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Recovery hurdles: The salary-cut cloud on consumption: Financial Express 4th Dec 2020

 Employment has been one of the victims of the Covid-19 lockdown. However, the data seem to present a contrasting picture. EPFO data shows job creation, and the government has used this data to pay, under Atmanirbhar Bharat 3, the EPF contributions of the employees and employers for the new jobs. CMIE data, on the other hand, has been indicating an increase in unemployment. Both approaches have their advantages as well as limitations.

Employment generates income for households, which then spend this and spur consumption demand; this, in turn, supports higher production, and, hence, growth. Therefore, income generation is the goal. Today, while there is some satisfaction over spending in the festive season (October and November), there is apprehension on its sustainability. This is why creating jobs is so essential.

Since the gradual easing of the Covid-19 lockdown began, post-June, things have changed quite significantly. Companies not only had stopped hiring new talent during the lockdown as economic activity had halted, as machine operations or services halted, labour had to be shed. With little hope of activity returning to normal, SMEs bore the brunt.

Those that wanted to be gentle on the staff invoked salary cuts either with absolute reductions, zero increments or by assigning the larger part of the salary to the variable component. In the latter case, if the company could not get back to normal, the variable pay would be cut significantly. The industries affected the most, right up to October, were hospitality, media, entertainment, tourism, aviation; non-essentials in manufacturing have crawled towards normalcy post-June as movement restrictions remained.

An analysis of data shows things were not all good for labour in the corporate sector. The accompanying graphic provides the overall salary bill for 2,957 non-finance & non-IT companies. The two segments are excluded as they were functional during the pandemic, and, hence, were not affected in terms of staff count. In fact, as of November, several in these two sectors have started paying increments and bonuses.

In the first quarter of FY20, the salary bill came down by 7.2%, which was followed by a 4.6% fall in the second quarter—a reduction of Rs 5,764 crore and Rs 3,751 crore, respectively. Thus, the cumulative fall was close to Rs 9,500 crore. This was mainly due to salary cuts and reduction in headcount by several companies; the services sector, which remained virtually closed during the first two quarters, was the worst-hit. It was only in October that things eased to an extent.

The number will surely be higher if the unorganised sector or the very small units which were the most affected by the pandemic restrictions, are included. This means a large overall income that could have translated into spending was drawn out of the system. Hence, a discussion on the revival of consumption, on account of pent up demand, has to be measured against this background. While discretionary spending does tend to rise during the festive, the sustainability of the same would depend on the purchasing power.

The private sector is clearly not up to this task. Post-September, some companies have announced that they would be restoring the salaries of employees, a good move given the unlock process is on. Several employees with housing loans—with the repayment moratorium ended—would find the restored salaries adequate to service debt. In fact, the corporate sector has put on an ambivalent show in Q2, where sales fell but profits surged, mainly due to salary bill savings. However, this is not how things should play out.

While restoring salaries is a good sign, uncertainty may throttle confidence and, consequently, impact spending. When it comes to spending, it is necessary to have high confidence levels, but this has been missing. And, the announcements of differentiated lockdowns being imposed by some states could mean restoration of salaries and jobs may get delayed further. This is not good news.

The government had taken steps in Atmanirbhar Bharat 2 to prod government employees to spend by allowing them to use their LTC for spending on consumer goods. While it was a sound move in theory, bear in mind that this would not change aggregate consumption but merely shift the spending from holidays to manufactured goods. Here, too, the condition that the LTC-amount-equivalent needed to be matched by ‘own spending’ of twice this amount is a dampener, especially in these trying conditions. To get a benefit on say Rs 1 lakh, one would have to pitch in Rs 2 lakh of own funds. In these uncertain times, drawing money from one’s savings to finance a purchase which carries tax benefits may not have much appeal.

Also, the government has released the bonus that had to be paid for last year during the festival season, besides providing interest-free advances to all staff. But, most of these measures involve giving the staff what was already part of their remuneration package, and, hence, does not really mean enhancing salaries. Normally, people tend to spend when their salary increases and getting what is already a part of their salary a little earlier than usual may not create any ‘wealth illusion’ to encourage spending more.

On the credit side, too, households have exercised caution, as witnessed in the change in credit in the six-month period if March to September. Retail loans increased by just Rs 18,000 crore, driven up by mortgages (which had the support of moratorium till August), and ‘other loans’ increased by a mere Rs 38,000 crore and while loans against FDs got pushed down by Rs 16,000 crore. Loans for durable goods as well as credit card spending has declined during this period, showing considerable caution in terms of borrowing for purchasing goods and services.

One of the growth engines for any economy is consumption, and this has been our Achilles heel for the last couple of years. Earlier, it was a question of more jobs being created. Now, the lockdown has induced companies to take certain stringent actions to protect their bottom lines.

This has involved salary-cuts and fewer additions to the workforce. This has to be reversed soon to restart the consumption cycle, and fewer variants of lockdowns should be the norm to ensure there is more certainty in business. Otherwise, the spike seen in October-November in consumer spending may eventually turn out to be a mere aberration.

RBI policy: Clearly more sanguine on growth, but cautious on inflation: Business Standard 4th December 2020

 The RBI monetary policy action in the last couple of policies was quite predictable, as inflation has been high and the economy has moved from the ‘lockdown’ to ‘unlock’ phase. This, in a way, has made it easier to take a decision and hence the market should not really be surprised. However, the immediate reaction was a slight upward movement in the 10-years G-Sec.

The Reserve Bank of India (RBI) has been working on the liquidity side to guide interest rates, especially on bonds, as given the large volumes of borrowings by the government, interest rates should have increased. The combination of open market operations (OMOs), operation twist and targeted long-term refinance options (TLTROs) has helped immensely to achieve this objective. In fact, the announcements made in the last policy of allowing banks to reverse the LTROs was a way of drawing back on the quantitative easing (QE), which was brought about in a definite way since March when the lockdown was imposed. Hence, there has been a lot of discretion showed by the central bank, as there have been large investments made by banks in the overnight reverse-repo auctions.

The RBI, however, in its statement has indicated that there is still room for monetary policy support for growth, which is not yet broad-based, as per the latest information available. Hence, one may expect that the RBI can cut interest rates based on the inflation trajectory. That said, a lot will depend on how food inflation moves in the next few months. The expectation is that inflation will be above 5.5 per cent for the rests of the year with Q3FY21 at 6.8 per cent and at Q4FY21 at 5.8 per cent. Quite clearly, the scope for rate cuts in the financial year will be difficult under these conditions. It is more likely that rate cuts can be invoked earliest in financial year 2021-22 (FY22).

However, there is assurance given that there will never be an issue on liquidity through various measures. The on-tap TLTRO funds will now be expanded to the 26 sectors identified by the Kamath Committee, as also healthcare. This brings it in alignment with the government’s move to extend the Emergency Credit Line Guarantee Scheme (ELCGS) coverage to these sectors in November. Therefore, the system need not really worry about liquidity.

These measures will actually ensure that while basic regulatory rates have not changed the market yields on bonds will remain stable and the infusion of liquidity as and when required will ensure that they are range bound. This benefit will percolate to corporate bonds, too, as pointed out by the RBI that spreads over G-Secs has returned to the pre-pandemic levels and hence in general borrowing costs should be stable.

The RBI’s take on growth is interesting as it is looking at marginal positive growth in Q3 and Q4. This is based on faster-than-expected recoveries witnessed in several sectors including services. While Q4 forecast is more or less in lines with the market, the Q3 forecast is unique even though growth is to be just 0.1 per cent. This will imply that the RBI expects sustenance of demand in December, too. If this does happen, it can be said that growth in Q4 could be even higher. The overall forecast of -7.5 per cent for the year appears to be in line with CARE Ratings’ estimate of -7.5-7.7 per cent.

The curious message we get form the statement is that inflation is no longer the only target and we are back to the old days when both growth and inflation were targets for monetary policy. There is, hence, no talk of raising rates even though inflation is going to be well above the 4 per cent mark through the rest of the year. While this could be due to unusual conditions this year, it will need to be seen whether this stance continues into FY22.

ON TV

 1st december 2020

https://www.timesnownews.com/videos/et-now/shows/is-eco-recovery-on-track-in-november-india-development-debate/82557

on TV

 on Times of india on 27th November 2020

https://timesofindia.indiatimes.com/videos/toi-original/gdp-growth-how-good-is-the-good-news-on-the-economy/videoshow/79439345.cms

https://www.boomlive.in/videos/boom-money/explained-why-india-is-saving-more-and-borrowing-less-9522

GDP data: Contraction can be ignored, but pre-Covid declining trend irksome: Business Standard 27th November 2020

 As the nation got into the ‘unlock’ mode, it was expected that growth in its gross domestic product (GDP) would improve sequentially, so the September-quarter contraction rate of 7.5 per cent does not come as a surprise, though it is better than our expectation of 9.9 per cent. The buzz around high growth in sales in the consumer segment during the festival-cum-harvest season has had its mirror image partly in the production numbers of September, as companies prepared for the same. Hence, the December quarter would be the test for sustenance of the revival seen in the last few months.

What do these quarterly numbers indicate? The first is that growth rates in all segments are better than they were in Q1, and there are strong chances of further improvement in Q3, with a possibility of positive growth in Q4. In fact, positive growth in manufacturing and electricity is the surprise element which can be related to the higher profit growth witnessed by corporates in Q2.

Second, the growth number for public administration and other services continues to be negative and this can be attributed more to the pattern of government expenditure where there was concentration in transfer payments in the form of free food and employment generation. The promise of higher capex made by the FM in the last months or so would get reflected in the next two quarters.

Third, the negative growth in consumption (-7.7 per cent) was again expected but shows improvement over last quarter. As the economy was unlocked gradually access to all physical products was open by September while services were generally closed and were opened in a discernible manner only post October. Consumption should progressively show improvement though the pace is uncertain.

ALSO READ: Q2 GDP data: India may see worst contraction among other economies

Fourth, investment remains low at 25.7 per cent this quarter too though higher than Q1 which was 19.5 per cent and the concern is that this trend though understandable for this quarter has been coming down for the last few years. This is probably the biggest challenge for the country as it seeks to reach the size of $5 trillion in nominal GDP. Investment has the accelerator effect in terms of generating growth. However, with private investment being fairly lackluster even in the pre-covid times, there has to be special effort put to reverse this trend.

It may be expected that the reversal of this process will gain some momentum in the third and fourth quarters and for this several things have to fall in place. First, the government should not be cutting on expenses in order to meet a fiscal target as the budgeted number of 3.5 per cent is anyway not attainable. Second, states too should focus on capex in the next four months to add to the investment demand. Three, with the momentum seen in spending this festival season, it should have hopefully brought in the correction from Q1. This is essential to keep the spending cycle moving. These three pieces falling in place could help to revive private investment too.

The next thing to look out for would be the RBI policy next week which would be focused more on the development front and provide official direction to growth prospects changes if any. Rate cuts can be ruled out given the prevalence of high inflation. The Budget would be the next big announcement in February and would be dependent on how the vaccine has progressed in the world as one can expect significant thrust on the health sector in terms of expenditure to ensure a safe environment next year. The call on the fiscal deficit level will hence be important.

While the country is now technically in a recession with two successive quarters of negative growth, it should not be worrisome as this is the case across the globe with China being the only exception. But what is a concern is that growth had started slowing down even before the pandemic as we have not been able to attack the twin issues of job creation which affects consumption and private investment which shows a downward tendency. This has to change.

There's no merit in blacklisting corporates wanting to start banks Free Press Journal 26th Nov

 

While there have been instances of connected lending to undeserving clients, this holds true even for PSBs and non-owner driven private banks, which has been highlighted by the regulators and action taken. Hence, merely because in an extreme case there can be fraud or wrongdoing which is more of an aberration, one cannot exclude an entire sector from the ambit of players to be considered.

he RBI’s recent draft guidelines for allowing corporates to set up banks has evoked some umbrage, which is probably not justified, as their inclusion in the list has been done after due deliberation. In fact, even in the earlier round, they were not barred from applying though a licence was not given to any party with such a background.

The main arguments against corporates coming in is that there is a conflict of interest and that there could be diversion of funds to their own entities. But this painting of the entire sector in black is incorrect. In fact, a previous RBI Governor has spoken against their inclusion on similar grounds, which is surprising because it begs the question that if the corporate sector is all black then why did the RBI work towards increasing the flow of funds to them in the earlier regime too?

It must be realised that there are strong exposure norms which the RBI has stipulated, to prevent undue risk-taking by companies and groups. This is regularly audited by the RBI in the inspection rounds and deviations are penalised. Therefore, there is no reason to believe that regulation will become lax now. In fact, it will become more alert.

The argument put forward again is that they would lend to their related entities. But aren’t these entities borrowing from other banks for their credit requirements? In fact, once the RBI norms are followed, there should really be no problem in lending as critics are confusing lending by ‘corporate owner bank’ with the concept of all lending to related entities being a fraudulent exercise. This is incorrect and baseless.

Banks have a criterion used to lend and also the price setting is based on the risk assessed. While there have been instances of connected lending to undeserving clients, this holds even in PSBs and also in non-owner driven private banks, which has been highlighted by the regulators and necessary action taken. Hence, merely because in an extreme case there can be fraud or wrongdoing which is more of an aberration, one cannot exclude an entire sector from the ambit of players that can be considered.

Two things are really required here. The first is that there has to be rigorous screening where applications are evaluated on a very objective basis. Besides the size guidelines which have already been stipulated, one consideration should be whether the company or the group has been an NPA in the last decade. This is a sufficiently long period to take stock of how well the company has performed in terms of debt servicing. Second, if there are any tax-related cases pending against the company, it can be considered a negative. Third, the ability of the group to diversify successfully would be a plus point. Fourth, the governance structures have to be evaluated because even family-owned businesses claim to be professionally run but could end up having only family members groomed to run the company. Fifth, any experience or episode of being in the financial arena through subsidiaries can be evaluated.

The second important thing is in the hands of the RBI. It is true that there have been cases of serious lapses on the part of individual promoters who ran private banks. With the wisdom of this experience, the regulator needs to ensure that the skill sets required to pick up these hints of misgovernance should be honed. Here, the onus has to be on the Central bank, as once a licence is given, it would be depositors' money that would be involved. There have been patterns in the frauds committed in all these cases and this should be a good starting point to enforce strict oversight, to ensure that these are not repeated.

India has had a mixed experience when it comes to having corporates start and operate banks. Therefore, it is not possible to conclude that it is a good or not-so-good thing. There have also been major misgovernance issues in both public and private sector banks and hence, merely keeping corporates away is no assurance that the best principles of governance will be followed. The answer is to impose stronger regulation, to ensure that the rules are obeyed. This way, the best can be obtained from the new players in this arena.

The clue hence, lies in thorough screening of applications, robust regulation and inspection to ensure that business is smooth. Even corporate-owner driven banks have had professional bankers running the business and there is no reason to expect things will be different this time.

Do we need new banks in the country? Financial Express 24th Nov

 Do we need new banks in the country?

November 24, 2020 6:15 AM

New entrants should consider buying an existing private bank that needs Assistance; This will mean ready infrastructure for the entrant and easy exit for a weak player

The last pertains to allowing NBFCs to convert to banks provided their asset size is above Rs 50,000 crore. Representative Image

By Madan Sabnavis

RBI’s recently released norms on ownership of banks raise a fundamental question: Do we need more banks in the country? The move towards the consolidation of public sector banks and the problems that have enveloped private banks such as Yes Bank and LVB should give reason for pause. Aren’t we looking at having big banks that have a strong capital base and can compete globally? Aren’t we concerned about the possible governance lapses in the conduct of some banks that has caused considerable upheaval at different points of time?

While having more players in any field is looked upon positively, the banking story is different. However, critics presented a counter view a few years ago when the on-tap licensing policy was announced. We have seen several private banks crop up since 1993; some have closed down, while others have merged for various reasons. It was either a case of viability or governance or simply a lack of long-term commitment. Exits were easy as the promoters left with a profit on most occasions. The so-called new private banks, which are over 25-years old now, are few in number, and allowing more players may not resonate well. Even among the last two new banks which were recognised, one has been merged with an NBFC. Quite clearly, it would be necessary to exercise caution here.

Some of RBI’s proposals merit comment. The first pertains to allowing corporates, albeit with certain conditions. In fact, even in the earlier round, this was allowed. There is, though, a strong reason for not allowing such entities as they have a vested interest. Therefore, screening of applications requires a lot of due diligence.

Corporates are basically borrowers from banks. They use funds to grow business. While the preconditions in terms of equity and dilution will be met subsequently, the challenge is to ensure that funds are not diverted to concerns which they have an interest in. In almost all cases of misgovernance that have come to light in the Indian banking space—and even globally—such diversion has been witnessed and discovered several years after the bubble burst. RBI will have to pay special attention to such banks. Large corporates operate hundreds of subsidiaries which are linked to the parent entity without the knowledge of the regulators.

Three ideas come to mind. First, once these are permitted to operate a bank, RBI needs to have some compliances/ disclosures in place to ensure that such developments do not take place. Second, some thought has to be given to the economic phenomenon of ‘unfair competition’, where entities dominant in the real sector can build the final link to the financial sector and create large monopolistic centres. While this concern may look exaggerated, such waves build over time, and as the new entity starts getting into M&As, at a later stage, it can carve out a dominant space in the banking sector. The Competition Commission could be consulted on this.

Three, when setting the criteria for considering applications, the last 10 years’ history has to be examined to show that these potential promoters have never had an NPA, or had involvement in any economic irregularity and so on. An objective scorecard should be used in such cases.

Another matter relates to the issue of mandatory listing. All existing banks are indeed listed, and it would be hard to ask them to act otherwise. Banks have to be seen as financial infrastructure, and ideally, should not be commanding such high stock valuation. But, across the world, banks are listed, and hence, it would be out of place not to allow listing in India. However, our history shows that promoters with little long-term commitment can start a bank, have it listed and as they unwind their stake, exit and make money in this process. It is the king of PE activity. Do we want such a route to exist? In fact, the norms that require banks to get listed within six years allow the promoter to make a profit as her stake is brought down to 26%.

The issue with listing is that, once complete, banks work on a quarter-to-quarter basis and have to deliver profit progressively to shareholders. This is one reason why they take on a higher risk to build size and income, which could come back to haunt them as NPAs. While it may be argued that the regulator should not be worried about the model as long as the banks are compliant, the cumulative write-offs in the system have literally eroded the value of the deposit holder’s money. As banks provide for NPAs, they are forced to keep deposit rates low and lending rates high, which is not what banking is about. This is admittedly a sticky issue as norms for dilution of stake and listing already exist, and it is hard to roll back now.

The last pertains to allowing NBFCs to convert to banks provided their asset size is above Rs 50,000 crore. Here, if one excludes the HFCs and PSUs in the finance space, not more than four or five would qualify. This is definitely a good opening as these entities have vindicated their commitment, especially for last-mile connectivity. But here too, RBI can put in conditions. The last decade’s performance record would be a useful start. Further, RBI can look at the number of deviations from regulatory compliances for these NBFCs and can use discretion on whether these lapses are of a serious nature or have been repeated.

Urban cooperative banks and payments banks have been allowed to apply to get converted to small finance banks. This is not surprising as there was always a question mark on the sustainability of payments banks’ and the cooperative banks’ models, which have not quite worked well. It would be interesting to see as to how many banks would opt for conversion. The small finance banks are niche players and have to, by definition, do only priority sector lending. Having more of such banks operating in the countryside will help in financial inclusion. But, having cooperative banks that have not been successful in this space and applying for conversion requires strict due diligence.

Is it possible to think differently, in light of the arguments forwarded here? Quite in the manner how RBI has worked to find suitors for private banks that have failed, is it possible for all the new entrants to actually first consider buying up an existing private bank that requires assistance or a UCB or a payments bank. This can be a way of solving the two issues of support for a weak bank and opening the doors to new players. This can be done for both new commercial (universal) banks and small finance banks. There will be physical infrastructure available for the entrant and an exit route for the weak bank. In fact, even the qualifying NBFCs should be made to consider this offer.

At present, there are several banks that are struggling to stay afloat but have basic infrastructure. A new bank will have to begin at the baseline. To align the two, RBI should actively consider this option which will bring in economies in operation. But, for sure, it would lead to questioning the necessity of having more players, which may not be there 15 years down the line, and then struggling to keep the weak banks afloat.

The Next Fifty Things that Made the Modern Economy’: IFinancial Express 22nd November

 Author of The Undercover Economist, Tim Harford, strikes once again with his book on The Next Fifty Things that Made the Modern Economy. For those who have read the first 50, this will be an interesting continuation. Harford’s first book as the ‘undercover economist’ took the reader through a lot of psychology and mind reading that goes into how the market works and how we react to it.

It hence became a kind of trademark with the author where one expects him to talk of the quirks that go with economic behaviour. His investigative mind took a different turn after Logic of Life and Adapt, with Fifty Things. The quirks that go with these inventions are still the highlights.

The author explores some very common things in life, which can be a sewing machine or a mail order, and then explains in a couple of pages how these inventions evolved. The tulip auction and their pricing are well known and a rudimentary factor like seasonality explained why prices increased very sharply and the product became valuable because of scarcity.

Harford excels in explaining these inventions or products because he is a very good storyteller, and his conversational style gets the reader involved with the plot. The writing does not stretch or get technical which is a big plus point or else the common person can be put off. By using only four or five pages to explain the importance of each of these 50 things, the book becomes very readable.

The book is in eight parts, with several subjects under each of these headings. There is a section called ‘Moving Money’, which has a few essays on different aspects of the sophistication which evolved in our financial system. SWIFT, for example, is what all of us use for transferring funds across the world where there is acceptance of such payments, as it is within the system of banks that are members. A rudimentary concept like SWIFT took its time to evolve but has eased the flow of money.

Simultaneously, it is possible for the USA, for example, to block funds that go to a rogue nation by using this channel. Another subject that he takes on is blockchain, which has become quite revolutionary with the introduction of bitcoin and other cryptocurrencies that use a different technology that is superior to even central bank money. There is also a chapter on credit cards which is again a very well evolved product, but the stories that go into the creation of these products make for good reading.

In the section on ‘Invisible Systems’, the reader will find the GPS story very interesting as all of us use this for moving around, but have probably never thought of stopping to find out the how and why of it. Similarly, in the section on ‘No Planet B’, Harford talks of some very ordinary things like fire and oil, and their discoveries and use. Interestingly, the search for a substitute for whale oil which was used for heating and lighting led to the discovery of crude oil.

There are these little tales on cellophane used for packing which came about when it was observed that wine that spilled in a restaurant messed the tablecloth, which gave direction to the thought of creating a substitute in plastic form. What we see today as cling film used for packing food is obviously a very evolved form of the same thing.

Included also is the miracle man for countries like India, Norman Borlaug, who was responsible for the Green Revolution.

The concept of recycling which started with discarded bottles and waste being sent to China for recycling is revealing. It germinated from the rather innovative practice of reaping economies in shipping. Ships which carried goods to the USA would have to come back empty to China. Hence bringing back waste made a lot of economic sense, though it created problems of damaging the local ecology.

The CCTV camera we use extensively in our residences and shopping complexes were an offshoot of the World War machinations where they were used to spot enemy camps on television screens. Pornography evolved from classical sculptures and architectural marvels dating back centuries to photographs, video tapes and now to the Internet, which gives the viewer the highest level of privacy.

Prohibition was a post-World War phenomenon and interestingly economists were all for this act as it was believed that drinking slows down human activity and Monday morning blues were due to hangovers. The well-known economist, Irving Fisher was an advocate for prohibition. Even the QWERTY keyboard on the typewriter has a story and there was rationale for making the display tougher. The keyboard could not take the load of multitude hits as experts crossed the 60 words a minute mark. To slow down the typing process, the QWERTY concept came in and worked, and remains with us today.

Harford hence narrates these stories to keep the reader engaged all through and whether it is Singer’s machine easing the strains on the fingers of women who could sew straight, to the origin of auctions which started in ancient times where girls would be auctioned to the highest bidder in communities and the proceeds spent on the poorer people—they make for revealing reading.

There was disbelief when Aaron Montgomery Ward offered utopian prices for various goods but never had a shop where the goods were displayed. People believed it to be a fraud, but the goods were delivered, and cash was paid only on delivery. Yes, this mail order system of 1873 is what we know as e-commerce today.

This book is not just interesting and educative, but could also be used in schools where children must navigate inventions in a rather mundane way. Clearly there are better ways of conveying these stories, and Harford excels at it.

Is the low interest rate cycle over? Free Press Journal 21st November

 For the common man, declining interest rates are a nagging problem as it affects earnings on savings. Ever since the lockdown, all interest rates have come down. The repo rate was lowered, which led to banks lowering the deposit rates quite swiftly. The repo rate came down from 5.15 per cent to 4 per cent after the announcement of the lockdown. The government was quick to react and lowered the rate on small savings by 70-140 bps. Banks have lowered the term deposit rates on one-year deposits from 7.75-8.20 per cent on March 27, to 4.9-5.5 per cent and that on savings deposits to 2.7-3 per cent, from 3.25-3.5 per cent.

Yet the RBI data on the financial savings of households has revealed an uptick in savings rate to 21.4 per cent in Q1 as against 10 per cent last year. This, however, is not hard to explain, as people had little choice when it came to their money. As consumption was curtailed due to the closure of shopping outlets for most goods except essentials and there was little choice in terms of deploying income, financial savings gained. This was manifested in an across-the-board increase in bank deposits, small savings, mutual funds, insurance and currency. Savings increased only because income could not be spent.

But one irritant so far has been the continuous high CPI inflation. The rate has been above the 6 per cent mark for four months, with food prices pushing up the index. With the latest October CPI inflation number at 7.6 per cent, term deposits are earning negative returns of around 200bps while money kept in savings accounts are in real terms, out of money by 450bps. They have little choice, as holding currency earns zero return and any movement to the stock market, either through mutual funds or direct investment, is fraught with risk. This is the expected syndrome when the monetary regime turns inexorably to the borrower. With the RBI always being in a ready position to provide liquidity through new instruments like the LTRO and its variants, these deposits also did not matter as banks were flush with liquidity. This has brought down the lending rates sharply, though it has not led to any growth in credit, as banks have been credit-risk averse in general.

The MPC had a clear mandate to control inflation, which is hard to influence, as it is being caused either on the supply side, such as food supplies and prices, or government intervention in the form of higher taxes. Under normal circumstances this would call for an increase in the repo rate, as low inflation had drawn members to decrease interest rates sequentially. However, this would not be possible, as the government has been working on reviving the economy, which involves the provision of cheap credit to industry which can expand and grow.

Such a situation also indicates that the cycle of declining interest rates may have reached its end and at some point, the RBI will have to increase interest rates. This is so because with a negative growth in GDP this year, there will be an upsurge next year, which in turn will necessitate such action, as inflation will increase even on a favourable base, due to the demand side pressures. Presently, global commodity prices are also stable in general but will start moving upwards and the threat of imported inflation remains in 2021. The present stance of being impervious to high inflation cannot be taken once we are out of the pandemic.

So how should savers view interest rates? It does look like there will be no more repo rate cuts this year. While inflation will come down numerically post-December, there could still be some room for the RBI to cut interest rates. However, keeping in mind the emerging scenario in FY22, the MPC may tread cautiously. The RBI has used the liquidity tool to tame the markets so far and this approach will be persevered with, to ensure credit requirements can be met by banks. But in a way, the RBI has been exiting the LTRO, by allowing banks to repay them, which has been taken up with alacrity. As demand for credit picks up next year, banks will be relying more on deposits to fund their lending operations and it is here that interest rates will probably have to be increased.

From the point of view of consumption, it is necessary that interest rates do not fall any further, as the potential spending power that is generated is quite high. Of the outstanding deposits of Rs 142 lakh crore, around 65 per cent may be taken to be term deposits, which is Rs 90 lakh crore. With an average interest rate of 5.5 per cent, the income earned is around Rs 5 lakh crore. A 1 per cent cut in interest rate means a loss of around Rs 90,000 crore. Assuming that half is spent while the other half, an amount of Rs 45,000 crore, gets reinvested in the deposit, is significant. The cuts this year, around 3 per cent, have denuded spending power by Rs 2.7 lakh crore annually. This is huge, especially when we talk of consumer spending during Diwali!

Is loan guarantee scheme serving the purpose? BusinessLine 17th November 2020

 

MSMEs are using funds from the Emergency Credit Line Guarantee Scheme more to pay off earlier loans than as growth capital

The Emergency Credit Line Guarantee Scheme (ECLGS) was one of the highlights of the economic package announced by the government in May, and it became operational on May 23. The scheme is basically a loan guarantee for all MSMEs which were operational as on February 29 with an outstanding of ₹25 crore (now ₹50 crore), where 20 per cent incremental credit up to ₹5 crore (now ₹10 crore) would be covered. These could be taken from banks, NBFCs and FIs. There have been regular updates provided on the progress of these loans. As of November 2, ₹2.03 lakh crore was sanctioned, of which, ₹1.48 lakh crore has been disbursed to 66.67 lakh units. This is impressive.

Some interesting observations can be made on this scheme and its progress. The first is that the scheme was to be on 20 per cent of outstanding loans, which as of end-February were around ₹12 lakh crore for banks. Hence banks can theoretically sanction around ₹2.4 lakh crore to this segment. NBFCs as of September 2019 had around ₹80,000 crore as outstanding to MSMEs in industry. Therefore, the sum of ₹3 lakh crore was quite generous. Given that the outstanding to sanction limits are around 75 per cent, a maximum of ₹2.25 lakh crore could be disbursed during this period which has been extended to end-November from end-October.

Second, the progress of this scheme based on tweets from the Ministry are given below.

Table 1 shows two contrasting pictures. The first is that the incremental sanctions have slowed month on month from ₹74,000 crore in the first month to ₹16,000 crore in October. This could mean that most of the MSMEs which fit the criteria and required funds have been covered making the marginal increase much lower now. The second is that the disbursements to sanctions ratio has gone up to the average level of 75 per cent which is sign of normalcy.

 

SMEs’concern

A concern of SMEs has been that this scheme works only for those which have exposures with banks and first-time borrowers are excluded. Besides, these loans must be SMA-0 or SMA-1 and hence the non-performing ones are axiomatically ruled out.

The third interesting facet, which is also puzzling, is presented in Table 2, which gives banks’ outstanding credit to the MSME sector which includes both manufacturing and services.

 

The data on disbursements made under this scheme shows that there has been an increase progressively albeit at a slower rate. However, banks which accounted for over 90 per cent of these sanctions in October have witnessed an increase of just ₹49,000 crore between May and September. During the same period there was an increase in disbursements of ₹1.13-1.37 lakh crore. How can this be reconciled?

The difference between the two is ₹64,000-88,000 crore. One possibility is that large-scale repayments have been made by the borrowers which looks unlikely given the conditions in the economy and this segment being the most affected by the pandemic. The alternative is that since these guaranteed loans have been given to existing borrowers who have outstanding performing credit as of February 2020, these funds may have been used for repaying earlier loans. This works well for SMEs as these would be at a lower interest rate; as they have been capped at 9.5 per cent or 1 per cent above the external benchmark followed by the banks.

This argument looks plausible because this has been a phase where SMEs were affected the most as they were buffeted by a combination of migration of labour, supply bottlenecks, credit availability, high default probability, and non-payments of dues among others. Such support through the guarantee would have helped many units service existing loans, which is why there is a gap between disbursements under the scheme and the relatively low incremental credit over the four-month period ending September.

Will the extension of the scheme till November help? Most certainly, as there is still a lot of funding space left — of around ₹1 lakh crore. It would however depend on how the demand-supply forces work. There has to be demand from the SMEs which can pick up as overall manufacturing has picked up, which will require additional funding. However, it should be remembered that within bank credit to MSMEs, the share of manufacturing is around one-third with the balance going to the services sector which is still not operational in a big way. Hence, the demand for credit from this segment could remain muted.

In fact, the reason behind the decreasing incremental sanctions under ECLGS can be traced to the services sector being closed in general. As the unlocking norms for November have not been altered from those in October, it is possible that this extension may not result in a significant increase in demand. On the supply side, banks have a lot of liquidity and hence can go ahead with lending provided there are borrowers. The issue of credit risk aversion to this class has been addressed by the ECLGS.

Restricted beneficiaries

The Finance Minister has now extended the scheme to 26 sectors and healthcare, which were identified for one-time restructuring. It is estimated that 4-5 per cent of the total loans may qualify for OTR and hence there is room for expansion beyond ₹2 lakh crore. However, as the condition is that they have to be SMA-0 on February 29, 2020, it would be the creditworthy units that would benefit. They too may be inclined to repay outstanding loans at this lower cost.

The target of ₹3 lakh crore will be met, but it would not be capital used for growth but for lowering interest cost.