It is going to take quite long to reach $5-trillion economy target: Interview with ET Now 18th December 2019 t

2021 will be an important year from the point of view that as the economy recovers, very gradually will the financial system be up to it in terms of assisting this kind of growth, says Madan Sabnavis, Chief Economist, CARE Ratings. Excerpts from an interview with ETNOW.

Are you taken a little aback by the kind of dire forecast that we have had for January? IMF Chief Economist Geeta Gopinath is saying that there is a possibility of a significant downward revision, that growth concerns remain and fiscal slippage risk continues to be high.This was quite expected because during the course of the year, almost all agencies including the Reserve Bank of India have lowered their forecast for growth in India. We should remember that we all started off with the budget which spoke of GDP growth at over 7%. That came down to 6% and now we are really talking of a growth around 5%. So, it is not really surprising that IMF is also going to downgrade the growth forecast

In fact, I am surprised they are doing it in January and not in December itself. But probably, they have their own processes when they review the economy. For this particular financial year, it does not look likely that there could be a significant recovery. Most of the upward movement in the growth rate in the third or fourth quarter is going to be caused more by the statistical influences rather than real growth being seen in terms of higher consumption or any kind of revival in demand. So this was something expected, not really surprising and I tend to think that it will move towards the 5% mark from 6.1% which they had earlier.

She has talked about how we may see continued slow growth for a while given the fact that the financial system continues to be fraught with risks and the process to fix NPAs is not fast enough. Also, rate transmission remains slow. Would you call this catch up commentary or is this a signal for what is to come in 2020?

It is a signal because what we have seen about the financial crisis is that it started off as a PSB issue, spread to the private banks and then to the NBFCs and now to the cooperative banks. The picture we are getting is that the financial sector is not out of the woods and there are still problems in terms of the NPAs. -- recognition of NPAs, capital issues for the public sector banks and so on. In this situation, the signal given by IMF is quite real because we are saying that currently we do not have too much demand for funds. I do not think that it is a major issue in terms of funding for corporate India.
But let us look at the situation when the economy gradually recovers and there is a demand for funds especially for investment. Is the financial system really geared for it? As of today, the answer is probably we are not really sure about it. We need to wait till March to see what the NPA numbers of the banking system are. We need to see how the NBFCs have gotten through the crisis.

We are already seeing the CP market being affected on account of the NBFCs being crowded out from here. Once we get the financials piece in the puzzle in place, only then can one talk of acceleration in growth.

2021 will be an important year from the point of view that as the economy recovers, very gradually will the financial system be up to it in terms of assisting this kind of growth.

The $5-trillion economy target is in place. According to the IMF chief, we will need 8-9% growth to achieve that by 2025?
Absolutely. This $5 trillion is something which we should keep out of our minds because it is going to be quite a long time before we reach this particular mark. When we are talking in terms of how do we get to this particular number, we need to have nominal growth in GDP reaching around 13-14% consistently for a period of five years.
Currently, we are talking of inflation in the region of 4%, we are talking of growth in the region of 5%. So, our nominal GDP growth is less than 10%. It is going to take at least six to seven years to reach it. Again, I would say what IMF has pointed out is quite right. We need 8-9% growth in real GDP, which we cannot see happening in 2021 or even 2021-22. It is going to be a bit of a stiff climb towards that particular target of $5 trillion.
She also expressed her concerns over the slow pass through of rate cuts that has been seen in India. How would you react to that?
I would have a slightly different view because I think when the RBI lowers the repo rates, that is a kind of a signalling rate and the way in which banks react, should be their prerogative. They have to look at their assets and liabilities, they have to see what are their costs and in terms of their incomes.

More important is the risk perception. That is how you bring about a change in the actual lending rates. It is going to be a mismatch between what the government and the RBI want to do in terms of signalling lower interest rates and how the banks are going to react, because today we are talking of a credit environment which is still definitely more on the risky side. Banks will be a bit cautious because the NPA hangover has been quite severe.

We are also talking in terms of the SMEs which seem to be the next burning point in terms of NPAs. The banks are being cautious in terms of the transmission. We are also seeing that deposits, financial savings are being affected. It is going to be a delicate balance between the two. Banks should not be hurried to bring about this kind of transmission change.

Economic slowdown: A long road to recovery: Financial express 16th Dec 2019

There evidently are no quick solutions here, and it can be said that most alternatives have already been explored by the government with limited success

Can anything really be done about the economy? Practically speaking, if it were so easy for a government to turn around an economy, there would be prosperity all around. All kinds of suggestions have been put up by the wise counsels and every option explored. Yet, it does not look like there is an imminent solution. The fact that there is little official acceptance that the slowdown is deep and hard to reverse, is important because as long as we believe that things are only transient, the deterioration will be fast. Using the argument that we are the fastest-growing economy sounds good for the pulpit, but does not really provide solace. The problem is three years old, starting with demonetisation, and the policy of ignoring the consequences has led to the present state.

What can the government do? The government, to its credit, has done virtually everything that can be done to revive the economy short of announcing doubling of the fiscal deficit. The motherhood statement often made that more reforms are required is open-ended and not specific. The government has addressed issues pertaining to the auto and real estate sectors besides enabling flow of credit to the SMEs. Its expenditure on projects is on schedule. Policies relating to recapitalisation of banks, merger of PSBs, disinvestment, labour laws, addressing the NBFC crisis, etc, have all been put in place.

RBI has, on its part, taken decisive steps in lowering the interest rates and opened the door to a regime of lower interest rates. Yet, there has been limited progress made by banks as the credit-risk factor lingers, and they are reluctant to lend. They have been goaded to lend to SMEs which may not be wise because it can build an adverse portfolio of NPAs. While retail loans are the flavour, it should be realised that if the slowdown continues, there is a good chance of delinquencies increasing as all home loans are taken with the assumption that the salaries are paid on time, and the bonuses and variable pay come in. Any pause here can have serious consequences for the system.

The economy is in the classic state of liquidity trap which was highlighted by Keynes during the time of the Depression, when lowering of interest rates ceases to affect demand for funds. This has happened in Japan and the euro region too, where interest rates have lost their relevance. The rudimentary theory of demand, supply and prices does not work as the underlying assumption of ceteris paribus no longer holds in the present context. Credit risk perception is high and banks do not want to lend money to all and sundry given the NPA overhang.

With both fiscal and monetary policy at the end of the road, there is little that can be done in the short run. Increasing the spending of the government by say Rs. 2 lakh crore is an option which looks unlikely, as it sends wrong signals to the market. Therefore, the ball is back in the court of the private sector.

The private sector would rather not get into infrastructure given the challenges of finance. Usually, these projects would not have a good rating to be able to command funds from the debt market. Further, with several large companies waiting for the IBC to resolve the debt issue, possible investors may prefer to purchase them in the market rather than start afresh. Add to this the fact that consumption has slowed down and it means that there is surplus capacity in most industries which has made further investment non-viable right now.

Therefore, the path to recovery is going to be a slow one. Three ingredients are required which have to fall in place and will do so only over a period of time. First, the financial sector has to get out of the labyrinth. It started with the AQR affecting the PSBs and later the private banks. Subsequently, the NBFC crisis has dealt a blow to infra finance, real estate and SMEs, thus choking the financial system. This piece has to be set right, and the news of possibly more hidden NPAs on bank’s books could prolong the recovery process. It has literally been a case of survival of the fittest in the financial world. This is within the control of the government, and RBI has to be expedited.

Second, the rural economy still holds the clue to the recovery process and in a way is a necessary condition, though not a sufficient one. It is critical as it is independent of what happens in the industrial world, and hence, the optimal output and price are the key determinants to demand recovery. Any disruption, as has been the case with the vegetables and pulses crops this year, would upset the applecart as there are inflationary implications that make monetary policy even more difficult to conduct. Clearly, everything is not within the control of any entity, and, here, the states hold the key. The focus has to be on making farming more attractive and should be run as commercial ventures rather than a sector to be sympathised with through loan waivers and cash transfers. Policy has to aim at increasing productivity of land and providing end-to-end solution till the marketing stage. State farming has to be seriously considered.

Third, job creation is necessary to generate sustainable income that will generate demand. Employment unfortunately gets linked with growth and normally follows the latter and cannot be created unilaterally. Unless there are more households with spending capacity, consumption won’t increase. As corporates cannot employ persons and keep them on the bench (given that they have already lost pricing power in the last three years), the emphasis must be more on gig workers who are able to generate income by working on a contractual basis as consultants. In the medium term, the education system should bring in courses that suit the needs of the day—specific engineering requirements or handling of back-office jobs, so that the human race does not head towards the standard courses of medicine, engineering and management. Demand will grow for such skill-sets, and short-term courses of 3-6 months which address these requirements will be appropriate.

Evidently, there are no quick solutions here, and it can be said that most alternatives have already been explored by the government with limited success. Removing administrative bottlenecks is a must; and retaining processes merely because there are legacy issues in various government organisations has brought impediments for entrepreneurship. This environment of doing business at the micro-level has to improve, and the federal structure involving multiple clearances and permissions needs to be done away with (just like what the GST has done) to smoothen the process. Getting in marginal improvements to break the World Bank Doing Business Code does not work except for getting in newspaper headlines. There has to be a deeper commitment.

The Economists’ Hour | Book pointing to the damage inflicted by economists: Financial express 15th Dec 2019

Economists also had their way with corporate policies and the author highlights the anti-trust legislation which was used in the USA to curb monopolistic power. Companies like General Electric, IBM, and Microsoft have all been under the scanner.

The Economists’ Hour is quite a fascinating book by Binyamin Appelbaum that traces the major influences of well-known economists on policy making. Economists have traditionally not been regarded highly for policy making and often lawyers were given precedence. They were valued for their ability to think but not quite for being able to do practical things. It was probably the Depression and its aftermath which gave them practical importance and since the Second World War, they have had their ‘hour’.

While being concentrated in the US geography as well as political history following the World War up to contemporary times, the author explains how economists like Milton Friedman, Arthur Laffer, and George Stigler, etc, wielded considerable power over policy making. Such was their influence that they were able to have considerable impact in countries like the UK, which is not surprising, but also China, Chile and Taiwan, where economists with such leanings were imported to formulate policy. In fact, these countries had used the services of economists, including Friedman, to formulate their approach for economic development and hence a lot of economic liberalisation could be attributed to their theories. Alexander Cairncross was welcomed in China while Margaret Thatcher had no use of his work in Britain.

The common thread in their prescriptions was that markets should determine everything, as the government everywhere was the problem. Therefore, from the period 1969 to 2008, which is almost four decades, US policy in particular was directed at deregulation, which was looked as a panacea for all economic ailments. Keynes and his economics dominated post-Depression years. In 1964, under President Johnson, Walter Heller got in the three major government programmes that are now followed in several countries in different forms — medicare and medicaid health, issuance of food stamps and subsidies. Heller agreed active management was not good but intervention was required for sure. Under President Nixon, too, it was Keynes that prevailed with high levels of spending that led to inflation. It was then that the wheels turned and the new breed of economic values got ingrained.

Friedman steered policy making, and his brand of monetarism, which came to be called ‘fresh water school’ as against ‘salt water school’ covering Harvard, Princeton, and Columbia, etc, where the existing order was espoused. The basic premise is that the market does better than what several bureaucrats sitting together can do and the underlying theme was ‘in markets we do trust’.

Interestingly, two specific arguments which flowed from market economics of Friedman which affected American society were in areas of conscription and rent. He looked at conscription as a tax on humanity which did not pay well and was analogous to the dictates of the Pharaohs of ancient Egypt who used slaves to build their pyramids. With constant lobbying he had these rules annulled and the youth joined the military out of patriotism and were supported by market-based pay. Similarly, rent controls were used as an argument for preserving equality but led to housing shortage as the rich did not buy property to rent out because of these controls. Removing them helped in reviving the housing market. He was supported by economists like Frederich Hayek, who attacked any action that would potentially lead to socialism.

President Jimmy Carter got in Paul Volcker as head of the Federal Reserve and reversed the spending principle and blamed excess profligacy, while Ronald Reagan blamed government spending. Volcker, on his part, blamed the unions for higher wages and inflation. He, therefore, continued to increase interest rates which choked growth. When President Reagan ruled, Arthur Laffer had his hour with the supply side phenomenon, which became very popular as tax cuts and expenditure increases became Reganomics, and across the Atlantic, UK under Thatcher followed the same principles. Laffer used taxes as tool, but got support from Friedman as it meant less government intervention through lower taxation, which is what the market wanted.

Economists also had their way with corporate policies and the author highlights the anti-trust legislation which was used in the USA to curb monopolistic power. Companies like General Electric, IBM, and Microsoft have all been under the scanner. The focus was always on ensuring that consumers get goods and services at the lowest prices. Here economist George Stigler had his hour as he worked against such laws and propagated antitrust laws to control government intervention. The premise was that that the government should not try to fix anything that is not broken. By doing so the system was justifying unions and regulation which led to sub-optimal states. The same was extended to utilities by Alfred Kahn, which ended up with significant deregulation.

While this is the good part of the story, Appelbaum, towards the end, highlights that such policy transformation during the economists’ hour has led to funnelling of the benefits to a small plutocratic minority. This goes back to the theory of Piketty, which is now gaining acceptance across the world as the economic structure has gotten skewed in favour of the capitalist. The financial crisis was the result of unbridled use of markets as a solution for everything. The market is not right if it is controlled by the elite, which has been the case in most countries.

The Economists’ Hour is very well researched and shifts across countries and time periods to blend the views of liberal economists with the prevalent regimes, with a little bit about the background of the protagonists. This should provide inspiration for economists who want to make a difference to look for new areas that need attention. There is hope to stay relevant.

What needs to be done to fix shadow banking: Financial Express Dec 10 2019

A pointer can be that RBI should consider integrating these societies into the banking system.

Every crisis in the financial sector brings to the fore the segment that has stirred the pot. When the NPA issue went out of hand, public sector banks (PSBs) held centre stage and levels of above 20% caused shock and umbrage. Later, private sector banks cleaned up their books and their NPAs came to the fore. Subsequently, the non-banking financial company (NBFC) crisis came to light, and after being lauded for their amazing contribution to financing India Inc, especially post-demonetisation, the flaws of asset and liability management (ALM) mismatches made them the fall guy. More recently, the PMC Bank exposé has brought to light the inherent conflict of interest in the model of urban cooperative banks (UCBs) and raised a different kind of storm. Against this background of sequential contagion across financial groups, how should one look at the financial system?

While banks have been closely monitored by RBI, the so-called shadow banking segment, i.e. NBFCs, were only partly regulated, and for all practical purposes were independent in operations. Hence, when they did put in their applications for a banking licence, the first thought that came to mind was that they would be subject to RBI regulations and norms like priority sector lending, CRR and SLR. Now with the PMC problem, attention has turned to the cooperative banking sector.

The financial system is, hence, quite large and goes beyond banks. To get an idea of the overall size of the institutionalised lending market, one can look at some numbers. As of March 2018, commercial banks had an asset size of Rs 152 lakh crore. NBFCs had a size of `21.76 lakh crore—i.e. 14% of banks’ balance sheet. Housing finance companies (HFCs) came in next, at Rs 11.6 lakh crore—around 8% of banks’ size. The overall cooperative banking system as of March 2017 was Rs 16 lakh crore (11% size) and can be called the ‘covered shadow banking system’ that has been in existence for long and yet has never quite been studied in detail. Hence, the non-banking segment is around one-third the size of the banking system or has a share of around 25% in the financial system (excluding All India Financial Institutions, or AIFIs, which comprise regulatory bodies like NABARD, NHB, SIDBI and EXIM Bank, and have a size of Rs 7 lakh crore).

The accompanying table provides some interesting information on this ecosystem. Data for all institutions except cooperative banks (excluding UCBs) is for March 2018, while it is March 2017 for the latter. This helps one grasp the magnitude of the financial system, which should ideally be integrated through regulation.

The interesting thing here is that the cooperative banking system comprises over 98,000 banks/societies; the number is really large. Intuitively one can see that regulating such units is a major challenge given the limited bandwidth of the regulator. The combined NPA ratio for them is 12.8%, which is very high, with the primary agricultural credit societies (PACS) in particular being horrendous at 26.6%. While the recovery rate is fairly high (75%) for them, the fact that these loans do not get paid on time does raise a question of evergreening that may be taking place. In fact, recovery rates for state cooperative banks (SCBs) and district central cooperative banks (DCCBs) are higher, though NPA ratios lower. The universe of UCBs is also wide, with there being around 1,500 such banks where the NPA ratio is 7.1%. Thus, there is a need to take a closer look at the models being used by PACS. Also following from the fiasco at PMC, there is a broader issue of supervision and inspection that is required, as this space is quite opaque with little known on how business is conducted.

For state cooperative agriculture and rural development banks (SCARDB) and primary cooperative agriculture and rural development banks (PCARDB) that offer long-term loans to farmers, recovery rates are 44-50%, while NPA ratios are high, too, at 23-33%. This is not a good picture even though the size of loans is not very high to cause any kind of systemic risk to the system. But for sure it is necessary to review the entire cooperative banking system that has an important role to play as it deals with the overall objective of financial inclusion since it covers largely the rural population and SMEs (when it comes to UCBs). By their sheer number, they are difficult to regulate as even maintenance of accounts does not tend to be formal as one steps down to the PACS level.

A pointer can be that RBI should consider integrating these societies into the banking system. The move towards getting in payments and small banks was to foster financial inclusion. Given that the ‘covered shadow banking system’ is large at Rs 16 lakh crore—a level that new banks will take years to achieve—integrating them with the formal system makes sense. Surprisingly, all the various committees on banking that have focused on reforms in commercial banking have not quite touched on this parallel formal institutionalised system, which occupies a very important place in the flow of credit especially to the rural and SME segments.

NBFCs and HFCs have a crucial role to play in the structure of finance as they have niche customers. HFCs have added a new dimension to housing finance and enabled the achievement of the objective of successive governments to provide access to households for buying homes.

At a broader level, RBI should ideally be regulating all these entities as a single regulator makes sense for better coordination. This also ensures that the scope for regulatory arbitrage reduces. From the point of meeting the objective of financial inclusion, quite clearly the ‘covered shadow banking system’ has a very important role to play. While nudging commercial banks to do their bit is okay in the short run, ideally the rural responsibility has to be shifted to the cooperative system, which, admittedly, has to be strengthened substantially. At present, the focus has been on creating a new category of banks, like small and payments banks, and merging PSBs. As part of this transformation, the integration of cooperative banks and NBFCs should proceed in parallel and the expertise created with the regulator.

Where households can save their money: Business Line 10th Dec 2019

Recent trends show a decent return in low-risk instruments. However, inflation has diminished the actual income on savings

The present environment, which is characterised by declining interest rates, stagnant economic growth, declining profitability of companies and high valuation of stocks, can leave the household confused when it comes to deploying money into savings. The pace of job creation has slowed, as has the rate of growth in incomes.

Obtaining high returns on savings is the goal of every household, and it goes with commensurate risk that may have to be considered. In this context, how have different avenues of savings fared?

The exercise undertaken here looks at the last five years and calculates the average returns over this period (see Table), where annual returns are summed and averaged instead of considering a CAGR, which ignores the returns in the interim period and looks at the two end points.

Hence, it is assumed that one holds on to the instrument for a year, and then moves out of the market and enters again at the new price, which can be an interest rate or value of index or price of product.

 

The Table thus gives the average returns on various savings options for the period 2014-15 to 2018-19. Alongside is also provided the standard deviation for the five set series which denotes volatility, meaning thereby that variation could be to this extent in any particular year.

This is important as it indicates that there can be an upside or downside, depending on the environment.

Long-term gains

The Table is quite interesting as it presents a fairly wide range of returns on various instruments of savings, from a -0.8 per cent for gold to 12.2 per cent for the stock market. This can be confusing for a household, as it is a hard choice to make. Stock markets give high returns over a five-year period, but if the savings horizon is less than this time horizon, there is both an upside and downside risk of 13.1 per cent deviation.

The RBI’s All India House Price Index is a theoretical option, as it tells how this market has fared. It cannot be strictly compared as rarely does anyone buy and sell houses every year. They are assets that would be held normally for a longer period of time, when they could yield high results.

But still, if a house becomes an annual investment, the downside is high with a high standard deviation. Therefore, it can be said that these two avenues would be medium- to long-term investments where there can be high gains made.

Avoidable avenues

Foreign currency and gold have been poor instruments of savings, and while the former is more theoretical as people rarely do trade in it (though derivatives are popular), the latter is normally held for the longer tenure and probably rarely sold. However, if gold was held for earning an income, the return would have been negative.

Also, in the case of forex, there are several factors which are at play — with RBI intervention being most common, either directly through purchase and sale of currency or indirectly through PSBs which can go against the market movements. Therefore, for individuals, to take a position in the futures market — which gets the gains of forex movements without actually dealing with the currency — is not a good avenue as it is necessary to understand the dynamics, which are closer to treasury desks than households.

Even in the case of gold, the movements have been quite volatile and returns have averaged negative in the last five years. It is only in FY20 that there has been a recovery in prices.

Therefore, while gold is held traditionally by households, the purpose is never to get annual returns, but rather to add to wealth or appreciation over a very long period of time, if at all one wants to liquidate the same. In fact, even within families who exchange gold during certain occasions like weddings, the transaction is decided in terms of quantity and rarely value.

Noteworthy returns

The choice then leans toward instruments with low risk (low standard deviation) and reasonable return, and here, the results are quite noteworthy. G-Secs and bank deposits had similar returns, with the latter surprisingly displaying higher volatility.

This is because banks have tended to revise the rates more often than the market re-priced the G-Secs. Also, while G-Sec yields have both increased and decreased based on market conditions, bank deposit rates have moved down continuously.

Small savings gave an inferior return relative to these instruments. This actually debunks the theory of bankers always arguing that they cannot lower their interest rates as small savings give higher returns. The one-year term deposit is less rewarding than a bank deposit. Normally, one compares bank deposit returns with those on PPF, which are superior due to the tax benefit. But the PPF also has a lock-in period with a limit on the amount of deposits that can be made in a year.

The surprise element is the AAA-rated bond in the market which gives a higher return of 8.3 per cent but also carries higher risk. The risk arises as these bonds not only reign at a spread above G-Secs, but tend to fluctuate more due to the risk factor. Hence they have ranged between 7.30-8.71 per cent.

Now, inflation for this period has averaged 4.8 per cent, which has to be subtracted from the above absolute returns to get the real return — ranging from 2.1 per cent to 3.3 per cent for deposits/debt and much higher, at above 7 per cent, for equity. For fixed-income earners, cumulative inflation is what matters, because an average inflation rate of 4.8 per cent for five years means cumulative inflation of 24 per cent, which actually erodes the value of the real principal that is being saved.

Quite clearly, when the effective income earned on savings gets impacted, the spending power too diminishes and affects aggregate consumption. This also presents a glum picture for deployment of funds, and it is no wonder that non-financial savings in the country have been declining over time.

Tools and Weapons | Angel or demon?: Financial express Dec 1 2019

Tools and Weapons | Angel or demon?

By: Madan Sabnavis | 

Published: December 1, 2019 12:23:11 AM

Let us look at the good part first. It is a leveller and depending on the extent to which countries are open and willing to invest or let the IT firms come in, provides equal opportunity to everyone.

Tools and Weapons, as the title suggests, is a treatise on the way one can use and abuse technology. Technology has always been viewed as an enhancer of efficiency and development, which has been witnessed formally since the industrial revolution started. Today, it has come to dominate every aspect of our lives, and all businesses are linked inexorably with technology. This is the good part of the story. There is also the darker side, and Smith and Browne, both working with Microsoft, have opened the debate on the so-called misuse of technology, which becomes hard to control at some point of time.

Let us look at the good part first. It is a leveller and depending on the extent to which countries are open and willing to invest or let the IT firms come in, provides equal opportunity to everyone. Hence, in the absence of any impediment, people everywhere can use Google or Facebook. Data is said to be the new oil and there are billions of such pieces across that have been stored and used for strengthening business processes and improving efficiency. Hence we have seen how simple technologies like Aadhaar in India have been quite remarkable, notwithstanding the misgivings of actually having a national registry of all citizens. How companies use pertinent information to further business is well known. This is when technology is used as a tool and no one can actually have any objections. Technology has been used to let the blind see things, historians discover the past and scientists pursue new strategies. But is there a darker side to this advancement?

The authors point out that the same technology has been used as ‘weapons’ to attack society and their essays on the issue are insightful. For example, the issue of privacy is always on our mind and there is almost constant debate around the world. We have reached a stage where it is possible for every action of ours to be tracked and deciphered by authorities, which can be a blessing as well as a curse. Terrorists have been caught by using data to find out their bearings and several possible attacks have been captured through such data. However, the misuse of the same has been seen where individual minds have been played with at the time of elections. Authoritarian regimes misuse such data to ensure that there can be no rivals in the political space.

Second, it has been observed that technology can very often be labour displacing, and this has happened gradually in some countries like India, but will be hastened as the speed of technology infusion increases. Jobs will be lost and skills cannot be re-learnt by existing employees as skill sets required are different.

Hence, less people will be required at the margin. In fact, this is where Smith and Browne point out that within countries there are several regions, especially in rural areas, which are cut off from technology and may never be able to leverage it. Here governments need to take action to ensure connectivity as, for instance, technology can transform the lives of the farming community through better spread of information on output, prices, climate, etc.

Third related to the above is the widespread use of AI, which is remarkable, but leaves society open to its misuse in the form of drones, which can even start wars. How do we check this misuse, as legal systems are not yet developed to tackle such instances and, more importantly, tracing the same is not possible unless the authorities have sophisticated systems?

At the international level, this can give rise to a different kind of show of strength akin to the Star Wars fiction we have seen, which in a way is scary. Also, as AI is based on algorithms and created by man, can there be biases deliberately created or those that come in naturally to distinguish across race and gender.

Hence, if AI is used to scan for best qualifications for a job, can there be biases which come in on gender or race, as facial recognition is one of the inputs that go into the exercise?

Fourth is cyber security, which is a major concern whenever technology is used by governments, companies or individuals. Hacking is always a possibility and financial systems can collapse if security is breached. This is often attempted by cyber terrorists who work to destabilise systems and breach databases so that everything is thrown out of order. It becomes necessary to keep building checks to ensure that systems are insulated from such attacks. But this has to be continuous, as hackers are always ahead of the curve.

Fifth, the authors also talk of social media and the misuse in the form of fake news and rumour mongering, which all of us know can be a major disruption as it can create chaos in any community.

The authors hence keep reiterating the need to retain humanism when using technology, but this is not practical as there will always be people and nations that will not follow the rules.

In fact, a debate often unresolved is the Snowden episode and whether the approach taken and revelations made are ethical or not. The jury is still out on this. Here they do spend some pages talking on regulation, as quite clearly there is need to regulate some aspects of technology.

Tools and Weapons is a very good book that brings to the fore the dangers that lurk as technology pervades our lives. It does pose questions for governments and technology companies as they need to find a balance. Countries like Denmark pioneered the concept of having a technology ambassador who liaisons with the corporate world to bring in harmony. This is an idea worth pursuing.

Putting the FM speech in perspective: Free Press Journal 29th Nov 2019

Speeches in Parliament are meant to be political in nature as they normally involve debates which address the opposition. Hence the FM’s address in the Rajya Sabha on Wednesday must be looked at from this perspective. Comparisons with previous regimes is relevant from the political side though is of less importance when it comes to sizing up the current state of the economy.

There is an interesting point that the FM made relating to a recession which needs discussion. A recession is technically a situation where an economy registers two successive negative growth rates in GDP which means output is really falling as distinct from a situation where the rate of growth has slowed down, which is the case today. The FM has also ruled that such a situation can never happen in India which is right in a way, though it cannot be ruled out, especially if the world moves into a 1930s-like depression. But the broader question is whether this is enough and reassuring?

There are three important points to be made here. The first relates to the state of the economy which is disturbing. Post demonetization there has been a distinct slowdown in the economy which has gotten magnified today with GDP growth slipping to a sub-5% level on a quarterly basis. What is striking today is that the three engines that need to fire either together or individually are dormant.

Consumption growth has been affected by low growth in employment and limited increase in household income. To top it, the continuous decline in interest rates on bank deposits has meant that the population that is fully dependent on interest income has had to cut down discretionary spending which has affected overall demand.

Investment has become stagnant and is at around 28-29% of GDP. The reason is that there is surplus capacity in most industries and with demand slackening over the last three years, there is less incentive to invest. Infra investment has little interest with both the demand and supply sides being dormant. Private sector investment has been low as with several large NPA cases under the IBC in segments like power, telecom, metals etc. which have become less attractive. On the supply side, banks are not too eager to finance infra investment and have preferred to go the retail way. Hence while the FM has rightly spoken of the positive steps taken by the government to recapitalize banks and make them stronger with RBI liquidity support, the willingness of banks to lend is still in limbo as the NPA overhang is a stern reminder of the asset quality issue.

The third engine is government which has gotten into a tangle due to low growth where revenue collections are missing their targets. There is a constant struggle to control the level of fiscal deficit and in this quest there may have to be capex cuts by the end of the year. The recent corporate tax giveaway will increase the deficit by at least 0.5% which is a concern. While disinvestment target will be met as the FM has made the announcement on the same recently, the same cannot be said about tax revenue.

In fact, GST is a concern and shortfalls here will also impact state finances especially if the 14% guaranteed amount is not provided to them. This can hence impact their budgets and capex.

The second point is that the government has actually done almost all that is required to help the economy and the over 30 announcements that have been alluded to by the FM are all positive measures. However, their impact will be felt only over the next couple of years as most of them are in the nature of improving business environment or correcting certain policies especially in the auto sector. The corporate tax cut and the real estate AIF to be set up probably are the only measures which actually involve money. Therefore, the reforms that have come in would yield result in the medium run and will have little impact this financial year. In fact, even for the corporate tax rate cut, most companies that have used the lower rate are likely to pay higher dividend or repay debt rather than go in for investment right now.

The third is the RBI too has already lowered rates by 135 bps and another cut cannot be ruled out. But the effect of such rate cuts has not been found in higher borrowings or investment and will not be because the environment is not conducive. Therefore, even on the monetary side there are limits to which policies work.

Hence, the economy is in a low equilibrium trap and this has been structural in nature. The upward path will be gradual. While the FM is right about the recession, the disturbing factor is that there does not appear to be any quick fix solution. The government and RBI have one their bit and the time taken henceforth for these measures to work out will be critical. Practically speaking it can take another two years before the economy moves towards the 7-7.5% growth rate and for FY20 it is likely to be less than 6% for sure and could be more like 5.5% with a downward bias. This would be a fair assessment of the state of affairs.

Groupthink approach to policy: Financial Express 25th Nov 2019

Interpretation and Group think are two driving forces of economic policies in India. Data and statements are open to everyone, but the way they are looked at is interesting. For a long time, we maintained, with a touch of hubris, that India was the best performing economy even if growth slowed down and fewer jobs were created. At the same time, there was an aggressive Groupthink on rate-cuts, which became self-fulfilling as all those who influence policy making thought alike.

However, things look quite different, and there is again a buzz.

Industrial growth in the negative territory and CPI inflation at 4.6% is disturbing. While it would be an exaggeration to call it stagflation, it is definitely a sign of low growth and rising inflation. This situation was never really envisaged, growth was to pick up on the back of the harvest-cum-festival season, while inflation was to fall due to a good kharif harvest. However, both have not quite played out.

IIP growth in September should ideally have increased for durables goods, in particular, as the e-commerce business was brisk, with both the leaders, Amazon and Flipkart, claiming high growth in sales and penetration to Tier 2 and Tier 3 cities. This should have been ideally backed by higher growth in IIP in September.

This also has not happened, and is a substitution for physical sales.

While harvest was supposed to be good, the delayed withdrawal of the monsoon and stormy conditions in November has damaged horticulture products and pulses in some parts. This translates into a fall in supplies, leading to a sharp increase in prices, which has upset calculations.

In such a situation, it is almost axiomatic for one to ask for another rate cut, which is now a habit. This is also happening in the US and Euro region, and, hence, is not surprising. In fact, there has been strong Presidential talk in the US, which is absent fortunately in India where it has been left to the MPC to decide on rate action. The argument being made is that, while inflation has increased beyond 4% and will remain in this terrain for the next few months (can cross 5% if vegetable prices go up further), it should not be considered permanent. Hence, focus should be on growth.

There are two things to be discussed. What exactly is the mandate of the MPC? Is it to react to current inflation number or expected inflation or core inflation or food inflation? Interestingly, one of the earlier Governors of RBI, in a press conference, had clearly said that the legislative mandate of the MPC was to target inflation, and that too headline inflation. There could, hence, be no deviation from this goal. Yet, the MPC has now taken a view that growth is more compelling. With inflation being in the 3% range, it has chosen to lower the rate by 135 bps since February.

The second, is that there is an anomaly in reasoning when one looks at the way in which Groupthink moves. The rationalisation is that since food inflation has gone up—core inflation has come down—there is strong reason to lower the repo rate. However, around six months ago when the headline number moved up and was driven by core inflation (house rent, education and health), food inflation during this period was extremely low, the same argument was never made, and the MPC had focused on the headline inflation number. Hence, it would be interesting to see if the MPC breaks away from its conventional approach of viewing inflation and moves to the core inflation aspect when deciding on the rate cut.

A rate cut per se has not quite helped spur investment. The 135-bps reduction is, thus, more of a policy move. It really hasn’t worked through the system. This is not surprising as there is less appetite for funds and the credit-risk factor is high. Ideally, change in policy rate takes time to go through banks, but markets should react with alacrity. In this context, let us take a look at how the 10-years GSec yields have moved over time. See graph for average 10-years GSec yields for the period December 2018 to October 2019. The repo rate has come down by 135 bps, the yield is down by only 77 bps, which means that the market transmission has not been that even.

This raises the question on why does even the market not react to the repo rate changes? Markets tend to take in a lot of information from different pockets when pricing bonds. Hence, the repo rate and the future direction of the same is just one factor. For these securities, there is considerable uncertainty on the government’s fiscal deficit and the incremental borrowing programme. The corporate tax rate cut is to lower the revenue by Rs 1.45 lakh crore. GST collections are not on track and there is not much momentum on the disinvestment front. Therefore, the yields reflect this sentiment.

There is a big difference in the way in which the Groupthink directs opinion and the MPC considers the same, and the way in which banks and markets react. Banks have been asked to use benchmarks for pricing their SME and retail loans. The transmission still has not been smooth. Also, the credit risk assessment continues to be apprehensive given the economic environment. Therefore, the way in which players react is different from the thought process of the MPC.

At an ideological level, it is pertinent to ask two questions. The first, whether we are right in targeting the CPI which sends conflicting signals once we get into the core and food inflation debate. The discourse on justification of rate action becomes weak as consistency fades when this picture of inflation composition changes.

The second, whether we should have fewer credit policies with the prerogative to intervene at any time when there is volatility. This is important because one of the reasons to shift to six policies was to remove the noise in expectations on policy. One used to be terrified of getting up in the morning to be told before 9 am that the RBI had slashed or raised the repo rate or the CRR due to adverse market conditions. But, today there is more certainity for sure as Groupthink has led to relentless interest rate cuts, linking the same with the objectives of inflation targeting has gotten blurred.

We clearly need to go back to basics. This is an issue also in the US, where the Fed has lowered rates with inflation at a low, unemployment at its lowest and a steady GDP growth. Friedman and Keynes would both have been bewildered.

Realty revival package, not convincing: Business Line Nov 22 2019

The AIF may revive economic activity and reduce NPAs. But it sends the wrong signals to developers guilty of malpractices

The ₹25,000-crore package for the real estate sector has been hailed as a panacea for a major part of its worries. As the package helps a select set of developers complete their projects — which were stalled primarily after being cut off from the financing channels due to slump in the sector and problems in the banking and NBFC segment — it prima facie looks positive. But this may be just a breather, not an actual cure for the challenges faced by the industry.

The scheme talks of the setting up of an Alternative Investment Fund (AIF) by the government, where ₹10,000 crore will be infused along with additional funds coming from the SBI and LIC — and probably sovereign wealth funds — which will sum up to ₹25,000 crore. The amount will be used to lend to around 1,600 projects which have approximately 4.6 lakh stalled housing units which remain incomplete.

Buyers needed

With this money, the builders can complete the projects and hence equilibrium will be reached. The AIF will include affordable and middle income group housing (where the value of a unit could be between ₹1.5-2 crore, depending on the location). The projects qualifying for the AIF would be those whose net worth, defined as the stock of sold and unsold inventory, is higher than the cost of completion of the project. D

In the absence of any such measure which provided finance to projects, the situation would have been worse. Hence any help from the government is better than no assistance. The present scheme offers support even to those companies which are NPAs or have been referred to the NCLT, but not under liquidation. One can see two positive outcomes here. First, the companies will be able to complete their projects. For buyers who are in a state of limbo, this is good news, as their dwellings can be completed and handed over to them.

The second plus point is that the banks and NBFCs which have lent money to these projects will now receive their payments and thus will be better off. To this extent, the creation of new NPAs will be low.

But for this to happen, the units need to be sold to recover the dues to repay the banks. Hence, a lot depends on whether the stock is sold or unsold. If it is the latter, then the issue of demand arises, as buyers are needed to complete this ring of success. For this, it may be necessary for builders to lower the prices.

Anecdotally it has been observed that the price correction is never really significant in places like Mumbai and Delhi, which are the two main centres besides other State capitals that have been identified. Will demand increase?

Purchasing power

Most of the problems that have been afflicting our economy in the last three years are on the demand side, which has affected supply.

The measure by the government is clearly on the supply side, which assuages the problems of the builders, but there should be purchasing power in the hands of the people so that they are able to buy houses. Lower interest rates can only cushion payments, but the basic purchasing power is imperative.

Even if this does work out, there are estimates that the total amount of projects that are stuck could be valued between ₹4.3-4.5 lakh crore, and hence the amount of ₹25,000 crore may be not be adequate and could be biased towards the set of 1,600 projects that have been highlighted.

Hence, while this is a good move to the extent of covering some projects, it is definitely not a cure for all developers.

Direct involvement

In economics, there is a theoretical concept of ‘moral hazard’: once a precedent is set, there is strong reason to believe that there can be further such schemes, which make the benefiters default in their obligations.

Depending on how the scheme is restructured in terms of the lending rate and the time provided for repaying the debt, builders may pull back on their commitments to potential homeowners, hoping to get this benefit in future. This is not very different from farm-loan waivers, except that there is a cost for the borrower.

But the problem for this sector was the unavailability of finance, rather than cost, because funding became difficult after the NBFC crisis began. By opening this door, succour is provided to the sector to an extent, but given that the size of the problem is much larger, the benefits would be to the targeted section only.

The government has evidently gone about addressing specific issues of various sectors, and the measures taken for automobiles and SMEs have been at the forefront, besides banking. This move can be considered to be more direct, because rather than having the RBI change policy and regulation to enable the flow of credit, the government is putting in money directly. The issues that need to be focussed on are the take-off of the scheme and the ‘terms of lending’. Also, the sifting of recipients would be important, and it can be assumed that this not be entirely be in this year, but would play out over a period of time.

One can hope that if this is successful, such a scheme can be extended to a larger set of developers over the next few years. But this may also lead to a demand for similar schemes to be set for other sectors too, where direct action works better.

This will be a challenge, because at the end of the day there are limited funds with the government — this amount has not been provided for in a Budget which is vulnerable to several shortfalls in corporate tax collections, GST, customs collections and disinvestment.