimham Committee also a long time ago when financial reforms were invoked.
Second, the government should create a fund to compensate banks for such loans that are vulnerable to the vagaries of nature and tend to get magnified when there is a drought. This is a challenge given the fiscal constraints that already exist, but diverting a part of the MGNREGA expense for this purpose could be an idea as this will qualify as development expenditure. To lower this burden, various state governments could be asked to chip in.
Third, the government could impose an NPA cess on all borrowings so that a fund is created automatically by any bank on its loans, which can be used to make provisions or write-offs for NPAs. This will push up the cost of funds for borrowers, but in a way they would be made to subsidise the vulnerable sections. An extension could be to have a cess on all tax collections, which can also help. Interest earned for banks in FY12 was around R6.5 lakh crore. Assuming 70% from advances of which two-thirds from non-priority sector, interest would be around R3 lakh crore. A 1% cess on this would yield R3,000 crore.
The other solution is to allow credit default swaps on loans, which is not allowed today. The advantage here is that the risk involved in this lending can be mitigated by a third party. The issue, of course, will be that the CDS price will be high for farm loans that carry greater risk than, say, one to an SME. But, if bank loans are brought under this fold, it will help them to cover their risk theoretically at least. Mutual funds, foreign banks, NBFCs, insurance companies (which already are in the business of providing crop insurance and weather insurance to farmers) could be possible sellers of protection.
Inclusive banking is certainly desirable, but by forcing it on financial institutions, we could be making it tough for banks, especially when they are more susceptible to turning into NPAs. So far, we have skirted the issue as it sounded politically correct. But with the incidence of such lending turning unsatisfactory, alternative routes have to be explored or else we will get caught in a contradictory world where the best practices of BIS have to mingle with the pro-nationalisation thought process of the 1970s and 1980s, which looks irreconcilable as of now.

Is a foreign governor better for RBI? Financial Express 4th December 2012

The appointment of Mark Carney as the Governor of the Bank of England is interesting for several reasons. This is the first time in the history of the bank that an outsider has been chosen on account of his profile being the best. But, getting in an external candidate for the job does raise certain issues, which would be more relevant when it comes to a country like India. Given that we have an external economic advisor, does a foreign central bank governor make sense?

To begin with, the advantages of having a non-resident governor could be looked at. First, a governor of a central bank who has run the affairs of the bank successfully certainly qualifies for candidature. If the performance has been exemplary, one quite clearly qualifies for a set of countries that have similar structures, such as Canada and England—both developed countries. But the same may not hold true if a central banker from a developed country were to be considered for a country like ours where conditions are vastly different and priorities less aligned to those pursued in the West.

Second, the outsider can bring in a fresh way of thinking to central banking, especially when this sector is in a state of flux. Experiences from other central banks’ handling of crises-like situations are always helpful when drawing up strategies for the domestic central bank. The crises witnessed in the US and the euro regions provide sufficient case studies that have been seen through by central banks via different strategies. These are real life experiences and not just from the text book.

Third, any outside governor brings along a certain modicum of independence, which is good since they would be free from past baggage, which can help in running the central bank. Often, one gets bogged down by pressures by the government or industry houses, especially in developed economies, where policy can be guided by them. Therefore, a corollary is that if a country is looking for the best person to run a difficult role such as heading the central bank, it should not matter where the person comes from.

While surely there are advantages in having an outsider, there are a good number of reservations for such a selection, which holds true more in developing countries such as India, and could also hold true for some western economies. First, an ‘outsider is an outsider’ and would not be aware of local conditions and would find it hard to reconcile the various brands of economics in practice across this group of countries. This makes adjustment to the environment, both within the organisation and outside, difficult. This holds more so in case the two geographies are vastly different, such as a developed and a developing country. An example here is the complex financial system like India’s, which has rigorous concepts such as priority sector norms and SLR, as well as NBFCs, cooperative banks, which makes coordination for an outsider more challenging.

This leads to the second point. There would be a tendency for the outsider to use models that are considered to be ideal and may not gel well with the local conditions. An example here is the pursuance of monetary policy that has to reconcile with fiscal goals that are quite different. Further, the financial systems are complex, and structured products, which were popular in the US though not so much in other countries, could be a puzzle for a central banker who has not dealt with them in his own regime.

Third, following from the second, in emerging markets in particular, the concept of an independent central bank is hard to pursue as there has to be harmonious working with fiscal policy. Asking the government to lower the fiscal deficit by reducing subsidies may make a lot of economic sense, but could be a difficult choice when development levels are low. A non-accommodative monetary policy would create frictions in working. In such situations, lasting an entire tenure would be difficult for a central banker, who could often be on the opposite side. Anecdotal experience shows that, finally, government power prevails and the governor has to accept or quit. The latter could be destabilising.

Fourth, from an ideological viewpoint, the post of a central banker is very crucial for any country—like, say, the head of the defence sector—and should be led by a citizen. A foreigner could be appointed as an advisor for the experience brought along, but the governor surely should be domestic.

On balance, it may be argued that while the British case has a greater probability of succeeding, the same may not hold true for emerging markets, including India. Governors of RBI have generally had some exposure to working in the government, which is helpful as they are practical and know how policies function. Working of the two arms becomes easier when there is understanding. Having a very independent governor can be an issue, especially if there is intransigence in aligning with other government policies. One must remember that the monetary arm of the government, the central bank, cannot work in isolation as its job is to harmonise the financial sector with the requirements of the real sector, where growth takes place. The situation is akin to a corporate where all departments have to work together in harmony, and a person who is home-grown would have an advantage.

Further, whenever one speaks of having a foreign governor for the central bank, an option always exists where home-grown experts actually work in foreign organisations such as IMF, World Bank or Bank for International Settlements where there is exposure to global best practices, which is of essence today in banking, with the Basel norms virtually dictating the rules of the games for all banking systems. Therefore, there may be no real requirement to look outside; in-house certainly looks the better option.

The Big Bank Theory: Book Review in Business World 3rd December 2012

Veteran financial journalist,Tamal Bandyopadhyay reconstructs the story of HDFC bank's growth into one of the sturdiest banks in India

 

A Bank For The Buck :The story of HDFC Bank By Tamal Bandyopadhyay Jaico books Pages: 344 Price: Rs 395

 

Writing the biography of an institution is a challenge. If it is to record its history, the objective is clear and the path is one of documentation. But if it is to tell the story of a dynamic organisation that epitomises innovation, the narrative sets paradigms. Else, the story runs the risk of having a limited audience, being familiar to those associated with the organisation, and the names may not mean much for the lay reader. So, reconstructing the growth of HDFC Bank — arguably the steadiest bank here — is prima facie an unexciting story. It does take one of the most accomplished banking journalists to add the necessary zing to the story.

Tamal Bandyopadhyay starts by talking about the ‘dirty dozen’ that set up the Bank, cherry picked by Deepak Parekh — who for all purposes — has been the ‘producer’ of this potboiler. Parekh, who carved the HDFC Bank story out, is technically an outsider, but he has steered right from its start through the entire mergers and takeovers to where it is today. Aditya Puri, managing director and CEO of HDFC Bank since its inception, is more of the ‘director’ of this saga.

Arguably the cleanest private bank in India by far, HDFC Bank has seldom strayed from the path except for a brief deviation on the forex derivative tryst, where the penalty was just Rs 15 lakh. It was more of a reputation hit. There was also the Roopalben Panchal case where it was caught on the wrong foot, but recovered as fast as it slipped. The bank was created by foreign bankers who had to deal with several tradeoffs in terms of pay cuts, risk and giving up good positions on foreign lands. The idea was to provide services of a foreign bank and create relationships and distribution channels of nationalised banks — the best of both worlds.

Getting the team in place was the hard work of Parekh, but getting in like-minded people made the concept work. Their initial days before the main office came up make interesting reading, but this is the joy or travail of creating organisations. HDFC Bank, unlike its closest competitor ICICI Bank, was not an innovator or risk taker, but an astute follower that blended commerce with prudence to be known as the bank with the best quality of assets. Minimising risks and running a diversified book allowed it to “eat well, sleep well”. The focus was always on net interest margins and enlarging the Casa (current and savings account) component in deposits.

Bandyopadhyay vividly narrates how the bank acquired customers. It started with Siemens and went about systematically from being a corporate-to-retail bank to enlarge its perimeter. The small and medium enterprises came much later. The bank also had its brushes with bad assets, including microfinance firms, but it was manageable given the low exposure. More importantly, it was swift to make an exit.

HDFC Bank will also be remembered as the only bank to be involved in a series of mergers, starting with Times Bank and then Centurion Bank. The process of physical and cultural integration was a challenge well accomplished given that Times Bank followed public sector giant SBI while HDFC Bank had a foreign bank tilt.

Bandyopadhyay says the bank is ‘doing ordinary things, the extraordinary way’. The same can be said of his narrative as well; he keeps the reader engaged. While he gets Puri’s colleagues to talk about him, the tilt is definitely positive. It would have been interesting to hear from detractors, which is important especially when the leader has been so successful. On a lighter side, it would have been interesting if the author had either discussed with Parekh or provided his own view on having the same MD & CEO since the bank’s inception and how it fits with the concept of corporate governance that has been epitomised by the bank. Also, Bandyopadhyay does not ‘choose’ as to who should be credited for HDFC Bank’s success: Parekh or Puri — as a journalist, he could toss the coin.

The borrowers take: Book review Business World 26th November 2012

David Graeber, an anthropologist, explains the evolution of debt through various societies and the way it is perceived today

Madan Sabnavis

 

Debt: The First 5,000 Years By David Graeber Penguin(Allen Lane) Pages: 544 Price: Rs 799

 

 

Discussing debt has become a favourite with authors post the sovereign debt crises that made writings on such topics good business. But rarely do we get to read an anthropologist’s take on debt and that is why David Graeber makes a mark with this extremely interesting book. Graeber explains the evolution of debt through various societies and the way it is perceived today. While typically one’s sympathies lie with the creditor, he prompts us to look at it from the debtor’s point of view. At times, when he raises a moralistic issue where he justifies the non-repayment of debt if the money is spent on the poor, Graeber provokes debate.

His views on debtors are quite novel. First, he says, countries were colonised and made to pay for developments they did not ask for. Can such debt be justified? Second, indebtedness also increased during wars and the loser became indebted when it was made to pay for reparations. Last, after the Opec crisis in the 1970s, oil producers earned truckloads of dollars which were lent to dictator countries at high interest rates, which were then embezzled. Later, elected governments were left with the overhang, which could not be repaid. How do we judge these situations?

Graeber is fairly caustic on the US, which urges third world countries to open up markets while running the world’s highest levels of debt. He does not miss a chance to chastise entities such as the IMF, which bully borrowers into following their western-oriented policies — a view echoed often by Joseph Stiglitz.

The author goes back in time to tell the story of how the concept of debt evolved. He delves into religions, which are invariably ambivalent when it comes to viewing debt. Debt is transformed into a sense of guilt that leads to self loathing. While religions are not against markets in general, they object to debt on commercial grounds. To tell the story of debt, one needs to know the language of the market place.

Graeber distinguishes between debt as a concept in a human and commercial economy. It varies across cultures. In Madagascar, an exchange is a way of cancelling debt, which ends a relationship between two individuals. In Nigeria, people lend neighbours stuff that has to be repaid in kind or cash at a later time. Societies expect a balancing of the equation. So, all transactions are viewed as a way of settling a debt. Taking this anthropological study further, Graeber goes into ancient Irish society where slavery came into being on similar grounds and slaves became a currency. Bonded labour was an outcome of a loan being settled through generations. This is also not uncommon in India. In ancient societies, the same was extended to prostitution, which was a way of repaying debt.

The commercial or money economy then changed the landscape of debt. From around 1825 onwards to 1971, the age of capitalism commenced with the dictates of Adam Smith catching on. An extended form was military intervention of the US in Vietnam, which led to an increase in its own debt. And that is ironically being financed now by emerging countries. Even today, it creates armies across the globe, whose maintenance is being financed by the rest of the world. So there is a contradiction between political imperative of establishing capitalism and its own need to limit its horizon.


The concept of debt as it has evolved has encompassed various emotions across ages — sin, guilt and redemption. What Graeber does is to expose the manner in which debt has been created and these relations exploited for the betterment of certain sections of society, while others, such as the US, get away easily. He shows this is not anything new but has been in existence for long, and even argued by religions. This is a refreshing and compelling treatise on debt written by someone who calls himself an anarchist.

Should gold loans be banned? Financial Express 30th November 2012

In the light of the need for financial inclusion, loans against gold are useful for both individuals as well as the SME segment, where the small entrepreneur can obtain loans easily
In a capital-scarce economy, where access to credit is limited, though growing, gold loans look like a good option provided the ground rules are put in place. Also, since we are talking a lot about financial inclusion, this particular mode of lending is effective for a number of low-income households who buy and hoard ornaments as part of tradition.
Gold loans are typically structured as secured loans where the holder gives gold or ornaments as a security and a gets a proportion of value of the same as a loan. The interest rate varies across banks and NBFCs who finance through this mode. Also, this is a quicker process relative to other personal loans and often is considered to be more dignified as the borrower need not give references, thus revealing his monetary status to others known to them.
Prima facie, this is analogous to the pawn system that exists in unorganised markets with a transparent face. It is a win-win situation for both the lender and borrower. The lender has collateral that can be easily converted to cash and since the loan given is a fixed percentage of value, the downside risk is limited unless the price of gold falls sharply. But given that these loans are normally for a shorter tenure, such a sharp decline in value would be an exception. Therefore, for the borrower, it is a good source of finance as it eschews the elaborate processes that would otherwise be involved in personal loans.
Also, since this security is provided upfront, the borrower need not have any major worry of having other property attached as the transaction involves only the ornaments or gold that is given to the lender.
In the light of the need for financial inclusion, this is useful for both individuals as well as the SME segment, where the small entrepreneur can obtain loans easily. In the case of SMEs, very often the owner has to pledge personal effects, which is limited when gold loans are taken. Therefore, such loans should be encouraged and there is no case for banning or restricting the proliferation of these loans.
From the regulatory standpoint, the safeguards have to be put in place as this business expands. Typically, there are three risks involved, of which two can be addressed. The price volatility in gold should be hedged by the lender simultaneously. Given that the FCRA Bill is likely to be passed, options trading would most probably be available, and hedging would be even more effective. Second, based on past price movements, RBI should fix the margin-lending norms, with a buffer so that any sudden decline in value of the collateral should still be above the threshold level. The lender should also have the right to call for additional collateral when such triggers are reached.
The third risk relates to the higher demand for gold, which has macro-economic implications for the country. But in a free market economy where one can buy imported cheese and motor vehicles, logically there can be no physical restriction on the purchase of gold.

Issues like food prices, PDS can hurt cash transfers plan in food: Economic Times, 29th November 2012

Cash transfers will become a reality soon, and one area that the government is going to align with this mechanism is the Public Distribution System (PDS).
While, prima facie, it appears to be a good idea, given that it removes quite a bit of inefficiency in the present system, there are certain issues that have to be addressed before we go in for the same as they could become obstacles in the implementation of this scheme.

First, the UID scheme provides an identity for a person, but by itself does not tell us whether the person is actually poor or not and whether or not requires to be subsidised. The present system of ration card is based on self-declaration where one mentions the household income to obtain ration. One of the inefficiencies in the system is that this benefit is not well-targeted, which means that the beneficiaries are not always those who are intended to get the benefit.
This leads to adverse selection that has to be addressed in the early stages before going in for cash transfers as, once implemented, it will be difficult to withdraw the unintended beneficiaries. Has this system of identifying the income of families been put in place?
Second, the PDS system provides essentially rice and wheat, along with sugar and cooking oil, which is delivered at a fixed price by the government. The procurement prices are fixed by the government, as is the issue price.
Therefore, both the farmer and the consumer are protected through these prices. Now, the consumer will get a cash transfer equivalent to the value of the quantity of these commodities.
While there can be a debate on how this money will be spent by the household, there are intrinsic problems in arriving at the right amount of money to be given to households.
Let us look at some retail prices at the extreme levels as presented by the ministry of agriculture for some of these proxy products for October 2012. The price of coarse rice varied from 16 per kg in Agartala to 33 per kg in Chennai. In case of wheat, it was between 14 per kg in Ludhiana to 36 per kg in Chittoor.
For sugar, the price varied from 31 per kg to 42 per kg in Ludhiana and Guntur respectively. For groundnut oil, the price band was as wide as 80-205 in Guwahati and Ernakulam. Clearly, we need a firm set of prices for various geographies as well as have differential cash transfers.
Are these systems in place? Presently, the issue prices are fixed. But once we move to cash transfers, the inflation rates in various centres have to be readjusted periodically. Do we have statistical tools in place for the same?
Third, today, we have an open-ended procurement scheme for wheat and rice where FCI procures as much as is offered. This is used for PDS, creating a buffer and a strategic reserve. Now, with cash transfers taking place, the PDS would be redundant. In that case, we would have to redefine the procurement system as the farmers' position would change as they cannot sell without a limit to the FCI.
 The concept of minimum support price (MSP) will get diluted as farmers cannot be assured of selling to the government at an assured price as the existing scheme has to be changed, else, the FCI will be loaded with over 60 million tonnes of annual procurement that cannot be used for distribution with around 32 million tonnes required as buffer in July as per the norms.
The farmers lobby will not be too satisfied with this move and it could be politically-sensitive. As a corollary, the role of FCI has to be reviewed as we have a large organisation that will no longer be relevant beyond the role of holding on to the buffer and strategic stocks.
Fourth, with the FCI now holding on to stocks only for emergencies, the warehouse spaces under its purview need to be put to commercial use. For this, the organisation has to create a viable business model as the space has to be handed over to the private sector. Today, the FCI has around 34 million tonnes of warehousing capacity that is used along with those of CWC and SWCs to hold on to the food grain stock in the country.
Given that either the FCI or the warehousing corporations will have excess space and have to let go, they have to learn to become commercial entities, which is a challenge given that so far they have run like government entities. Has this work begun at the ground level?
Last, we have around five lakh fair price shops spread across the country that enable the PDS. Once cash transfers are in place, these shops would become redundant. Have we thought of what will happen to these outlets considering that, on an average, they involve deployment of 2-3 persons, which means 10-15 lakh jobs? While most deal with other products too, the same may not be sustainable and they would have to be compensated.
Today, one of the main fears of FDI in retail is what will happen to the small retailers. Here, we have a government action that could pose a similar threat to these shops.
Clearly, while cash transfers are a sensible option for a country like ours, we do need to address these issues before implementing this scheme, else, we would run into certain contradictions as all these issues are intertwined and gigantic structures have been built that also involve political compulsions that cannot be separated. Unless we address them, we may just end up putting the cart before the horse.
 

CRR cut won't have much impact on liquidity or interest rates: Economic Times 14th November 2012

The RBI's stance on interest rates has come under discussion in the recent past. Banks have argued for a rate cut to enable them to lower interest rates. In the same breath, some have also debated in favour of a CRR cut on the grounds that this will enable them to lower rates. The FM has been asking the RBI to take action, while the RBI has been selective this year in terms of lowering the repo rate (April) and the CRR (February, March, September and October). The RBI evidently sees interest rates and inflation more from a macro view and implicitly looks at real interest rates. But, how do banks react to rate cuts? Are they really sensitive to rate changes or are they just asking for more?
As a corollary, how do liquidity and G-Sec yields respond? A repo rate change alters the base rate, directly depending on the bank's borrowing from this window. The deposit rates movement is quite discretionary as the bank has a choice to pass on the benefit or simply add to the bottom line. In case of CRR, banks have to perceive it as an increase in the supply of funds to be able to lower rates. But if they get invested in G-Secs, then CRR action may not really matter.
Let us look at the first year — October 2010 to October 2011. The repo rate was increased by 250 bps during this period. Banks increased the deposit rate (for one year as reported by the WSS-RBI), by 125 bps, while the base rate of banks increased by 233 bps. Quite clearly, any rise in interest rates gets reflected less in deposit rates, while base rates increase by almost the same range. G-Sec yields rose by 77 bps, which is the market perception on risk-free bonds, indicating a premium of around minimum 150 bps on commercial lending.
The repo rate was lowered in April by 50 bps, while changes in CRR were invoked prior to this move and subsequently in September. On a partial equilibrium analysis basis, the base rate moved down by around 18 bps by October, while deposit rate moved down by 25 bps. These changes, however, may not be attributed to just the repo rate cut as the CRR was also reduced periodically. Looking at CRR reductions now from February onwards — there were two successive cuts in February and March. The deposit rates did not change till October after the September relaxation in CRR, while the lending rate went down gradually by 17 bps till September, before another CRR cut was invoked.
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Therefore, CRR cuts did not change the structure of interest rates significantly, though base rates were relatively more responsive. Banks have hence held on to deposit rates in this situation. Curiously, liquidity, too, was not really affected on all the three occasions, as the amount released got absorbed in the system almost immediately.
Lending from RBI remained high in February and March (Rs 1,40,000-1,50,000 a day) and was at lower, though still high levels till June (Rs 90,000-1,00,000). The notional benchmark of 1% of NDTL being the ideal amount traded on this window was breached.
The conclusion is that CRR cuts do not really matter much in terms of impact on liquidity or interest rates, especially, when there is a large liquidity deficit in the system. The G-Sec market has been more responsive with the 10-year yield moving downwards by 45 bps since April, when repo and CRR cuts were brought in. The market hence is more alert to policy changes and reacts well as per economic theory. Therefore, what has been observed is that banks do react to repo rate hikes with alacrity and raise deposit rates by less than the base rates, which improves profit margins. But, when CRR is reduced or repo rate is cut, there is some level of intransigency in rates.

Also, CRR reduction certainly does not ease liquidity and is more of a signaling device, which is picked up, albeit, quite mildly by banks. The G-Sec market is more robust in comparison. Hence, even if one would like to throw the onus on RBI for getting the economy started through rate cuts, the reaction of banks is not certain, because somewhere, they do, even though they may not admit it, look at the true economic cost of capital when deciding on their interest rates. Relentlessly asking the RBI to lower rates is one part of the story, but the reaction from the system is certainly more interesting.

How about real estate futures? Business Standard 12th November 2012

Madan Sabnavis: How about real estate futures? They could offer investors high, stable returns and, importantly, a transparent benchmark of prices Madan Sabnavis / Nov 12, 2012, 00:30 IST When inflation is close to 10 per cent most of the time and an investor wants to maximise returns, the nominal return should be more than the inflation rate. Typically, the stock market is considered the best bet, while government securities (GSecs) give the most conservative yield, though the relative risks are proportional. Bank deposits are somewhere in between. One area that has not been looked at closely is the real estate market.The National Housing Bank (NHB) tracks an index called the Residex, which looks at residential housing prices over 15 centres. This has been reckoned from 2007 onwards, and is tracked on a quarterly basis. Now, there are some very interesting observations over the 4.25 years ending March 2012. First, 11 of the 15 centres gave an average compound return that was positive against the Sensex, which declined around 3.5 per cent. In fact, nine centres gave returns between 12 and 20 per cent. Also Read Related Stories News Now - Markets gain as Nov inflation eases - Growth will be a bigger challenge in FY14: SBI - Life insurance policy sales fall 8.22 pc in FY12: Govt - Air India Express to get its act together to fight competition - Land Bill to address old land disputes More Second, Hyderabad, Jaipur, Kochi and Bangalore are  centres that reported negative returns. Third, the highest return was clocked by Chennai at 30 per cent, followed by Faridabad with 20 per cent and Bhopal with 18.3 per cent. Mumbai gave a return of 16.3 per cent and Delhi 13 per cent. Clearly, this is one avenue that the investor has not seriously considered, given the capital outlay involved. These returns cover inflation adequately, which averaged 7.6 per cent on a compound basis during the period. Against these returns, the average price volatility, which is a symbol of risk, was 42 per cent for the Sensex, while it was above 30 per cent in two cities, between 20 and 30 per cent in five cities and between 10 and 20 per cent for eight cities. Clearly, real estate appears to be less volatile than the stock market and, hence, less risky, prima facie, in terms of idiosyncrasy. This becomes important because it also relates to risk-return tradeoff. The GSec market, on the other hand, had a volatility of just five per cent, but gave a yield of 6.7 per cent, which does not cover inflation. The idea that needs to be worked on is whether we can think of going in for real estate “futures” in the same manner that the forex derivative market has evolved. This will give individuals an opportunity to actually start investing in this market, ultimately helping in efficient price discovery, which is absent today. The contract will be on the Residex – which NHB announces – so the settlement price will also have to be declared by NHB. It has to be non-deliverable and cash-settled. Who will buy and sell these futures contracts? Individual investors can go long if they expect prices to move up, or go short if prices are expected to fall. Real estate agents and builders would also be keen to cover their risk as hedgers as will buyers of property, who can benchmark their own exposure to property with these indices. This way, they are covered as either buyers or sellers. The advantage for the investor or speculator would be that unlike today, when the person borrows money to invest, this will be based on a margin calculated by the commodity exchange, which will be much lower than the cost of the project. The minimum lot size could be fixed at Rs 10 lakh, depending on the location. Currently, there is no way of hedging risk when it comes to property. Once a buyer contracts for a price and starts paying instalments, and the price comes down, there is an implicit loss that can be covered on the exchange now (though this has not really been prevalent in recent times when prices move only in one direction). The same holds for developers who would have actually borrowed in the unorganised market at very high interest rates. They run a relatively higher risk given that capital investment is higher. This risk can be lowered through hedging positions on the exchange. The same holds for second-hand property, which will automatically be linked with the Residex. The interesting part will, of course, be the daily settlement prices that have to be either polled by the exchange or declared by NHB. While this may not be possible on a daily basis, a weekly quotation can be attempted. With trading widening, there would be a tendency for the futures traded prices to feed back into the spot prices of property, thus making it more efficient, since it will be based on market forces and not on the builders/real estate companies, as is the case today. Prevailing prices today are opaque because property dealers are able to hold on to unreasonable prices at a time of a decline in the market. While the structuring of the contract has to be designed carefully by the commodity exchange, the Forward Contracts (Regulation) Act needs to be amended to allow for indices to be traded. This is not allowed currently, but would go a long way in the development of other products, too, which will add to the efficiency of the system. Given that the government has announced that it would be running this Act through the Parliament, there is a good chance that if passed, the Forward Markets Commission, would have the power to put intangibles on the table, which will include indices — which is what the Residex is. But, the real estate sector will surely get better organised and transparent, which is the need of the day.