It is back to currency: Economic Times, 19th April 2017

The elitist view is that cash is not required for daily transactions and that digitalisation is the way forward. If the local vegetable vendor was comfortable with e-wallet, so could be anyone else. This was also the stance taken midway through the demonetisation programme, which had started off as an anti-black money crusade and changed track to digitalisation. How has the public responded?

When there was less currency in the system, as there was a hiatus in the supply of new notes, it was natural that the public took to the electronic mode or reduced spending. With currency gradually being brought in by RBI, the picture has changed and there has been a tendency to gravitate back to cash. The table gives total volumes of transactions through the electronic payments for the last four months and juxtaposes the same on the outstanding currency in the system.

Currency in the system fell sharply by December. It is expected that the RBI will provide full supply by end-June, unless there is a conscious decision to hold back circulation.

The interesting part which emerges is that the overall level of electronic payments has come down over the last two months after having peaked in December. In November, the level was lower as the public had to adjust to the new system of working without cash. The dip in these levels following currency expansion does indicate that the system is veering towards earlier equilibrium. The volumes of card transactions have declined and the only segment, which is very small in size, the UPI (Unified Payments Interface) which facilitates e-wallets through the banking system, has been increasing.

There are some messages here. First, the public loves to hold cash as it is convenient and most preferred. Second, if one were to consciously print less currency, then there could be an increase in the electronic payments, though it could also lead to a higher velocity of circulation. Third, the use of cards can be made popular only in the case the cost of transactions comes down. At 2% merchant rate, it is fairly high. As these charges were waived in November and December, the use of this mode increased. Fourth, the issue of security has to be addressed.

Even today, people prefer to withdraw money from a bank rather than from an ATM. The recent incident of fraudulent notes in the ATM has raised a broader issue of what recourse is available in case a bank refuses to accept such an incident? Fifth, cyber security is extremely important because there are constant fears that accounts can be hacked or debited incorrectly. Redressal mechanisms are quite inadequate.

For going digital, it is essential to bring some rudimentary elements. First, it is awareness where people get to know how to use these options; second, giving incentives such as discounts. Forcing people to go digital as a punishment is not sustainable. Third, power supply in rural areas is essential to enable use of cards. Also connectivity on handsets is unavailable in the hinterland.

Such migration is a slow process and the government has to take a lead and spend money in creating structures, which it is not willing to do given the fiscal conundrums. At present, the system is moving more towards imposing punitive charges on bank customers, so that they are forced to move away from cash. This is not a solution, not just because it impinges on an individual’s freedom, but it also exerts a burden on society. The cost of Rs 2,000 currency note is Rs 4 per piece, can revolve 100 times without any further cost. If the same ‘value’ circulates even 10 times involving Rs 20,000 worth of transactions, society pays Rs 200 at a merchant cost of 1%! The question is are we willing to pay for this?

Wholesale banks a must for financing infra needs: Financial Express April 17, 2017

The result was that these DFIs got themselves converted to universal banks under much fanfare and both ICICI and IDBI became banks through reverse mergers with their commercial banks outfits. (Reuters)

The concept of a Wholesale and Long Term Finance (WLTF) bank is part of the scheme of differentiated banks that has been in the news of late. The creation of payments and small banks was also part of this agenda. One is not sure if these banks will make a major difference, but those promoting the same evidently have their plans in place. A corollary in the success of these banks would be that commercial banks have not been successful in spreading financial inclusion and have not harnessed use of technology. In fact, the regional rural banks and structure of cooperative banks have to be critically analysed in this context as they have not delivered.

Now, the WLTF bank concept is not really a new one as there was the rather strong and convincing structure of the Development Financial Institutions (DFIs) that existed from the 1950s to the beginning of the 21st century. The 3 institutions, IFCI, ICICI and IDBI, can be credited with building India by providing long-term finance to industry. The system was straight-forward, one where they were able to get funds at concessional rates and on-lend to industry. With the onset of financial liberalisation, this relation was severed and they had to borrow at market rates. This also meant that their lending rates had to be increased and the model ceased to be viable.

The result was that these DFIs got themselves converted to universal banks under much fanfare and both ICICI and IDBI became banks through reverse mergers with their commercial banks outfits. The main advantage was that they got access to current and savings deposits which account for around 35% of total deposits; that helped lower the cost of funds. But, given the structures of assets and liabilities, there were bound to be tenure mismatches when lending to infra projects or long-term projects.

More recently, IDFC has gotten converted to a commercial bank, and IFCI, too, is keen on doing the same. Quite clearly, it does appear that the era of DFIs is on the way out and those that remain are EXIM, NHB, NABARD and SIDBI, which are actually refinancing organisations. How do WLTF banks fit in now?

The purpose is to provide long-term finance exclusively to corporates, including infra companies and SMEs. These banks will do only wholesale lending, keeping retail loans to the minimum. Funding cannot be through regular deposits, but it is mentioned that there can be current deposits besides term-deposits of high value. They can issue bonds and can also subscribe to the same which are issued by corporates and hence play the role of market makers. They can also go in for borrowings from banks, CDs or securitisation etc.

Do we require such banks? The answer is “yes” as the present system cannot quite handle the demand for such funds. Commercial banks, including PSBs, have preferred to lend to the retail segment where the delinquency rates are low. Therefore, having banks which focus on only long-term lending will be very useful and add a new dimension to lending as banks continue to focus on short-term lending.

Will a public purpose be fulfilled in case WLTF banks come in? The answer again is “yes” as these banks will fill the gaps that exist in the system today. The demand for funds is high, given investment rate is quite low at 27% . If it has to be pushed up to 35%, alternative avenues need to be sourced as banks, ECBs and the debt market have their limitations. This new genre of banks will definitely add value.

How viable will they be? Once the WLTF matches the tenures of its assets with liabilities, there will be a good fit between the two. At present, AAA-rated bonds come with a rate of between 8-9% with the lower-end being reserved for public-sector companies. AA-rated bonds can range between 9-12%, while a higher rate has to be paid in case the rating is in the A category. Therefore, WLTF banks will need to get a very good rating to get a borrowing rate of 8-9%.

The banking system operates with high spreads between deposit and lending rates. Today, the spread between the base rate and one-year deposit rate is 275 bps. In FY16, the difference between cost of deposits and return on advances was 330 bps. Cost of funds was around 6%. With WLTF banks procuring funds at 300 bps higher than the banks, adding 330 bps spread will push up costs for the borrower. Will companies be willing to pay this much, especially when they can borrow directly from the market?

For WLTF banks to succeed, several options need to be explored. The first issue is how to lower the spreads for the WLTF bonds. Having bricks-and-mortar structures would add to costs and hence the option of being primarily an internet based bank can be considered. Second, the WLTF banks can be made to apportion lending activity across both credit and debt markets. A 50-50 division will be useful as they can lend directly in the bond market for bonds which will be higher-rated. This will also be the preferred route for higher-rated companies. The balance lending should be based on collateral with insolvency laws in place. Also, RBI should focus simultaneously on credit enhancements to be provided by banks on such bonds which may be subscribed by the WLTFs.

Third, the WLTF banks should be freed completely from CRR and SLR obligations. The CRR is a disincentive while SLR will make them gravitate towards G-Secs. Fourth, RBI can set tenures for their lending, i.e., not less than five years or such a norm, but should give the freedom to lend to any sector. Bringing in priority-sector-like norms will impede their activity.

It should be remembered that WLTF will be starting with the handicap of lending to the non-retail segment and taking on higher risk as these loans would be of a long tenure. Focusing on infra projects and term-lending makes FIs more vulnerable to NPAs and hence, prima facie, the last decadal developments are a dampener. In short, there should few inhibiting clauses in the terms of engagement for these banks, or else potential promoters would be at a disadvantage. An issue which should be kept in mind while giving permission is that all banks—including private sector—ones have faltered on asset quality when such long-term lending is concerned. How can one be sure the story is not repeated here?

WLTF banks could be a useful way of channelling funds to the sectors that can’t be handled by commercial banks. But given the past history of FIs, it will be interesting to observe the interest that may be shown by the players. Integrating this concept with the objective of developing the bond market will be possible, and should be pursued. Ultimately, any player who chooses to enter the fray would work around the financial viability of such projects before making an application. The pitfalls in the earlier dispensation of DFIs need to be addressed in detail by the applicants to reassure the central bank that these models can work.

On the money: An excellent book that presents various facets of demonetisation: Book Review Financial Express April 16, 2017

A significant part of the demonetisation drive was that while almost the entire country was inconvenienced by its implementation, there were no protests of any significant variety.

Demonetisation in India has probably been one of the most controversial steps ever taken and, given the top-down approach, has elicited a cautious response from critics. While economic implications were more forthright from critics, the release of latest data on growth by the Central Statistics Office vindicates the government’s stance that the impact was negligible.

Rammanohar Reddy, a well-known economist who headed the prestigious Economic and Political Weekly, takes a rather dispassionate view of the move and presents a cogent discussion on the subject. A significant part of the demonetisation drive was that while almost the entire country was inconvenienced by its implementation, there were no protests of any significant variety. Therefore, if the government looks back on this move, it could always claim that the nation was in support of it—this can be buttressed by state government elections results, where the electorate was agnostic to this move.

Reddy starts off with the definition of black money and covers both the aspects of white money—not accounted for through the tax system, as well as dealings in illicit activity. He highlights how some of the activities of former Tamil Nadu chief minister J Jayalalithaa—the case had come up in courts, leading to the conviction of a close associate—were all done through the banking system, not cash. Hence, linking all black money to cash would be a spurious conclusion to draw.

The question really is, how much of the 86% currency that was demonetised actually resided in this form? As there has been little information provided by the government or the RBI on how much money has moved out of the system, we will never know if the assumption that black money would be unearthed by demonetisation was founded on firm ground. Neither will we know the exact impact on growth, as there are time lags in effect. Also, as the re-induction of currency has taken the economy towards normalcy, the direct impact has gotten blurred. Hence, the answer to this question will remain open-ended.

What is clear and unequivocal, however, is that the implementation was quite unsatisfactory, and this can’t be defended on any ground. Here, the author takes us on a tour to see the impact on different sectors. Mandis came to a standstill, as there was no cash. Sowing got delayed, as wages could not be paid. The manufacturing sector, too, had a similar affliction, where units could not pay labour. While credit facilities and bank transfers helped make payments to various parties, wages could not be disbursed. This was true for the retail trade as well, which saw some agonising months of sharp decline in business. As a large part of the population earns a livelihood selling goods on streets, absence of cash made life difficult for them too.

At the theoretical level, Reddy gives a detailed analysis of the RBI balance sheet and surpluses. This is insightful, as the issue was raised very often in the course of the debate, where there were arguments and counter-arguments on how money—which disappears from the system—can or can’t lead to transfers to the government. Reddy also gets into the trauma faced by banks, where two months were spent only dealing with currency and irate customers, a cost that can’t be measured. Banks also had to face other problems like surplus deposits and the accompanying cost, which dented their income statements. This led to measures by the RBI in terms of increasing the cash reserve ratio and, subsequently, bringing in market stabilisation scheme bonds to absorb the surplus liquidity.

Two interesting issues that merit some mention relate to the digitalisation theory and the 50-odd regulatory changes made along the way. The first one is that the government was not sure why it was implementing demonetisation. As Prime Minister Narendra Modi never mentioned digitalisation in his speech on November 8, it appeared to be more an afterthought argument provided to save face when it appeared that all the currency in the system was going to return in the form of deposits. The author feels that, in this respect, the scheme was not really well thought out. Reddy also provides statistics to show that some of the poorer states in India have very bad connectivity and, hence, asking for such a transformation might be quite meaningless.

The frequent changes in regulation during these two months on ‘what can and can’t be done’ were another manifestation of the absence of a well-planned strategy. While defenders of these changes have argued that this was the best way to get at the dodgers, the number of regulatory changes was still quite high.

At the ideological level, an issue that the author raises and which has also been emphasised by former RBI governor YV Reddy in the foreword of the book, pertains to counterfeit currency. A fundamental question is, why do we have to import paper from outside to print currency and, as a corollary, why can’t we have such a facility within the country? Reddy also warns that in case this measure turns out to be a failure—which we will never know—the entire war against black money will get diluted and people will lose faith in the system.

Demonetisation and Black Money is an excellent book that will appeal to the common man, as well as the professional. It has been researched thoroughly and the references provided in the discourse provide proof of that. While one can see a tilt in Reddy’s inclination towards the scheme being a failure, he is willing to keep an open mind and has presented the government’s view as well. This makes the book an excellent treatise on the subject.

Growth and asset failure: Financial Express 14th April 2017

The NPA issue has now come to occupy centre-stage, with there being a clarion call to set things right.

The NPA issue has now come to occupy centre-stage, with there being a clarion call to set things right. There are two aspects to this. The first is the build-up and recognition of these NPAs and the second is their resolution. The focus, today, is more on the second part. The major challenge is that if these assets are to be disposed of, then someone has to put in money (in case of ARCs) and bankers have to be willing to operate without fear for selling cheap. Unfortunately, no one is willing to put money on the table, and bankers are not confident about neutral repercussions in the future.

One of the reasons for high NPAs is the practice of better recognition of these assets being pursued as they were swept under the carpet by being called restructured assets in the past. Curiously, when this was done, no one objected and such acts were justified as being necessary on account of projects failing due to extraneous conditions like policy impediments. But doesn’t this hold for almost all loans that turn bad when conditions turn adverse? How serious is this issue today?

To put it in global perspective, the accompanying table provides four major indicators for banking systems in 15 countries for the latest quarter of 2016 as presented by the IMF. The countries chosen are a blend of developed and developing nations to highlight these patterns. Countries in Africa and CIS have been excluded where numbers are extreme.

India is high up in this list with Italy, Portugal and Russia being above us. The number of 9.2% compares with Cameroon, Algeria, Bhutan, Armenia and Hungary which have ratios between 9-10%. This is not good news considering that we do claim we are one of the front-runners in growth and development in the world.

The second column gives data on the ratio of NPLs adjusted for provisions to capital, which is a better way of depicting NPLs in relation to capital. Here, too, we do not do well with 38% of capital being vulnerable to be wiped out on this score. Italy is disastrous, while Portugal comes close to India. Spain is quite high at 29% and Germany, surprisingly, with lower NPL ratio has 21% of capital being vulnerable to NPLs. This ratio is important as it captures the combination of NPA and capital adequacy as it indicates the adequacy of capital in the light of impaired assets.

The last two columns provide information on both return on assets and return on equity, where we are ranked 9th and 11th, respectively, and hence well below the median value. Providing for these NPLs does push down profits and gets reflected here.

Two thoughts come to mind. In India, the outstanding debt from the formal sector is around `130 lakh crore and includes banks, corporate debt market, ECBs, financial institutions and NBFCs. Banks account for around 60% with outstanding loans of `75 lakh crore. If one were to look at NPLs in other segments, the picture is stark. In case of FIs, it is less than 1/2%. For NBFCs, it varies between 3-5%, depending on whether they are deposit or non-deposit taking entities. For both corporate debt and ECBs, the numbers are almost negligible—though arguably only the better borrowers have access to these markets.

This means there is fundamentally something different in the systems of banks that led to the build-up of NPAs and that does not get replicated in other segments. Clearly, the credit systems need to be examined in detail to pinpoint where the fault lines lie. It would be a combination of the credit appraisal techniques and understanding, decision-taking, follow-up processes as well as the quality of borrowers as those which are not good would also have no other source of borrowing.

The second thought would call for debate. There are two parallel developments in the economy. First, we do take pride that ours is the fastest growing economy and has been for several years. The question is that as all growth has to be financed by the system, there is a chasm when one puts in the second part of the piece, which is bank NPAs. Is it that we have achieved high growth by being injudicious in lending—an allegation that is often made in China where banks have been pushing in funds to keep the wheels rolling at a fast pace?

This is interesting because, as the table shows, high NPAs normally go along with countries that are on a decline and have deep problems in the real sector. The euro crisis dented growth prospects of several nations which get reflected in these numbers. But the Indian case is unique because growth has been high with focus on infra creation (also the case in China) as well as capacity additions in industry in the face of easy availability of cheap funds. But it does appear that ever since the economy slowed down post FY14, the NPA issue has come to the fore with the same getting highlighted when RBI spoke of their recognition.

Given that such magnitude of NPLs has built up over years and not due to single quarter disturbances, we need to introspect. Has it been a case that we have fostered high investment and growth through reckless lending? We have heard of the rise and fall of the junk bond market where companies borrow at high rates as they carry commensurate risk. Is there a parallel in the banking sector? This is important to address because if we are working on a new path to growth where finance will still come from the banking sector, which will be equipped with more capital, it should not be a case of return to imprudent lending.

Moralistic bans can really hurt the economy: Business Line, April 13, 2017

Tobacco, alcohol, meat, romance — the morality meter’s ticking to cut these industries down to size

The series of bans issued in the last few months has affected the lives and livelihood of several people. These measures have strong religious and moralistic undertones that are defined by the elite. In India often these over-sensitive elites raise issues which are taken up with greater alacrity by the legislative and judicial systems compared to more serious issues such as poverty, crime and unemployment.

The fact that there is judicial sanction for steps against smoking and drinking implies that procedures of the law and the Constitution have been adhered to, which makes it a more or less permanent development. In fact, it may be expected that there will be further consolidation of these bans — the liquor ban could move into cities from highways as accidents happen on all roads.

Economic sins

The tobacco and liquor industries have been particularly affected over the years. The tobacco industry involves as many as 50 million farmers with the valuation being in the region of ₹75,000-100,000 crore as it also involves informal products that are marketed. The alcohol industry, more a lifestyle product, is valued at around ₹250,000 crore and again spreads across the organised and unorganised segments.

Both the partial bans, which restrict the sale and use of the product based on location, are premised on the proliferation of negative externalities that affects the general public in the form of being either a health hazard or a public threat.

Smoking and drinking are considered to be economic sins, and have been under the radar for a long time. The emphasis was on personal health with the only intervention being the provision of statutory health warnings. However, now things will be different.

Besides those who work in these industries, there would be a secondary impact on the hospitality business too as both are linked with users who either eat out or at home. As the logical extension, these partial bans will lead to producers moving away from such activity. The decline of these industries will have repercussions on the supply chain as well as the hospitality and entertainment business which get linked to the user end. This excludes revenue loss for the government which is substantial as sin tax is probably one of the few economic impositions which confronts an inelastic demand curve.

The third serious ban, which is not a sin but a habit which offends the moral and religious sensibilities of certain sections of society, relates to cow slaughter and the associated regulation on selling meat.

Here too, the economic implications are interesting. The meat industry is valued at ₹1,75,000-₹1,80,000 crore with most of the activity in the unorganised sector. It also has a large export market which could go up to $5 billion, with India being the largest exporter of buffalo meat. The decision to come down heavily on any illegal activity in this sector.

At a more micro level, the idea of moral policing, which has caught up of late, also has economic repercussions. Pushing youthful romances indoors, besides affecting individual choice, impacts the restaurant, hotel, and florist business as with every population of 1 lakh couples not indulging in ₹100 of expenditure per outing, pushes back the system by ₹1 crore!

Loss of revenue

One is not sure if implementing these measures would improve the moral fabric of the nation, but it does displace a large populace and leads to loss of revenue, both for the government and the entrepreneur. In fact, it has been argued that the government has not fully banned the use of tobacco because there is a farmers’ lobby to protect which simultaneously yields high revenue — almost ₹35,000 crore. While the government could look for alternatives in terms of funding the deficits, providing employment would be challenging. Curiously, if tobacco was considered a ‘bad good’, it could never have been allowed as an industry.

Hence, every ban has a serious economic effect. Banning dance bars in Maharashtra was intended to protect the moral sensibilities of male youth. With around 1,500 of these touch-points being affected by the ban involving almost 100,000 workers, sales of around ₹5,000-₹8,000 crore per annum was involved.

Rehabilitation has rarely been taken on by the government; the consequence has been unemployment and destitution. In case of tobacco and meat, the issue is even more pernicious as there are workers at the ground level who directly work on the crop or are involved in the meat supply chain.

The other fallout on economic activity is the migration to underground premises which often results when ‘bad habits’ are hindered. A good example of an activity banned in most countries is prostitution. But the business is widely prevalent: India is a leading nation with the industry valued at around ₹55,000 crore — it comes after China, Spain, Japan, Germany, the US and South Korea. Liquor and tobacco have easy routes into the market through illegal channels.

The effort to create a moral society with strong religious proclivities is laudable. But for balanced development to take place it is essential that all the displaced people are provided alternative jobs through budgetary allocations; the unemployed populace can make our much-touted demographic dividend a liability. For industries, it is time to introspect as the regulatory risk for their own sector will always be an uncertainty.

Will the rupee continue to appreciate or head south: Outlook Business 14th April 2017

For the rupee to stay robust, both the current and capital account need to be strong and that doesn’t seem likely. In the current account, we could see a decline in remittances and software receipts. The first would be triggered by falling oil revenues in the Gulf impacting remittances from Indians employed in the region. Further, Trump’s curbing of H1B visas would have a direct impact on software receipts. Besides, as interest rate in the US inches higher, we should see the FPI flows into the Indian debt market ebbing. High interest rates in the US will also scuttle the possibility of external commercial borrowings by companies and higher deposits from NRIs. Further, the RBI would not want the currency at such levels as it will hurt competitiveness of exporters. Over the next six months, we could see the rupee head lower to 66.5.

Donald Trump’s argument wrong, immigrants not the cause of unemployment: Financial Express, 5th April 2017

ne doctrine reiterated by US President Donald Trump as well as advocates of Brexit is that there is a need to protect employment in a country that is being progressively impacted by a rising immigrant population. This has become a political issue, which has evidently been supported by the public in concerned countries, judged by the way they voted. In this context, it is useful to look at how immigrant stocks exist in the world today. There are several countries that are underpopulated and do require immigrants, especially at the lower-skill levels, as local population would be less willing to take up such jobs given the remuneration involved as well as social status considerations. There are also skilled jobs that are taken on by immigrants in host countries, which come at a lower cost for employers and hence work both ways.

In 2012—the latest year for which World Bank data is available on immigrant flows—India led the group of immigrants with an outflow of 2.6 million people. The country was followed by China with 1.8 million, Columbia with 1.45 million, Lebanon with 1.25 million and Pakistan with 1.08 million. The host country that took in the highest quantum was the US, with 5 million. Clearly, there are strong push factors operating where migration is invariably to developed nations that offer not just employment but also a better life. This can be a reason why Trump had taken up this issue at the time of elections.

The accompanying table provides the share of immigrant population to total population in various countries, along with unemployment rates. This is important because the distribution is interesting as countries have different ideologies to immigrant population with similar structures. Also, while the argument put forward often is that jobs are lost to immigrants, actual unemployment rates may not be that serious or out of line with those in other nations. Broadly, there are three sets of countries that witness high immigrant flows. The first set comprises those that are underpopulated and depend on external labour—this holds true for Gulf Cooperation Council countries where over 70% of the population consists of immigrants.

The second set, which includes countries such as Switzerland, Canada, Australia and New Zealand, are in a different league, where there is thin local population but high non-natural resource-based activity which requires a different kind of skill-sets. These countries typically have immigrant population in the range of 20-30%. A number of European countries and the US fall in the third category, where there is more of a push factor than pull force. The desire to work in these countries is high for the migrating population as these are the most sophisticated economies with developed economic structures and, more importantly, offer a plethora of education facilities which, in turn, provide a corridor for jobs. Further, with the US and the UK having the advantage of the widespread use of English language, it becomes easier for skilled migrants to communicate as well as find work.

In between are the refugees from West Asian countries, who would move to whichever country that does not close doors to them, and given their proximity to developed European nations, they tend to go there; this has been aided by the decision taken by some of these nations to take in a fixed number of immigrants over a period of time. Now, how have unemployment rates behaved across these nations? There is a natural rate of employment that Milton Friedman has spoken of, which will vary across countries. This is the minimum level that has to be tolerated by the concerned countries even when growth is high, and is fixed for various countries based on their own standards. Normally, a rate of 4-5% would be accepted as the median level, which goes with the structures of developed economies, and can go higher for developing countries at 5-6%. Those with a very high ratio, as France and Italy, would be outliers for the present as they seek to move out of the low equilibrium trap that has been brought about due to the adherence to the euro doctrine where there is an emphasis on government spending which has affected growth ever since the advent of the Greek crisis.

The unemployment rate in the US and the UK at 4.7% is close to the natural rate, and hence does not really display a scary picture. Germany has a lower rate, but then it has been a better performing economy right since the financial crisis started. The immigrant population stock is significant, but it does not appear to be seriously coming in the way of provision of jobs. Therefore, it is possible to argue that while countries would like to protect their own jobs, the issue of immigrant population becomes serious only in times of a downturn in the economy. A fast growing economy would definitely need labour force to expand in a similar proportion in order to keep the system moving. The euro region has an average stock of 12.2% and the US number is not much away from this median rate.

Public debt management: Should RBI handle both monetary and borrowing policies? Book Review Financial Express, 2nd April 2017

he issue of public debt management has always been on the discussion table. There are, as usual, differing views on whether or not the RBI should handle the issues of management of public debt, as well as monetary policy, with there being compelling arguments on both sides. Charan Singh, a very distinguished economist with experience in both the central bank and academia, weaves together a very interesting collection of articles authored by various experts on the subject.

The view, which comes from authors like former deputy governor of RBI HR Khan, argues that the two can’t be separated and the central bank in India has done a very creditable job in handling this dilemma. The RBI has been known to be fairly independent, which has been proved over the years, and hence to say the conflict of interest that potentially exists has not been handled adeptly would be incorrect. In fact, based on the factual, it can be argued that if the RBI was subservient to the government, it should have been lowering the interest rate all the time to ensure that the cost of borrowing is kept down. But the allegation often made is that it has not lowered interest rates in a timely manner and been very hawkish on inflation due to an obsession with the CPI. Therefore, in terms of actual developments in the market, the RBI has handled the situation without any bias and has not let the issue of public debt come in the way of monetary policy formulation.

What then can be the arguments against a single authority handling both the issues? It is true that whenever one searches the global arena for templates, there are always several cases where the two functions are handled separately by different institutions. Hence, there are case studies that support the creation of a separate public debt management agency. Here, Singh provides a good argument that around 50% of government debt, which includes both central and state, goes beyond market borrowings like small savings, and is handled outside of the RBI. So why not have even this part of debt transferred to a centralised entity? The counter-argument could, however, be that a large part of these liabilities are exogenous in nature and cannot be controlled, and hence do not quite require management as such. But then it can be said that there will be better alignment in interest rates across various debt instruments, such as small savings and market borrowings, in case there is a unified agency.

On the Public Debt Management Agency (PDMA), K Kanagasabapathy, who has also worked with the RBI, has argued that it would still be better to move gradually to its creation, as it will enhance coordination efforts. But it should be independent from both the RBI and government, which is interesting and challenging, considering that the latter would be appointing members to the PDMA. This agency, it has been suggested, will also additionally handle the cash balances of railways, post, telecom, pension funds, etc. This should definitely spur some deep thinking on the concept of separation of responsibilities of public debt and monetary policy formulation.

There are other papers on the FRBM and fiscal discipline where the issue of flexibility and prudence are also addressed by authors in the final round table. Interestingly, a point made on fiscal consolidation is quite compelling where author RK Pattanaik talks of the four ‘Fs’, which have to be considered. The first is ‘fiscal empowerment’, where the objective should be to maximise fiscal revenue. The second is ‘fiscal transparency’, which is really important, as creative accounting is often used to make the numbers look palatable. Here, for example, the system of recognising expenditure when it is actually made allows the scope to defer payments for expenditure incurred so as to show better fiscal numbers for a year. Such rollovers should be avoided.

Third, ‘fiscal marksmanship’ has been spoken of where there should be less deviation between budgeted, revised and actual numbers. This is, of course, difficult, but finance ministers have to be conservative to begin with. Often in order to placate the markets, FMs tend to overstate expenditure on the capital side when presenting the budget and then cut back on the same to balance at the end of the year. Last, ‘fiscal space’ should be provided, wherein counter-cyclical polices are pursued to manage fluctuations in thOn state finances, there is an interesting paper by R Pandey where he points out that there is less flexibility in raising resources for these sub-sovereigns. Ironically, it is because of this constraint that states have been better able to comply with the fiscal targets, as they cannot go beyond what is allowed through market borrowings. But this can be a drawback when it comes to choosing sources of funding, especially on the external front, where it has to be done through the centre. In this context, it is also argued that states also have little reason to perform, as all state debt is treated on a par, as there is the system of ‘automatic deduction mechanism’ for repayment of market debt by the RBI, which ensures that there can never be a default. A more competitive environment on state performance rating on the fiscal side can make the cost of borrowing different for various entities. The takeaway is that there is an urgent requirement to bring in reforms in this area.

This book is a must for policymakers, as well as academicians, and should stoke greater debate on the subject, as we move towards the resolution of this dilemma. Singh has put together the papers and deliberations that took place at the ninth Annual International Conference on Public Policy and Management in this volume, which should find a prominent place on your shelf.e economic environment.

In FY18, all major pieces on the ‘real economy’ side have to be re-threaded – will we look back in anger or satisfaction?: Financial Express, March 30

The economy will be entering a new phase in FY18 where it appears all the major pieces on the ‘real economy’ side have to be rethreaded.

FY17 has been tumultuous for the Indian economy, which had otherwise started on a note of optimism. The incidence of demonetisation has thrown attention off-track with several arguments and counter- arguments being made to decipher the effects of this move. In the last five months, there has been a lot of diversion of attention from the state of the economy with the government trying to argue that the economy was not affected by demonetisation. In fact, there are some votaries who have put forth the view that the economy is better off. Interestingly, even the Budget and post-Budget focus has been more on catching black money than pushing forward the economy. In June 2016, when it looked like that there would be a normal monsoon, it was widely assumed that the economy would move upwards and the government did not rule out 8% growth for FY17, even while the more conservative RBI settled for something half way through the 7-8% mark.

Rural demand and consumption was to provide the impetus accelerated by government spending on infra that would, in turn, bring in more private investment. But the story took a different turn and the final direction is still nebulous. What are the positives for the economy? First, agriculture has been the bright spot on this canvas, and going by the GVA numbers put out by the CSO, growth would be 4.4% as against 0.8% last year. This is to be evenly spread across both the kharif and rabi crops; and for a change, the country is grappling with the problem of surplus production of pulses, which has led to prices coming down well below the MSP.

Second, as a result of the good monsoon and harvest, the CPI inflation has gravitated downwards and from a peak of 6.1% in July has come down to 3.7% in February, which is well within RBI’s radar of 4% with a band of 2% on either side. Third, with inflation being low, RBI has lowered the repo rate twice by a total of 50bps, which is a big push for the industry, especially since the MCLR has also been brought in to ensure better transmission of interest rates. Fourth, the stock market has been buoyant most of the time, and not withstanding Brexit, Donald Trump and demonetisation, will be ending on a high compared with a base of 25,341 in March 2016.

Fifth, the external scenario has changed, though a low base effect has contributed to both exports and imports increasing by 2.5% and 2.3%, respectively, during the first 11 months of the year as against negative growth rates last year. Sixth, a major achievement, for which RBI has to be commended, is on the forex reserves side where an increase of nearly $45 billion was witnessed as they climbed to $364 billion. While the increase is not significant, the achievement was in maintaining this level, notwithstanding the outflow of the FCNR(B) deposits with virtually an un-noticeable imThere are, however, some scars on this painting. The first relates to the GDP growth, which has been projected by the CSO to be 7.1%. While this number looks more sanguine than the substantially lower numbers projected by economists, the fact is that it will be lower than 7.9%, which was attained last year. Considering that FY17 should have been better than last year, it is tempting to conclude that this shaving off growth by 0.8-1% was due to demonetisation as there was nothing else amiss in the economy. The other concern which is now an old story is the investment scene. The Gross Fixed Capital Formation rate has been moving down continuously on a quarterly basis and would be 26.9% this year as against 29.2% last year. Quite clearly, private investment has not yet been inspired and the government’s role has been limited.

While the Centre has been spending close to R2.7 lakh crore in FY17, it is too small a number compared with the GDP number of around R150-160 lakh crore to make a major dent. State governments are grappling with their deficit numbers and are working to adjust with the UDAY debt that has been taken on by most of them. Third, industrial growth, which is reflective of job creation, is still downbeat with growth being just 0.6% in the first 10 months over a low base of 2.7%. The finger points to consumer goods and capital goods which have stagnated. Fourth, bank credit growth has been lacklustre and would be one of the lowest this year at 3.7% till March 2017, compared with 10.5% last year. It would be a big surprise if this number goes beyond 5-6% this year.

Fifth, banks appear to be in a major mess, with the NPA issue still in suspension. While banks are to clean up their books by March 2017, one may have to wait for another quarter as these levels are now close to 9.5% (stressed assets ratio would be higher). The disappointment here is that there is still no clear roadmap of how the government will be addressing this issue for banks in general and capitalising PSBs with the purse strings still being held tight on account of the FRBM rules. Last, while the equity market going by the Sensex has been buoyant, equity issuances have been cautious at just R0.61 lakh crore as against R1.02 lakh crore last year. This is again reflective of low investment activity.pact on the exchange rate.

There are some grey patches which do not quite provide a clear indication of the state of affairs. These include the flow of foreign funds. While there has been some hype on FDI flows, the latest balance of payments data shows that for the first nine months of the year total inflows were $33.1 billion as against $33.5 billion—indicating thereby that flows have been stable. FPI inflows were negative this year till January at $3.3 billion, though equity flows were positive at $1.9 billion. Both the interest rate scenario in the US and the quantum of investible funds in developed countries were factors that played in both debt and equity markets.

Further, the exchange rate has been very stable and one of the best performers. While this is good news especially when compared with the situation in FY14, a strong rupee lends a disadvantage to exports. Hence, the good management of the FCNR(B) outflows has resulted in a stronger rupee on the flip side. Last, the government’s stance on the fiscal deficit, though prudent, is indicative that there will not be more money being spent beyond what is mentioned in the Budget. The economy will be entering a new phase in FY18 where it appears all the major pieces on the ‘real economy’ side have to be rethreaded. The positives that have been traversed in FY17 were largely guided by external factors like global environment or monsoon, which have to sing the same tune again to sharpen growth prospects.

Assembly elections triumphs reassuring for BJP, but will test : Financial Express 20th March 2017

The outcome of the state elections for the BJP though very reassuring, would also test the government when it comes to pursuing reforms

he victory of the BJP in the state elections has been viewed from two points of view, both of which are important. The first is that it is a vindication of the demonetisation scheme; and as a corollary the government now derives a lot of strength for pushing reforms. These assertions need some discussion.

It is hard to say whether or not the results were a vindication of demonetisation as the results prima facie show that two out of the five states gave an absolute majority to the BJP while three didn’t. It may be asserted that demonetisation affected two sets of people—the rich and not so rich. The rich, which is certainly in the minority have either escaped from the net; or are at the periphery been caught, but do not matter when the electoral numbers are looked at. The lower income groups which are more diligent when it comes to voting have never really cribbed when the scheme was on and were philosophic about standing in queues (they are so used to standing in long queues for kerosene, rations, water, etc, that it does not matter). Besides the thought that it was the rich that was going to be affected created an air of schadenfreude which was satisfying.

More relevant is that the government can now take on a more aggressive stance on black money and probably go after benami property which is on the agenda. This may not be good news for the real estate sector which has particularly been impacted by demonetisation. The idea of demonetisation did not require any Parliament assent, but was projected to be immensely unpopular with the people. However, the government may decide to go slow considering that the two schemes attacking black money in Swiss accounts and in currency have met with limited success (the latter should be known only after the results are put up by the government).

The issue on reforms is quite deep rooted and hence thought provoking. Typically, there are four reforms which are pending for action that could require assent from the Rajya Sabha too. Here again, it must be noted that given that the members are nominated to this House once the present subset retires after six years, there would be a time lag before which the election successes translate to higher physical numbers. It would probably be in 2018 that this majority will accrue on the floor.

The four reforms that are to be completed relate to land, labour, PSBs and FDI in retail. The government is definitely better placed when addressing these polices. However, these issues are quite ticklish as there are no easy solutions given their complexity. The present growth that has taken place in the economy has not been associated with large volumes of employment being generated, which probably explains why there has been a sharp increase in value added in manufacturing but not in industrial production. The latter is related to employment generation while the former is not.

Therefore, the government will have to bear judgment whether or not this is the right time to go in for such reforms especially so as the developments in the US could push back employment opportunities at the upper end of the skill curve too. Further, it should be pointed out that governments are normally wary on labour reforms as when jobs can be lost, it can affect the electorate in a more decisive way as it affects the people at the lower level. Hence, any move to get in more flexible labour laws would be an extremely bold move.

The second issue which is tricky and has been deferred relates to land. Bringing about easier sale of land is another bold reform that the government can take. Here Parliament can pass the Bill in both the houses, and the states where the BJP rules could implement the same by passing a vote in the assemblies as land is a state subject. Here again keeping in mind the general elections of 2019, there has to be thought given on whether it would be wise to have the same passed at this juncture. Land reforms have become controversial as they involve issues such as sale of farm land to industry, the level of compensation to the selling owners, rehabilitation of displaced people who do not own but work on the land being sold, the minimum consent required to have a deal made and the concept of social audit. What can be expected is that the government in a couple of states could experiment with this reform as a pilot case to test for the feasibility of the same.

Third, sale of PSBs could be an easier one to tackle as it involves only the employees of banks and the Unions which can be a major disruption though not too voter-sensitive given the numbers involved. The present overwhelming support received from the electorates with the BJP forming governments in four of the five states would be an opportune time to go ahead with this move that has been on the cards for long. This is a low-hanging fruit that can be plucked given that there is pressure on the government to resolve the issue of NPAs and capitalisation.

The last reform which would again be at the door of the Parliament would be getting in FDI in retail. This would be a bold step given the number of people involved who are likely to be against such a move notwithstanding the fact that domestic organised retail has met with limited success. Thus, while such a move would send strong positive signals to foreign investors that the government is keen on pursuing progressive reforms, it may not go down well with the affected people.

Hence, the outcome of the state elections for the BJP though very reassuring from the perspective of getting to hold multiple reins of the chariot, would also test the government when it comes to pursuing reforms. This is so as the last mile of the ascent is always the longest and most arduous where hard decisions have to be taken. Given the character shown so far, one can be hopeful that accomplishing these tasks would be taken on with earnestness. But as every bold decision can have ramifications in terms of voting patterns, especially as it affects jobs and livelihoods, it will be hard to complete the symphony.