Banking In 2018: Business World : February 2018

2018-19 will be a year in which the banking system will have to get back on its feet despite all the aches and pains while the doctors (government and regulators) take a call on the structures that will be maintained

The last three years have been quite revealing for the banking sector which has led to several corrections that will hopefully strengthen the financial system. The story started with the asset recognition norms being put in 2015 which should ideally have been spotted by the auditors. Similarly, the sudden recognition of restructured assets being camouflaged NPAs corrected an error which was in place. With this work being done what can one expect in the coming year?

First, the end of new NPAs being recognised should be behind us by March. It was to have happened in 2016 which got prolonged to 2017 and, hopefully by March 2018 should be a thing of the past. Second, the capital that is required to put state-run banks back on their feet is now in place. Indradhanush spoke about it, which was followed by the more recent announcement of putting in Rs 2.11 lakh crore of which Rs 1.35 lakh crore of recap bonds are to come in, with Rs 80,000 crore coming in February - March with strings attached. This will improve the regulatory capital status of banks under PCA (prompt corrective action) and enable faster growth in credit for banks well capitalised.

Third, the government would have to decide on two bold measures against the screen of the general elections coming up in 2019. Will they be able to offload stake in state-run banks this year? While it will be a bold move, the timing will be important. The stock market has been quite munificent this year which had enabled the disinvestment programme to sail through. Will this be repeated in fiscal ’19?  The second is bank mergers. While mergers are another way of camouflaging weakness by horizontal summation of  balance sheets, the sticky issues pertain more to the challenges of rationalisation of staff and branches.

On the operational side, one can conjecture that the Reserve Bank of India will not be lowering interest rates for sure. Inflation has been in the five per cent range and the possibility of an increase looks more likely depending on the oil-price trajectory. The last three years have been happy ones where good monsoons and low oil prices kept everything in check, which vindicated the stance of the Monetary Policy Committee that four per cent target was reasonable even though the last ten years’ data prior to the formation of this committee showed that inflation was above five per cent in nine of the ten years. Therefore, potential borrowers would have to be cautious on this score.

Second, the overall demand for credit would still be subdued for two reasons. As the Insolvency and Bankruptcy Code has not yet resolved any of the initial cases and there are others lined up, the larger companies who are in this circle are also big borrowers in the system will stay away for some time. To the extent that there is a pickup in demand for credit, companies would prefer to move to the market and both the corporate debt market and commercial paper market can expect to witness some momentum.

Third, on the demand side, banks have to reconsider the conundrum of maintaining lower deposit rates and higher spreads as this has caused a diversion to the mutual funds segment. Therefore, supply of funds will continue to be a challenge for them and has to be addressed by the system.

On the whole 2018-19 will be a year in which the banking system will have to get back on its feet despite all the aches and pains while the doctors (government and regulators) take a call on the structures that will be maintained.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

Q3 numbers suggest GDP growth is on the right path, finally: Business Standard 1st March 2018

The assurance that one gets here is that the shadows of GST may be receding and that a near-state of normalcy would be reached by March-end
 The economy definitely looks to be on the recovery path based on the third quarter (Q3) data presented on gross domestic product (GDP). GDP growth has been fairly well spread across all sectors, which is more important rather than being concentrated, with the services sector dominating. Manufacturing, too, has shown good signs of growth which was expected, given the impressive growth seen in the Index of Industrial Production during this quarter. A boost has also come from the kharif harvest which when put besides the second Advance Estimates of agricultural production does indicate that the number will be sustained for the year. A major factor affecting these numbers in Q3 was the post-goods and services tax (GST) positive impact, following a downturn when the tax was introduced. Production levels appear to have stabilised as economic agents have adjusted to the new system and have rebuilt their inventory. Further acceleration from hereon would depend largely on demand conditions working out with consumption being the main driver.
For the year, too, the Central Statistics Office (CSO) is expecting GDP growth to be 6.6%, which would imply that in fourth quarter growth would be in the region of 7.1%. The government once again is to take the lead with 10.1% growth, which is probably the only element which could see a downside risk because given that the fiscal deficit is already 113% of what was targeted for 2017-18, there could be some expenditure cuts in order to balance the Budget with 3.5% fiscal deficit. In the Budget, the government had announced a cut in capital expenditure to the extent of Rs 300 billion in the revised number for FY18 over the budgeted number. Otherwise, the number of 6.4% growth in gross value added looks very much on the cards. The construction sector performance needs to be highlighted here since it has contributed well to GDP growth, which is a result more of the government focus on roads as the private real estate space has been fairly lacklustre in the year. This is also being corroborated by the core sector data that show cement growing smartly in November-January, which indicates that things will remain positive in the next two months, provided the government does not cut back on expenditure. Does this mean that the economy is on a high growth trajectory? Not yet would be the answer as the present performance of the year at 6.6% will still be lower than the growth rates in FY16 and FY17 as the economy is running at less than 7% this time. However, the assurance that one gets here is that the shadows of GST may be receding and that a near-state of normalcy would be reached by March-end. Therefore, 2018-19 could start on a positive note, with no negative policy overhang as was the case in 2017-18, which had to carry the shadow of demonetisation for the first quarter. The interesting data point on gross fixed capital formation is, however, interesting as the CSO has spoken of a flat number of 28.5% for all the three years. This signifies a significant upward revision from a lower number of 26.4% projected in the first Advance Estimates that needs to be reconciled. The investment proxy indicators such as finance, new projects, etc. do not tell the same story. 

Bad loan resolution: Banking on RBI’s new framework: Financial Express 20th February 2018

The major problem with tackling the NPA issue is that you are ‘damned if you do and damned if you don’t’. This is the challenge RBI or the government faces when it announces any measures to put things in order. When the Insolvency and Bankruptcy Code (IBC) was not there, the lament was that nothing effective was being done, and that there was some modicum of courage missing in the system. Once it came in, the reality hit the corporate sector that if default issues were not resolved, then they would have to pay for it with the ultimate threat being of liquidation. This had the corporates complaining that it was too harsh. Escape routes, however, did exist, with various prevailing schemes of RBI being in force such as CDR, SDR, S4A, etc. Such measures helped to kick the can.

The same held for bank recapitalisation, when it was pointed out that it was the responsibility of the government to capitalise PSBs as they owned them. When capital was to be infused, critics were quick to retort that the inefficient banks should not be capitalised and that taxpayers’ money was being wasted by good money chasing bad banks.What should the government do?

The latest move by RBI to get in the new revised framework to tackle NPA resolution has met with similar opprobrium. The idea to do away with CDR, SDR, S4A, etc, is commendable, because with a plethora of measures of reconciliation which were not quite able to deliver the results, there was no point in having a series of such schemes. They have, over time, become routes used for camouflaging the tainted part of the loans. It is much simpler to lay down certain standardised ground rules for addressing the issue of NPAs in a time-bound manner, which is important so that the resolution process is quick.

What does this new approach do? It says that for loans above Rs 5 crore, there has to be a regular monitoring of such exposures where defaults on repayments or interests are slotted into three buckets of three 30-day tranches. This has to be reported to the central repository every week/month, as per the norms laid down for being in default or SMA, respectively. There can be no argument on this norm as it will ensure that there is accountability among lenders.

Next, RBI says that every lender should have a board-approved plan for resolution of stressed assets. This makes it easier that once there is a default with respect to any borrower, all the lenders get to know of it and seek to resolve it based on the options of regularisation of payments, restructuring, change of ownership, sale of asset, etc. By having such rules in place, it makes it less ambiguous, which will make banks take action rather than worry about whether they are doing the right thing or not.

The resolution plans so formulated are to be complete in all respects and agreed upon by the lenders. If the account is large, then there needs to be an opinion given by credit rating agencies for the residual debt. The process now becomes transparent and would make bankers feel more comfortable. This is a good move as otherwise banks would have an interest in the implementation of the plan as they were involved in such lending. By getting an independent agency to give a verdict, this additional pressure would not be there on bankers.

The notification says that for amount higher than Rs 2,000 crore as of March 2018 under any of the existing schemes for restructuring, these cases have to be resolved in 180 days. Further, in case resolution plans of large accounts are not implemented as per these timelines, lenders shall file insolvency application, singly or jointly, under the IBC within 15 days from the expiry of the said timeline.

Are these measures drastic? From the borrowers’ point of view, it may be interpreted as being a bit hard. But from the standpoint of sanitising the banking system, clear-cut policy guidelines are required to ensure that the efficacy of NPA resolution process culminating with the IBC framework is robust. There would, however, be some disruption caused as these cases are expedited with all such lending being scrutinised closely by banks. In all such resolution policies, there is always a case made out that such measures could deter risk-taking ability of enterprise. But, there is also the counter argument that if there are rules relating to lending and repayment, they have to be honoured or else the credibility of the system gets affected. The balance could hence tilt more towards banks rather than the borrower.

It must be pointed out that RBI has been exhorting large borrowers to move over to the debt market to meet their requirements rather than the banking system. The practice of lazy borrowing is prevalent in corporate India, where it becomes easier to borrow from the banks than the market where the terms of engagement are tougher due to relationships built with banks. As a corollary, the market is more demanding and requires greater care to be taken when investing money and hence, in a way, sieves out the best.

There has always been a need to plug a lacuna in the system of the IBC where companies and banks were able to take shelter in the various other reconciliation schemes that were in vogue. This needed to be plugged to give more teeth to the IBC. These different schemes still gave scope for evergreening of loans, which has now been stopped with the mower now being put in motion. This should definitely give more confidence to bankers as well as other stakeholders which were overdue. At the margin, there could be some companies that have entered the NPA zone due to pure economic adversity. But they would have to go through the said laid-down resolution process; and while they could get affected negatively, it could be considered as the collateral cost, which is unavoidable when there is any bold reform.

Will NPAs now rise? There would be an increase in magnitude, though the numbers would be a hard conjecture. At the margin, the cleaning-up operation involving higher provisioning will hurt for some more time, but it would be worth the pain and make the process complete. Companies and banks would henceforth also be more discreet in the market, which will help strengthen the system in the medium run.

From credit risk to operations risk in banking: Lessons from the diamond heist : Economic Times 21st February 2018

The common angst among bank customers is that every time one wants to get work done through a call centre or net banking, there are a series of passwords and checks that have to be gone through before reaching the destination. There are OTPs which come on mail and phone that have to be entered and only then you can proceed with the transaction — which can be as innocuous as transferring money from your bank account to another bank account which is in your name. With such rigour that has to be adhered to at this rudimentary level, it does come as a surprise that when money instructions are transferred through the guarantee route (the now infamous LoU), things could go through seamlessly within the system without such checks. The recent issue concerning fraud in a PSB branch is significant for several reasons which go beyond the usual umbrage raised when it involves deposit money. This holds in fact for any banking misdemeanour but tends to get blown up when a fraud occurs. First, the incident highlights that systems are not foolproof. In fact, when use of technology was limited in banks, manual intervention ensured that all the requisite approvals were received. Now with operations being automated, systems are efficient, but if they can be hacked or tampered with, tracking is hard as there are a plethora of transactions taking place on a real-time basis. Second, the case is a manifestation of failure of the systems in all concerned banks and not restricted to where it was perpetrated. So, quite clearly, the cog is not just with one bank but with the entire system where such acts went undetected. While the problem was with the use of SWIFT, there could be several such instances of tampering which have not come to light because no one knows that  By Colombia Third, the next question which comes up relates to the audit process. As all banks are audited annually, it is curious that such a fraud could not be detected for almost 7 years. Hence, there is a challenge of strengthening these processes as there could be other areas where such frauds may be residing in the system. While it is easy to blame the auditors, the fact remains that no system is perfect and there would always be lacunae as 100% audit of all operations is not possible. The message here is that we need to move towards the ideal situation as fast as possible. Fourth, the banking system now seems to be enmeshed in a peculiar situation where the worry has gotten deflected from credit risk to operations risk. The NPA brouhaha was caused due to failure in assessing credit risk, which has now snowballed to this dimension where funds are not available to make the system resilient. Now, banks would need to focus simultaneously on risk from fraud. Fifth, given that public sector banks are involved in this episode, the responsibility of reinstalling faith falls on the government. Depending on what the final amount is, the banking system has to make such provisions from internal resources, if they exist. Several banks are already afflicted with falling net worth, which means that they may not have the wherewithal to pay for this loss. In this case, the government has to step in and provide the capital once again. This is becoming progressively more onerous for the government, which has already stretched the band artificially through the recap bonds. Sixth, the present episode quite definitely makes a mockery of the idea mooted earlier in the FRDI Bill. Any such move towards shifting the responsibility of bank performance to deposit holders is quite meaningless because of the asymmetric information between banks and deposit holders. The latter do not know how good  Service At present, the only assurance that deposit holders have is that the RBI has never let a bank fail in the private sector and it is implicitly assumed that all PSBs are as good as the government. Therefore, the resolution of the present crisis is a litmus test for the faith people have in the government support for these banks. As a corollary, it may be expected that the banks will not be allowed to go down under. A broader question worth pondering over is what happens when all PSBs are privatised and such a fraud occurs. Who bears the cost then?

Bank deposits have been yielding lower returns, this makes them inferior financial products: Financial Express 14th Feb 2018

Notwithstanding the fact that both corporates and bankers want interest rates to be lowered further, households have confronted a wall in terms of returns on deposits, which have come down to the extent that they are unattractive. The fact that the policy of banks is to make deposit holders ‘pay as you go’ ensures that all services are charged. The recent controversy regarding deposit holders being responsible for a pay-in if the bank balance sheet turns bad has added another dimension of fear in their minds. It is against this background that the recent shift from bank deposits to mutual funds should be viewed.

The accompanying table 1 shows how the weighted average interest rate paid on deposits moved in the last five years along with the weighted average spread for the banking system. The rates have been reckoned as of March of the year.

There are two distinct phases here, with 2015 being the turnaround year. Interest rates moved marginally downwards in 2014 and 2015, after which the decline was rapid. The period up to 2015 had the repo rate move up by 50 basis points (bps) and then lowered by 50bps, which explains the weak movement. Subsequently, the repo rate has come down by 150bps, while the weighted average cost of deposits was down by a little over 200bps. The curious point to note here is that the bank spreads, after coming down by 19bps in 2015, increased sharply by 70bps to 3.89% in October 2017. Evidently, banks have lowered deposit rates at a higher rate than their lending rates and increased their spreads, which could also be used to address the issue of making provisions for non-performing assets (NPAs). However, the story from the deposit holder’s point of view is that they have gotten a less-than-fair deal from policy changes.

An outcome of this changing interest rate structure is that there has been significant migration to the mutual funds market. Table 2 captures the changes in outstanding deposits for 2014-17 for the year ending March, while the last column looks at changes between March and December 2017. The same has been done for the assets under management (AUM) of mutual funds for the same period. There has been a continuous decline in the quantum of incremental deposits over this period, while AUM has increased sharply in FY17 and FY18 (nine months). In fact, FY17 was significant because deposits too increased sharply, mainly due to the demonetisation exercise where perforce cash had to be put in deposits. The fact that households went in for mutual funds at a higher rate indicates the shift in pattern of savings. Further, interest rate on small savings has also been lowered and is indicative that households are looking for higher returns on their savings.

A concern is that the shift to mutual funds has also moved towards equity-oriented funds, which, in turn, has helped to spike the stock markets at a time when foreign portfolio investors have had a preference for debt. Table 3 provides information on shares of various components of savings in bank deposits and mutual funds under various headings.

The share of bank deposits in incremental deposits plus mutual funds’ investments (i.e. incremental AUM) has been coming down continuously from 88.5% as of March 2014 to 73.3% in March 2017. Significantly, the decline in the first nine months of the year is quite stark, at 25.6%. Bank deposits have been yielding lower returns, which are also taxable; this makes them inferior financial products even for risk-averse households.

Table 3, in fact, reveals some interesting facets of investment preferences within mutual funds. Debt funds have been a close substitute for bank term deposits without the flexibility of withdrawal. In FY15, the share came down mainly due to the long-term capital gains tax being imposed by the Budget, with the condition of a lock-in of three years. But the sharp fall in bank deposits subsequently has made this avenue more popular, with a peak being reached in FY17, as demonetisation caused cash to be put in bank deposits and mutual funds at a fast rate.

The even more interesting part pertains to equity funds, which have suddenly become very attractive for households looking for higher returns. With most mutual funds giving returns of above 12-15% over time, the temptation to go in for equity-oriented funds has been high. The more conservative have gone in for balance funds, where at least 65% of investments are in equity, which hence end up giving a lower return than equity but higher than pure debt investment without the tax encumbrance. In FY18, exchange-traded funds too have been working well, especially the ones floated to invest in PSU disinvestment.

The danger here is twofold. High investments into equity schemes have made the stock market look more buoyant than convincing, as the economic data points do not justify such valuations. The second is that banks will face a major challenge going forward, unless they are able to increase their interest rates, which may mean compromising on spreads. If the deposit base does not grow, then lending will be an issue. In addition, as a substantial part of the incremental deposits flow to the government as statutory liquidity ratio investments, a liquidity crunch cannot be ruled out.

In fact, the current recapitalisation bonds scheme is predicated on banks investing their surplus funds in them, which will be a challenge.

From the regulator’s point of view, the possibility of major losses being incurred by the amateur investor when there is a correction in the market could lead to chaos should be a concern. While nothing can theoretically be done, it can lead to a major shake-out in this space.

Merely hiking MSP is not a panacea: Business Line February 14th 2018

Pricing is one part of the story; delivery is more important. A radical change is needed in farm products marketing

The issue of minimum support price will always be mired in controversy. Ideally, the market should be setting the price with all checks at manipulation being in place. However, in our complex society, farmers are a major constituency from the political standpoint as well as suppliers of basic inputs for the rest of the economy. It is not just the share in GDP that matters but also the purchasing power provided for other industries being linked directly with other sectors. Besides, the mandi system is opaque and farmers are at a disadvantage when they enter these markets. Therefore, price intervention is required.

The MSP is set by the CACP (Commission for Agricultural Costs and Prices) and is normally active for rice and wheat at all times where the FCI is the procuring agency. For other crops, while MSP is announced, it becomes active when there are cooperatives or state agencies procuring the product based on circumstances.

This is because market prices would normally be higher than MSP and the machinery for procurement, storage and disposal is weak. Hence, while oilseeds or cotton are procured in limited quantities, in general the market is the place for sale. In the last couple of years pulses were also in the procurement loop while sugar has also featured at times.

Good in principle

The Government’s announcement to increase the MSP to 1.5 times the cost is laudable as it ensures that the farmers get a higher price and income. It has, however, not been clarified whether the cost being referred to is the A2+FL concept which is actual cost plus farm labour or the C2 concept which is comprehensive and includes interest paid, rent, etc. The table tabulates these concepts for eight kharif crops for 2017-18 and juxtaposes the MSP with the costs as well as those with the new multiple. Further, the market price has been placed alongside, which is the lowest average monthly price between September and January for the country based on AGMARKNET data. The observations are quite revealing.

The table shows that for the present kharif crop the market prices have been lower than the MSP for five of the eight crops with the exceptions being paddy, soybean and cotton. Paddy is the surprise element because the market price is higher for a product which has an active and efficient procurement system. Second, the MSP has been placed higher than the A2+FL cost and is at least 20 per cent higher. For cotton and moong it is between 20 and 30 per cent, while for paddy, maize, soybean and groundnut it is 30-40 per cent, and almost 60 per cent for tur and urad. Third, for five of the eight products, the MSP is higher than the C2 cost concept.

The Government now needs to make clear what is being referred to when we speak of 1.5 times the cost — A2+RL or C2? Using the former would mean making some upward revisions for the crops. However, if C2 is being used then the increase would be substantial as the market price to C2*1.5 multiple would be upwards of 1.5 times the current market price.

Delivery matters

Pricing is one part of the story but delivery is more important. Higher prices would mean a radical change in the way in which farm products are marketed.

To begin with it would be necessary to create structures where the Government — Central or State — gets involved with procurement of crops. Volumes would be large as almost all the kharif crops now rule below the MSP since production has been very good. Therefore, organisations for procurement have to be identified; these will have collection centres across all the markets. Ideally, they should be located at all mandis where the crops are sold.

Second, procurement is always for an average fair quality. This would require some grading and assaying to ensure that sale takes place to the Government. For rice and wheat the manual inspection system has been established; the same has to be developed for other crops.

Third, the Government should be able to have warehouses ready to store the produce as even today the handling of rice and wheat stocks faces several challenges.

Fourth, once procured, disposal becomes important. In the case of rice and wheat, there is direct linkage with PDS and buffer stock, and hence a system has been established. What does one do with, say, groundnut or maize? Will the Government become the seller of agri products because once procured, the product has to be sold or stored?

How about compensation?

A way out is to not procure but to compensate the farmer with the difference between the price received at the mandi and the MSP. But given that there are intermediaries along the way, the farmer may get bypassed in such a transaction. Besides, mandis are opaque, with records not being maintained. This can be gauged by the numbers on arrival of crops noted on the AGMARKNET website which, at best, covers 20-30 per cent of the total marketable surplus of any commodity.

These issues are pertinent because merely announcing MSPs may not make a material difference unless all the accompanying questions are addressed. At present, as the table shows, the market price is lower than the MSP. Yet farmers are not able to get the MSP as there are no channels existing for them.

Curiously, even though MSP for rice is lower than the market price, the FCI continues to procure (admittedly quality issues would account for a large difference between the two prices).

While the new proposal has elicited more comment on the cost to the Government, to make these higher MSPs meaningful it has to be ensured that all the systems are in place to procure and then dispose of the same. Otherwise it will be a plan only on paper.

Book Review: The GDP conundrum: Financial Express 11th February 2018

Whenever we evaluate the economic state of a country, the first indicator to look at is GDP. This is quite common today and becomes significant, as we can use the same measure to compare GDP growth across various countries because the methodology tends to converge in the course of time. As Indians, we love to say we are the fastest-growing economy. Earlier, China would talk of this coveted position. But is this a fair measure?

David Pilling, in his rather interesting book titled The Growth Delusion, examines in detail the concept and, more importantly, highlights its serious shortcomings that actually make it a poor indicator of the economic health of a country. For a student of economics, it would be like going back to college, where the same limitations were learnt. For example, the services of housewives in India go unaccounted for, while those in the West have a value, as the work is paid for, which makes the number an understatement.

But let us go back to the basics. A starting point is that the calculation of GDP can never be precise, as the economy is too large to be actually surveyed completely. Samples are drawn across economic streams and the results blown up to reflect the whole. Reading through this book would be a great comfort for the Central Statistics Office in India, as it has been pointed out that, even in England, few people have confidence in the numbers that are announced.

The credit for evolving this concept goes to Simon Kuznets in 1934. He recognised the limitations and wanted illegal activities and government activity excluded, as these did not add to welfare. Here, Pilling brings up issues like ‘sins’ (like drugs or prostitution), which add to the domestic product, but are not included, as they are part of the grey economy. This is one reason why GDP calculated by output, income and expenditure methods does not tally. At the same time, products like liquor and tobacco are added in GDP, but cause health issues that can lead to expensive treatment. Should these industries be excluded or repercussions adjusted for the negative fallouts?

Other conundrums that come up are exemplified by the outcomes on health in the US. When one is registered for government health insurance in the US, the cost of any procedure is just a fraction of the market price and this number gets included in the GDP. But for the same treatment, a person without insurance would be paying a very high price. Should adjustments be made here?

Another issue raised pertains to the environment. China grew very fast with high investment outlays and a sharp jump in the number of automobiles on the road. This led to high levels of pollution, which affects life expectancy, as well as the working life of people, which gets reduced. How does one account for such negative effects? One way is to ignore them, as they will get reflected in, say, a couple of decades when the economy slows down due to these factors playing out.

Further, an interesting facet brought out in the Internet age is that the economy has actually shrunk as we go online. There are fewer people required to issue tickets or even handle stores, with online bookings and home delivery on the rise. This has an impact on the GDP, which tends to slow down, as there are fewer jobs being created in relative terms. While this is not an issue with GDP conceptually, it’s something that one should keep at the back of the mind, as such growth does not tell us anything about employment. It’s relevant because with artificial intelligence becoming the norm in the future, the link between growth and employment will get severed.

Pilling also asks a question as to whether or not high growth in GDP with higher inequality makes sense from a welfare perspective. This is pertinent because in the age of Piketty, inequality has become a major issue, which, when combined with the distribution of wealth, tells another story. Another interesting observation made is that when we talk of average per capita income, we should be looking at the median and not the arithmetic mean because the latter gets skewed by extreme inequality and wealth distribution. This becomes relevant in India where the inequality levels are stark, especially in the past 20 years following economic reforms, where a capitalist-oriented economy has been fostered.
A well-known limitation of the GDP number is in the context of developing economies, where there is a very large informal sector. Here, it’s virtually impossible to know the true numbers because households tend to understate their income, as they fear that the tax authorities will come after them. This has been a problem even in India with the introduction of GST, where small players are hard to get inside the fold.

Pilling has a chapter on India, where he raises the now famous debate, or rather acrimonious argument, between Jagdish Bhagwati and Amartya Sen on the growth situation in India. There is still no clarity on whether growth without development is acceptable or not. It is clear, however, that after 20 years of growth, the benefits have not trickled down to the poor adequately and hence the story could be flawed. Sen’s argument was that Bangladesh, with a lower GDP, had made better progress in terms of development and social advancement, which matters more. In this context, the gross happiness index has also been discussed, where other dimensions of overall development can be measured.

Pilling provides a 360-degree view of the concept of GDP and its limitations. Governments in general like to overstate and overemphasise the GDP size, as it helps them show that they are doing well. Also, as almost all comparative indicators like fiscal deficit, debt, current account balance, etc, are linked to GDP, a higher denominator helps the cause for sure. But what can be concluded from reading this book is that, first, GDP measurement is heavily flawed, biased and can be calculated to suit the regime. Second, the calculation is never comprehensive and is based on samples and assumptions, and could tend to overstate or understate. Third, there are several negative outcomes from production and growth that are not captured in the number. Fourth, GDP per capita should always be based on the median and not the mean due to the issues of inequality and skewed distribution. Fifth, we also need to have a concept that subtracts the ‘ills of growth’ from GDP. Net domestic product takes into account only depreciation of capital and not health, environment and social effects.

Is there an alternative right now? Honestly, the answer is no, and it’s only after a lot of effort has been put in do countries try and converge in terms of conceptually calculating their GDP. Getting information on issues like environmental degradation and human illness caused by such growth is very difficult and, hence, this will remain merely a concept for a very long time.

Three key takeaways from the RBI's policy review: Business Standard 7th February 2017

The Reserve Bank of India (RBI) kept its key interest rate unchanged at 6 per cent for the fourth time in succession at its final bi-monthly monetary policy review of the fiscal, citing concerns about the inflationary push by rising global crude oil prices. The author looks at the rationale behind the RBI's decision to maintain a neutral stance in its monetary policy review.There are three main takeaways from the credit policy that was presented today. First is that the RBI is broadly in consonance with the Economic Survey with regards to growth. While GVA growth for FY18 has been put at 6.6%, it would broadly amount to around 6.7-6.8% growth in GDP for this year. Also heartening is the fact that its projection for FY19 at 7.2% would also mean GDP growth in the region of just less than 7.5%. At any rate, this would be an improvement for the economy. More importantly, the RBI has pointed out that the recap of banks will help in fostering investment as banks would be better equipped to lend now.The second highlight is the view on inflation. There is an acceptance that higher inflation is here to stay with us which means that the number of 5.1% projected for Q4 would actually move upwards in H1-FY19 to the region of 5.1-5.6% before retreating to 4.5-4.6% in H2-0FY19 provided monsoon is good as the base effects come into play. The policy has rightly pointed to the importance of the Budget in this number. It has brought to the fore the fiscal deficit and borrowing programme which can lead to higher demand pull forces. The fact that there was slippage last year means that ti cannot be ruled out this time too.

More importantly, the increase in customs rates on several goods as well as the proposed hike in MSP would lead to cost-push inflation. This is where the government comes in. The Budget has been agnostic to price support in the downward direction of fuel products which can be gauged by the unchanged fuel subsidy as well as higher duty collections on fuel products. Now, if the oil price remains elevated a tough call has to be taken whether or not to provide the extra subsidy or cut duty rates to quell inflation. The ball would be in the government’s court.The third interesting takeaway in the policy is the indication that while a neutral view has been taken, the upward trajectory of inflation can be interpreted in two ways. The first is that for the first half of the year, with CPI at 5.1-5.6% there is definitely no possibility of a rate cut. Further, if this number is breached there could be a rate hike instead to ensure that inflation is under control.Curiously, this time no member has voted for a rate cut, which is significant as there have been calls seen in the past for a rate cut by a certain section of the committee. In retrospect, the majority stance does stand vindicated as the MPC has unanimously raised its projections on inflation.The RBI also is cognizant of the rather tardy transmission mechanism of rate actions to the customer and hence has spoken of linking the base rate with the MCLR, where the latter is more responsive to policy changes. This would help considerably in terms of transmission and make the system more efficient.Contrary to expectations, the RBI has not spoken on current liquidity and GSec yields but has given indications that it would be ensuring that there is never a liquidity crunch through its own actions of reverse repo/repo and OMOs. This should be assuring the markets.In the development part of the policy, there is mention of the FBIL (Financial benchmarks India Limited) taking control of bond valuation and currency rates besides MIBOR. A question is whether this will mean FIMMDA going in for some re-invention?

Finally, a healthline for India’s poor: Business Line 6th February 2018

An insurance scheme that allows 50 crore people access to quality hospitals can work as a global model

Imagine a hutment dweller on the roadside in possession of an Aadhaar card. The child is down with very high fever or maybe the man has a cardiac arrest.

In panic, the wife does not beg for transport and rush the patient to the municipal hospital, where she would have to wade through officialdom to get the patient to share a bed in the ward —which has dirty sheets and houses a couple of street dogs.

This is the situation in many a government hospital. Instead, she rings for an ambulance and gets one from Lilavati, Apollo, or Max Hospital. The patient is taken into an air-conditioned room and the operation is performed.

Does this sound like fantasy?

A great model

This will be a reality because the National Health Protection Scheme has promised to cover 10 crore families involving 50 crore family members with health insurance cover of ₹5 lakh for secondary and tertiary hospitalisation.

Nothing can get better than this; the Indian model can serve as a global one where the government shows the way. Once it is successful, it can be replicated in developing countries.

The positive part of the programme is its coverage: 500 million poor family members, which approximates with a realistic picture of poverty in the country. Most academic exercises which show that the poverty ratio has come down are evidently off the track and hence never find acceptance.

With the Government speaking of 500 million, it means that around 38 per cent of the population is underprivileged and deserve not just medical cover but also a livelihood.

In fact, once this lot is identified, then other schemes can be linked to this sub-section of society.

Financing challenges

The Budget has made this positive announcement and added that resources will be provided for the same. At the financing level, this will require some innovative methods.

Scanning the websites of various general insurance companies, the quotations for covering a family of five persons where the oldest person is less than 30 years old for ₹5 lakh, yields an average of ₹11,000-13,000 per annum. Multiplying this by 10 crore families, the outlay would be Rs 1.1-1.3 lakh crore per annum.

The amount is a recurring one, and has to be paid every year by the government. In fact, the amount would increase, as with higher age groups the premium moves up commensurately.

Further, in this category of people covered, the incidence of disease is also higher, due to low access to superior medical facilities. Therefore, from the point of view of a medical insurance company, the payouts would be the highest for this category of insured.

A premium of ₹11000-13,000 per family would definitely be used up with higher claims for each and every family covered. Even though this means big business for the health insurance companies, it would not be profitable.

It is likely that the onus will fall on the public sector general insurance companies.

Their level of discomfort would increase, considering that there was also an announcement to merge and list the general insurance companies.

A way out is for the States to contribute a fixed proportion. However, this would be difficult as almost all States are facing a stiff fiscal position with limited funds for executing their capex projects. Therefore, funding will come fully from the Centre which if borrowed separately in the market under ceteris paribusconditions would mean a fiscal deficit of almost 20 per cent of the total i.e. 3.3 per cent to increase by 0.66 per cent on a recurring basis.

The government can subsidise the scheme and make the families pay a part of the premium.

But these families do not have the wherewithal to make such payments given their very low levels of income, which barely provides them with one full meal a day!

Coverage concerns

While funding is a major challenge, implementation too would be a logistics exercise. Enrolling such people is always difficult. Just like the farm insurance scheme which promises a lot but covers very few farmers, access to this grandiose scheme would be limited as most would be excluded.

Aadhaar and Direct Benefit Transfer are definitely structures created to ensure better delivery but they have to be made accessible to all deserving people.

There could be resistance from private hospitals. The insured poor would prefer to go these hospitals as they get better treatment from the best doctors.

But as they have no money, the government health-card should ensure there is cashless hospitalisation.

Hospitals normally do not encourage such transactions as there are delays in receipt of payments from when dealing with the insurance companies.

Given the magnitude, insurance companies would not make money on these policies when pooled. It would be impossible to settle claims leading to non-viability of the business.

Therefore, it is essential that loose ends (there are several of them) are sewn neatly before such a scheme is introduced.

Conceptually, the programme is compelling, but it would be hasty to rush into it, given the complexities involved. The limited success of farm insurance is a reminder of the implementation challenges.

A real chance

But if we can crack this one, then we should be able to extend this to education too where we dispense with government schools and open the doors of private schools to the poor, where the state finances quality education and the poor really stand a chance in life.

At present, their degree from an Indian language college or certificate from government school ensures that their disadvantage is maintained when competing with one with a convent-educated background.

This should change.

Another lengthy pause by RBI: Mint: February 6th 2018

The run-up to the monetary policy is different this time as there is less pressure being put on the monetary policy committee (MPC) to lower interest rates. This is on account of two reasons. First, the trend in inflation has been northwards which has in fact, led to conjectures of possible increase in interest rates in the course of the year. Second, the focus has been a lot on the Union Budget which has deflected attention to an extent. More importantly, the numbers in the budget do not suggest that either liquidity will ease or that rates will come down. The market reacted negatively with yields moving up.

The monetary policy has been reduced to a decision being taken on interest rates by the MPC with limited doses of structural issues being addressed as critical subjects like NPAs or bank capitalization are outside the system. Further, the call on rates is with the MPC which has been given a target inflation rate with a band to examine. In the past, CPI inflation within the band limits has elicited differential responses. Therefore, it is a decision taken on not just the CPI inflation number but expectations on the future trajectory.

CPI inflation has been increasing and peaked at 5.2% in December. There is reason to believe that the number will be higher for January too. Therefore, at this present juncture, lower inflation may be ruled out. Besides, the internals of inflation are pointing towards hardening of prices especially those relating to fuel. The house rent impact too would continue to linger for another 4-5 months and hence statistically keep the inflation number elevated. Further, while the impact of higher MSP on inflation should not be overstated, it would, at the margin, lend an upward bias to the CPI index—though this would become relevant only in FY19 when these prices are announced. 

The budgetary content would probably reinforce the argument that a pause on interest rate action is required. First, the fiscal slippage witnessed in FY18 was significant and came in even lower than it would have been had capex not been pruned by around Rs30,000 crore. The target for the fiscal deficit for FY19 has been kept lower at 3.3% and involves a similar level of gross borrowing target for the government. Any slippage on revenue (especially tax or disinvestment) could result in higher borrowing. Second, the government has fixed an interest rate range of 7.35-7.68% for the bank recap bonds which though fixed based on a formula indicates that the government does not really expect interest rates to come down in this year. Third, the budget has assumed a neutral inflation rate of 4-4.5% based on the nominal growth of 11.5% growth in nominal GDP which can be split between 7-7.5% in real GDP and 4-4.5% in inflation. This number looks a bit aggressive considering that inflation has been in this range with relatively stable oil prices. As it is not expected that crude oil prices will cool down in the next 6 months, this number would tend to be higher. In fact, this is a heroic assumption made as the fuel subsidy has been fixed at the same level of last year, while excise collections on diesel/petrol have increased, which indicate that there would not be any extra support from the budget on fuel prices. 

At the ideological level, there could be discussion on how to look at CPI inflation as the Economic Survey has provided an alternative view. While global central banks and the RBI are looking at monthly changes to take a call, the Survey has mooted the idea of using an average concept which was 3.3% till December which was below the 4% mark and should provoke a different response from the central bank. Conceptually, there can be no denying that this is an idea worth debating by the committee.

The RBI had earlier put a forecast of 6.7% for GVA growth for FY18, which is unlikely to change this time with a call more likely to be taken in April. The RBI could also provide some guidance on future inflation, which was put in a range of 4.3-4.7% for the second half of FY18. This will be important as while GST rates have been lowered on several goods higher oil prices and consequent fuel prices would work in the other direction. RBI’s take would be interesting. 

Still walking on the FRBM road: Business Standard 1st February 2018

The finance minister has maintained a fair deal of continuity in the Budget, while adhering to the FRBM path, which is pragmatic. Working backwards at a fiscal deficit ratio of 3.2 per cent, the monetary situation has been kept in equilibrium as there will be untoward pressure on liquidity. At the same time, there has been an uptick in expenditure which will help increase investment from the public side  and thus aid growth. But it should be noted that in the absence of private investment picking up, there will still be pressure on capital formation. Housing, roads and railways appear to be the favoured sectors that can forge strong backward linkages with steel, cement, machinery and metals in a gradated manner and compensate, to an extent, for the slowdown witnessed due to demonetisation. 

Two areas that need to be observed are consumption and savings. While tax relief provided to individuals should help bring about a push in demand for consumer goods, they may not be adequate and will have to be supported by higher growth in income and employment. Nonetheless, the Budget has made provisions for encouraging consumption to the extent that it is possible. There are no specific measures to boost savings. It is more a case of income saved on tax being used for either consumption or savings. Given that consumption was impacted by the note ban, it is likely that tax saved will be used for consumption.

Eco Survey: It’s all about interpretation: Business Line 1st February 2018

The Survey, for example, is not too concerned about savings flowing out from banks to the capital market

As Frederick Nietzsche said, there are no facts, only interpretations. This would just about be the case when one reads the Economic Survey for FY18. The Survey is a detailed update on all aspects of the economy and does not work with data which is not known. Hence, the so-called facts are available to all but the conclusions drawn change after reading the report. The Survey is evidently sanguine about the future to the extent of being gung-ho provided some glitches are addressed with expediency. As it is an interpretation of facts, it does turn around several views which were held before the report came out. How then is one to look at it?

Successful or struggling?

The Survey has forecast GDP growth for this year to be 6.75 per cent, which is higher than the CSO’s. It further puts a number of 7-7.5 per cent for FY19 and the interpretation by corporate heads is that the economy is almost going to start galloping from next year if the upper mark is achieved. Now, GDP growth in FY16 was 8 per cent which came down to 7.1 per cent in FY17 and could go up to 6.75 per cent in FY18 and say, 7.5 per cent in FY19. Does this mean that we are on the trot or are we still struggling to get back to the 8 per cent number?

Here one would have expected the Survey to devote a chapter on the cost of two major reforms that have been undertaken by the Government which have cleansed the system for sure and made it more efficient, but left a cost-trail which ultimately gets reflected in the lower GDP growth number.

Demonetisation and GST have definitely added transparency to the tax system and resulted in more taxpayers. But the disruption caused to small businesses and agriculture has been significant; else there is no explanation for lower GDP growth in FY17 and FY18 as monsoons have been good, inflation low, crude oil price benign, CAD low, fiscal balances under control, rupee stronger, foreign flows higher and interest rates lower.

Between hope and conviction

As the Survey takes an independent view of economic conditions and has gone ahead to advise the Government to set realistic and credible fiscal targets for FY19 rather than target a low number which cannot be achieved, it may be expected that the next edition will provide a detailed analysis on the cost of reforms. In fact, the Survey has also pointed out that the IBC, though good, has to work its way through time to ensure that it is relevant. The same holds for the tax litigation issues that need to be resolved or else the ‘doing business’ climate would be dented.

One reason for the growth optimism as has been interpreted is the expected pick-up in investment and industrial growth. Here one is not sure if this is a hope or a conviction because the major issue afflicting the economy today is demand, which has not been the focal point of the Survey. The analysis admits that low capacity utilisation is a cause of low investment, but this can be traced to low consumption demand in the last three years. This is a serious issue because if households are not spending, and have been buffeted by the two major reforms, then the clue to higher growth is employment generation and higher income.

The Survey does present a different set of data on employment based on social security data to show that there are more enrolled persons in the non-farm sector which is interesting as this angle has not been explored earlier. Employment data based on corporate annual reports for the formal sector or the labour department surveys do point to low growth in job creation. However, extrapolating this growth in social security enrolments should have led to an upsurge in consumer demand . This has not happened and the expectation is that it would take off next year.

Surprising position

While emphasising the role of investment in stimulating the economy the Survey clears the path by saying that the twin balance sheet issue has to be addressed, which also means we need to see more resolutions coming in the next couple of months. While this is a valid point, there is some analysis to show that higher investment is better than lower savings which is supported by select cross-country examples. This is interesting because at present, our investment and savings rates are both declining.

The Survey expects investment to pick up especially from the private sector (while the NPA issue is tackled) but believes that this mismatch would not be serious for the economy. Anecdotally, a high current account deficit can create a different set of problem when savings trails investment. Here, surprisingly, the Survey is not too concerned about surplus financials savings generated mainly due to demonetisation flowing out from banks to the capital market. This has been taken to be a positive fallout of demonetisation where funds have been directed to the market. A concern everywhere now is that as the market appears to be overvalued and is due for a correction, there could be significant losses for households that have moved to such riskier avenues to earn higher returns relative to deposit rates which are falling.

Now, these returns are linked to interest rates prevailing in the banking system. Here the Survey takes the unconventional route of interpreting inflation on an average basis and arguing that CPI of 3.3 per cent for the first 9 months is lower than the 4 per cent target. One can sense a case being made for a rate cut when the MPC meets after the Budget. This is a novel way of interpreting inflation targeting indeed!

What can the Budget do for agriculture? Business Line 26th January 2018

The issues are specific and relate to pre- and post-harvest expectations and concerns, calling for holistic solutions

Agriculture has always occupied the headlines as it is a sensitive sector. When specific crops fail or the monsoon is unfavourable, there is a tendency for farmers to be under pressure and this leads to issues like fall in income, indebtedness, suicides and loan waivers.

When the crop is excessive, prices fall sharply, resulting in lower income for farmers. This leads to a different set of problems of distress and invariably there is talk of increasing minimum support prices (MSP). As a rule, all governments emphasise the concerns of farmers before a budget and it is not surprising that there are several expectations that have been built around this issue.

Practically speaking, it must be understood that agriculture is a State subject and while the Centre can build the superstructure, the infrastructure has to be developed by States. More importantly, these measures work only in the medium- to long-run provided they are sustained over a period of time. If this is accepted, then the role of the Union Budget can be looked at realistically from two aspects of agriculture: pre-harvest and post-harvest.

The pre-harvest issues for farmers involve procurement of inputs, irrigation, credit and insurance. These functions have been traditionally provided by the ‘adathiya’, which is being replaced gradually by the formal system. The Centre, on its part, has chipped in directly by setting targets for farm credit, which is largely adhered to by banks which by statute have to lend 18 per cent of total loans to agriculture. The Pradhan Mantri Fasal Bima Yojana puts a cap on the maximum premium to be paid as a percentage of sum insured between 1.5 and 5 per cent, and lays down the compensation norms in case of failure.

The challenge here is to educate the farmers and also ensure that when there is a crop failure, the compensation is immediate and seamless. The indirect benefit is through the fertiliser subsidy, which, though being targeted better, has an unpaid bill exceeding ₹1 lakh crore. Provision of funds for irrigation is largely a State initiative or a shared responsibility where the Centre plays the secondary role.

On the post-harvest front, the route is longer. Transport, storage and sale are the direct links that have to be built. This takes time as it involves other sectors and organisations as well as regulators (WRDA for storage, APMCs for marketing).

Budgets can make some allocation for encouraging specific activities but cannot singularly solve them. Even eNAM (electronic national market) requires coordination with States and APMCs. Further, while eNAM is a superb concept, practically speaking it is vibrant only on paper. Farmers need to be aware of such markets and should have access to warehouses to enable delivery. As warehousing is not all-pervasive, most farmers would be out of the frame. Further, once they reach the warehouse, they should be able to deposit the goods and have them assayed independently. Lastly, they should be able to take decisions on the price as there would be several grades being sold and the best price available has to match their price.

While electronic markets usher in transparency among existing players in mandis, getting farmers to sidestep the adathiya would require a lot of effort, which is not in the domain of the Centre.

There is talk about MSPs being increased. While this is a practice twice a year just at the time of sowing the kharif or rabi crops, the experience so far is that generally market prices are higher and hence MSP becomes a benchmark price for the market. Such calls are not taken in the Union Budget. 2017 has been exceptional year where prices went well below MSP for specific crops such as cotton and soybean.

More importantly, active procurement takes place only in rice and wheat, which are linked to PDS. There was procurement of tur last year due to overproduction. However, the problem is that the Government has to create the machinery which includes not just the systems but also storage facilities. This calls for some allocations in the Budget, though admittedly it would be a medium-term exercise.

At present, the approach is more knee-jerk, where surpluses are absorbed for a single year and then abandoned when production is back to normal. It happened for sugar earlier and tur this year. A clear plan on procurement is something that can be mooted by the Centre which has to be in partnership with the States.

A subject which falls within the realm of the Union Budget is the NREGA programme, which is implemented through the States. This is a critical programme which provides employment to farmers especially between two farming seasons and also doubles up when there is crop failure. The focus so far has been on allocations, and has run fairly well as the wage paid becomes the standard in industry.

There has been some criticism on the unproductive work assigned under this scheme, which is valid. Ideally, if ministries work in unison such labour can be paid the NREGA wage to work on constructive projects which can be linked to other plans of ministries such as roads, railways, urban affairs and so on.

There is a question mark on whether the Budget would tread the road of waivers for farmers. There is already an interest rate subvention cost which is taken on by the Government. The Centre has clearly passed on the onus of waivers to the States within the space afforded by their fiscal balances. It will be interesting to see if there is a change of stance given the deep nature of this problem.

Hence, specific allocations are unlikely to increase significantly. It would help if a thumbs up is given to futures trading in a wider basket of farm products as it will provide price protection for farmers, which has worked well for contracts of chana, soybean and soy oil on NCDEX. This would be a positive for the farming community.