Take the 12 big NPA cases as a serious experiment: ET Now 5th July 2017

ET Now, Mythili Bhusnurmath, Consulting Editor, and Madan Sabnavis, Chief Economist, CARE Ratings, discuss RBI and rate cuts and also how insolvency rules are going to work out in India. Edited excerpts: What is your thought on what the RBI would do as far as inflation goes in lieu of GST? Mythili Bhusnurmath: That is very difficult to say but at the moment, we have not seen too much of disruption because of GST. Whether that is because it is early days is not clear. The CPI numbers may not show much of an impact on GST because the CPI is predominantly weighted by food and the prices are not expected to change at all. It is services that are likely to go up and services inflation will not really show up in the CPI numbers. Given that the CPI numbers have been pretty soft in the past few months, the CPI numbers per se may not go up. RBI really will have a very tough call because of economic activity also. So far, we have not seen too many signs of disruptions but there are some rumblings under the service. One really does not know of course it is early days it has been less than a week since we launch GST and the RBI meet is only in August so meanwhile you also have suggestions from other central banks that they are all on a tightening circle or likely to soon launch a tightening circle with the Fed even talking about shrinking its balance sheet. It is going to be a very difficult call for the RBI. We will have to wait and see how GST pans out on the inflation front. RBI is not going to get much help particularly for its neutral stance. It is going to be very tough but being the RBI Governor has always been tough and having an MPC does not make much of a difference really because ultimately the buck does stop with the RBI Governor. He really is the man who has the casting

Madan, do you share my views on the RBI being in a very tough position really and the MPC does not really make much difference because ultimately the buck stops with the RBI Governor? Madan Sabnavis: I would have a very different view because I feel that with the MPC coming in, it is supposed to be based on a consensus. In case of a serious disagreement and if it is evenly balanced, that is when the RBI really steps in. But the whole concept of deciding that monetary policy is going to be guided by a single factor. Inflation targeting and the decision about whether inflation is going up or down is likely to go up or down is going to be decided by the MPC. That makes things fairly simple. Only in case of a logjam, is there a casting vote for RBI. Today, it is quite difficult for anybody to stand back and 03:55 PM | 10 JUL MARKET STATS EOD Search for News, Stock Quotes & NAV's 7/10/2017 Take the 12 big NPA cases as a serious experiment: Madan Sabnavis, Care Ratings - The Economic Times http://economictimes.indiatimes.com/markets/expert-view/take-the-12-big-npa-cases-as-a-serious-experiment-madan-sabnavis-care-ratings/printarticle… 2/4 say that RBI should be lowering the interest rates and why is it not doing it because the decision has actually been taken by a committee which has academicians who surprisingly generally have been thinking on similar lines as the RBI so far. Mythili Bhusnurmath: You are right on that but the problem really is that the MPC really has a single mandate -- price stability and getting inflation within that 4 plus/minus 2%. But the RBI is a full service central bank. The RBI has responsibility for much more and that really is the central dilemma. What does the RBI do? How does it marry the two -- an MPC which has a much narrower mandate with the central bank which has a much larger mandate. To my mind, that is where the confusion arises from. Do you think the three members from the RBI on the MPC will have to keep those other aspects also in mind? That will cause them to perhaps cast their vote quite differently from the outside members? Madan Sabnavis: No not really on account of the mandate being given that monetary policy is going to be formulated by a committee which is going to target only inflation. RBI does keep talking about forex situation and growth but generally if you look at the way in which monetary policy is targeting inflation by just looking at CPI numbers and in case it is expected to go up or down, that is how decision is to be taken. The difference is the way in which one interprets expected inflation. I think that is when we had difference of opinion in the last MPC meeting where one member probably felt that it is time to lower interest rates though I think the kind of cut which he are suggesting did look a bit high under any circumstances. It is a wholesome view that has been taken by the RBI but to my mind what really goes into this particular policy is only the interest rate and that is where inflation matters. But when you are talking about the concerns of the RBI, it cannot just close the books and say that okay we have taken a decision not to do anything on interest rates. Let us sit back and not bother about the other things. Of course, action is going on all the time on the forex front and also in terms of growth and the way in which bank credit should be revived by resolving the NPA issue. It is definitely a much broader canvas for the RBI or for any kind of central bank. MPC’s mandate is just to look at a narrower effect of interest rates and since normally it so happens that whenever we talk of a monetary policy, the only question is will interest rates be lowered or not. In case it is not, then what is going to happen in the next policy? We tend to just look at this particular single factor of interest rates. Mythili Bhusnurmath: Absolutely and other aspect of monetary policy which perhaps matters a little bit is that the financial stability and that is a very crucial aspect of monetary policy. The latest Financial Stability Report (FSR) of the Reserve Bank of India in fact does not give a very happy picture at all. On the contrary, far from the NPA situation getting resolved, the RBI is FSR says that in fact the position is going to worsen and the worst case scenario shows it crossing 10% by 2018. Do you think the way we are attacking the NPA problem is the right way to go about it or have we somehow shot ourselves in the foot in the process? Madan Sabnavis: I think it is worth taking this particular chance which the RBI has taken. The very fact that these 12 big cases have been referred for insolvency, is a very good move because so far we have not really seen any kind of solution coming up and this whole issue of NPAs has been on for almost a decade. Nobody has really been able to resolve it. We have had these asset reconstruction company, debt recovery tribunals, S4A all various kinds of schemes but we needed somebody to really say that look we are going to take a decision about what has to be resolved and how it is going to be resolved.

I am quite sure there are going to be these continuous problems. Essar is probably just one case, there would be more of them which would be probably feel that this may not be the right way to go about or them being penalised more than the others. Since the start has to be made, I think rather than doing nothing, what the RBI has done after getting the blessings of the parliament by being given this kind of power to do so is to move things ahead. While the immediate scenario definitely does not look very much different from what was it last year, one can think that probably in a couple of year’s time, we would definitely manage to resolve some part of this NPA build up. Mythili Bhusnurmath: Yes certainly one has to really go after the company and ensure that the company also shares some of the pain but the code wants to ensure that a lot of “unscrupulous”, promoters do not go to court and stall the entire procedure. But clearly that has not happened because you cannot really prevent anybody from going to court on some ground whether it is arbitrary rule of law, natural course of justice etc Does it really mean that unless you really amend the legal system, you are really going to end up in the same logjam? Madan Sabnavis: It is very much possible but we should also see that practically speaking we cannot really change the judicial process just for the sake of the NPAs. The kind of problems which we have because of legacy issues or something which is ingrained, cannot really be changed even in a another decade or so. Things are going to move slowly. There are going to be these difference of opinions and redressal will be sought in courts. There are going to be delays but we will just have to wait and see whether out of these 12 cases, which are going to enter this particular stream whether a certain part of that gets resolved. I would still say that rather than do nothing or keep waiting for something to happen, these are certain definite steps which have been taken which should also send a very strong signal to other parties who may be trying to delay on their payments hoping that they could get away with it. Now you know very clearly that there is a particular system which is in place which could also put you into it in case there are any kind of major defaults. Mythili Bhusnurmath: But here my issue really is that NCLT has admitted it you have appointed an insolvency professional, they are going to try and run companies and come out with answers and they have never run a company before. I know I will be a disaster as an entrepreneur. So all these insolvency professionals who are perhaps very sound as far as theoretical knowledge is concerned but these are complex businesses and they are trying to come up with answers. Are we really in some way trying to transplant systems which have worked in the West and trying to put them in our kind of scenario where business is not easy? Are we being a little naive when we think an insolvency professional can come up with solutions which bankers, the promoters, the company has not been able to come up for whatever reason? Madan Sabnavis: I full agree with you first as an economist that yes we cannot run any business. In fact, if I were ever to be given any kind of a target or any kind of business target to be achieved, I do not think I will ever be able to do it.But that is on the lighter side. But in terms of insolvency professionals, that is a very pertinent point. In fact, even the concept of saying that a bank can be running a company may fall flat on the face because you require a different kind of an entrepreneurship spirit to run a company. I am quite sure that the current kind of people we have as insolvency professionals will not really be that competent to run these complex cases because we are really talking about companies which have gotten into deep trouble for various reasons and which have not been revived with the professional management. Now suddenly asking some outsider to come and do it is definitely going to be a major challenge. Mythili Bhusnurmath: The ultimate answer seems to be the insolvency court, liquidation, in which case are we in danger of stripping away assets which have been built with a great deal of difficulty in a capital scarce country? How do we guard against trying to preserve whatever assets we have created, at the same time not allowing unscrupulous companies to get away with the kind of defaults that there have been in the past? Madan Sabnavis: No, I think that is definitely a very genuine concern which we have in terms of what happens to these particular assets in case we are going for liquidation unless we are able to really sell it off to some other bidder. But again looking at some of the industries which we are talking about, if I am talking of a power plant where we already have excess capacity, I doubt if anybody would be willing to buy a power plant. Similarly, it might be difficult to find a buyer for a steel company. In case, if we just let it go, then there is a case of loss of assets and recreating the same kind of difficulty when economic conditions change and we require these kind of assets to be built. I would go back to saying that we just have to wait and see how these 12 cases are resolved because it is a serious experiment which is being made and we are not quite sure what the costs are going to be. On paper, it looks like that they can be resolved if we go step by step. But by the time we realise that these hurdles are there at every particular step and the last case of liquidation would also be probably the most serious issue for any of these assets which are being resolved

Using bank merger to raise resources will not provide new model to investors; here is why: Financial Express: July 4, 2017

The raison d’être for having a bank merger is to bring about economies of scale to the company so that it becomes globally competitive. The Narasimham Committee-I of 1991 had recommended that the system finally should move towards having a handful of national level banks which can compete globally. Looking at the way things have turned out, one is not sure if this is the motivation behind the present idea of bank mergers considering that while it is nice to have large banks, Reserve Bank of India is ironically trying to move banks out from large exposures. The thrust is on moving these large borrowers to the corporate debt market, which is a prudent move in the light of the asset-liability management (ALM) challenges that banks face. However, the curious thought here is that any discussion on bank mergers does not involve protagonists with large sizes. It is more a case of the strong absorbing the weak to make the combined entity more respectable. The sense one gets is that it is more to address the health of weaker banks that mergers are being considered and the motivation is definitely not to create mammoth sized-banks.

Since the talk is of having two public sector banks merge, is there any a priori justification from the point of view of the business of banking? Or is it just a way of adding the weaker numbers to the stronger ones? This would effectively tantamount to a mathematical summation of two balance sheets to make the final picture more digestible. One way out is to look at whether or not such a merger improves the usual yardstick of CAMEL (Capital adequacy, assets, management capability, earnings, liquidity) stronger for the merged entity?

To provide some flavour of numbers to such a process, two banks have been considered here—one which is the largest in terms of the size of assets in FY16 and the other is one of the smallest banks with some distinct stress on the quality of assets (see accompanying table). These are selected at random and could just be any two entities. Capital is always a factor which is critical in banking. The ratios of 13.18% and 10.08% are both above the statutory requirement. Adding two banks’ balance sheets can improve the ratio if the capital to risk (weighted) assets ratio (CRAR), of the weaker bank is lower.

But most Indian banks are adequately capitalised, at present, and such an addition may not materially change the position of the combined bank. For the system, the amount that can be lent will not change. In fact, what is important is whether or not this new bank can raise capital from the market by virtue of its new strength? As it is a summation of two banks, the overall ability will get constrained by the net effect on profits thus affecting valuation. Besides, if the combined bank remains owned by the government, it would not matter as the bank will still operate as a PSB which will not matter materially for an investor.

How about asset quality? Here, the ratios were 5.1% and 9.0% respectively, which will come down in the case of a merger to somewhere between the two numbers. This is a play with numbers because the non-performing assets (NPA) ratio can be lowered by increasing the denominator which is what several banks did in the past. Mathematically, a larger denominator through a merger can accommodate a higher numerator. But fundamentally, this does not resolve the NPA problem (the numerator) though it improves the ratio and the gross NPA quantum remains unchanged.

Management is an important aspect of the CAMEL model. Here again, it does not matter as both the banks have similar management personnel which are shuffled often by the government. As long as the business ethic does not change, swapping heads may not be have limited impact. PSBs have long been subjected to government pressure by virtue of the ownership to complying with all the policies which have political overtones. This ranges from loan decisions including the loan melas to waivers to opening Jan-Dhan accounts. No discernible change would accrue on account of this merger. In fact, there would be cultural issues that require concerted assimilation as surprisingly the operating practices and systems in various PSBs are different and adjustments would have to be made.

Operating platforms may be different necessitating concerted effort at integration. Earnings are the next factor that should get enhanced to improve the CAMEL model. When a merger takes place normally there are synergies to be harnessed. This could be in terms of say CASA deposits, retail asset portfolio, branches, location advantage, ATMs, etc. The present concept of a merger would only mean rationalisation of staff (through voluntary retirement if acceptable) and closing down of branches. Looking at these two banks, the wage component of the cost bill is similar.

The staff composition is stronger for officers in case of the smaller bank though rural and semi-urban penetration is slightly lower in terms of branches—which should not matter today given that this job is now with small and payments banks. While the cost of deposits and return on advances vary, the net interest margins (NIMs) for the two banks are close to one another at 1.81-1.84%. Hence, staff and branches are the two props that are there to lower costs. Liquidity, which is the last parameter, would normally not be an issue as weaker banks tend to hold on to more government securities, as they have moved to narrow banking. The investment deposit ratio is higher for the smaller bank at 38.4% which reduces the liquidity risk in case of adverse times.

The table gives a hypothetical case of a merger between one of the biggest and smallest banks in the country as of FY16 where the latter was also stressed with NPAs. Some of the ratios are interesting when compared. Looking at the table closely, it does appear that it is possible that when trying to map two such banks it could mean similar structures with the differentiating factor being the NPAs and future capital.

The objective of creating a larger bank is definitely not the point here, and hence may be construed as being myopic in scope. Using a merger to raise resources will be an attempt to use these combined numbers rather than providing a new model to investors. Interestingly, all bank mergers in India were results of either failures or loss of interest by promoters in the private banking space or non-viable models. Attempting such moves when balance sheets are clean may be more convincing than in the present conditions.

Piketty & more: Thomas Piketty’s landmark work is dissected and debated in a series of essays: Financial Express July 2, 2017

Thomas Piketty kicked up a storm a couple of years back with his book, Capital in the Twenty-First Century. He did point to the perils of capitalism, which fostered the creation of greater inequality to the extent that capitalists got to control policymaking. This, in turn, only exacerbated inequality. He had spoken of inequality from both income and wealth, but his worry was about the latter. A simple thumb rule was that we can see a problem brewing in case the return on capital is higher than the growth in income. His solution was having a progressive tax structure. The basic arguments are simple and proved with data and, hence, the 700-page treatise should have found a silent place on the library shelf. But this must probably be the most debated and contested book in recent times, with several critiques revolving around the methodology, as well as solutions.

It is against this background that After Piketty: The Agenda for Economics and Inequality has been put together with a set of 22 essays under four headings: Reception, Conception of Capital, Dimensions of Inequality and Political Economy of Capital and Capitalism. In the end, there is a response from Piketty as well. It is as voluminous as the book it seeks inspiration from, with the reader having the option to skip the chapters that get too theoretical or mathematical. They are well summarised, as well as introduced, which makes it easier for the reader to navigate this tome.

The first section, Reception, is as the word suggests, an introduction to the subject, which starts from the success of Capital in the Twenty-First Century and is followed up with commentaries from probably two of the world’s greatest economists: Robert Solow and Paul Krugman. It is argued that inequality has increased in the USA, with some of the contributory factors being erosion of minimum wage, decay of unions, globalisation, competition from low-wage workers in poor countries, technology, etc. Therefore, there are stark differences between the top 1% and the rest, with several numbers thrown in to show the widening of the gap.

Krugman points out that both politicians and economists are responsible for not bringing up this issue for active discussion. The disturbing fact is that we are now in a situation, where we are back on a path of patrimonial capitalism, where the commanding heights are controlled by dynastic families. While inequity exists in Europe and the USA, there is more redistribution by the government in Europe, which makes conditions more bearable. In the section on capital, there is an interesting essay on slave capital, which contributed historically to inequality. This piece by Diana Berry blames the government directly for bringing this inequality, as the slaves were never paid their due wages.

Eric Nielsen emphasises the concept of human capital and mobility of labour. This was not captured by Piketty and the author puts it on a par with physical capital. Another angle brought in by Laura Tyson and Michael Spence is the effect of technology and globalisation, which replace lower levels of skills quite swiftly from routine tasks. Technology makes obsolete certain tasks like the bank teller’s. Globalisation brings in outsourcing through cheap labour, which makes, say, labour in the USA worse off, thus extending inequality.

Technology, hence, will be an important aspect that explains inequality, as people adjust differently to such wide-sweeping changes. Also, education becomes important for bringing about less inequality, but access to quality education matters. In this context, there is also some discussion on the ‘fissured workspace’, where jobs keep getting outsourced by function and, hence, those originally working in specific lines are pushed out and have to compete for limited space at the same lower level, as several non-core activities are being outsourced by organisations to others.

The next section is on the various dimensions of inequality. A contrarian view is expressed by Christoph Lanier, where he shows that in the 2000s, inequality has actually come down in countries. There was a slowdown in growth in inequality for the average developing nation and, hence, there is convergence across countries, as per this study, which makes interesting reading.

There is also an essay that looks closely at Piketty’s utopian solution of creating a global database of capital and a progressive tax on wealth. Here, it is argued that these are at best ex-post solutions and carrying such a database is going to be thwarted by inertia. Another essay on the macro models of wealth inequality argues that wealth is concentrated, but there is significant mobility within its distribution, especially during one’s lifetime.

Heather Boushey has a feminist interpretation of patrimony-based capitalism, where she argues that women get discriminated all the time. Such inequality, it is argued, will lead to macroeconomic instability. It also makes financial systems less stable (we can see it in India, too, where loan waivers are necessary when we want to correct inequality). Further, the wealthy, who spend the most, get affected when the asset market becomes volatile and affects their incomes. Such concentration also leads to economic slowdowns when spending slows down.

The last section is on the political economy of capital and capitalism. One of Piketty’s arguments was that mass enfranchisement was inadequate to bring about equality and what worked was a war, where capital was destroyed and the ensuing war-induced taxation corrected these fundamental flaws. Marshall Steinbaum supports this view and also says that, historically, it has been observed that wars and depressions discredit the policies and power of political establishments. There is another view that, historically, wealth inequality is driven by extractive and inclusive institutions. Institutions underlying wealth accumulation may be ‘inclusive’ for citizens granted such rights, but will be ‘extractive of others’, which are also the marginalised groups.

One can always argue if Piketty was right or wrong, but what is important is that he has got everyone thinking, and inequality is definitely being spoken of seriously everywhere now. Nowhere does one accept plain vanilla economic growth as being ‘the be all and end all’ objective to be fulfilled if not accompanied by equality. If economic growth has to take place, we need to have more inclusion for growth to be sustained. The view that wealth-founded inequality is stark can’t be denied and is more serious, as it also has links with politics and policymaking. You only have to look around to see how far this is true.

Repo rate: Data show no guarantee that by merely lowering rates, credit growth will pick up: Financial Express June 26, 2017

 issue which generates controversy every now and then is whether or not interest rates should be lowered. It is almost axiomatic that just before a credit policy is announced, there is a clarion call for lowering of interest rates. Is this really justified? The decibel levels for lowering have increased ever since the decision to target CPI inflation number at 4% (with a 2% band). With inflation below 6%, it is logical to argue heuristically for the same. Inflation-targeting makes sense, but ideally the path for action should be defined, like if inflation moves from 5 to 4.5%, the repo rate will be lowered—so on and so forth. While this would make policy more objective, it would be predictable and remove discretionary power of the MPC. To this extent, the MPC can deliberate on the appropriateness of a rate-cut.

There are some questions here. First, does lending increase if repo rate is lowered, assuming that banks pass on part of this? Second, is interest rate the only, or even the most important, factor that determines borrowing levels? Third, is there a risk involved when rates are lowered and lending increases sharply, leading to the build-up of an adverse portfolio?

The accompanying grahic provides movement in both bank credit growth and the repo rate since 2000-01. The coefficient of correlation between the two variables is low, at -0.03. While the sign is negative, the number is too small to relate the two absolute variables. However, in terms of changes in the rate of growth in credit and changes in repo rate, the sign becomes positive 0.26 (meaning thereby that when repo rate is lowered, the change in rate of growth if credit also declines, which is not what is normally expected) but it is not significant. Hence, statistically the relation between the two is weak.

Data also shows that the highest growth in credit was recorded in the phase 2005-08 (29.1%) when interest rates increased by 175 bps. Similarly, the lowest growth came in the last three years of 2014-17 when growth in credit was 8.1% with repo rate coming down by 175 bps. Quite clearly, the relationship between the two variables is not very clear, and there is no assurance that by merely lowering rates, growth in credit will pick up.

This leads to the second factor of the importance of interest rates in fuelling bank credit growth. Access to funds is important for two reasons: investment and working capital. For the latter, there is always the possibility of accessing the CP market which is what was witnessed in the phase of declining interest rates where o/s CPs increased at an average of 56.3% (though it was also high in the phase of high interest rates between 2005-08, at 39.6%). Hence, in this case, the transmission of interest rate matters for firms which choose between the two modes of finance. However, when it comes to investment what is relevant is bank credit. Here it has been observed that demand factors play a role. With low capacity utilisation levels, there is less demand for credit from industry. Companies do not invest merely because interest rates have come down. Conversely, when demand conditions are robust, they would not be loath tFurther, the current frustration in banking, involving NPAs and stalled projects, has played a role in hindering demand for credit. There are two forces hindering business. Demand is low as there are few viable projects with several projects being in abeyance. Second, there is less enthusiasm from banks to lend, and where it is to take place, the risk factor is high—to the extent that even though the base rate or MCLR has come down, the cost of borrowing for such projects is still high. Putting these two demand-based factors together, lower rates do improve the profitability of indebted companies by lowering interest costs. However, for such rates to translate into higher investment, the demand-side factors have to pervade.

Third is the aspect of credit standards, which tend to be compromised during phases of high growth in credit. It may be recollected that during the phase of high economic growth, when GDP growth ~8.5% prior to 2011-12, bank credit growth was at an impressive annual average of 22.2%, with lower interest rates as the government and RBI provided a dual stimulus to the economy. This was the time when heavy investments were made in infrastructure as banks funded several projects in this space as well in steel and natural resources. The downswing that followed quite sharply has resulted in the build-up of NPAs.

There is hence a warning signal here. Lowering rates for the sake of boosting credit growth may be hasty when conditions are below normal. Pushing bank loans through lower rates tends to bring in indiscipline in lending which can lead to build-up of adverse portfolios. The Chinese case stands out where lending by state-owned banks was accelerated to create infrastructure, resulting in NPAs. In retrospect, we may have replicated a similar model with similar dimensions. The important thing is that the interest rate should reflect not just the cost of capital but the risk involved.

Today, retail loans appear to be the flavour as it is believed that the possibility of NPAs building up is lower. Such an approach, combined with financial engineering, led to the financial crisis in the US in 2007-08. Hence, bank lending should be based on judicious principles as the overall credibility of the financial system can be questioned. Therefore, discretion should be called for when linking lower interest rates with higher growth in credit. While prima facie, the link appears alluring, banks need to be cautious on the lending side. This is the takeaway.o invest even at higher interest rates.

Why corporate social responsibility is yet to become strategic, business tool: Financial Express Book review June 25, 2017

Corporate social responsibility is probably one of the most spoken about subjects these days ever since it was made mandatory by the 2013 Companies Act. The issue is really debatable, as asking companies of a certain size and profits to keep aside money for bettering society raises questions of whether companies are responsible for this after paying their taxes to the government? Isn’t it the government that is supposed to do this job? But the counter-argument is that since corporates are using society’s resources of land, labour and things like water, etc, they owe it to society to pay back. While touching on this issue, Kshama V Kaushik, in her book, CSR in India: Steering Business Toward Social Change, provides a kind of omnibus on the issue of corporate social responsibility. It discusses not just the meaning, coverage and implementation of CSR in India, but also provides a view of what companies have been doing.

The important thing about CSR is the spirit in which it is pursued by companies. The Companies Act does try and ensure that the spirit is followed and elaborates on what all can be done and what is not acceptable. Hence, transferring funds to a government scheme is not CSR. Similarly, while all stakeholders are involved in this effort, expenses for fulfillment of any act or statute will not be permitted under this umbrella. Further, salaries paid to staff overseeing CSR, even if it is a separate department, will not qualify for CSR expense.

However, the Act allows conducting CSR through a third party, provided it is registered as a trust with a pre-defined track record. Also, it can be done through group entities or their holding companies. Similarly, such expenses may be pooled with other companies, provided they are able to apportion the same for the purpose of reporting. Hence, the Act is quite firm here, or else companies might use escape clauses to minimise this cost.

The author also takes on the issue of comparing CSR with government programmes. It is believed that the CSR effort will have more intensive multiplier effects than a government programme—like in education or medical care. The government is trying to get companies more involved with CSR, while appealing to their ethical spirit rather than paying lip service through mere compliance. The author also talks of the role of the board of directors and the committee that is responsible for it.

Interestingly, there are some examples of companies that have been following this Act even before it became mandatory for them to allocate funds. The story of the Tata group and its activities in Jamshedpur, Mithapur, Babrala, and Hosur are well-documented. Similarly, the Birla group has a similar history; the work of Wipro and SAIL has also been highlighted here. On the other hand, the dealings and operations of Union Carbide, Enron and Coca-Cola are given as examples of what should not be done.

The book is well researched, with the author delving into the 2014-15 results of the BSE top 100 companies to bring out some interesting results. The amount involved was Rs 6,720 crore, but only 78% of the amount was spent on CSR. Further, around 60% of the companies failed to spend the total amount that they were supposed to. The most preferred areas for deployment were education and livelihood, poverty and health. This constituted about Rs 2,900 crore, which is quite encouraging. Few have shown interest in technological incubators or in promoting innovation. Not surprisingly, most spend through third parties, which makes it more convenient from the compliance point of view. Companies that had been involved in philanthropy for long use their own foundations or trusts for implementing CSR. Also, environment is not a major target for This can be because of probably consciousness being generally lower in India and social needs being more pressing. Also, as there are more third parties already in this field, it becomes easier. The author concludes that CSR is yet to become a strategic or business tool. The book is a complete manual for companies on what should be done and how to go about it. By giving examples of companies that have made a difference, others, too, should get inspired. Both the legal part, which is mandatory, as well as the ethical issues, are explored in some detail by Kaushik in this book, which will be of use to all companies.

The author also believes that by doing good, companies can enhance their social capital. She concludes by putting forward the view that the ‘art of giving is an art’, and the new Act makes it a legal science. Linking programmes with corporate strategy might not always be nuanced, but it is necessary.

What could have been discussed and thrown open to debate is how some well-known companies, whose activities actually work against society in terms of labour and land displacement, pollution, etc, also appear to do well on CSR spending. How is one to evaluate such issues?directing CSR, unlike in the West.

A fundamental distortion in farm policy: Business Line JUne 19, 2017

Overemphasis on support prices distorts markets and creates storage issues. A focus on productivity is called for

Looking at the way the agrarian crisis has built up in different pockets, it does appear that the overall approach to agriculture is marked by reactive, rather than clear-sighted, proactive thinking. Almost all policies are geared towards ‘price’. It is assumed that getting this right is the panacea for all the problems. It is not surprising that the focus has deflected from enhancing productivity, which is the right answer to most problems in agriculture.

The MSP fixation

There are four major issues with MSP.

First, the concept of minimum support price (MSP) has distorted the market. While MSP is effective for rice and wheat, where there is physical procurement by the FCI, it is only indicative for other crops. Increasing the MSP more to suit the interests of farmers rather than linking it with market dynamics has distorted the pricing system. Hence, when the MSP of soyabean is increased, market prices would increase even if the crop is good, as the MSP sets a benchmark. The MSP hence becomes an income-setter rather than a fair market price. Its contribution to inflation has also been distinct.

Second, the recent intent to criminalise sales taking place below the MSP makes no sense as the MSP does not distinguish between grades; it refers to an average fair quality. By forcing sales of higher quality at the base price, both farmers and traders are put in a spot. Such policies will induce farmers to lower their standards and pitch for lower varieties. Buyers would be reluctant to pay a higher price for a lower quality, and this can lead to a stalemate.

Third, procurement has been fixed for rice and wheat which is linked directly to the PDS. The back-to-back arrangement works well but is restricted to specific crops. Further, being an open ended scheme, the FCI has often been flooded with surplus grain which leads to problems of storage and wastage. It has been observed that in the past there have been sharp movements in production of pulses, sugar and oilseeds, which can upset market prices. There is a need to have minimum stocks of all such vulnerable commodities. Therefore, procurement and price stabilisation has to be undertaken for other commodities if it is to be meaningful.

Four, the Essential Commodities Act can be invoked at any time to restrict the amount that can be stored by the wholesaler and retailer. While the concept sounds right as it can tackle hoarding, the point missed is that most crops are harvested once a year and then stored for the rest of the year. Someone has to store the crop or else it cannot be made available to consumers throughout the year. This involves a cost of holding as well as risk of loss of quality, which is borne by the intermediary. How does one distinguish between storing and hoarding?

Five, trade policy is warped for farm products. At times, there are bans on exports. In times of shortage the time taken to recognise a shortage and import through a bidding process is long and time consuming. Often by the time imports arrive prices are already on the descent. There are also no policies for exporting surplus wheat or rice; if there is a cyclical failure, the government runs the risk of being blamed for having exported the commodity in the previous years. This was an issue with sugar in 2010. Hence, both exports and imports of farm products along with their strategies have to be defined for easy implementation.

Loan waiver concerns

As for the waiver issue, NPAs are a result of policies which skew the farmers’ income and ability to repay debt. Farmers choose crops based on the previous year’s prices. When a large number migrate to this crop as was witnessed with tur in 2016, prices come down sharply due to overproduction. This has created an anomalous situation where farmers’distress coexists with surplus production. The government is not in a position to absorb these surpluses as there is no system in place. The decision taken now in Madhya Pradesh, where traders are forced to buy soyabean at a higher price, creates problems of a different nature. The combination of MSP and absence of procurement has led to the present crisis in several parts of the country.

The concept of loan waiver is inherently flawed. Forgiving any loan creates a moral hazard, as it penalises those who are compliant. There is a perverse incentive to default in the knowledge that there would be similar waivers in future, which becomes self-fulfilling. The waiver scheme becomes a contagion, whereby farmers from all States demand the same dispensation, which becomes catastrophic for the State finances.

What then can be a solution? The MSP should be linked with procurement which in turn should not be open-ended or else there will be distortion in the market. The FCI, for example, is the biggest hoarder of rice and wheat by virtue of its mandate.

Rather than protecting the income of farmer, the incentives should be to increase productivity, which can mean access to seed and irrigation. Making the NAM (national agriculture market) real is a long-term solution but linking the same with contract farming or direct sale in towns and cities could be better still. Prices should always be determined by the market to reflect the demand-supply dynamics, and there should be no intervention.

Instead of focusing on prices to deliver income, the government should ensure that all crops are insured at least in the vulnerable areas. All farm loans should be linked with insurance so that the bank gets covered for loan loss while the government pays its share on insurance premium (which the present crop insurance scheme is supposed to entail).

Loan waivers should be the last resort and must always be made conditional so that there is no incentive to cheat. The criteria should be rigorous to ensure there is no adverse selection – which is a challenge given the level of political interference.

Quite clearly, the entire approach to farming has to be revisited. Short-term, emotive approaches should be eschewed.

Employment in India: Why skilling, reskilling the labour force has to be pushed forward: Financial Express JUne 19, 2017

With farming becoming less attractive and migration being the result, the demand for employment is increasing disproportionately at lower levels. Clearly, the effort on skilling and reskilling the labour force has to be pushed forward in all areas.

A comment often made is that while growth has taken place in the economy, there has not been commensurate growth in the jobs created. If this were so, it is a worry because growth without employment is not desirable as it cannot be sustained and the fabled demographic dividend that we speak of can become a demographic liability.

Data on employment is sparse and hence it is hard to arrive at absolute numbers, though there are some disparate pockets where such information is available. The concept is nebulous because while it is possible to get information from the organised sector, it is not easy for the unorganised segment where different concepts exist such as usual status, weekly status and so on.

Agriculture is typified by excess labour (disguised unemployment) which can migrate to the cities between two harvests and get counted as employed labour in construction. Employment exchanges provide some data, but often those registered would already be employed and would be seeking better opportunities. The same holds for all the web portals for jobs.

The government sector is, however, more transparent and this is where one can look for such trends. The public sector had an objective of job creation when India got independence and hence an entire retinue of staff was created that segmented labour across various categories of Class I-IV. Post-reforms, the idea was to cut down on staff so as to improve efficiency, and the influx of technology made labour redundant. Hence, even within the public sector, there was a focus on reduction of employment. While this has been pervasive, often the headcount is reduced and re-enters from the back-door through outsourcing models that do not get captured in the direct employment numbers. Various state governments have outsourced such labour in the areas of security or other menial jobs, or have not replaced the retired gentry in certain categories.

How do some of these numbers stack up? From the Union Budget documents, the total headcount can be ascertained for the central government and the numbers have varied over time. From a peak of 33.28 lakh in 2013-14, the headcount is down to 32.84 lakh in 2015-16. The economies have presumably been invoked in the lower categories where a combination of retirement schemes and non-replacement of such staff have been combined. Within this group, railways have a dominant share and witnessed a marginal decline from 13.34 lakh to 13.31 lakh.

In case of central PSEs, the picture is similar. From a peak of 14.90 lakh in 2009-10, the staff strength has come down to 14.04 lakh in 2012-13 and further declined to 12.33 lakh in 2015-16. Hence, there has been a fall of almost 2.5 lakh over this period, which is quite a sharp change of 17.2% in a segment that is largely unionised.

Public sector banks present a different picture, given the topography. Here, the staff size has been increasing from 7.27 lakh in 2009-10 to 8.67 lakh in 2011-12. But it came down to 8.27 lakh in 2015-16. The officer category increased from 2.78 lakh in 2009-10 to 3.26 lakh in 2011-12, and further to 3.76 lakh in 2015-16. With volumes of business increasing, it does appear that the non-officer grade of staff has come down quite sharply. This may be attributed to two factors—the first is that technology has led to labour redundancy in basic operations like visiting a branch, and the second is that the retiring staff is not replaced at this level as the requirements have come down.

Another institution that heralds the public sector is RBI, where there has been a major rationalisation of staff, with the number coming down from 19,207 in 2010 to 15,854 in 2015 (December). This is sharp fall in headcount for an institution that was a significant employer.

At the industry level, which includes the private sector, the Annual Survey of Industries provides some date on progress in employment generation up to 2014-15. Here, too, the picture is not very exciting. For the quinquennium ending 2014-15, the growth in employee stock increased by an annual average of 3.4% compared with 6.9% for the preceding quinquennium. In fact, for the period 2012-13 to 2014-15, GDP growth averaged 6.5% while employment growth was just 1.2%. Hence, at the industry level, growth in employment has been lacklustre, notwithstanding steady growth in GDP.

Employment, hence, has become a major issue for the country and, as has been seen, even the public sector is moving towards rationalisation in a bid to improve efficiency. The central government has the added pressure of making allowances for the Pay Commission, which leads to higher payouts, which, in turn, puts pressure on budgetary numbers. The gains from lower headcount would be offset by these incremental payouts. PSBs and PSEs have also been looking towards enhancing efficiency which is labour displacing at the lower levels though higher skills are still required.

Therefore, the issue is of the ability of the economy to provide employment to people with differential skills. Automation and proliferation of technology—which can see driverless cars or drone delivery, making several skills redundant—has been witnessed in most manufacturing processes. The private sector, guided by the objective of maximising shareholder value, will be working on minimising fixed costs, which is labour, and hence will move more towards higher skilled labour force. The public sector, too, is turning more towards the market ethic and is progressively answerable to the public. Thus, employment is the least important objective for government-related organisations. What then happens to those at the lower level?

FRBM targets: On states’ borrowing, compelling need to go for fiscal reform: Financial Express JUne 12, 2017

RBI’s study on state finances has highlighted the travails that lie ahead for them as the discipline observed in the past has been disrupted.

RBI’s study on state finances has highlighted the travails that lie ahead for them as the discipline observed in the past has been disrupted. The performance of states varies quite significantly and the FRBM (Fiscal Responsibility and Budget Management) norms that were invoked and have worked well have gotten diluted over time especially with Ujwal DISCOM Assurance Yojana (UDAY) being launched. But are states to be treated on par when they access the market for loans? The present situation is one where all states are considered to be as good as the centre, as it is implicit that all debt will be honored and serviced with RBI stepping in if there are problems. It is this nature of securities, called state development loans (SDLs) which allow states to raise funds in the market, and institutions hold them as they can be used for regulatory compliance.

If there were a distinction between states on the basis of which they raise funds, the market would become more discerning and those which are not run well in the fiscal sense will have to pay a higher price for borrowing funds. Hence, when the central government borrows at say 7% in the market, the SDLs average 50 bps higher and all get the funds at virtually the same rate.

Differentiation will be a way to get them to run their budgets better. An analogy can be drawn to public sector banks which borrow at different rates even though they are all owned by the government and there is an implicit assurance that there will be no default.

RBI’s data in its report on state finances presents a wholesome picture. At the end of the day, the debt-to-GDP ratio is the most important indicator since if revenue cannot match the expenditure, then there have to be borrowings which result in higher debt and higher future interest payments. The FRBM now talks of states bringing down their debt/GDP ratio to 20%, which can be taken to be a norm.

The accompanying table clubs various states on this ratio for FY17.

At present, the corporate bond market exhibits fairly divergent spreads over government securities (GSecs) for a maturity of say, 10 years. While AAA bonds are priced at 90-100 bps higher than government securities of similar maturity, AA average 140-150 bps, A at 340-350bps and BBB 450 bps. This is how the market would treat corporate bonds with different ratings which are of investment grade.

Now, if a similar system gets imbibed in the SDL market, the assumption which can be reasonably made is that all of them are investment grade. The five ranges provided above could be classified into four, with probably the 20-30% range of debt-to-gross state domestic product (GSDP) being covered in the second category. These bonds could be priced hypothetically at 25bps higher progressively across these bands. Hence, the best states gets funds at 7.5% and those down the pecking order would be at 7.75%, 8% and 8.25%. Left to the market, the pricing could go anyway and will depend on how the demand for such securities develops. Banks, who are the main subscribers, would subscribe to these securities based not just on the returns, but also the investment valuation norms which would hold for them.

Alternatively, Reserve Bank of India could administer these rates such that some states end up paying a higher cost. If this is not possible, the premium can be loaded as a surcharge which goes into a special SDL fund created and maintained by the central bank which can be used for specific purposes as can be laid down in the charter. By having such pricing, states can be made to discipline their operations.

The main point is that all states should not be borrowing at the same rate. With Ujwal discom assurance scheme coming in there has been a major financial engineering exercise where `2.33 lakh crore of discom debt has been taken over by the states. As all such transactions are a zero-sum game, the original lenders have lost out on interest at the cost of assurance that the bonds would be serviced on time and principal repaid (though the discom debt is normally guaranteed by the state). As long as they resided on the books of the discom they were considered to be sub-standard assets. But UDAY has converted them, almost like alchemy, into higher rated bonds priced at just around 40-60 bps higher than SDLs, which is odd because once the bonds reside on the state government books, the distinction between UDAY and SDL fades. In fact, an argument against UDAY has been that through statistical accounting the debt of discoms has been conveniently transferred with both the state government and company being better off without any punitive action.

How can states be forced to work well? One option is to hold the 3% fiscal deficit rule and make no exceptions. Hence, as the interest cost rises, which has to be serviced, the state would have to cut back on the expenditure. But given the system of accounting, which is based on actual cash flows, states could defer payments into the new year and keep this scheme rolling over time so that they work well within the frontiers. To counter this, the accounting system should change from actual to accrual basis, so that there are fewer escape routes. Such a move will also help to ensure that there is credibility to the spread that is charged to states with differing debt levels. Alternatively, states which cross prudent limits must be asked to pay more for incremental credit over what is permitted so that they become more responsible.

In short, there is a compelling need to go in for state fiscal reforms which involves setting fiscal responsibility and budget management targets, making states more accountable for the budgetary numbers and tightening the accounting standards so that the system is well knit. As states are to take on the future losses of dicoms, too, which may lead to less pressure on these companies to revise tariffs as they are sensitive issues, checks have to be built or else compliance becomes a rollover process which erodes the sanctity of fiscal reforms. Clearly, there should be some deterrent built into this system.

Deconstructing economic policy Economics of India - How to Fool All People For All Time by Madan Sabnavis

Book Review by Ishan Bakshi

deconstructing economic policy Economics of India - How to Fool All People For All Time by Madan Sabnavis

Lessons from NPA saga: Economic Times: 7th June 2017

The NPA issue has wider implications than its resolution because there is an uncomfortable thought that the high growth rates that were achieved during the earlier part of this decade had compromised credit standards. That is how all bubbles form and erupt. Business cycles are a norm with their amplitude being shorter in this globalised world and phrases like the ‘great moderation’ —which typified the US growth story— no longer can be taken to be a given. There are lessons to be learnt.

First, when there are phases of high growth in credit, which is commensurate with GDP growth, there could be the germination of such problems. Till around FY11, annual growth in credit averaged above 20% for the quinquennium and the NPA ratio was in the region of 2.3-2.5%. This phase was also associated with higher GDP growth and stimulus through fiscal incentives and lower interest rates. Further, the investment rate had reached the level of 35% at a time when infra was in focus.

Quite clearly, banks were extravagant with their standards of lending as it was assumed that good times were there to stay and the growth trajectory would cross 10% per annum. Hence, fast growth in business in any segment should raise the red flag. The second cog in the wheel came about in the subsequent period when growth slowed down as there were several irregularities in policies in mining, telecom, power, which led to a jump in NPAs. However, rather than recognise them as NPAs, the approach was to create a new category of restructured assets which had differential treatment in accounting.

This was a major flaw where standards were compromised to show a better picture. It was something like lowering pass mark in the civil services exams to enable more candidates to pass. Now, the NPAs got camouflaged even while the number rose to 4.5% by March 2015.

The disruption was the asset quality recognition syndrome in August 2015 which magnified the level of impaired assets and affected the credibility of the system. Analogies were drawn to the phenomenon of crony capitalism in East Asia where the financial system financed exponential growth in the nineties. Such growth models are clearly not sustainable. The third part is the resolution aspect where several attempts have been made over the years with the major hitch being the decision on how to get the assets off the books.

This is a practical challenge as taking haircuts on sale of assets is dicey. Further, one is not sure of which assets should be offloaded. This is where the recent legislation empowering the RBI to provide direction is helpful. Will it work? It should be more effective than the earlier measures as it plugs one loophole though the quantum involved is unknown.

Should the RBI be monitoring commercial decisions taken by banks? Logically, it should as it is now getting involved with the resolution of such decisions when assets turn sour. A thought can be that the RBI should periodically announce the vulnerable sectors and warn banks on excess exposures.

Alternatively, the exposure norms for sectors should be capped to ensure less concentration. But such an approach runs the risk of some industries being starved for funds as the market would not welcome those who have no access to bank finance. Another option would be for the RBI to pick up signals when there is high growth in credit- teaser loans are potentially dangerous. There will always be a clamour for low interest rates by banks which can lead to injudicious lending in a bid to meet business targets and enhance shareholder value.

A way out could be that there are fixed guidelines under which an NPA should be disposed of in a pre-decided manner. Based on certain per-specified financial indicators of the defaulters, the haircuts to be invoked can be programmed so that the terms are laid down objectively, leaving less room for discretion. Simultaneously, there would be need to create structures for absorption of such assets either through a bad bank or the legal processes for dissolution. And the last, banks which have a certain threshold level of NPAs could be subjected to rules on payment of dividend, growth in business (narrow banking) and management rewards until such issues are sorted out. A tough call, but considering that deposit holders’ money is at stake, any relief should be made conditional.

Lower banks’ intermediation spreads: Financial Express 5th June 2017

When the RBI Deputy Governor talks of the need for banks to charge customers more moderately, it can be construed as a wakeup call.

When the RBI Deputy Governor talks of the need for banks to charge customers more moderately, it can be construed as a wakeup call. With deregulation, banks have the freedom to charge for everything when the account is not in the category of ‘inclusive banking’ which has tended to make banking with one’s own deposit an expensive affair. One can be charged for cheques, entry to the bank, dealing with cash, using ATMs, etc. The explanation given is that when the bank is providing you with premium service, then it has a right to charge for the same. Banks first moved customers from the counter to the ATM to “save costs”, and now are charging them for access to both the modes beyond a point. And given the near oligopolistic nature of the system, everyone ends up charging the same amount and the customer has little choice.

Critics have raised some queries here. A pertinent issue is that while every bank is cost-conscious and justifies charges on grounds of additional costs being imposed on their profits and shareholder value, the fact remains that banks use deposit-holders’ money to make their money. There is already a charge on deposit-holders in terms of being paid a lower interest compared to what banks receive on loans, which is called the cost of intermediation. But, there is a problem of NPAs, where money at the end of the day is not put to the best use—which is what banks were supposed to do on behalf of the ultimate saver—and is often termed as a case of failed intermediation. And interestingly, unlike any other public limited company which provides capital to the enterprise, a bank runs on deposit-holders’ money and yet punishes them for every breath of air inhaled.

The actual spreads of banks in India are amazingly high. RBI provides data of the average rate charged by banks on outstanding loans as well as fresh loans. Also the average interest on term deposits is available, and given that 65% of deposits are term deposits, 10% in current account (zero interest) and 25% in savings account (25% at 4%), there is a lot of free money also available to banks. The accompanying table provides some interesting information.

The cost of intermediation is hence quite high, at above 5%, when reckoned on the basis of outstanding loans and around 100 bps lower on fresh loans. Banks always justify the stickiness in lowering lending rates as only new deposits are re-priced while all loans are reckoned at new rates. By using the concepts of average cost of deposits and average return on loans, this constraint is eased.

Is such a high cost of intermediation fair for the deposit-holder who can actually get a much higher rate theoretically if the money goes directly to the company? The theory of intermediation does state that besides the flexibility provided to deposit-holders on money kept with the bank (which can be contested today since every action is actually charged separately), banks need to charge for superior risk analytics as they bridge the asymmetry between the lender and borrower with specialised knowledge. However, the NPA story over the last 5-6 years shows there were flaws in the process—both in terms of evaluation and recognition of impaired assets and banks have not quite redeemed themselves. Would it really be fair for the deposit holder to see their money not being put to prudent use?

This issue is important because the provisions being made for NPAs can be brought into the picture. Based on FY16 ratios, around 85% provisions were made for NPAs. Assuming similar proportions prevail for FY17, the ratio of provisions to outstanding deposits would be in the range of 1.8-2.1%. From the deposit-holders’ perspective, the intermediary is actually giving the deposit-holder an interest rate of 5.6% and taking a spread of 4-5% (depending on fresh loans or o/s loans) and making a provision for what can be termed as ‘failure in intermediation’ of 2%. Intuitively if banks were able to evaluate risk better, they should be in a position to either reward deposit-holders better or charge lower rates to borrowers.

There is hence a case for the structure of interest rates of banks being revisited to ensure that the spreads are minimised. Maintaining high spreads which act as a useful cover for weak credit assessment is just neither justified nor sustainable. There is this constant clamour that RBI lower interest rates. Almost 10 out of 10 commentaries on interest rates always ask for rate-cuts even though just by lowering rates, one cannot make corporates or individuals borrow. The result has been that banks have tended to push business by offering loans with relatively less stringent standards. The result is that not only do banks continue to charge higher rates to lower rated companies (as the MCLR of 8% as of March 2017 matched with 9.72% for rate charged on fresh loans) but also have built up an unhealthy portfolio.

Deposit-holders, for their part, are in a tight spot as there are few avenues for venting their grievances as they are not organised. Demonetisation revealed that deposit-holders are yet to get used to the electronic medium and the fact that currency is coming back into the system means that cash is the most preferred mode of transactions. Customers probably do have a right to voice their concern over the banking charges of various services. Given that banks are operating on very high intermediation spreads, there is a hence strong case for lowering them