Book Review: Information overload: Financial Express 22nd April 2018

The sheer amount of data today is changing decision-making, thus changing the rules of capitalism

Capitalism has always been known for being driven by market mechanism. Conventional wisdom argues that markets are considered to be efficient and the interaction of all players gets reflected in the concept of price. This becomes the leading indicator that drives transactions and makes capitalism an efficient economic system. But this is passé and the rules of the game are being rewritten, where the concept of price being the driver no longer holds. More importantly, the day is not far when it will not matter. This is the crux of Viktor Mayer-Schönberger & Thomas Ramge’s new book, Reinventing Capitalism in the Age of Big Data. The structures are more complex today, with customers being more discerning; and the invisible hand can’t capture all the aspirations adequately.

Big data is in, and all companies rely heavily on such information to draw up their strategies. A simple retail shop that tracks what you do in terms of looking at products and choosing those that you buy sends out signals to the outlet and, hence, also the producer as to what your likes and dislikes are. Companies producing consumer products can analyse the purchases taking place in different locations and draw up plans on new products. Also, such data helps managements to decide which areas require a marketing push for future sales.

In fact, there was a time when price became the clinching factor. But in this age of e-commerce, there are other factors that go into a purchase, like colour, size and texture, which make it easier for a customer to choose with a good deal of accuracy. This is also time-saving, as an online portal covers all brands and options. The authors, thus, argue that in a data-rich market, it is no longer possible to condense a multitude of preferences into a single price. In fact, price becomes an oversimplification when it comes to representing any market.

The authors feel that markets will be driven by the pooling of such data. The decisions made on what to produce and the mechanism to deliver it has undergone significant changes with the help of big data, as it gets used along the value chain. Even at the P2P level, conventional relations may break down, as options unfold and all players are able to interact with a wider section of customers or sellers. This is a paradigm shift that has already started.

Mayer-Schönberger and Ramge also spend a few pages on the peer-to-peer lending concept that had caught on, especially at the smaller level of loans, where people lend and borrow based on information available on the counter-parties. We can actually think of this mode of borrowing, based on big-data analytics, gradually getting into the traditional banking space, where both sides are better off. Big data would give potential lenders all the information of the past behaviour of a potential borrower and this would enable the lender to decide whether or not to lend.

This is an important message for regulators across countries who have to build systems to ensure order in the market. This will be a new world for them, especially when regulation is strong when it comes to depositing money; it is a different ballgame when people choose to lend to others on their own volition.

Several companies are also fully into using big data to formulate future strategies. They have started reshaping markets, from energy to transportation and logistics, and could go even into labour and healthcare. Efficient operations of truckers in the US with the use of data is one example. Similarly, we have seen how taxi services like Uber and Ola are more efficient with the use of data, ensuring maximum use of the vehicle and minimum waiting time for customers. Even in education, big data is being used progressively in the West to map teachers and schools with students. The idea is to go beyond ‘good enough’.

The greater use of technology, where the use of artificial intelligence will be the next step can be scary when it comes to jobs. Here, the authors still seem positive and do not see it as a limiting factor, but look at it more from the point of view of enhancing efficiency.
Another issue that is pertinent is the availability of data to everyone. In a traditional market mechanism, it is assumed that all people have access to the same information, which is not true, as there is information asymmetry in all markets that enables sellers to reap higher profits. But in a data-rich economy, the same might happen where some companies or players have access to more data than others. This is a concern and the final answer will only be known with time.

But the authors are convinced that this is the way forward, which will be closer to optimal than the existing market system. Data-rich markets will help people make better decisions and enhance the overall volume of transactions, leading to higher growth. Those who are not used to technology, or the classic Luddites, will have to change, or face being sidelined from the system.

For companies, there will progressively be a choice to automate decision-making, which sounds odd today, but is being pursued by some firms. This is where AI is coming into play, and there could be a future where companies do business with algorithms in place. Such tools are available for trading on stock markets or commodity exchanges where there is no manual intervention. This might sound scary for those whose jobs are at stake, but can’t be ruled out. Also, the absence of human intervention can make the systems too rigid when run on algorithms. A balance surely would be the way out.

A new governance framework for banks: Business LIne 21st April 2018

The current crisis in the banking sector provides a good opportunity to clean up the mess and put the house in order

The recent banking scams have led to an understandable sense of outrage as it involves issues of propriety and governance.

The irony is that what started off as a problem with PSBs, which had the critics and private bankers argue for privatisation – has come a full circle with the focus now shifted to private banks. As this story involves several elements — the government, central bank, banks and other stakeholders — this is a good opportunity to get the house in order.

Any kind of financial crisis offers an opportunity for introspection where rules can be reformulated to bring them in sync with the new order. It is necessary to continuously revisit systems, laws and practices and bring them up to date.

But it should be highlighted that none of the irregularities witnessed recently has involved any loss to any deposit holder and even the share prices have reverted to their arithmetic mean.

The banking scams have brought to focus not just the lack of transparency in the functioning of banks but also that of audit and inspection practices.

Also the allocation of responsibility for identifying and ensuring remedial action is nebulous and needs to be delineated now.

There is now a blame game on, where the question is — why has a concerned party not looked at a certain aspect of the controversy?

The debate has taken on a moral tone, but the questions raised cannot be refuted or dodged. But certain clear lines of thought can be put down and the new rules can be formulated so that there is less ambiguity in future.

Banks’ perspective

Let us look at the issue from the point of view of banks. First, in a private bank who is to uphold the moral responsibilty?

Is it the CEO, or executive Board members or the non-executive Board members? This issue is important because whenever there is a conflict of interest, it has to be clear as to which executives are to be held accountable.

Now if it is the CEO who is accountable, then does that imply that none of his relatives can have any credit dealings with the concerned bank?

This seems unreasonable and one way to get around this problem would be to disclose the financial dealings of the relatives, if any, in the Annual Report or the bank’s web site.

By making such disclosures upfront, the bank can ensure that no questions are raised in future.

Hence greater transparency is the key to avoiding such ‘conflict of interest’ issues.

Second, the performance of bankers has come under the lens now which was never the case before. Can the central bank or the government have a say in the salary package of a private company? The answer is probably ‘no’ because in the private sector Boards take a call on this issue.

There are no penalties for the government officials non-performance and their tenures are safe. If regulators fix or approve pay packages of the regulated, then that should hold good for all industries. So whenever companies make losses, the regulators should hold back bonuses – but this doesn’t seem reasonable.

What happens then in the telecom, power or petroleum sectors? Therefore, this should also be debated and the rules must be clearly laid out.

CEO tenure

Third, the tenure of the CEO is always open to debate. Allowing anyone to carry on for more than a term of say five years is a call taken by shareholders or Boards.

But allowing such extensions also lead to creation of power centres affecting the grooming of second rung leaders.

Ironically in PSBs, CEOs have short terms as they get their positions closer to retirement while in private banks they begin their tenures at an early age – and can often get a stint of more than a decade before they retire.

This is also an issue that needs to be looked at as it has given rise to controversies in recent times.

Regulator’s perspective

From the regulator’s side, the issues that need to be addressed are:

First, the responsibility of the Boards should be clear on issues of governance and any deviance from regulation or conflict of interest should be discussed at this level.

Second, the presence of a nominee director of the regulator on the Board, though controversial, is justified as he is the ‘ear of the public’ and ensures that all compliances are in order.

Third, when audit reports are carried out on banks, the lacunae or important findings should be made public so that everyone is aware of them. It can be put up on the web site of the regulator or the concerned bank.

This is one way of ensuring that banks become complaint.

Fourth, as a practice of good governance, the regulators too should disclose on their web sites the names of the relatives of the senior officials who are employed with the regulated entities. This will add to transparency in operations of the system.

Lastly, any deficiencies in compliance should be reviewed within a specified period of time and highlighted to the public so that it puts pressure on the bank to perform. Therefore, as was in the case of a bank where audit had pointed out that the core banking system did not capture the SWIFT data and no action was taken, it should have been made known to all.

Otherwise the purpose of audit and inspection becomes a closed affair which remains hidden until a crisis emerges.

So this is the right time to take the necessary action in revising the rules and regulations concerning the functioning of banks, their boards and CEOs.

Rather than getting over obsessed with moral issues, a practical way would be to strengthen the regulatory framework and review it every two years based on the banks’ response. More importantly it has to be revisited periodically – maybe every 3-5 years.

Toxic loans mount: Are banks to be blamed? Asian Age: 15th April 2018

ndia's bad loan problem ranks among the world's worst as the NPAs (non-performing assets) accumulated by Indian lenders are higher than those of banks in most major economies, including US, UK, China, and Japan. India ranks fifth out of 39 major world economies plagued by bad loans, according to a report by Care Ratings. Countries with higher NPA ratios than India's are part of the  distressed group of nations in Portugal, Italy, Ireland, Greece, and Spain.

The genesis of the NPA problem can be traced to the post financial crisis era when loose monetary policy was followed to prop up the economy. Low interest rates and high growth in credit helped to spur the economy which was driven by investment in sectors such as telecom, steel, mining, power, engineering etc. It was felt that India was poised to grow at an accelerated pace with the decoupling proves from the world economy setting in. At that time it was never expected that the 8% plus growth in GDP could be any other number and with a touch of hubris was assumed that there was only one way to go.

The advantage of having extra capacity in the form of lacunae in the infra sector in particular meant that there was large scope for investment. Policy makers, economists, corporates and analysts were gung ho about growth which supported over investment. Trouble started when there were a series of what can euphemistically be termed as irregularities in several sectors involving natural resources and policy. The iron ore scam, coal scam, 2G scam etc. set back progress in investment. Projects came to a standstill on account of these scams combined with what was called policy paralysis where bureaucrats did not want to take any decision.

Heavy investment in telecom through spectrum auctions delivered capacity but combined with falling prices affected the growth prospects. Power plants were started with enthusiasm, but the logjam in coal allocation meant that the companies could not produce power. Add to this the unprofitable Discoms which were not able to honour their PPAs as they were making heavy losses, the power sector went further downwards.  The steel industry was affected by non-availability of coal and iron to begin with followed by excess capacity which resulted as steel was dumped by China.  Stalled projects fed back into the engineering sector where surplus inventories resulted followed by surplus capacity. In case of several such ventures, the promoters abandoned the projects leading to a high level of stalled projects that were estimated to be in the region of Rs 4-5 lkh crore when the NDA government took over.

The UPA and NDA governments claimed that these projects were cleared, but most of them became unviable as the backend were in disarray. This led to the creation of NPAs in these sectors. In Indian ventures typically investment is debt financed where equity is a smaller part and hence when projects are abandoned, the banks had to bear the brunt. This got reflected more in the PSB balance sheets as they were primarily financed by them while the private banks kept a distance. These numbers grew over time.

The story takes a twist when the Corporate Debt Restructuring concept came in. It was a risky concept to begin with because while a special CDR cell discussed these issues and allowed for restructuring the debt in terms of tenure and interest rate, it ended up being a case of ‘kicking the can’, wherein the problem was deferred. In fact there was a perverse incentive to reclassify and restructure these loans under this umbrella. As the scheme was supported by the government and RBI such an evergreening process was never questioned. In fact, there was strong justification for reclassification as restructured assets and it was argued that these assets failed since external conditions had deteriorated and hence different kind of treatment was required. This was probably the error made as the loans got rolled over, especially in these sectors which are today the big NPAs.

Subsequently, in end-2015, a decision was taken that there should be a fair recognition of NPAs-asset quality recognition, which transformed these restructured assets into NPAs. This was followed by the IBC with the leading cases being taken up in different batches. Hence the high NPAs witnessed especially in the infra sector are a result of all these storylines which have played out.

Can the banks be blamed for this creation of NPA stock? The answer is not clear because when money was lent, it was never expected by anyone that they would fail as they were the leading sectors. In fact the entire growth story of China was based on heavy investments in infrastructure, which led to the double digit growth rates on a sustained basis. Therefore, while the judgment was incorrect, it would be hasty to think beyond commercial calls that were made. At the margin there could have been governance issues where specific industrial groups were favoured, but almost all these NPAs were loans given to reputed companies in their fields. It was a case of project failure where the business models did not work.

Was there any cronyism involved? This could have been there in some cases, but the large numbers we are talking of in the region of 12% of outstanding credit as stressed assets cannot be linked to such cronyism.

Should they have been identified earlier? Here the answer is yes, because the concept of restructured assets was flawed to begin with which only deferred the problem without solving it. The subsequent efforts at resolving the NPA mess through different schemes were apologies at resolution.

Is the present resolution process a solution? To an extent yes, as it will keep aside these bad loans which have built up. But it could also mean that future investment could be impeded as the fear of failure of the projects can keep investment back. Further, bankers too may be unwilling to lend to these sectors and prefer the retail route.

The issue today is that it is not clear whether or not all the NPAs have been identified and whether these sectors are clean. The resolution process is in progress and the end result would be important as it will determine the future direction for these industries. They are critical components of the growth process. The reforms at the Discom level have not worked their way, which is a concern. Telecom appears to be better placed while in case of steel, the availability of bids for the NPAs is encouraging. More importantly, it is essential to know that there are no more such assets in the closet or the pain will get prolonged.

Should state development loans go with differential rates? Economic Times 11th April 2018

dan Sabnavis An issue which has been raised often is whether or not all states should be able to raise loans at the same rate for balancing their budgets. As all state development loans (SDLs) are considered to be sovereign debt which also qualifies as SLR securities, the level of governance of finances does not really matter. The states which end up borrowing at the lowest weighted average cost are those which have borrowed more when yields were down and not because the market favoured them. The states with better finances rightly argue that their debt would be rewarded by the market in case differential pricing was possible. State governments run different kinds of budgets. While some are fiscally astute, others tend to be more flexible in their ways. Similarly, the quality of the budget can vary with some focusing on capex and other productive expenditures such as education, health, agriculture, etc, while others may prefer to allocate more on subsidies based on political motivations. The reason this does not matter today is because there is sovereign guarantee on all loans taken. Therefore, there is a case for distinguishing the quality of debt of any state government based on the evaluation of the finances which addresses the question of whether or not the state has the wherewithal to service its debt if not backed by the concept of soverign  ‘fact, even the withdrawal of the SLR status can bring about a difference in which debt of two states are viewed. Another argument in support of this idea is that while municipals are also a part of the federal structure at the tertiary level, their debt does not enjoy ‘government’ status. Urban local bodies (ULBs) do the same work as the central and state governments in terms of development and also have the power to raise taxes and other fees as laid down by the Constitution. They also get transfers from the Union and state governments for carrying out their tasks. Yet municipal debt is not guaranteed by states or the Union government and carries credit risk just like a corporate. Given their weak finances, they are unable to borrow from the market which, in turn, has come in the way of developing a municipal bond market. This being the case, there is a strong argument for removing sovereign status of state debt.

However, on the other side, this may not be feasible. First, there is already a large quantum of outstanding debt of states of the order of Rs 23 lakh crore, which will have to get re-rated once they are evaluated on a different scale. Second, various state governments incur expenditures which are also being done by the Centre — such as subsidies and waivers. Hence, ideologically what is good for the Centre cannot be bad for states. Third, some states account for the bulk of production of specific farm products which are subsidised. Withdrawal of such subsidies would mean that the entire country would get affected through supplies or prices which are not a good sign. Fourth, suppose a state is not well rated and finds few buyers for the paper, then the Budget would get into a tizzy. Fifth, there are already in place FRBM rules concerning revenue deficit, fiscal deficit and debt levels for various states. As long as they are being adhered to, there should not be any concern. Can we really say that a state that continuously run a fiscal deficit of say 2% with less expenditure be better than one which touches 3% on a regular basis? Sixth, with GST in place, the scope to introduce new taxes or increase tax rates is virtually ruled out. Hence, under these conditions, would it be right to put conditions when there is no control over revenue? Last, the market does not get to reprice the central government debt howsoever large it may be (which is driven by liquidity conditions and accommodation made by the RBI). Therefore, asking the states to pay now differential rates which are already higher by 50-60 bps would not be right. The point to be made here is that governments are not corporate bodies as their goal is to bring about development and, for this to happen, they do undertake several expenses which may not be commercially judicious. Therefore, within this thought process, FRBM rules appear to be the best solution where states are forced to operate within these limits. The time is not yet suitable for bringing in the concept of differential pricing.

Book Review: Nassim Nicholas Taleb’s ‘Skin in the Game’ ...Financial Express April 8, 2018

Nassim Nicholas Taleb is all praise for US President Donald Trump because he has made idiotic mistakes and lost money as an entrepreneur, and hence can be trusted because he has his skin in the game.

When the great musician Yanni held his most famous concert at the Acropolis in Greece in 1993 (the album was released in 1994), he had put in $2 million of his own money into the initiative. This was a big risk, as the outcome was uncertain, but it worked. When Metallica came to India, and the concert was cancelled in 2011, people were disappointed and the organisers were blamed, but their reputation was unaffected. More recently, Justin Bieber supposedly took the Mumbai audience for a ride by lip-syncing in 2017, but he still remains an icon with admirers. So how does one judge which artiste had more stake in the game or, what Nassim Nicholas Taleb would call, ‘skin in the game’? Taleb, better known for his two trending books—Fooled by Randomness and Black Swan—in his new book, Skin in the Game, explores the payoffs that are inherent in any activity that we pursue. This can be from taking decisions at the government or corporate level to simple advice given to our neighbours. Do we have enough skin in the game? The issue really is that payoffs in life are asymmetric and, hence, actions taken today that lead to failure later can never be penalised, which was the case with the financial crisis that made former treasury secretary Robert Rubin Taleb’s favourite punching bag through this book, as he had cornered $120 million from Citibank before the crash. When corporates fail, the bonus may not materialise and the stock value may be down, but CEOs never get penalised. Today, for example, the NPA issue in India has not seen any retired management officials being held responsible, and the blame is laid more on an intangible entity with no name or face.

Skin in the Game is an interesting book, as Taleb brings in a lot of stories, especially from Greek literature, besides his own experiences, to drive home the point that unless we have stake in what we are doing, there would be asymmetric payoffs. A doctor has his skin in the game, as successive blunders will earn him a bad name and make him lose patients. The same holds for architects or lawyers, who need to have good reputations, as clients always look to see whether their money is being paid to someone worth the cost. But when we give advice to others, we really have nothing to lose and, hence, don’t have skin in the game. The one class of people Taleb says he despises openly is bureaucrats and policymakers, because they have no skin in the game. They have a fixed tenure and can do anything with justification. But if things do not work, people end up suffering, but nothing happens to these people. If one probably brings in this theory to the demonetisation exercise, one can see the absence of skin in the game. While technically something that does not rhyme with the public will speak as action during elections, such episodes tend to be forgotten along the way. Another group of people he asks us to be wary of is economists and academicians. This class gets too theoretical and beyond reasoning when they use crafty models to come to some weird conclusions. If they remain as academic papers, there is no harm, but if used in the system, the results can be disastrous. This is similar to what author Morris West had indicated in his famous book, Cassidy, where he warned readers to be careful of professional economists, as they can lose elections for the government and yet have their tenures secure in universities—they have no skin in the game. The narrative is all about such stories and the reader can have a quarrel over many such examples that have been put forward by Taleb. He is all praise for US President Donald Trump because he has made idiotic mistakes and lost money as an entrepreneur, and hence can be trusted because he has his skin in the game. He is critical of Thomas Piketty, whom he lambasts for false reasoning.

The same will probably hold for the Reinhart-Rogoff controversy, where they had apparently used incorrect data to link government debt with growth. Merton and Scholes have been blamed for the financial crisis, where their models failed—but they have themselves lost nothing. Their reputations remain virtually intact even today. However, Taleb, who got his hands dirty being a trader, is not clear on whether he wants academic work to have models and math or not. He takes the view that models can’t be used for real-life trading, where he has a point. However, he attacks Piketty for the absence of models in his voluminous book, Capital in the Twenty-First Century. This could make it confusing for the reader at times. At another level, Taleb takes his argument to religion, where he insists that Jesus Christ was the one who had his skin in the game, as he got crucified! Hitler had his skin in the game, and whether or not the cause was right, he played the game and died for it. Bush and Blair had no skin in the game when they invaded Iraq, and continue to live happily even though it was a major political faux pas. It is left for the reader to decide what she or he agrees with, but the book is enjoyable. It is written in a brusque fashion, which is typical of Taleb. Interestingly, he is full of praise for himself—he has skin in the game and, hence, retains US citizenship and pays taxes, unlike others who want to reside in the country, but claim citizenship elsewhere to escape taxes. But don’t all corporates do that for tax planning, which is legitimate? He makes several such forceful points in the book. He is also against journalists, because they have no skin in what they do. But the counter-argument is that if they do, it would be considered biased reporting and, therefore, his argument becomes weak. Besides, all media channels have a reputation to protect, as traffic is related to credibility and that is skin in the game. Skin in the Game is definitely a good book, written by a former market player who, though self-opinionated, does make one think hard every time there is any action to be taken. He ends with a whole list of what we should watch out for: no life without effort, opinion without consequence, facts without rigour, virtue without risk, religion without tolerance, decision without asymmetry, wealth without exposure… the list can go on.

Why fiscal 2018-19 will be different: Business LIne April 7 2018

As a pre-election year, the govt may go easy on tough reforms; inflation may be a worry despite RBI’s benign view

The 2018-19 fiscal year will be a particularly interesting albeit challenging one. FY17 and FY18 were two normal years on the domestic side while a less amorphous structure evolved for the global economy. The world economy looks stronger than before notwithstanding the move towards protectionism in the western world and an unchanged level of uncertainty on the political relations in the oil world. The comfort which was experienced on several fronts in the last two years may not be available this year which can potentially cause volatility.

First on the policy front, the government may prefer to be conservative in the face of a pre-elections year. This was one of the reasons why radical steps were taken in 2016 and 2017 on demonetisation and GST with 2018-19 being the cooling period. Therefore big bang reforms may not be expected, though the government has quite adeptly brought in reforms in most sectors in the last 3-4 years. Labour and land are the two stickier issues which would have to wait as farm distress and low employment growth have limited the contours of feasible reforms in these areas.

Second, the comfort of lower inflation may be over and while the present CPI number appears to be well within the 4-6 per cent band of monetary policy tolerance, the upside risks appear to be more than the downside possibilities, although the RBI in its latest policy has toned down its inflation projections. Oil is steady at $70 with an upside. Besides all the demand pull factors that have been benign so far would begin to move in the other direction. It must be remembered that low inflation also goes with loss of pricing power for corporates. Any revival of corporate power would be manifested in price changes, which remains a risk today.

Third, the direction of interest rates looks stable given the RBI’s recent stance. While the argument for rate cut would have some foundation in case inflation comes down sharply, it looks more likely that status quo will prevail. The government’s borrowing programme has been loaded heavily in the second half and by kicking the can to bring down rates in the short term, the risk of higher rates from October onwards cannot be ruled out.

Fourth, the rupee has been very strong in the last two years and the expected depreciation has not taken place despite a widening trade deficit. One reason has been the weak dollar vis-a-vis the euro caused by the policies being pursued. But there is reason to believe that US President Donald Trump’s ‘America First’ is aimed at making the US a powerful economy which includes a strong dollar. With a widening CAD, the possibility of a weaker rupee cannot be ruled out. While this is good for exports, volatility in the market is more definite, which will call for central bank action if the limits are breached.

Fifth, a recovery in the developed economies goes along with rising interest rates. This means that investors would get better returns and a stronger or stable dollar will mean reversal of capital flows from emerging markets. The quantum of FII flows in equity has been low tending towards negative. However, the debt flows have kept things moving which can change this year. The same holds for FDI. While India has managed a smart amount of $45 billion (equity) in the last three years, it is unlikely to be exceeded. Here again, most of the policies in the West are aimed at high spending on infrastructure which would provide opportunity for investors.

Sixth, while it is true that the monsoon pattern cannot be interpreted on the basis of past data, two very good monsoons could be followed by a sub-optimal one this year.

The Skymet has, however, projected a normal monsoon this time too. This will be a concern as the action so far has been more on increasing MSP as an answer to the problems of farmers as there has been surplus production for two years. Now an uneven distribution of rains will underscore the crux of sustainable agriculture which has been ignored in the good years. The impact on production, foreign trade and inflation would be important here.

Correction imminent

Seventh, the stock market has been belligerent in FY18 where it was hard to find linkage with fundamentals. This being the case, the general expectations are that a correction is forthcoming and would be witnessed this year and the Sensex could go below 30,000. This has been exacerbated by the recent stand-off on the trade war between the US and China towards the end of March but could gather momentum in the coming months. Therefore, the high returns earned last year would not be replicated this year.

Eight, given this set up, the fiscal targets put forward of 3.3 per cent deficit for the year could have a downside in terms of the final number coming in higher. The very good disinvestment proceeds in FY18 can be attributed to favourable stock market conditions. If this is not repeated then it would be tougher to go through with the ambitious plan of ₹80,000 crore.

The banking conundrum

Ninth, the banking system will probably be the biggest conundrum for the government to resolve. The present crisis in on several sides and until it is evened out, will remain a drag.

High NPAs where the numbers are not yet identified, limited resolution of the IBC cases, capital shortages for growth of banks, governance issues etc, have all meant that the focus will be on a lot of housekeeping and ordinary business would be under pressure especially on the lending side.

Last, growth for the year has also been assumed by the government at less than 8 per cent, which is lower than that in FY16. Hence, while the tag of fastest growing economy will probably be retained, there may be less comfort internally with most of the conditions turning volatile. Private investment still appears to be stagnant while states are also not in a position to invest given their tenuous fiscal structures. The central government had cut down on capex last year and this could happen again in case conditions turn adverse.

Therefore, while the economy looks strong from the outside, the factors that have contributed to this vision could be under various pressures that could cast a shadow. This makes the year particularly important.

Banking Sector in FY18: A roller-coaster ride for sure: Financial Express 4th April 2018

The banking sector, in FY18, went through a lot—from mounting NPAs & the IBC coming into force to governance lapses and talk of privatising PSBs.

The banking sector has gone through another tumultuous year, having its ups and downs. The focus of both the government and the Reserve Bank of India (RBI) was to make the system robust and ensure it was on the right track. It was particularly challenging, as all solutions that appeared to have been found confronted new obstacles that made them look like mirages.

First, the NPA issue, which is at the top of the mind, appears to be still on an unknown road. It was hoped that the asset quality review process would have been completed by March 2017. But, these assets have been increasing every quarter, and while it is now hoped again that March 2018 would be the end of the tunnel, one cannot be really sure about it. The NPA ratio is close to the 10% mark, while the stressed asset ratio is above 12%.

Second, the Insolvency and Bankruptcy Code (IBC) came into force and the 270-day norm would be coming up for some of these cases. There was an evident haste in concluding that the IBC would be a panacea for NPAs. What has been noticed during the course of the stories playing out is that the resolution processes are complex and the bidding system controversial, as promoters have been trying to get back their own assets. To top it all, promoters are quite expectedly using litigation to prolong the resolution process, which builds another hurdle. It does look like that the haircuts would be deep for most of these cases, which means that the balance sheets of banks would be affected further. And, this would drag into FY19.

Third, the government has worked relentlessly to capitalise public sector banks. This has been done through direct infusion as well as recap bonds provided for in the Budget. The allocation has been pragmatic to all banks, which deserve the same. There has been some apprehension on the approach of using accounting practices to capitalise banks, but it definitely does help the concerned banks. However, until the NPA issue is resolved for these banks, the infusion of capital will, at best, help keep them afloat and address the issue of provisions, and may not be adequate for funding future growth. Therefore, more infusion may be required by the government.

Fourth, all the talks on disinvestment of the government stake in PSBs have not moved beyond discussion, with different views being expressed by government spokespersons at various points of time. Admittedly, it is an uphill task, as going below 51% is an ideological dilemma. Anything higher will help garner resources for the government, but not change the fundamental way of governance. Indradhanush had spoken of giving banks freedom in recruitment, ESOPs for management, and so on. But, there has been little movement here. This being the case, selling a part of the stake to, say, a private bank may not help in any kind of restructuring. The debate will carry on in FY19.

Fifth, governance lapses were noticed across all categories of banks. While the recent fraud emanating from specific companies in the jewellery segment has shaken the audit processes in the system, several non-PSBs have also been found to have understated their NPAs. This means that processes and procedures everywhere in the system need to be revamped and serious housekeeping is required to ensure that the probability of repetition of these deviances is reduced. The overhaul of the audit process would have to be taken up with alacrity by RBI in FY19.

Sixth, the combination of frauds in some banks and IBC presence has also slowed down banking activity, especially on the lending side. The threat of being referred to IBC, in case of a default, has made companies more cautious about investing money in new projects. This can be a serious problem for the economy, as such a fear can thwart the rate of growth of private investment, which is the missing piece in the growth story so far. Bankers are also wary of being caught in the web of the 3Cs—CBI, CAG and CVC—and could go slow on lending. This could be one of the inhibiting factors in the coming year when demand for credit picks up.

Seventh, there has been pressure on banks to push lending to the MSME sectors. This could be the next big challenge for banks from the point of view of a fresh build-up of NPAs. It should be remembered that the SME segment was affected the most by demonetisation and GST, and, hence, their ability to service debt could also come under pressure. While financial inclusion is necessary, aggressive lending to this sector could have its pitfalls, which is what should be looked at closely in FY19.

Eighth, banks were affected by the sudden hardening of yields on government bonds as a result of the prices falling, with RBI indicating that it expects inflation to go up. This led to a MTM problem for banks, which were already saddled with making higher provisions on NPAs. Further erosion has been prevented by the government in March by announcing a lower level of borrowing for the first half of FY19. But, we have only delayed the inevitable as the second half will turn sticky for banks.

Ninth, banks were caught in a situation where growth in deposits slowed down considerably. In FY17, they had increased sharply on account of demonetisation where households had to deposit their cash. In FY18, as currency entered the system, households withdrew money from their deposits, which led to a slowdown in growth. This got exacerbated when credit growth picked up, leading to a tight liquidity situation.

Tenth, lending has gravitated towards the retail-end, which has been a silver lining for the system. PSBs too have been aggressive here, as it is a safer avenue. In FY19, banks, however, will have to strike a balance with lending to other sectors to avoid concentration in assets as well as enable funding for other productive assets.

Banks have also witnessed some very positive developments in the form of successful IPO of a new bank, well-functioning of the payments banks and small banks. More importantly, there has been a jump in the use of alternative methods of payment through the electronic mode. The volumes registered on UPI, IMPS, NACH, cards, etc, have witnessed smart increases this year, thus, meeting the objective of the government to go digital.

FY19 will be a period of some serious house-cleaning for the banking sector so that the final balance sheet looks more reliable and credible. In a way, it was fortuitous that most of the slips took place in FY18, when such operations were on the way so that the spring cleaning can be extended to other parts of the system too.

Govt’s borrowing programme: Adopting a new approach: Financial Express 27th March 2018

The announcement of the borrowing programme for the first half of the year was an important signal for the market, considering that the liquidity is tight at present with greater dependence on the repo auctions (term).

The borrowing programme of the government for the first half of FY19 is quite unique. After a long time, the first half of the year will witness less than 50% of the targeted amount of Rs 6.05 lakh crore being issued. The market was expecting the ratio to be maintained at 60% or slightly lower, given the prevailing liquidity conditions. The latest announcement will assuage the market to an extent, but it has several implications, which could become serious during the second half of the year. First, the government expects liquidity conditions to remain tight for the next six months. Otherwise, there would have been a natural tendency to borrow more during this period. Normally, during the first half of the year, there is less demand for credit, and deposits increase at a higher rate, leading to excess liquidity that can be mopped up by the government through G-Sec issuances. This is not expected, as per the implication of the announced programme. Second, the government would be issuing more of floating rate or CPI indexed bonds, to the extent of 10% of the Rs 2.88 lakh crore being borrowed. This is, again, indicative of the acceptance that inflation would tend to be higher, which will get reflected in the bond yields too that, in turn, will be the cost for the government. Both these concepts are interesting and should find favour among the players.

Third, the press release also talks of the new benchmark securities being introduced. This is a good sign for the development of the G-Sec yield curve. At present, there is more liquidity in the five- and 10-year tenures, while the others remain fairly illiquid. By getting in more benchmarks, especially at the lower spectrum of two and five years, there could be generation of liquidity that, in turn, will help even the yield curve. This is quite desperately required in the market to set standards. Fourth, the development of a smooth yield curve is also pertinent in the context of the government’s and RBI’s attempt to develop the corporate bond market. For the development of a corporate bond market, we need to have an active secondary market, which depends on having available rates or prices for various maturity of securities. This will normally be benchmarked against the G-Sec yield, and while such spreads exist for the 10-year paper to an extent, the same is not visible for other bonds. Focusing on such period of maturities will also help develop prices for corporate bonds that are a prerequisite for the evolution of the same.

Fifth, the distribution of securities across maturities is also interesting. This time, it is being well spread across various tenures and not concentrated at the far end, which was the tendency in the last few years. This will eschew the threat of bunching up of debt repayments in future, which is the case today. While there was a strong argument for having long-term maturities to prolong the repayment cycle, spreading them across different maturities makes sense as it also reduces the cost of debt that would be locked in the current year, besides avoiding the bunching of repayment. It, however, remains to be seen whether this policy would be pursued in the coming years too, or whether this would be more tuned to the current liquidity conditions.

The announcement of the borrowing programme for the first half of the year was an important signal for the market, considering that the liquidity is tight at present with greater dependence on the repo auctions (term). Deposits are not increasing at the same level rate, while credit growth is relatively swifter. The aftereffects of an upsurge of deposits last year following demonetisation have got reversed in FY18, leading to a very low growth rate as households have taken their money out of banks. Banks, interestingly, already have excess SLR to the extent of 7-8%, which means that there are high MTM losses to be booked on March 31. (This was also the case in December 2017 when they had to book losses following the increase in yields). With interest rates expected to increase in the coming months as inflationary expectations look negative, banks may be less willing to invest in G-Secs since they will have to take on a higher loss on portfolio—do they have any other option in the face of rising NPAs? This could be another reason for lowering the quantum of borrowing in the first half.

The problem of liquidity, however, can get accentuated in the second half of the year, and the market could turn volatile if growth in credit picks up sharply, provided the monsoon is good. This is the typical busy season that witnesses increase in demand for credit from agriculture, industry and retail. If the government is going to push through a higher borrowing programme, then there will be liquidity squeeze that will necessitate intervention from RBI through some aggressive open market operations as well as term repo funding to ensure stability. It must be remembered that, for FY19, the government has also buffered in a high flow of small savings, which has been increased from Rs 75,000 crore to Rs 1 lakh crore, according to the announcement. In case there are any shortfalls here, as these flows are exogenous and depend largely on how households behave, the overall market borrowings may have to be increased unless the government resort to higher drawdown of cash balances to manage the deficit.
Also, the overall cost of borrowing could come under pressure during the second half of the year, if liquidity becomes tight. This is something that will be monitored closely by the market.

Putting tariff hikes in perspective: Business Line : March 21, 2018

oreign trade will slow down as the focus turns inward for developed countries. But this will be just another passing phase

The recent decision taken by the US to raise the tariff on steel and aluminium should be viewed against the broader framework of the fissiparous nature of globalisation today. Whether the jingoistic slogans are ‘America First’ or ‘Make in India’, the thrust is on reviving economies by focusing on nationalistic pride or security issues. Either way, implicit is the acceptance that globalisation may not be the best way as it is a one-sided process.

Skewed concept

As a concept, globalisation has been skewed towards the developed countries which have gained even more ever since the Washington Consensus was accepted by all nations. This meant that trade, services, investment, domestic policies and so on were geared towards what Washington thought was right.

The same dictum has been reinforced in a very subtle manner through two routes. The first is through global competitive benchmarking wherein a template exists on what countries should be doing to become more competitive (WEF) or become easy places to do business in (World Bank). Such regular ranking perforce tunes the policies of governments to becoming more open to global forces which, in effect, are imports and investment from the developed world. Local issues are often given a skip. The credit rating agencies have added their bit by imposing western norms of what is appropriate and all countries move towards these signposts.

The other route is even more subtle wherein domestic economists get very good jobs in the IMF or World Bank which then qualifies them to return to their home countries as policymakers. Automatically they get tuned to espousing the Washington Consensus. An added dose here is the WEF which is a big meeting place for the bastions of industry (who finance their own travel and stay at Davos) and get to interact with everyone who is involved with globalisation. These egotistic tours work well for multilateral institutions and developed countries as these people become indirectly their representatives when they practice advocacy for more liberalisation.

Further, the egos of the emerging markets were played up by relentlessly focusing on all the highly populated relatively higher income nations under BRICS — countries like Angola or Chad would never feature in global forums which included only potential markets for the West. Ironically, nations categorised as ‘developing countries’ suddenly got segregated from the others and were bracketed under emerging countries and also made their presence in wider groups like the G20 where they ended up speaking the language of the West.

If we compare these examples with what happens in India, the resemblance will be clear. The spread of globalisation has been good as it was a win-win situation for everyone. Countries welcomed imports and investment as it helped improve quality of life and gave access to foreign funds which supported markets as well as the balance of payments. In fact, emerging markets no longer look to the IMF or World Bank for assistance as the commercial borrowing route has opened up; these institutions are now more advocates of globalisation and supply experts to these countries for policymaking.

When internal growth stops

Western countries have been the drivers of liberalisation due to three reasons relating to limits for internal growth being achieved. First, high levels of income coupled with affluence have meant that there is little scope for expansion and emerging markets are the only way out. This has been done through FDI and exports, which are a legitimate manner of spreading economic imperialism. Second, the low growth in population affects the potential consuming class in these countries and poses a challenge to future growth. Third, a rapidly ageing population also means that consumption falls over time and governments spend more on healthcare. Hence, spreading the tenets of globalisation supports domestic growth.

The WTO came back into action to further these agreements but was heavily tilted to begin with. While all countries were to give up quotas and lower tariffs, movement of labour was never part of the deal. The reason was that the developed world retained the prerogative to regulate the inflow of labour while ensuring that their goods flowed seamlessly to the rest of the world. This is something India has opposed in all such forums.

These arrangements worked very well as long as the world economy did well and the developed countries which set the rules of the game were on the growth path. After the financial crisis, the US in particular has found it tough to move out of a low equilibrium trap with quantitative easing policies delivering only to a certain extent. This is also the case with the euro region and Britain where growth has been of a lower order in the last decade.

This is one of the reasons for them to indirectly oppose the rules of free trade, which have been exacerbated by the proliferation of xenophobia. The demand now is for more symmetric trade and investment rules. Donald Trump’s appeal at the time of the elections and the support for Brexit followed by similar tendencies in Italy and France are indicative of the realisation that unhindered globalisation does lead to loss of jobs, and this matters at the end of the day.

Inward-looking future

So, what will the next ten years look like? Definitely there will be a move to become more closed as domestic concerns dominate. Foreign trade will become a slower engine for growth, and this will impact smaller emerging economies. Foreign investment will still seek foreign frontiers but companies may have to also look internally to expand their capacities. Countries like China may witness fewer such outsourced production. The WTO would, for all practical purposes, be a ‘deferment congregation’ of suspicious members always keen to impose anti-dumping duties when they sense unfair practices.

The positive part is that this will only be another passing phase. While the next couple of years will lean towards protectionism, the change in the growth trajectory of the world economy should help restore a new equilibrium. This, despite being along the path of the Washington Consensus, will be more gradual and less stringent.

Debt Servicing: Caught in the fiscal debt trap: Financial Express 20th March 2018

Ideally, debt servicing should be resolved internally and receipts like divestments can be used to partly finance such redemptions. even options like spectrum sale can be used.

Whenever we speak of the Budget, there is an obsession with the fiscal deficit number to the extent that the edifice of any such document is built around this ratio (expressed as % of GDP). Foreign agencies also harp on the debt level, which leads to controversies on what should be included or excluded from the concept. But, the final deficit number of 3%, or 3.3%, or 3.5%, becomes the benchmark for evaluating the efficacy of the budget, and there are several critiques on the quality of such spending.

There is a sense of relief and satisfaction when we move towards this number. But is this the ‘be all and end all’ of budgets?

One aspect of the budget that has missed attention over the years has been the debt-trap, mainly because we were well away from this pitfall for quite some time. Further, the FRBM rules never speak of this concept, because, somewhere along the way, this idea has been given a miss. One of the reasons could be that since money is fungible, it is hard to say what part of the budget’s resources is used for financing development/non-development expenditure, or to repay the debt. But intuitively, if the debt servicing component of the government approached the gross borrowing number, then it results in a fiscal debt trap (FDT).

This concept is important because even while the prudent debt measures are maintained through some adept statistical handling, additional borrowing reckoned in time period ‘t’ has to be serviced through the years, until it is redeemed. Hence, larger quantities borrowed today would have to be serviced continuously, and add to the debt servicing cost. Progressively, governments have been elongating the borrowing time liability through issuance of longer term tenures of debt and often switched debt to ensure that bunching up does not take place. But, debt has an interest component, which has to be paid every year and increases rapidly over time.

In the last 10 years, for instance, gross borrowings of the government has increased at a CAGR of 3.9%, while interest payments have risen by 11.7%. As a result, the debt servicing component has increased sharply. In fact, the share of interest in overall size of the budget has been above 20%, which implies that a fifth of the budget is committed to the service aspect. Add to this, the redemption of loans, and the outflow can get quite substantial.

The accompanied table gives the FDT numbers over the years. Data is provided for the gross borrowings of the central government, interest payments, and the ratio of government debt servicing to borrowings calculated in two ways. FDT-1 takes into account normal redemptions, while FDT-2 includes also the switches that have been made during the year.

Interest payments have increased by around 2.7 times during this period, which is also the rate at which the normal redemptions have increased. Adding the switches to debt redemption increases the multiple to 4.5 times. Hence, the divergence between the FDT-1 and FDT-2 becomes stark after 2015-16, and has now peaked at 129% of borrowings in 2018-19. Even under the debt servicing, including only normal redemption, 2016-17 was the cutoff year when the ratio of 100% was crossed.

An FDT is significant because it underscores the fact that debt servicing has become a major burden for the government, and that the overall borrowings are not able to cover this aspect of debt servicing. This, in fact, puts more pressure on the revenue collections to meet other commitments like salaries, subsidies, defence expenditure and capex. The ability to increase these components, or those outside this circumference, will depend on higher revenue being generated.

This aspect of debt also needs to be looked at when working on the fiscal deficit and outstanding debt numbers. The debt servicing component will keep increasing over time as with longer maturities of government debt, interest payments will keep getting higher in magnitude. With upwards of `51 lakh crore of debt to be serviced every year, this pressure will keep increasing, and put pressure on the fiscal space.

Ideally, debt servicing should be resolved internally and receipts like disinvestments can be used to partly finance such redemption. Going ahead, even options like spectrum sale can be used for making redemptions. This would ensure that there is less pressure on the regular flows of revenue. Unfortunately, disinvestment is being used today to shore up the budgetary balances, and lower the fiscal deficit and, hence, borrowing programme. Hence, while the gross borrowing programme has been contained in the region of `6-6.25 lakh crore in the last five years, the progressive interest cost and redemption have pushed the government further into the debt trap.

There can, hence, be argued a case for lowering the size of the government expenditure in order to address this issue of debt trap, whereby resources are earmarked for addressing the issue of redemption and other channels used for making the interest payments like RBI surpluses, PSU dividends, etc. This is a tough call, given that the central government appears to be the only entity that has been spending on infrastructure in the last three years in three critical areas—roads, railways and urban development—where private investment is not forthcoming. A tradeoff exists.

Going ahead, as part of fiscal prudence, the government has to focus also on debt servicing. The narrow triangle of revenue deficit, fiscal deficit and debt-to-GDP ratio is passé as the concept of already being in a fiscal debt trap is scary—if the same of states is also added, the picture could look even more grotesque.

Book Review: ‘Demonetisation and the Black Economy' Financial Express 11th March 2018

The author is hard on the RBI, which preferred to remain silent rather than clarify various issues, considering that there were several changes made by the central bank in the conduct of exchange of old notes over the two-month period, which had bankers in a tizzy.

The subject of demonetisation has been immensely controversial, as almost everyone has a view on the motives behind the move, as well as its impact. Supporters aver that it has cleansed the system at the cost of a minor inconvenience of two months. The fact that digital transactions have caught on vindicates the move. More importantly, the way of doing business has been cleansed. Those against demonetisation argue that nothing much has been achieved and the economy took a big hit; and that the exercise was a failure. These arguments are well founded and can go to the extent of being driven by emotion. This is one reason why we require an academic examination of the subject that is based on strong arguments supported by facts. It is here that Arun Kumar, who is a well-known expert on black money, has gone into the details of this subject in his book Demonetisation and the Black Economy, where he critically examines each and every argument that was given at the time of demonetisation. Let us look at some of his arguments. First, demonetisation is never the solution to black money when the economy is going well. While it is definitely a major problem in the country, conceptually linking cash with black money is an egregious assumption that led to the unsuccessful results of the move. People can easily use cash for transactions and pass it on to others as working capital expenses. Second, the fact that the government changed the goal posts is a clear acceptance that the initial objectives of addressing issues of back money, counterfeit currency and terror funding were not addressed by this move. It also showed that the government was not sure of its motives to begin with.

Third, as virtually all the cash is back into the system, it can be argued that the intended impact did not work out. Being an economist with a socialist bent of mind, Kumar does talk eloquently on how two vulnerable sections of society were affected by this move—farmers and SMEs. He also links the effect on SMEs to the rise in NPAs with banks, as this section was affected perceptibly with large-scale unemployment in the face of collapse of business models that were driven by cash. Similarly, he attributes farmer distress to paucity of cash in a year when farm output had risen and prices had fallen. He takes this argument further and concludes that contrary to the GDP growth numbers put out by the CSO, growth would actually have been nil or negative if the full impact on the unorganised sector was taken into account. This is open to debate given the extreme conclusion that has been drawn here, but is nonetheless a view to be considered. A very insightful chapter in the book relates to the failure of institutions that came out in the open when demonetisation was announced in November and implemented over two months. This makes for interesting reading. While the reader may have her view on his argument, the author definitely provokes further thinking on the subject. On the political side, he points out that the Cabinet was not taken into confidence, which lowers the importance of this institution. Next, the Prime Minister did not think it proper to answer questions in Parliament on the subject, which the author terms as the institution of ‘accountability in a democracy’. He, however, admits that creating a Robin Hood-like image did pay rich political dividend in the elections held in various states, which cannot be disputed. He is also hard on the RBI, which preferred to remain silent rather than clarify various issues, considering that there were several changes made by the central bank in the conduct of exchange of old notes over the two-month period, which had bankers in a tizzy. The entire banking system came under stress and was severely damaged, as bankers spent months trying to deal with cash as a result of which normal business suffered. The RBI also paid a price in terms of lower surplus earned.

The next two institutions that he has spoken of are interesting. He believes that statistical organisations like the CSO and Niti Ayog went on to say that there was absolutely no impact on the economy in terms of growth or employment, which was incorrect given the ground reality. Last, even the Budget was drawn on the assumption that there was nothing abnormal in the economy on account of demonetisation, which raises the issue of credibility of such documents. All these arguments are hard-hitting and the author is direct in his view and steers clear of being diplomatic, which is typical of an economist from JNU. As there is a lot of research at the ground level that has been used to form these opinions, the author has done a thorough job and the views cannot be questioned. Even the protagonists of demonetisation would probably silently agree with most of the assertions made here. At the theoretical level, he has argued that the reason why demonetisation will never work to curb black money is because the people responsible for it—corrupt businessmen, politicians and the executive (which includes bureaucracy , police and judiciary)—what he calls the triad, has to be broken. Otherwise, black money will continue to flourish and by simply hitting the common man hard in a bid to draw out such wealth is futile and harmful for people. Does one chop off the nose to cure a cold? This is how he ends his book, which says it all.