Towards de-industrialisation? Financial Express 14th December 2013

We have drawn some amount of solace from the latest Q2 GDP growth numbers, which indicate a possible recovery over Q1 from 4.4% to 4.8%. The contribution to growth is more from the farm and services sectors, which is commendable. However, a broader issue is whether or not GDP growth can be feasible at higher levels with the manufacturing sector playing a minimalist role? This issue is serious because the pattern so far has been a growth model that runs on services. These services are almost broadly divided equally across the organised and unorganised sectors with transport (excluding railways), trade and restaurants being mainly in the latter. Growth in these sectors cannot be sustained unless there is high growth in industry—manufacturing in particular as services support business activity.
It is here that it is often argued that India missed one important step in economic transformation where we shifted from an agrarian to service driven economy without really having an industrial revolution. The question is whether there is reason to believe that there has been de-industrialisation in the last two decades? The de-industrialisation hypothesis can be looked at from four points of view. The first is the growth rate in manufacturing relative to other segments. The second is share of manufacturing in GDP, which will indicate its relative importance. The third is share in capital formation—here one should distinguish between infrastructure and manufacturing as investments in mining or power would not really be classified as manufacturing. Last, in terms of employment have there been signs of migration to other sectors? If all or most of these are visible, then there is a problem as the diminishing importance of industry is not good for the future of an economy that still has gaps in terms of unemployment, poverty, inequality, growing urbanisation, social amenities and so on. The accompanying table provides information on these fours aspects of de-industrialisation. The averages for four quinquenniums have been calculated to iron out single year disturbances through extreme numbers. The four pre-requisites of the de-industrialisation hypothesis can be analysed sequentially. Growth in manufacturing has been cyclical across the time periods witnessing alternately high and lower growth rates in these periods. While this trend is similar to that witnessed in overall GDP growth, the intensity of decline or increase of manufacturing growth has been steeper both ways. Two conclusions may be drawn. The first is that higher manufacturing growth does propel GDP growth, but a slowdown does not bring down growth to the same extent as the other sectors provide support. Second, we evidently have to work on this sector if we are looking at double-digit GDP growth rates in future as the services sector can buffer against a decline but cannot, on its own, drive GDP growth on a sustained basis. The share of manufacturing in GDP has remained more or less flat over these periods. This is interesting because during this period of 20 years the share of agriculture has come down sharply from 26.7% to 14.5%, but has not gone in favour of manufacturing. It has shifted in a big way to services with the non-government sector gaining the most. The other interesting conclusion here is that the government is not too intrusive, as the share of personal social and community services has varied between 13.1% and 14.4% during this period. The capital formation story is even more startling. The share of manufacturing has come down from 38.8% to 28.8%, which can be contrasted to levels of above 35% in countries like China, Korea, Malaysia and Thailand. The shares of services has again increased with the three sub-groups—trade, transport and communications; finance, insurance and real estate; and social and community services—witnessing an increase of between 3% and 4% in share over this period. Within industry, construction has witnessed a larger share, which may be attributed to the focus on building roads, airports, ports, etc. This gives one the sense of de-industrialisation where less investment is being channelled to this segment. It also reflects the existence of spare capacity in industry, which could be one reason as to why larger doses of investment are not taking place. Last, the employment profile follows the same trend as in GDP and capital formation. The private organised sector has been used here to gauge whether this sector has provided more job opportunities to labour. With a diversion being witnessed from the primary to the services sector, it is not surprising that manufacturing is attracting less labour in the organised sector. The share has been declining continuously through the four points of time chosen and a fall of over 10% is quite alarming. Interestingly, again the services sector has dominated and, within this group, the finance sector has been the major beneficiary with the share increasing from 3.6% to 20.5%. Quite clearly, given that the remuneration packages offered in this sector are higher than that in manufacturing, there is a disincentive to work for this sector. What does all this indicate? The manufacturing sector has certainly lost its sheen and there are traces of the process of de-industrialisation which is more of a voluntary nature, unlike in the pre-Independence days when the colonial model was to make countries less industrialised with the focus being on agriculture and extraction of raw materials. Should we do anything about it? Yes, it is necessary because the services sector-driven model is not sustainable unless manufacturing grows. The solutions are known to all as to what should be done to drive forward industry which should get translated into action lest we lose this major foundation which appears to be weakening over time

Next 14’ & the future: Financial Express 8th December 2013

Book Review of Catch Up by Deepak Nayyar

After the financial crisis of 2007, the theory of decoupling has gained importance, and it was felt that developing countries could lead the world economy irrespective of what happens in the developing world. While this phase of elation lasted through the sovereign debt crisis from 2010 onwards, the present power of US tapering dilutes this theory. How exactly should we look at this balance of economic power, and is there a historical context in which we should analyse these trends?
We often talk about how powerful countries like India and China were at one time and that there was a transformation when the balance of economic power moved towards the West, where we see the developed world today. The present emerging markets or developing countries have gone through a name change in the form of being ‘underdeveloped economies’ to the ‘south’ part of the ‘north-south’ concept. But today, there is active discussion on how developing countries could be controlling major growth impulses. To explain this and more, Deepak Nayyar in his book, Catch Up: Developing Countries in the World Economy, broadly divides the economic history of the world into three parts: pre-1820, 1820-1950, and the period after the 1950s till date. The developing countries in his data analysis belong to Asia (minus Japan), Africa and Latin America, while the developed world includes the ones from North America and Europe, and Japan, excluding the Caribbean. Till the 1820s, developing countries dominated the world in terms of both population and income, and hence, when the decline came about, there was a deep fall in prosperity in these countries. The developed countries ‘caught up’ and went ahead after 1820, which was also the time of the industrial revolution, which spread across these countries at different points of time. Growth in trade, investment and migration contributed to this phenomenon and Nayyar points out that the division of labour, which emerged, was unequal. There were several reasons for this transformation, all of which contributed partly, though did not explain fully the story. Culture played a role, where the protestant ethic of Weber played its part, as it was religion that goaded people to work hard and make money. Marx would have said the dialectical process did not quite take off in Asia, but worked in these countries, and which helped to bring about this change. Another reason could be geography, where the temperate climate helped to grow more crops and was more congenial for working hard. Also, being close to the oceans and seas helped in furthering trade. But Nayyar feels that finally institutions that were created were the ones which decided whether countries remained rich or moved towards low levels of income. Where governments were extractive, which was the case with developing countries, economies declined quite sharply. In case of developed countries, the economic and political institutions helped strengthen these countries. Nayyar goes on to explain how the advantages of cheap labour and capital helped herald the industrial revolution in the UK, which helped bring about a slew of innovation across sectors. Simultaneously, the concept of colonisation had caught on and raw materials that were procured helped speed up the processes in the colonising country. This was also the time when traditional industries collapsed in developing countries. There is a lot of data provided by the author to show how the balance shifted to the so-called West. However, following World War II, there was a transition in the other direction, with developing countries ‘catching up’. Within these nations, Asia performed better than others and the only handicap was the growth in population, which lowered the per capita income. The pick-up took place more specifically from 1980 onwards, which was the time when we can recollect the challenge posed by the Asian tigers. This was also the time when there was wide-scale migration to the West, where money was remitted in return, which helped to provide these countries with the requisite foreign exchange for further development. The structure of the economies also changed from agricultural to manufacturing and services, which provided a boost to growth, as the multiplier effect was higher. Here, once again, Nayyar emphasises the role of the state, as accelerated progress was achieved with the help of positive policies with respect to trade, industry, institutions, interventions, etc, to make them globally competitive. If we juxtapose our own Indian story with this development, we can see the results emanating after we went in for economic reforms in 1991. It is here that Nayyar brings up an innovative term for nations within the group of developing nations, which have their own path, called ‘Next 14’. These include Argentina, Brazil, Chile and Mexico in Latin America; Egypt and South Africa in Africa, and China, India, Indonesia, Malaysia, Korea, Thailand, Taiwan and Turkey in Asia. There are three reasons, according to him, as to why these have become important: size, growth and history, even though there is diversity in income. Now, within these nations, he observes convergence in income in Asia, divergence in Africa and stability in Latin America. Once again, he emphasises the role of institutions in explaining disparities in the growth stories of these nations. However, notwithstanding these paths, he clarifies that rapid growth and income do not mean that the absolute number of poor has come down. What then are the prospects? All exercises done by scholars show better prospects for these countries in the years to come and there should be greater convergence with the developed world by 2050, if not 2030. This is so because they have a lower base and a large young population. Further, wages are lower in relative terms and this will enable them to compete on costs with the outside world. Also, given the spare capacity, the probability of improvement in productivity is also higher in the earlier stages of growth than in the latter part, which is good news for them. But, he rightly points out, the ‘Next 14’ cannot on their own be growth drivers for the world economy. They can complement, but never substitute the developed world, especially the US. This probably addresses the question posed in the beginning, as to whether we have entered a decoupled world. Nayyar, of course, is an economist of the highest calibre, who looks at an issue that has not been explored to this length. While it could be a bit academic, as it looks at tomes of data, it is a book that cannot be missed.

Is the economy on the mend? - NO: Hindu Business Line December 7, 2013

Against a rather dismal economic performance in FY13, there may be indications that the economic fortunes have turned around. Yet, we may have to be sure before drawing any conclusions.

During Q1, the economic conditions turned negative. Growth slowed to 4.4 per cent, and industry continued to slump. The rupee fell as foreign investors withdrew due to possible Fed action on quantitative easing (QE). Households preferred to hold gold. Inflation remained whimsical and monetary policy uncertain. The silver lining was that the government cleared a number of investment proposals. Also, the monsoon forecast was positive, which meant output would be normal, that would temper inflation; rural incomes would be spent on industrial goods.

Inflation worries

But the story did not unravel like this. The first six-eight months do not quite reinforce the belief that we have overcome these problems. First, industry continues to stagnate. Low core-sector growth for October dispels the turnaround theory. Second, investments that have been cleared have not taken off. The debt or credit market does not point to a corresponding demand for funds.

Third, inflation continues to be high, with consumer inflation in double digits. Prices of food have gone up, affecting consumption of non-food items and eroding savings. Fourth, the RBI perforce has followed an anti-inflationary stance to keep real interest rates positive and encourage savings. But this will delay investment decisions. Fifth, while the Finance Minister sounds credible when he says that the 4.8 per cent fiscal deficit number will not be breached, it will have to be at the cost of capital expenditure. This will affect growth, considering that over 84 per cent of the fiscal space has been used up. Sixth, the lower growth this year (pegged by the Finance Minister at 5 per cent), against the 7.4 per cent Budget assumption, will mean slippage on tax collections. Seventh, while the harvest has been normal, the link with inflation has been severed due to pricing policies as well as high current levels of inflation. The latter enters the pricing decision of farmers.

Gold, the silver lining

A big positive has been the decline in gold imports. While the current account deficit has improved, one should remember that growth in exports has taken place over negative growth rates last year (compared with April-October 2011, they were a tad lower). While the share of exports in GDP (Q2) is high, it is not really a case of exports becoming an engine to growth. The $34 billion of FCNR swap money sounds impressive, but one is still not sure if this is fresh money, churning of existing deposits, or substitution from other NRI deposits or remittances.

There is still hope that consumption would pick up during October-December and some cleared projects will fructify on the ground. Inflation could moderate statistically and a gentle recovery may take place. But there is too much uncertainty.

Society and selves: Financial Express 1st December 2013

Book review of Interrogating India's Modernity by Surinder Jodhka

Indian society has evolved in terms of structures, processes and dynamics of social institutions. While modern institutions of democracy have changed and the idea of citizenship has become popular, ethnic identities and religious beliefs are still strong and entrenched. The question is how do different sections of society participate in this modern India, where issues like religion, caste, urban spaces, global branding, changing hierarchies, civil society and democracy dominate? More importantly, do we really manage to reconcile these differences? These are the issues taken up by Surinder S Jodhka in his book, Interrogating India’s Modernity: Democracy, Identity, and Citizenship (Essays in Honour of Dipankar Gupta).
The book is a collection of 11 essays and pays tribute to the contribution of Dipankar Gupta, one of the most reputed social scientists in the country. Gupta’s views on three issues are brought to the fore before putting forth views of other sociologists. The first is his take on the concept of modernity, which is actually a way of life, where there is little differentiation based on birth. Yet, in Mumbai, which is regarded as the bastion of modernism in the country, we have seen the rise of strong ethnic values typified by the Shiv Sena. While such a movement was expected to decline, this one has not. There have been explanations given, such as this was done by capitalists to break unions. But the fact that the lower- and middle-income classes supported the movement dispels this argument. Second, there is the issue of stratification on which he has a different explanation. While there is a hierarchy based on superiority, lower castes do not quite accept it and still prefer marriages within their own caste, spurning inter-caste weddings. Also, while the idea of sanskritisation did show aspiration, it did not lead to convergence with a higher caste, but only a claim to an equivalent status. Third, the issue of citizenship is serious; we have seen during riots in Mumbai and Gujarat when Muslims have had to periodically prove that they are citizens of the country. This is an unhealthy development. With this encapsulation of some of Gupta’s thought-provoking theories, the author takes in contributions from other social scientists who hold Gupta in high esteem. TB Hansen talks about the growth of cities in India and tackles the issue of communities being forced to live together for better identity and protection. He gives examples of how ‘mohalla committees’ set up in the aftermath of the Mumbai riots had only Muslims taking part, while Hindus stayed away. The result was that Muslims now tend to live together and have been secluded from the mainstream. Another example given is of south Indians, who stay in specific areas in Mumbai, where the twin entities of identity and protection are offered. Jonathan Parry surveys life in the Bhilai Steel Plant and concludes that in these societies, class matters more than caste and, invariably, people belonging to an organisation hierarchy would typically be eating together, where caste or any other social background does not matter. The difference is between naukri, which is permanent employment, and kaam, which is informal work. In a similar light, Andre Beteille expounds on the growth of the middle class, which has ensured that the polarisation spoken of by Karl Marx has not taken place. People enter a class based on education, work, salary and job type, and stratification is more on these lines. In fact, a secretary and managing director of an organisation would belong to the same class based on family income or wealth, and it is no longer the case of hierarchy deciding status. Further, with emerging lifestyles and aspirations, there is movement into this class. At another level, Kriti Kapila distinguishes scheduled tribes from castes and the reservations made for them. While in case of castes, it has been done to right ‘a wrong done over ages’; in case of scheduled tribes, it is more a case of bringing them into mainstream society and hence the motivation for integration. This was brought in after independence, as the British had not done much to alleviate their miseries. In a more contemporary context, Gurpreet Mahajan writes on the growth of the move towards civil society and the anti-corruption crusade that has been launched by Anna Hazare and his followers. This could be more an act of people being pushed to the wall and a cry for better governance, which will pick up as the level of intolerance of the general masses grows. As we can see, this is one of the major political issues, which could tilt the scales in the coming elections. There is also an interesting essay by Christopher Jafrelot, who examines the growth of Hindu nationalism and the now-common mode of governance through what we call coalition governments. Some common threads in extremist parties are that they always accept the rule of law. Second, they invariably dilute their ideology at the time of elections to attract outsiders and appeal to a wider audience. Third, when they do not get a majority, they look at coalition parties, who do not normally share their ideals. Last, they emancipate themselves from their extreme positions and move on successfully. The glaring example is that of the BJP, which has finally followed the path of moderation when in power. This, according to him, is the only way to take the country along in a smooth manner. Two other essays are quite illuminating. The first is by Bimol Akoijam, where he talks of citizenship and what has transpired in our context. In particular, he discusses the use of the Armed Forces Special Powers Act (AFSPA), which gives the military powers without any fetters. This, according to him, has been probably overused in places of insurgency, such as Jammu & Kashmir and the north-eastern states—extraordinary powers being used to tackle ordinary issues. Naxalites do talk of overthrowing the government, yet we do not see the application of AFSPA. The other engaging piece is by Sumanta Banerjee on democracy. In the West, citizens have democratic space and rights. It is not so in Asia and here, he gives the example of khap panchayats in India, which have their own laws that punish citizens for marrying out of caste. Yet nothing is done to exterminate these self-styled courts. Quite interestingly, he points out that the US is also no less intolerant, as seen by its reactions to WikiLeaks or its own invasion of Afghanistan or Libya. Then he gives the well-known statistics of how many MPs in India have criminal charges and how many are millionaires—315 of them. More than 25% belong to the industry, trader, builder and business classes. Can we expect a true democracy here or will policies be geared towards their own good? The judiciary, too, is not above all this and the constant use of TADA or POTA to terrorise one’s own citizens makes one think hard about what democracy is all about. The book is brilliant and puts together some of the best minds to write freely on issues where the media could get shy. By adding the sociological angle, there is a lot of explanatory power added to some things we see around us. Gupta should be pleased with this collection, as this is a great acknowledgment of his work.

Understanding GSec yield movements: Economic Times 27th November 2013

The GSec market is probably considered to be the only liquid one where secondary transactions take place. But, actually there are only a handful of securities that are traded and more importantly once the security loses tenure - a 2023 implicit 10-year bond becomes a nine-year bond in 2014 - it loses market interest. But still the 10-year GSec becomes the barometer of interest rates in the system for want of an alternative. How should this security be priced? The implicit yield in the past three months has varied from 8.18% to 9.15% - a differential of around 100 bps. The crossing of the 9% mark has caused commotion in the market, and quite understandably so, as the basic underlying factors appear not to have changed. Can any theory be fitted here?

One way is to look at the state of liquidity in the past three months. The repo auctions are more or less fixed with around Rs 40,000 crore being the daily inflows from the RBI based on the 0.5% NDTL mark. The MSF has become the effective indicator of liquidity. Here too, the amount averaged around rs 40,000 crore in August, rs 66,000 crore in September and Rs 37,000 crore in October. Yet, the rate has remained virtually unchanged at a weighted average of 8.46%, 8.5% and 8.57% respectively. Therefore, liquidity in the system cannot be an explanation.
Another way is to just look at the differential between the repo rate and the yield in different phases. When the repo rate was 7.25%, the average variation of the 10-year GSec was 125 bps above this rate. It came down to 110 bps when the repo rate was raised to 7.5% and decreased to 100 bps at 7.75%. Quite clearly, this theory cannot explain a yield above 9% as 8.75% should be the upper limit.
Bringing in some statistical tools, a regression analysis, linking changes in yields to changes in repo rate on a monthly basis for the past five years, gives a rate of around 8.65% to be the ideal rate when the repo rate is 7.75%, which is close to the crude calculation done earlier. Adding inflation (WPI inflation as CPI data is not available) as another explanatory variable brings the yield to 8.67%. But both these relations explain between 22% and 30% of the variation in the 10-year GSec rate. Intuitively, this also means that the rest is being driven by non-quantifiable factors. What could these factors be?
Sentiment is one factor that can be driving prices of government paper and hence yields. The market believes that the RBI will probably continue increasing rates since inflation appears to be still a hard nut to crack. Also, the RBI has made it clear that inflation control is the primary aim and the CPI, which is higher than the WPI inflation number, is of more consequence. Therefore, expectations of rate hikes can keep yields higher. Significantly, no fresh news on inflation came in when the yields jumped up.
Second, the Fed tapering programme has its role to play in our daily lives. Any good news, like the announcement that more jobs have been created in the USA, leads to the conclusion that the tapering will start soon, even though the unemployment rate has inched up to 7.3%. But this is interpreted as an indicator of further interest rate tightening by the RBI, which, in turn, drives up the rates. But the impact of these measures would be more or less transient for a couple of days and rates should return to equilibrium as these are typically single day sentiments.
Third, movement in exchange rates also impacts the interest rates. While a long-term coefficient of correlation between exchange rates and GSec rates is low at 22%, on a daily basis, the two do move together, especially if the exchange rate moves faster. Therefore a sudden movement of the exchange rate from 61-62/$ to above $63, automatically gets reflected in the interest rates moving up. This sounds plausible, but should again be mean reverting once the exchange rate corrects. A part of the reason for the rupee to fall in November has been the shifting of part of the OMC purchase of dollars to the market from the RBI. This, combined with the prospect of the closing of the swap window for FCNR deposits, has caused a modicum of panic in the money market too.
Fourth, the reaction of banks with these rates works both ways. When banks raise interest rates, which have been done by some of them, the tendency is for the market to follow suit, which can explain partly the increase in rates. If this is sustained, it will tend to feed back into the system and cause banks to reconsider their options.
Fifth, an explanation given often is profit booking where some entities, be it banks or FIIs are selling and thus making a profit. Excess selling leads security prices to fall and rates to rise, which can contribute to the upward movement. This explanation, however, is not borne out from the trading volumes in GSecs, which has been stable at Rs 30,000-50,000 crore in the past 8-10 weeks. In fact, in November, when the yields moved up, the total volumes traded were lower.
The conclusions that may be drawn are that yields can only partly be explained by factors such as RBI rates or inflation and around 70% of variation is caused by a variety of factors - each one stepping in and out in short phases. While it is hard to pin-point which factor is working decisively from outside, the market will have to factor all of them to cover all options.

 

The 22.7-billion-dollar question: Financial Express: 27th November 2013

The biggest success story of our efforts to strengthen the rupee and bring back hope has been the opening of the swap window by RBI on FCNR deposits in September. The latest number of such inflows is $22.7 billion and with the month yet to end, it could move up to $25 billion or even $30 billion. This has been a unique way of garnering dollars for an economy which confronted a shortfall. How has the tune played out and are there any concerns?
The concept is quite straightforward. If banks raised fresh FCNR deposits with a tenure of above 3 years, they could give the same to RBI at the existing exchange rate and be assured that when they had to pay back the deposit-holder, they would get it at the same rate with an addition of 3.5% swap rate, calculated on a half-yearly compounded basis. Intuitively, the rupee depreciation for the bank would be 3.5% as against the market swap rate of 7%. Therefore, for any transaction reckoned at say R63/$, the cost at the end would move to R70/$. While this may look like a gamble because the rupee could just appreciate by that time instead of decline, the same deal in the market would have come for around 7%. This was a reason why banks never aggressively marketed this product. This has a dual advantage in that it has helped to get dollars as well as augment deposits which have been used to finance both credit and investments. The FCNR deposit rate was fixed to LIBOR/swap rate plus 400 bps for such deposits at the upper-end. Therefore, with the FEDAI announced rate being 0.70% for 3 years and 1.4% for 5 years (as of October-end), the deposit rate could go up to 4.7% and 5.4% respectively. Add to this the swap cost of 3.5%, the cost of such funds would be between 8.2-9% with no encumbrance of CRR and SLR. At the base rate of around 10% for the best borrower, banks could still earn 1% return. Therefore, banks have been enthusiastic about this deal since it has straight away added liquidity to the system at a time when domestic deposits are not increasing due to negative real rates and inflation concerns. This has been a boost to the FCNR deposits which have hitherto not been very popular in the structure of NRI deposits in the country. Out of the $390 billion external debt as of March 2013, long-term NRI deposits were around $71 billion of which only $15 billion was FCNR. NR(E)RA deposits were around $46 billion. Quite clearly, the present deal of offering higher rates and swap has helped banks to market this product. In fact, inflows of FCNR were just $220 million in FY13, indicating that these deposits are not preferred by banks.Now, what we have done is actually allowed funds to be raised at around 8-9%, with the exchange risk being taken on by RBI in case of depreciation, and banks in case of appreciation. In fact, this is similar to the IMD or RIBS that we had earlier when there was paucity of forex in the country. The difference is that these deposits are being offered by banks and not as bonds by the government (or SBI as it was on the earlier occasions). It is therefore akin to a sovereign bond, without explicit government guarantee. There are two issues here. The first is that because we are picking up around $25 billion, it adds to our external debt which will cross $400 billion through this measure. But funds through this route sound more dignified and not desperate as a sovereign bond or loan would. The second is that at the time of redemption, there will be a provision that has to be made, as it is unlikely that RBI will roll over this swap, which means that banks will not be willing to go ahead with this scheme as the risk will be on them unless, of course, the rupee appreciates. Earlier, when we went in for RIBs or IMD, they got rolled over into FCNR deposits as the holders of these bonds were NRIs. Therefore, in a way we have postponed the problem and the assumption is that we will have surplus dollars to pay back these deposit holders. An interesting outcome is that while there is talk of all these dollars coming in, which quite clearly should be fresh money unless other accounts like the NR(E)RA, which is the dominant form, have gotten swapped for these deposits. But, where have these dollars gone? While it is true that the data points for these receipts and RBI information on forex reserves is available till November 15 at the moment, our foreign currency reserves increased from $246 billion on September 3 to $249 billion on October 4, and $256 billion on November 15. This is the time period when our trade deficit has come down sharply and FII flows, in net terms, have turned positive. If all this money was fresh, then these reserves should cross $270 billion by the end of the month taking our forex reserves closer to $300 billion mark. This will take us back to the FY11-FY12 days when these levels prevailed. The swap window has been a smart move in the short-run as it has gotten the dollars without affecting the financial flows of the government. RBI is subsidising this deal by paying up the balance 3.5% on the swap—the cost is around R5,500 crore to R6,500 crore depending on inflows of $25-30 billion. On the other hand if the rupee strengthens, banks will have to bear a cost, unless RBI decides to waive it. Should this be a policy for the future? Probably not, as we are tinkering with the markets which should ideally not become a habit. It should be the last resort, but never be the first option.

Work in progress: Book Review of McKinsey's Reimagining India: Financial Express November 24 2013

Summary: The problems are well-known, and there’s not much on the practical way forward. Despite that, the 60 essays in Reimagining India make for an interesting facet of the India growth story

Mckinsey's re-imagining India comes just at a time when controversy has been stoked by Goldman Sachs’ comments on India’s polity. McKinsey brings together independent views of several reputed authors and celebrities. There is the general tendency to hammer the government, which has become a fad these days, as the concept of a ‘government’ is not an entity that responds. There is a proclivity to private enterprise, praise for the Gujarat model and hope in the middle class (also the favourite of McKinsey). The general drift at times is towards self-eulogy and critiques of the present form of governance, which is not unexpected. There is little credit given to the government for anything positive that has happened and hence it is refreshing to read Bill Gates, who puts India on top when it comes to eradicating polio using its own resources, something that wasn’t expected, given the size and population of the country.
There is also a good word from Eric Schmidt, who said that the next Google could come from India. While the senior Google official laments that Internet exposure is low in India at 150 million, he is sanguine that this will pick up to a penetration level of 60-70% in the next five years. He sees the Internet holding stage in education, banking and financial services, lifestyle, e-trading and even better governance, but is wary of censorship.Most of the views are based on experience or impressionistic views, which read well in newspapers, but may not be based on sound research. Take, for instance, Ruchir Sharma, who runs down India’s performance on the grounds of benefiting from an overflow of global funds and low base, and not due to the ‘managerial genius of New Delhi’. Yet he contradicts himself when he praises some of the BIMARU states that shine, forgetting that they, too, have benefited from the low-base effect. Or a sweeping statement that we go in for reforms only in a crisis. While the 1991 crisis was the trigger, historical experience shows that reforms are spread out across time to enable absorption. It would be facetious to say we went for reforms only in 1991 and then sat back. Similarly, he shows disdain for the government, saying it should abandon the tendency to be ‘self-satisfied and make excuses’. This borders on hubris and arrogance, something that is rarely displayed by even foreign entities. One may assume it is the author’s personal view and not of the company’s. Government bashing is also highlighted by Gurcharan Das. For people like him who espouse that India Inc did well notwithstanding the government, the question to be posed is why anyone is complaining now when the government has supposedly come to a standstill. Real entrepreneurship should reveal itself. The fact remains that nothing would have happened if the government had not provided support not just through reforms, but also sops in various fiscal and structural forms. The power of the private sector is further extolled by Mukesh Ambani, who traces the story of Reliance Industries and shifts to education, where the best quality is provided. A point missed, however, is that the education he speaks of is elitist and out of reach of the common man. On this subject, Madhav Chavan has an interesting take: social spending on education tends to look at volumes rather than quality, which does not help disadvantaged students. Srinath Reddy explains the irony in Indian healthcare, where foreigners come to India for the best and cheapest treatment, while basic health facilities are not available for the domestic masses. There are some positive stories told, though they are confined to specific pockets of this vast country. Sonia Falerio gives examples of lady sarpanches in remote villages who are trying their best. Muhtar Kent has Coke’s trysts with empowering women and villages, and how they do it by providing access to water, electricity and even property rights, which fit into their own business model of spreading their product to rural areas. Howard Shultz shares the Starbucks experience with Tatas, which is again a positive for Indian enterprise. Nandan Nilekani has faith in his UID, but laments the leakages. The problem with the entire system is one of scale and, more importantly, identification. As it is based on personal declaration, the system is flawed when used for a distribution programme because it cannot exclude beneficiaries based on facts. However, being the pioneer of this project, he does not admit the faults in the system and argues that it will help plug leakages in the system. It is always engaging to read what foreign authors and journalists write about India. There are four interesting pieces here that are appealing. Patrick French talks of the polity and is positive about the electorate, which actually rejects non-performing governments. In fact, he is all admiration for the country’s free press and the fact that everyone feels they have a stake in the country’s governance. Let us see where he gets critical. Democracy functions, but governance does not. Once elected, one gets protection from legal proceedings and is really unaccountable. The rule of law does not apply and if you complain, there is a backlash—so true when anyone tries to oppose the government, when raids are a corollary. Often, politicians get elected to protect them from convictions. Besides the money power, French talks a lot of dynastic politics, where one has five times better chance in case one is connected. This works more than business, but the two are interlinked as funding comes from business. This is not so in countries like Britain, where Tony Blair’s offspring cannot become the Labour Party leader, unlike India, where it is hereditary. Edward Luce draws parallels with the US democratic systems. Both of them are in disarray and are national bywords for dysfunction and inertia. According to him, the UPA has a chief problem of a diarchy, where there is ‘power without responsibility’ and ‘responsibility without power’. Second, caste and religion have taken the zing out of the system and third, after 2010, the UPA has not been able to function on account of the multiple scams. The US is no better a state, as the Congress has not been able to pass critical bills since 2009. On the issue of India and China, Yasheng Huang rebuts the theory that China ‘can’ because of the absence of democracy, while India ‘can’t’ because of this freedom. He asks why China could not under Mao, while Taiwan did under similar dictatorial regimes. Similarly, Singapore has done what India cannot and South Korea, with laissez faire, also did, while North Korea couldn’t. Or for that matter, Pakistan, with an authoritarian style, has made limited progress. Victor Mallet warns of the concept of demographic dividend, which we tout as being the big one for us. He cautions that this could be a misnomer because while the private sector produces 10 million jobs a year and 12 million enter the workforce, if there are no jobs and hence no income, then it is a recipe for disaster. There are four other good, thought-provoking articles. The first is by Zia Mody, who sounds exasperated at the time taken by our legal processes and cites the examples of Ajmal Kasab, where it took four years for the case to finish, and Sanjay Dutt, whose case went on for 20 years. Interestingly, there are 31.2 million cases pending, of which 80% are in the lower courts and four million in the high courts (of these, one million lie with the Allahabad High Court). Rajiv Lall talks of the contrasts in our systems, where we manage a huge monstrosity like the Kumbh Mela involving 30 million people superbly, but are not able to manage the process of collecting garbage in the same city. This sort of sums up our mindset towards infrastructure and its development. Suhel Seth, in his uninhibited way, blasts the media for its cozy relations with both business houses and politicians due to a strong symbiotic relation. At a more intellectual level, Ashutosh Varshney talks well of our federal system, where people are still proud to be an Indian first. It has failed in the north-eastern states due to our own neglect. But there is a lot of crossing of such regional barriers, with the IPL being an outstanding case of diversity. Giving more power to the states has helped a lot. Of particular impact is the last piece by Christopher Graves of Ogilvy PR, where he works on the term ‘Incredible India’ as the brand to be used by the country, and to get over the propaganda by the states. Interestingly, he distinguishes between a branded house and a house of brands. We have started as a branded house and are moving to a house of brands. What does the book achieve? Nothing significant as the problems are well-known and only articulated by celebrities. McKinsey has its own staff writing articles on the way forward, which are also often bromides reiterated by practitioners. Besides, the consultant’s view on reshaping any economy is well-researched and appreciated. The title may sound out of place, as there is not much really on what the new India should be and a practical way forward. However, if one assumes that a writer has the right to express opinions with the usual human prejudices, then the book is interesting. But, more importantly, it is highly readable.

The NPA conundrum: Financial Express 20th November 2013

One of the highlights of the BANCON held in Mumbai was the verbal assault launched on banks' non-performing assets (NPAs) by RBI, quite clearly out of exasperation. This is a continuation of the point made forcefully by the Governor of RBI when he took over. There are actually two parts to this sordid development. The first is that NPAs have been increasing and that something has to be done by banks quite seriously. The second is the growing phenomenon of debt restructuring, which in a way can be termed an euphemism for the same, padded up to look different. In the olden days, this used to be called ever-greening when banks overlooked NPAs by giving fresh loans. Critics aver that Corporate Debt Restructuring (CDR) is similar in direction though the mechanism is different.


To begin with, let us look at the conventional definition of NPAs. Ever since the economy started slipping, companies have found it difficult to service their loans leading to NPAs' volume increasing from 2.4% in FY11 to 3.0% in FY12 and around 3.6% in FY13. In absolute numbers, they stood at around R1.9 lakh crore in March 2013. The usual reasons are high interest rates and low corporate performance due to pressure on sales and costs resulting in inability to repay loans or service interest payments. One may assume that there is less of mala fide intent and that the ‘wilful defaulters’ category is not predominant.

The restructuring story is even more interesting. The CDR website shows that the volume of restructured debt has increased continuously, touching R2.72 lakh crore as of September 2013 from R0.9 lakh crore in FY09, and was at R2.29 lakh crore by March 2013. In terms of a ratio as a percentage of total advances, CDR was higher at 4.4%, and even traditionally this ratio has been higher than the declared gross NPA ratio.

The argument given in favour of CDR is that loans have to be restructured when the project cannot take off due to extraneous conditions. We all know that several projects are held up when the government’s policy changes or the government does not put in its own share of capital to co-finance a project due to fiscal constraints. When an environment clearance cannot be procured or mining laws create an impasse, then the borrower is disadvantaged. As these are lumpy amounts, the propensity to turn bad is faster and nothing much can be done except restructure the loan as it is beyond the purview of the promoter.

The critics of CDR have two arguments here. The first is that when a loan does not perform, in the absence of malicious intent, which is normally the case, there is always a genuine problem. But when we are talking of channelling deposit money of the public into such projects, there is a certain degree of vulnerability to the financial system, especially if this number is as large as it is today. This also means that the appraiser’s judgement was not right, which affects the deposit holder. Adding the NPAs to CDRs, the total would stand at 8% for FY13, which is quite scary. The second is that in the absence of any regulatory norms on the classification of such loans, banks may just be incentivised to reconfigure a part of their NPAs as restructured assets, though admittedly there is a rigorous process involved for a CDR case. If this happens, then it would be analogous to ever-greening, which is an issue.

In fact, to get a hang on how banks' income statements are affected, let us look at FY12 which is the latest year for which RBI has provided information on the accounts of our banking system. Total assets of banks were R82,993 billion. Profits were R816.58 billion, yielding a crude return on assets of 0.98%. For the same year, the total provisions made by banks were R915 billion of which 42% were for NPAs, i.e., R381 billion. In FY12, NPAs were 3% of the total advances while the same ratio for restructured assets was 3.2%—nearly the same. Suppose all of them were actually treated as NPAs, then the same amount of provisioning would have had to be made—which in turn would lower net profits to R435 billion—with the return on assets coming down to 0.52%. Now, this is an extreme case and can be debated and debunked. But the point is that restructuring of non-performing loans is a serious issue and given the extent if their prevalence, there is a strong reason to move assets across these categories.

Therefore, RBI is fully justified in warning banks on this issue. Presently, there may be no systemic risk and it is being assumed that banks are trying their best to get the most from these assets and once the economy recovers, the repayments and interest payments will flow through. But we cannot brush aside this problem and do nothing about it. Quite clearly, the appraisal and disbursal processes have to be made more robust.

The problem is even more serious as getting legal redress is not easy and extremely time consuming. While recovery agents can knock on the doors of a retail borrower, the rules are skewed in favour of the large borrower. Therefore, the only way to eschew this problem is not to have it. The onus should be on the banks to control the increase in the number of NPAs to retain the sanctity of the system. This also leads to an interesting issue—that of the grievance of companies, especially in the SME segment, that funds are not easily available. RBI, on its part, must address the broader issue of compelling banks to get into inclusive lending, where such risks may be high and will ultimately impinge on the quality of bank assets. Evidently, at some stage, we must be practical when it comes to lending and let this sense override emotion.

Banking on India: Financial Express 9th November 2013

What could be the response of foreign banks to the new set of RBI guidelines which gives them greater scope for expansion if they convert their Indian operations into subsidiaries? This follows up on the guidelines released by RBI earlier and seeks to provide some momentum to India's expanding banking sector in the manner that was followed for private banks. While offering sops like greater number of branches, the guidelines include several caveats to buffer the system against any risk that could emerge from the opening up of the sector as well as eschew domination by foreign banks.
It is necessary to evaluate and grasp the importance of these banks for our financial set-up. Foreign banks were considered models to be emulated when we went in for liberalisation in the nineties which led to the creation of new private banks—Indian private banks, in a way, were much like the one abroad, bringing in all the goodies offered to the masses. This was in the form of more products and technology which helped to unleash competition. As on March 31, 2013, there were 43 foreign banks with 334 branches in a total of 92,114 in the sector. Their share in the net worth of the banking sector was 15.3% while it was 2.3% for employment. Quite clearly, these are technology-driven banks with deep pockets that rely less on headcount. However, they are better pay masters with the staff cost being 18.2% of the total expenditure as against the 13.0% average for the entire sector. In terms of business, they accounted for 3.9% of deposits, 4.5% of credit and 8.7% of investment, which is not bad given their number. In terms of operations, they do better than the rest of the sector primarily because their perimeter of operations is limited. Their cost of funds is lower at 4.05% as against 6.12% for the sector, while the return above the cost of funds is higher at 5.50% (4.21% for the sector). The return on assets was higher at 1.94% (1.03%) and their net NPAs were lower at 1.01% (1.68%). Quite clearly, in case these became benchmarks that are emulated, the sector would be healthier provided this is scalable. What could be the level of interest of these banks in becoming subsidiaries? Looking at this list of 43 banks, there are only 6 which are significant players. Out of them 2 have over 50 branches, 2 around 40, and the remaining 2, between 10-20 branches. These 6 banks accounted for 81% of deposits of foreign banks and 75% of credit. Quite clearly, there will be limited interest for the remaining 37 banks in this new deal unless they fall in the mandatory category which was set up after August 2010. Also if these six banks were to become wholly-owned subsidiaries (WoS), they need not bring in more capital to begin with as their new worth is already above R500 crore (only one bank has equity of less than R500 crore).The basic issue is whether these banks are really seeing a viable business model in expanding into non-metros/large urban centres. There are arguments on both sides. While the present set-up has worked in terms of maintaining the market shares over the years, the model will not help scale up the business in any big way unless there is movement to the relatively lesser banked areas. On the other hand, becoming a WoS and getting national-level status will provide access in terms of geography but the contingent obligations of priority-sector lending and opening of branches in unbanked Tier-5 and -6 cities would be a consideration that will come in the way. Here, RBI is insisting on brick and mortar branches rather than access through the internet. At the operational level, these banks have not had any experience in this segment on account of the branch expansion restrictions. Hence, getting into rural banking will mean setting up a new establishment in terms of hiring laterally to get the right people to create business. Even today, on the account of perceived entry-barriers into these branches, the masses are not on their network in urban centres. Now, getting into the rural areas would necessarily mean a change in approach which will also increase the costs as all such inclusive banking means keeping accounts that hold low-level deposits. Therefore, it will really be an individual call for a foreign bank to take on how much it would like to compromise depending on how important India would be in its global plans.However, it does look like that if foreign banks prefer the WoS route and enter in big numbers, the gains for the country would be more than that would probably be for the banks themselves as they have to give themselves several years before breaking-even in these territories. RBI has put up a fence around possible foreign domination of the sector by fixing the point of no-further-entry for foreign banks at the point when their net-worth reaches 20% of total. It is already around 15% today.Two interesting clauses are in respect of ownership issues. They could get listed within the FDI limits or even look at M&A activity. The first step would help in pushing up valuation as these banks are certainly more profitable as a group which will command value on the bourses. The other step would be a way out in adhering to the norms laid down by RBI with respect to number of branches and priority-sector lending. RBI will have to spell out its policy on this aspect more clearly because the decision of a foreign bank to become a WoS would make more sense if there could be an acquisition as part of the deal. The new policy on foreign banks is hence progressive considering our own tryst with deeper financial liberalisation, though the individual banks will have to take a call on whether they would really like to get their fingers wet. It would depend on the time horizon that they are working with, and plain vanilla entry, prima facie, does not really look appealing. It is unlikely that more than a couple of the large banks would find the terms attractive as the latter stand at the moment. Add listing prospects or M & A options, spelled out clearly by RBI, and the possibilities multiply and look much better.

Doing business index a wake-up call: Financial Express 4th November 2013

The World Bank ‘Doing Business’ ranking is controversial because all those countries rated in the lower order do not like it and feel that the methodology is suspect. However, based on a relatively objective criterion, the World Bank ranks countries on how easy it is to start and close a business and traverses through a set of 10 parameters. The latest report for 2014 is quite timely given the uncertainty on the economic front and, in a way, is a revelation as we get to know where we stand.
There have been several discussions on the myriad issues relating to delays in getting papers moving and consequently, delays in getting projects started on account of an impasse at the decision-making level. Quite clearly, a domestic investor knows that there are issues here when it comes to clearances. There is also flip-flop on policy when it comes to FDI as that means going through Parliament. Even if these concerns are kept aside, how do we fair in the ordinary course of business life?India’s rank comes down by three notches from 131 to 134 in a set of 189 countries. This is significant for two reasons. The first is that we are moving down the echelon which will affect our own long-term attractiveness for investors. The second is that we are placed even lower than countries like Bangladesh, Kenya, Honduras and Egypt. Also, while we do like to compare ourselves with the others in the BRICS group all the time, India is placed uncomfortably low in the list. South Africa leads at 41, followed by Russia at 92, China, 96 and Brazil at 116. This relative scale is certainly not something to be proud of and the fact that there is a downward movement indicates that we need to address these issues, else we would be the outlier in the BRICS group. The picture is also quite disappointing if one considers the individual ranks across the 10 parameters. We do very well on two counts, which have helped to keep our ranking where they are. The first is access to credit, where we are placed at 28, and the other, in terms of protecting the investors, we are placed at 34. Quite clearly, the financial sector is our strength, and the credit should go to Reserve Bank of India (RBI) and Securities and Exchange Board of India (Sebi) for keeping us ahead of the other nations. In fact, the orderly development has ensured that we have not felt any primary effects of any global economic crisis. The other 8 variables tell a disappointing story. Our rank is 186 when it comes to enforcing contracts, 182 for getting construction permits, 179 for starting business, 158 for paying taxes. We do better than our overall rank in case of trading across borders (132), insolvency laws (121), getting electricity connection (111) and protecting property (92). It is well known that banks struggle to get their debtors to pay up and the laws are skewed in their favour. Also, the red tape and the antiquated procedures make getting clearances difficult. Therefore, these numbers do not really surprise. An interesting statistic pointed out by the World Bank is that last year, 114 countries brought in 238 changes in their regulations to enable convenience for business. These reforms were across all these 10 variables so that there would be fewer hassles for those doing business. Unfortunately, India does not feature here, meaning that there has been virtually no conscious effort made to address any of these issues, which has in turn led to a slide in the rank as other countries moved ahead. In fact, 29 countries have brought in 3 or more reforms to improve their systems.The World Bank, in this report, also calculates the potential for every country and then shows how far the country was away from this ideal situation across the time period of 2005-2013. Here, India has moved ahead in case of ‘starting business’ (still less than 70% of potential), ‘credit access’ (above 80%), ‘payment of taxes’ (just above 50%), ‘trading across borders’ (a little above 60%). At the cumulative level, the nation has come to around 55% of the potential, which is not saying much.This is where the irony lies. We have seen a lot of foreign interest in the economy notwithstanding the tardy nature of our administration as well as the controversies surrounding the allocation of public wealth. Investors do see a lot of potential in the country given the size of the population, growing incomes and severe lacunae in various sectors which makes investing an attractive option. The developed countries are already operating at a plateau level of capacity utilisation where incremental growth can only be marginal. This is where size matters and China and India are the two potential markets for such investors followed probably by Brazil. At the domestic level, business normally takes in these factors as a part of their costs and plan accordingly. Intuitively, it can be realised that if we are able to address these ten issues, we can make India an even better business destination and lower the cost of doing business, which will help entrepreneurship develop. Today, we are all talking of focusing on inclusive growth where the SME segment is often spoken about. These units encounter these challenges along the way making it difficult for them to break even. In fact, if one looks at these ten elements of what can be called the superstructure required to do business, 6 of the 8 issues can be addressed relatively easily. These are: ‘starting business’ (single window clearance, which admittedly we have been talking for long but not doing much), ‘construction permits’ (should be automated and driven by rules), ‘getting electricity connection’ (need to streamline procedures), ‘protection to property’ (have clear property laws and amend all dated regulation), and ‘payment of taxes’ (online payments with less human intervention and collection of tax source to avoid post-payment ambiguity). The issues on insolvency and enforcement of contracts, which are related to one another, have to be taken up at a higher level since it requires our judicial processes to be revamped. Seeking redress today is time-consuming as banks grapple for a solution with their NPAs.Rather than being critical of the World Bank Report, we need to treat this as a wakeup call to reform our procedures and rules for doing business as the economy is quite literally, to use the cliché, at a crossroad. Foreign investors should feel reassured when they bring in their dollars, and Indian enterprise should not be looking outside the frontiers in desperation which has already begun and needs to be reversed. It would then be a win-win situation for everyone.

Convergence for change: Financial Express 27th October 2013: Book Review of The Solution Revolution

Today, despite the fact that we all argue for market-driven econo-mies with less government presence, we invariably want the government to be everywhere. It has to look after the economy, the banking system, eschew a financial crisis and rescue institutions as and when it happens, look after infrastructure, environment, education, health and so on. This is just not possible and often different arms of the government are working at cross purposes. One department works towards healthcare and spends money to lower the incidence of coronary diseases and diabetes, while another provides subsidy to the sugar industry. What is the way out?
It is here that the authors, William D Eggers and Paul Macmillan, conceptualise what is called a solution revolution, where a large number of entities, some openly, while others silently, play a role in addressing these issues. While NGOs and social entrepreneurs are the better-known entities, MNCs and individuals can also make a difference once they become a part of the solution revolution. Concepts like ride-sharing, impact-investing or crowd-funding are all part of this set-up. The questions that will be posed are: Who are the players and what drives a solution revolution? How do we grow the movement and how can we, as individuals, become a part of this movement? The authors argue that there are six features of a solution revolution, which develop, not really by design, but mostly from random initiatives taken by entities or individuals. These serve as templates to be followed by others, which, in turn, work to create this structure. These are wave makers, disruptive technologies, scalable business models, impact currencies, public value exchanges and solution ecosystems. Let us see how these work.When we talk of wave makers, as the term suggests, these are people who make a difference and names like Bill and Melinda Gates strike us when we think of philanthropy. This involves a series of entities again. There are investors, like Acumen, which identify businesses that are dedicated to the poor and invest in these enterprises. It could be a hospital chain in India or women issues in Africa. Next, we need conveners who are able to get these kinds of investors to invest in these businesses. Then step in the innovators who do social activities without a fee and those that are commercial, but make a difference. An example could be the 1298 ambulance service in India, which charges patients according to their ability to pay, and fills in the lacunae of such facilities. Crowd-sourcing becomes an important ingredient here, where the public plays its own part, thus creating a virtuous circle. They give examples of companies that would fall in this category such as Coca-Cola for water management, Shell for poverty reduction, Unilever for sanitation, Procter and Gamble for tetanus vaccination, etc. They work to either double or triple their bottomlines—financial, social and environment. This, according to them, can be called ‘Robinhood redistribution’, where the rich finally pay for the poor in this model.The second feature of a solution revolution is the existence of disruptive technologies. Here, the authors give examples of how mobile phones and social media have revolutionised communications. Add to this the concept of cloud computing, where a large amount of data is available for analytics. These technologies, combined with the Internet, have made transactions of various kinds possible. They give the example of how millions of Indians signed a petition against corruption, which exemplifies the power of social media. The third ingredient that the authors talk about is business models that can be scaled up. Here, they show how car-sharing works wonders as it not only saves on fuel costs and the environment, but also lowers the demand for parking space, which was used in Freiburg, Germany, to create gardens that could be used by citizens. Similar scalable models are to be found in the area of education, where we no longer have to have classrooms, tables, chairs, teachers and other amenities when learning is imparted through the online mode. This model can be scaled across frontiers and, hence, involve a larger audience. And the beauty of these models is that they are commercial, run by private enterprise and yet cheaper as they cut across infrastructure costs. Fourth, impact currencies are defined by Eggers and Macmillan as anything that provides economic functions we can associate with fiat money. These currencies come in different forms. For environment, we have carbon credits, which can be traded and add value to society as well as the players. There are ‘currencies’, where a company links investment to an outcome. eBay, for instance, has a clear policy that allows it to invest only in companies that have a social impact. Citizen capital is another example of an impact currency, where social groups create value from open spaces. At a different level, reputation is another form of currency. Kiva Zip enables ‘person to person lending’, which brings both parties together on the Net. Other non-quantifiable currencies are the supply of data, where the value is realised when a crisis strikes. The authors give examples of how maps available online were actually useful for both evacuation as well as relief operations across the globe when natural disasters strike. This again is a non-government initiative.Impact currencies, in turn, have created the fifth constituent of a solution revolution—public value exchanges. New platforms have been created to enables such exchanges. As mentioned earlier, Kiva enables loans to be transacted, and crowd-funding is an extension, where investors are willing to chip in once the cause is agreeable. The organisation here does not manage the projects, but enables funding by doing due diligence and then throwing it open to the public for their consideration. Last, a solution revolution is related to the creation of ecosystems by companies, which build the necessary linkages. Unilever in India has improved sanitation standards in rural areas in a unique way by building this ecosystem. Using women entrepreneurs to sell custom-made products for the rural folks, the project also involved providing access to these women to funds from MFIs. Offering a mark-up of 7%, they were able to service their loans through their sales and also retain the surplus income while inculcating the new hygiene standards among the people through such products. The authors actually exhort the readers to join the solution revolution by changing the lens through which we see the world. By providing examples all through the book, it makes interesting reading and some of the initiatives taken by companies could be really inspiring. But there are doubts on the scalability of such an answer that is posed by this book. Most of the examples provided are independent actions of enterprises working towards a similar goal, which makes a difference to the specific targeted communities. It is not a concerted action, which is probably needed for an outright revolution. While this will work in the long run, it is not yet a revolution as almost all these models have a commercial value and is philanthropic in a limited sense. Further, the authors do not address the issue of any specific country and social dynamics as well as regulation, which can put spokes along the way. Yet, this is probably the only way we can move given the limitations of the government in terms of financial ability and competence to address these myriad issues. This is a must-read book.

Interest rates: the case for status quo:Business LIne 26th October 2013

The RBI has taken a fairly one-dimensional stance on monetary policy in the last couple of years by linking it to inflation rather than growth. The concept of inflation has varied from generalised WPI and CPI inflation to more specific indices such as core and food inflation.

With the WPI and CPI inflation numbers coming in higher for September, there is a natural expectation that the central bank will increase rates on October 29.

However, there are compelling reasons to believe that the RBI will adopt a neutral stance this time, given the singular conditions that we are witnessing.

INFLATION OUTLOOK

First, while inflation has been higher in September, there is reason to believe that prices would move downwards from October onwards, since we are expecting a good kharif crop which should lead to tempering of food prices. This being the case, a final decision can be deferred for the next policy in case inflation does continue to increase.

As monetary policy is ideally forward-looking, waiting for another month and a half will not do much harm.

Second, the government has been talking of pushing personal loans through incentives such as additional capitalisation for banks beyond the Rs 14,000 crore budgeted for the year.

Some banks have taken the cue and lowered interest rates during the festival season ostensibly to encourage borrowings which will boost consumption.

This being the case, increasing interest rates by the RBI will send confusing signals to the market.

As we are working towards pushing forth demand for consumer goods, status quo in repo rate can be justified.

Besides, as we are banking a lot on the spending cycle being rejuvenated this season, increasing rates at this time will spoil the party. Third, the rupee has become stable in the last month partly due to strengthening of fundamentals, with trade deficit coming down and FIIs in equities turning positive.

Therefore, there is less compulsion to increase rates now to defend the rupee as the internal forces are working well.

In fact, the MSF rate could be lowered this time by 25 bps, as it does appear that the MSF rates were tinkered with keeping the exchange rate in mind while the repo has been sued more for signalling policy stance, with focus on inflation.

BEST OPTION

Last, the Finance Minister has been reiterating that interest rates should come down and even recently has urged banks to lower their lending rates.

With such pressures being exercised, the RBI will probably pay some heed to this concern, and while it may not be possible to lower the rate given that inflation has been rising, a compromise would be to leave rates unchanged.

Therefore, it does appear that a status quo on interest rates would be the best option given that there is lot of hope that the festival season will be associated with more consumer spending and lower inflation.

October rain has passed: Financial Express: Ocotber 26th 2013

The month of October has been quite eventful in world history—for example, the October Revolution in 1917 saw the Bolsheviks depose the Russian Tsar. This October, too, there were fears of a revolution, albeit of a different sort, with the US government shutting down and a default looming large as the Congress battled it out on the debt ceiling. The rock group Guns N’ Roses would have probably crooned ‘October (November) rain or storm’, but finally, it was not to be and turned out to be a damp squib. The problem, though not solved, has at least been deferred, and the global economy can breathe easy till early next year—January 15 is when the federal government's funding comes up for approval again and February 7 is deadline for raising the debt ceiling. Given the backdrop, certain points need to be ruminated on.
First, the quality and role of politics is the almost the same across the globe. While we are overtly critical when there is an impasse in our Parliament and get ballistic with terms like 'policy paralysis', the same happened in the US—realpolitik dominated the day with the Republicans and Democrats not willing cede their respective grounds on the Affordable Care Act. Why do we in India make a big deal of the Food Security Act (FSA) when the largest economy in the world isn't doing any lesser? Just that, in our case the issue is food for the poor, in theirs, it is health. So, the US impasse was indeed a case of politics dominating economics with the world watching in disbelief. Everyone knew that there would be a solution simply because things could not be left in a state in which there was no solution. The suspense, however, was around how exactly the impasse would end.Second, the fact that the policies of the government have to be sanctioned time and again by statute has lessons for us. We have the FRBM Act which lays down rules to be followed. However, resetting fiscal deficit targets is the prerogative of the central government and this is where we can borrow from the US story. Can expenditures be capped, as they are in the US, so that separate permission from Parliament will be required if they have to be exceeded? This way there will be an additional layer of discipline. Presently, the financial minister has worked well around the 4.8% fiscal deficit target, but the issue is whether we can go further. The US model is quite interesting because all such bills need to pass through the Senate and the House of Representatives (where President Obama does not have a majority). Third, a curious fact that got little notice is that even though the US was on the brink of a default for the second time in the last 3 years or so, the credit rating of the country remained intact. It is true that being the anchor currency in the world, dollars can be printed at will, though this is, quite prudently, constrained by regulation. But, despite the fact that the default was credible, on the back of the shutdown, none of the global credit rating agencies have gone for a downgrade. This is where there is ambivalence in the outlook of rating agencies, where India is under the scanner almost every month for a possible downgrade, whether the heat is over the FSA or a high current account deficit or growth figures. This is a pertinent issue which the Indian government has to contend with on a regular basis—the anomaly stands out with the US retaining its rating. It is not surprising that the world is asking for alternative approaches to credit rating which are less skewed. The question is whether or not we are missing something somewhere considering that the possibility of a credible default did cause upheavals in the forex, money and capital markets across the globe where the losses outweighed the gains. Fourth, unless the US changes its laws giving the President unlimited powers to raise the debt ceiling on his own without having to go through the channels, the issue to be debated is whether or not it makes sense to invest in US treasuries. Today, out of the US's $16.7 trillion debt, $5.6 trillion is held by other countries—their surpluses are invested in these bonds. Will this continue with the same level of comfort as before? Countries will soon be looking for alternatives though, admittedly, the options are dwindling with the euro being fragile as well while no developing country's currency is acceptable yet to the developed nations. While gold is an option, given the volatility in gold prices, this may not be meaningful at this juncture. Therefore, the dollar will prevail for some time. Fifth, any correction in the fiscal balances by the US government has implications for the revival of the global economy. Today, the Federal Reserve is working towards tapering its QE programme based on the premise that growth is picking up as unemployment numbers become more acceptable. If it were so, then the equilibrium gets distorted if the US government stops spending. The only real option for the US government is to give up on healthcare. But that would mean political defeat. Alternatively if any other expenditure is compromised, it would mean a setback for growth. Either way, the world economy will continue to be wobbly as the search for a solution lingers. Clearly, there are lessons to be learnt from this episode, considering that it will happen again. The way in which things work in the US are definitely laudable where even the government cannot take things for granted. However, keeping the credit rating unchanged poses a dilemma for analysts given that any default can rock the financial markets all over with a large volume of transactions being reckoned in dollars. Surprisingly, even the CDS rate did not show confidence as it jumped from 22 cents per $100 in September to 38 cents just before October 17. Markets do not spare even the biggest.

Solving the conundrum: Financial Express: 22nd October 2013

One of the areas that Dr Raguram Rajan focused on when he made his first speech as RBI Governor was quality of assets. He had indicated that RBI would be looking closely at these numbers and their originators and that there would be little lenience shown to them. Growing NPAs has been an issue in the last two years with a lot of camouflage being alleged by some in the form of restructured assets.


While the talk has largely been on corporate loans that have gone bad, it is also necessary to look at the delinquencies in the priority sector. For example, in FY12, around half of the NPAs of public sector banks emanated from this sector, which contributed to less than 30% of outstanding loans of banks. We have also seen that there has been a lot of thrust being put on inclusive banking, meaning thereby that banking has to be taken to the poor so that they have access to the formal system and do not have to go to the moneylenders. To this effect, RBI has linked new bank licences with the opening of 25% branches in non-banked rural areas. The contention here is that while NPA growth is serious, there can be some contradictions with the objective of inclusive banking as the propensity of priority sector loans going bad appears to be higher than that of regular loans.

Priority sector lending has been spoken a lot by banks as it is politically correct to do so. Also, there has been the non-bankable segment that was supported by MFIs, which later became controversial on account of the high rates charged. Using counter-intuitive logic, if the non-bankable was bankable, then banks would have already been there. Given that banks did not lend to this segment, as most lending is collateral based, and this segment does not generally have collateral to offer and also have more granular demand in terms of quantum, this action was deliberate. Now that we are refocusing on this segment through new banks and, at the same time, talking of controlling growth in NPAs, there is need to revisit our logic.

The accompanying table provides information for the ratio of gross NPAs to total outstanding loans for public sector banks for both priority and non-priority sector loans.

The table shows that the levels of NPAs in priority sector are not just higher but multiple times that of non-priority sector. The non-priority sector loans have risen sharply in FY12, which was the first year of economic decline in the country when the proclivity for NPAs to increase became sharper. This was also the time when restructured assets increased, which got exacerbated in FY13. In fact, total debt restructured increased from R1.10 lakh crore in FY11 to R1.50 lakh crore in FY12 and further to R2.29 lakh crore in FY13. Therefore, the numbers in the table rebound to be much bigger in FY13 for non-priority sector loans.

What are the solutions? In case of inclusive loans, there appears to be little that can be done as banks have perforce to lend to risky segments. A way out is that instead of the government keeping aside money for recapitalising public sector banks, they should be asked to raise the same from the market. The allocations set aside for capitalisation can be disbursed to all banks to write-off loans in this segment. This way banks will be incentivised to lend to this segment as the risk will be partly hedged. Such funding from the government’s perspective would be akin to, say, the MGNREGA programme or food subsidy programme. To make it effective this can be made conditional on being more efficient with NPAs on the non-priority loans.

The challenges for non-priority sector loans are many. To begin with, one must separate the wilful defaulters from those who have genuine problems. This is difficult because the structure of Indian corporates is such that promoters’ liability is restricted to their equity stake and hence the enterprise loss is not theirs’. As a result, the promoter with NPAs can still live the good life. One way to check this is that defaulters should be banned from taking further loans. This becomes difficult because if the cause is genuine, then the penalty is too harsh. Often loans to revive the enterprise are the only way out to get the money back in the long run. But knowing this, companies can choose not to perform, knowing well that they have to be bailed out as they cause a systemic risk in the system. This is a major moral hazard in banking.

How do we solve this problem? There is enough knowledge on defaulters provided by credit information bureaus. There is evidently a commercial angle to this story which still makes banks lend money. At one extreme, corporate debt restructuring should not be allowed. But then there are lots of projects that have been held back due to circumstances beyond their control, such as clearances or land acquisition, litigation, etc, and would be penalised. But such genuine causes would be there for almost all non-wilful defaults. The onus should be transferred to banks through an incentive scheme as outlined earlier.

At a different level, we need to have early warning indicators for NPAs, and the best way out is to have all bank loans rated by a credit rating agency (a lot of them are rated already under Basel II implementation for assessing risk-weighted capital). Credit rating agencies have more stringent criteria for rating and any movement in such ratings should send a signal to the banks that the account is not in order. This way banks can take action at an early stage and not wait for the three-month delinquency mark to be breached before such classification.

It should be recognised that the financial system is getting complex where business cycles are bound to affect the economy and the quality of assets of banks. At the same time, there are compulsions to make banks responsible towards social causes, which can be debated but is inescapable. The government should work towards marrying the two, by funding these NPAs and making it contingent on performance in the secular space. It may just work.

Life, interrupted: Financial Express 20th October 2013 (Book Review The Chaos Imperative)

In The Chaos Imperative, Ori Brafman and Judah Pollack advocate the need for a modicum of ‘disruptive ideas’ in a structured environment to kickstart change or to deliver superior results.

ery often, one tends to be satisfied with the status quo and, therefore, as a corollary, would not like to shake the applecart. This holds in our own lives, as well as that in the life cycle of organisations. Brafman and Pollack, in their book titled, The Chaos Imperative, argue, as the title suggests, that it is essential to really bring in chaos into our lives so that we do better. It is the beginning of progress. In a way, it is not very dissimilar to the Schumpeterian version of creative destruction, though the authors do not really talk of rebirth from destruction, but focus on the necessity of a certain high modicum of chaos to deliver superior results.
In their world, we need disruptive ideas in organisations to kickstart a change, just like how the plague in the 14th century actually got the continent of Europe to restart life and bring about development of an unparalleled magnitude. So much, that people lost faith in the church and the rich channelled money to educational institutions, which sprung up in Vienna, Florence, Prague and their like rather than the church. This was what one could have called a tipping point. Also, the church recruited priests who were rejected earlier, which, in turn, brought in fresh thinking. Hence the plague created what the authors call ‘white space’, which is essential for organisations to leverage. In fact, in Florence, the Basilica of St Mary had to be completed and redesigned, which gave rise to the likes of da Vinci. The rest, as it is said, is history.
The authors speak of three kinds of ingredients for bringing in what is called contained chaos. They call it contained because chaos would be of a specified order before it turns disruptive. They are ‘white space’, ‘unusual suspects’ and ‘organised serendipity’. Let us see how these work.
Chicago’s 37 Signals actually gives one month off to all employees so that can they go home and recoup and come back rejuvenated with new ideas and thought processes. Having such a scheme is an extreme case where all employees lock the office and leave. They enjoy the freedom for some time, but then regroup among themselves and discuss the way forward with one another, and come back with new zest to not just perform better, but implement their ideas. The idea is to essentially give them space to think and improve their productivity.
In fact, at a more down-to-earth level, they give an example of having two classes in a school where students are tested on their productivity by simply having two kinds of environment in which they operate. One class works continuously with a small break, while the other spends more time in class, but has breaks more often, where students can talk or play or just do nothing. Tests showed that the second class performed better simply because they had time to think and come up with different solutions. It is now accepted that, typically, the human mind cannot concentrate hard for more than, say, 45-60 minutes at a time and by allowing a break, the cells could be recouped. This was white space being provided to the students. Other examples given here are those of Albert Einstein who was not a good student in class, but attained what no one else has ever done. The story of JK Rowling is also narrated where she conceptualised Harry Potter when her train was stuck between London and Manchester, and she saw a boy lost, standing there not knowing from where he had come. Steve Jobs was very good at calligraphy, but used the white space to move into the IT field.
The second case of ‘unusual suspects’ is interesting where the premise is that we can get a lot from people where we least expect. An example given here is that during the Romney-Obama elections, everyone bet it would be Romney who would win. All the polls said exactly that. But there was Nate Silver who was good at predicting baseball games results and he got Obama right. This is the case of an unusual suspect who could deliver even in an organisation. They give the example of Cisco, where employees are moved across departments. The premise is that normally in a normal-structured environment, workers are loyal to their boss and not company. Also, often they may not be doing what they are actually good at. Therefore, such kind of rotation helps not only in personal satisfaction, but also drawing what one can call superior results through such selection of unusual suspects. Here, they show how a real estate worker in the company shows value for Cisco in a stadium where the company can provide links with the scoreboard.
The third way of creating chaos is through ‘organised serendipity’. How does one get people from different backgrounds into a meaningful discussion that generates new ideas and actions? There is an interesting example of how patients in a hospital suffering from a disease called MRSA, posed a threat to the doctors and nurses too, and to avoid infection, they had to wash their hands regularly and also bathe the patients with water. But water was available downstairs, which made it a challenge to maintain hygiene. Getting everyone, including the janitor, to solve the problem helped because the janitor knew where the valve was on the floor as it was covered by shelves. Therefore, a simple solution was not known to the others and by getting in everyone, the problem was addressed.
In fact, top management schools also follow the principle of organised serendipity because there are fixed proportions of seats kept for those who have domain knowledge or experience, another slot for uniquely talented students from, say, the sports domain, yet another block for students with different ethnic or religious backgrounds and the last for people with life experiences. The idea is that they all help to provide perspectives from different sides as they come with varying backgrounds. An owner of a steel mill or a homemaker will add to the quality of discussion in these classrooms. Often parties are a way of organising serendipity. Restructuring offices without cabins creates an open culture and encourages exchange of ideas, and at times could stimulate new outlooks that are helpful for the organisation.
The authors conclude that keeping chaos at bay comes in the way of innovation. The three ways of creating this chaos are quite interesting, and they have used these principles in the US army to motivate the soldiers and get the best from them. That is saying something because in the military, rarely is one really allowed to think for himself, as indoctrination is more towards compliance without questioning. If it worked there, it should certainly help organisations flourish. That is the major take-away from this book.

Fiscal jugglery: Asian Age 17th October 2013

The finance minister has taken a stance contrary to that of the International Monetary Fund, and some others, in calculating GDP projections for the current year. At the IMF forum in Washington recently, Mr Chidambaram questioned the world body’s assumptions. He is confident of 5-5.5 per cent, while others put their money on GDP ranging from 3.5-4.5 per cent. The 5 per cent mark is significant because psychologically anything less sounds defeatist. CARE Ratings figures project growth at 5.1 per cent, subject to assumptions being fulfilled.
There are two major reasons why growth should look up now on, while there are two other positive factors working in the background. The first is that the monsoon has been good. Going by the first advance estimates of agricultural production, farm output will be higher this year, which means there will be good spending power. In the past, there was a tendency for incomes to be diverted more to gold and jewellery. This impacted consumption and savings. While the rupee value of gold has increased in net terms, the physical restrictions placed are probably more important. This, combined with conventional spending during the festival season by even non-farm households, should provide a thrust to spending.
Recently the government also announced that it would capitalise banks (news reports suggested that government would pump in an additionl `5,000 crore into banks for this purpose) which sold more consumer loans. This has prompted some public sector banks to drop their lending rates. At the margin this should boost consumer spending. The importance of consumer spending on durable goods forges strong backward linkages with the basic, intermediate and capital goods sectors. While this virtuous circle is a strong possibility, it is built on the premise that rural households do not divert their income to gold.
The second reason for optimism is the government’s indication of clearing investment proposals amounting to `3.8-5 lakh crore. At a pragmatic level, one may not expect all these to fructify this year, given that Indian industry still has spare capacity. But even if 15-25 per cent of these proposals materialise, there will be a turnaround in investment, pushing up industrial growth.
While overall industrial growth would still be in the region of 1-2 per cent for the entire year, a foundation would have been created for future growth.
On the other side, somewhere along the way we are also witnessing the right signs in growth in exports. Though built on a low base, as growth was in the negative region last year, exports will still positively impact growth at the periphery. The rupee depreciation would have also helped in providing an advantage.
Further, the construction space is an area where some action can be expected. The core sector data shows that steel and cement have been relatively buoyant, indicating some movement in infrastructure activity. With support also coming from the services, especially finance, trade and transport, an overall growth rate of 5 per cent could be maintained this year. But, the big assumption is the strong link between farm incomes and spending on consumer durable goods.

UPA or NDA - Who did better: Business Standard: 16th Ocotber 2013

As elections draw close, it has become a part of the propaganda for each party to claim that the country has fared better during its regime. If we move beyond the rhetoric and take a look at the basic concept of such comparison, the approach could be flawed. Economic indicators cannot be linked to a regime, because, frankly, policies implemented in one regime will work with a lag. Similarly, a drought or a global financial crisis can strike a government hard, where it may have little control. Liberal trade policies pursued will impact the current account deficit (CAD) at a different point of time until they are rolled back. Therefore, such comparisons tend to be controversial and the conclusions drawn could be a case of contrived serendipity.

Yet, for the sake of academic argument, it is still worth examining how governments have fared in the last 15 years or so in terms of economic performance. The National Democratic Alliance (NDA) government ruled from FY00-04, the United Progressive Alliance (UPA)-1 reigned between FY05-09, and UPA-2 from FY10-FY13 (FY 14 is still on). UPA-2 is different from UPA-1 not just because of the composition of the alliance, but also because of the controversies that were associated with the regime. Performance numbers have been averaged for each period on an annual basis rather than compound growth rates to eschew end-points biases.

The table has placed the variables in a specific pattern. The first six variables are areas where UPA-1 has superior results to the NDA. But also quite significantly, in five of the six parameters used here, UPA-2 was lower than that of UPA-1. Agriculture was the exception. Again, within this block of six variables, UPA-2 was clearly better than the NDA on three counts: gross domestic product (GDP), agriculture and power. It was higher in case of capital formation, though the NDA also did fairly well. But the NDA scored better than UPA-2 in terms of industrial growth and marginally better in fiscal deficit. In case of debt to GDP ratio of the central government, the NDA did better than UPA-1, though it was inferior to UPA-2.

What are the conclusions that can be drawn here? First, the UPA has been more inclined towards agriculture during its two tenures, hence the resilience we have witnessed in output numbers has been an achievement. Second, capital formation growth has been higher in the UPA reign, though the second tenure has definitely seen a slowdown that can be attributed to both lower GDP growth, that is demand, as well as the controversies that have consumed administrative time. Third, UPA-1 brought in some economies in industrial growth, but that has not been maintained in the last four years. Quite clearly, whichever government takes over, the focus should be on reinvigorating this sector. Fourth, fiscal indicators show clearly that UPA-2 has moved away from prudence unlike UPA-1 and the current focus of the finance minister on containing this number is laudable, but ideally should be achieved not through project expenditure cuts but control on non-development expenditure. Fifth, the control, of the debt to GDP ratio is an achievement under these conditions since this is one indicator that the world is also watching closely. Last, GDP growth has also followed an inverted "v" pattern, rising during UPA-1 and declining in UPA-2 (the number will be even lower if the fifth year is considered).

Let us look at where the NDA regime has been more successful. First, on inflation, the performance has been much better with the consumer price index inflation number going lower than the wholesale price index. Quite clearly, the pro-farmer pricing policies followed by the UPA has probably achieved better crop results, but has affected the cost of living of the common man, which is critical when it comes to elections. Second, in terms of CAD, the NDA managed better with a surplus that deteriorated sharply during UPA-2. The liberal import policy was responsible for this trend. However, remedial measures have been invoked of late that will help to improve the situation. Last, the exchange rate has done better here with a limited depreciation. UPA-1 had to contend with high appreciation too and the currency was more volatile. For the NDA, standard deviation was 4.2 per cent, while for the UPA it was 9.1 per cent and 7.2 per cent respectively.

The UPA can definitely take credit for higher amounts of foreign direct investment and foreign institutional investors that came in during their regimes, though this is more of global factors at play than specific action from within. Therefore, these variables have not been included. In this context, a surprising outcome has been how the country has fared with regards to the governance - the Corruption Perceptions Index of Transparency International. The index, though low, has improved almost continuously from 2.7 in 2001 to 3.6 (out of 10) in 2012. This indicates that notwithstanding the controversies in the last couple of years, the nation has progressed on this score. A tempting conclusion is that what came out in the open was already known and on the aggregate things have only been improving. The same holds when it comes to the Human Development Index that shows an improvement in score from 0.461 in 2000 to 0.547 in 2011. In both these cases, India's rank remains very low.

On balance, it looks like the performance has been quite even. The NDA has done better on inflation and managing the external account and also was steadier on the fiscal and industrial side. The UPA has been more pro-farmer, and delivered better GDP growth and ushered in higher investment. More importantly, the country is silently moving up the ladder in terms of governance and human development, which is comforting.