On TV in March 2020

On NDTV on issue of Yes Bank bailout plan


https://www.youtube.com/watch?v=JGfnAH-4syQ



On ETNOW on issue of coronavirus and RBI etc.


https://www.youtube.com/watch?v=JjWR2hcWQjc&list=PL51KTBvlQFEGKEOQ2njcC9-J9PvvhGVKQ&index=5&t=0s

Rate-cut no cure: Globalisation stands threatened due to Coronavirus outbreak: Financial Express March 17 2020

In the last credit policy, the MPC didn’t touch the repo rate, and chose other routes to ensure better funds-flow to corporates that would result in lower interest rates. With CPI inflation being high, and unlikely to come close to the 4% mark even in April,a repo rate cut wasn’t possible. There have been developments since February, besides advice from the government to lower rates, to stimulate the economy. The response to coronavirus, which has raised the spectre of a possible global economic slowdown, has been one of them. Initially, various governments remained confined to mere talk of going all out to fight the virus—central banks gave assurances that interest rates will be lowered, and the ECB even assured markets that liquidity will not be a hindrance.

Interestingly, when the Fed cut interest rates by 50 bps, bringing the range to 1-1.25% (it has come down to near-zero after Fes’s rate-action over the weekend), the markets let it go by like ‘idle wind’. The move intended to raise spirits, as it meant cheaper funds for all. However, the tepid response implied that liquidity, and cost of funds can’t really fight the virus. With growth slowing, companies shutting down, and countries restricting human movement, the Fed rate cuts don’t matter.

This is logical—monetary policy response to a virus is not too relevant. True, if rates come down, as they have on fear of a recession, so will borrowers’ costs, but they will not produce or invest more when activity comes to a standstill. Hence, monetary policy action under these conditions can be a palliative for industry, but not really revive growth, which will be driven by the course and longevity of the virus.

What, then, will RBI do? When the Fed lowered rates earlier, the markets expected RBI to react—which it did, through a statement on its website. The markets conjectured a rate cut before the policy date. The discussion was whether it would be of 25 bps or 50 bps. Internally, the impact, so far, has been limited, confined to preemptive closures—MNCs asking staff to work from home. The spread, though sporadic, is not alarming; while supply chains, tourism, trade, and exports have been affected, the tipping point hasn’t yet been reached. RBI’s course of action will be awaited.

It is still unclear if RBI can lower rates without the MPC’s advice, or whether such a meeting can be called ahead of the policy in April. But, judging from evidence from other countries, it looks unlikely that the rate cut will stop the economic downslide. The 135 bps cut in the past hasn’t really impelled growth, which is to slide to 5% this year; further cuts, though beneficial to borrowers, cannot revive the economy. Interestingly, interest rates had already come down sharply, with the Tbill rates lower by 20-30 bps post the February policy, meaning all loans linked with Tbill (retail, SMEs, etc) would be benefiting from the global panic that has driven down rates, notwithstanding the country’s high inflation.

Can the government do anything? Again, the answer is negative. While the government can increase health-spend, the absence of treatment facilities means that fiscal policy is also ineffective. It may work well after the virus’s impact comes to an end, but can’t turn events right now.

Hence, neither monetary policy (a supply-side response to the crisis) nor fiscal policy (a demand side response) will be presently efective. India has to be prepared for lower growth, depending on the intensity of the pandemic. In a scenario where India unaffected but faces collateral damage, supply chains will be hit as imports distortion can upset production processes. Auto, electronics, and pharma, would be worst hit by this. Tourism, hospitality, and transport, too, face disruptions.

Will GDP growth, then, decline? Prima facile, the answer is yes as the epidemic has struck at a time when recovery was expected. The government and RBI expect a 6% growth in FY21. Even if there is no shutdown in India, the impact of global developments can’t be ignored. A three-month lockdown can shave at least 0.5% off Q1growth.

Growth in FY21 was predicated on recovery in consumption in the automobiles and consumer goods sectors. These segments face possible supply chain challenges, which can affect Q1 growth prospects. Some clue can be obtained from Q4FY20 growth as February and March will witness the first effects. Exports will surely be depressed, and the recent oil imbroglio doesn’t augur well for the global economy, though India would gain from lower import bills.

This recession will be unique in that it wouldn’t be caused by a financial crisis (1987, 1997, or 2007), or an oil crisis (the 1970s), or any political conflagration. The concept of a global slowdown due to a virus, in the era of modern medicine, questions the concept of globalisation.

With economic protectionism leading to breakdown of trade agreements and eruption of trade wars, the viral outbreak questions the principle of comparative advantage, and dependence on other countries, as collateral damage can be significant even if nations aren’t directly impacted.

Companies will have to revisit their supply chains, and industries their business strategies. The earlier episodes of virus attacks—swine flu, zika, and SARS—were localised, with a lesser global impact then the present one. Globalisation stands exposed under these conditions, and more importantly cannot quite be addressed by policy.

Book Review: All the Wrong Turns – Perspectives on the Indian Economy: Financial Express 15th March 2020

There are a lot of encomiums that we tend to associate with India’s progress. The book, All The Wrong Turns, which takes a look at the past 70 years or so, attempts to correct this misconception. In what can be a valuable read for students of Indian economics and critics alike, the authors argue that we seem to have joblessness growth and quite a bit of uncertainty on many aspects of the economy that are enmeshed in contradictions. The authors deal with issues in separate chapters, with the six as good as little booklets on the subjects of agriculture, manufacturing, foreign trade, fiscal policy, banking and institutions.

A theme that runs through the discourse is the high level of contradictions that we witness in these sectors. In agriculture, for example, there are statistics to show how we are leaders in production of rice, wheat and horticulture products. Yet there is a lot of farm distress, as we have never managed to tie the several loose ends together. A lot of progress made during the Sixties and Seventies, through the Green Revolution, lost steam decades back. Our policies are flawed, as can be seen by the defective approaches of providing free power and, hence, water, which has impacted the environment for generations to come. Overuse of fertilisers and the rather ambivalent approach to using hybrid seeds finds some thought-provoking discussion in this section.

The authors introduce readers to the approach to manufacturing since independence right through the planning process and the period of post-reforms. We have never really witnessed sustained manufacturing growth, which creates jobs and ensures the cycle keeps moving. Why should this be so? Here, the authors take a rather interesting position, where they talk of our rather stodgy approach to public-sector enterprises that are maintained for ideological reasons and where the government does not want to give up control. Second, they also bring to fore the problems with the much-talked about SME segment, which has been given successive incentives, but has never come of age and seems to be stuck with low value-added goods that can never allow it to reach the scale required to bring in sustainable growth. This model works only where they are producing niche products. Also, non-resolution of the two major reforms concerning land and labour has held back this sector.

The analogy for foreign trade provided by the authors is quite appropriate: think of a student who studies very hard and gets 90% marks in the board examination. Yet it is very difficult to get admission at the next stage because all students are doing better. This is our foreign trade situation, where we have a strong base, but we have not really managed to make any major inroad into other markets. India has done very well in services, which include exports, but has not made any major stride in other products where countries like China have gone much ahead.

On the issue of banking, the authors are quite clear about the pain points. They talk of the four major sub sectors that form the superstructure of the system. The RRBs and cooperative banking structures need to be revisited, as they have served little purpose. The DFIs, which did add value and helped create infrastructure in the economy, are now history. The PSBs, which are the largest and critical part, have fallen into the NPA trap due to absence of focus and independence, which was not the case with private banks and which tended to do better.

An interesting feature of PSBs which is highlighted is one of concentration, which increases the risk, as they all have a common business focus, which can be due to common ownership where direction is provided. The analogy that best describes this is a boat in stormy weather where 70% of the people in terms of weight all sit on one side and refuse to disperse!

With Raghavan being one of the authors, the Keynesian story is very well explained and he shows how we have incorrectly interpreted the theory. While Keynes spoke of government stepping in when the private sector was not there to invest or spend, we have turned the tables and made the government the driver along with the private sector. The result has been high deficits and continuous overshooting of the targets. This has put severe constraints on monetary policy where accommodation is required.

On institutions, the point made is that those created by the Constitution remain robust, while those done by the Parliament and ministries are not because of the way of funding and appointments. The book is very well written by the two experts and those by Raghavan can be spotted easily due to his fairly acerbic style. The approach followed is quite novel, where historical perspective is provided before getting into a critique. The former should help the students, while the latter will appeal to the practitioners. Either way, it should find space on your bookshelf.

Issues with MPC’s inflation targeting: Business Line 13th March 2020

The monetary policy committee needs more clarity on what form of inflation to target, and whether growth is a factor

There is some talk of the review of the Monetary Policy Committee (MPC) framework, which is quite logical given that it has been in operation since October 2016 and calls for stocktaking. The MPC has worked well given the mandate which was clearly spelt out in terms of targeting a CPI inflation number of 4 per cent per annum with a band of 2 per cent on either side. This was supposed to be the single goal of the committee, and at times, has been held sacrosanct.

However, with these broad contours being maintained, the MPC has chosen to generally decrease the repo rate even while the direction of inflation may not have been downwards. If one were to review the issues which can be revisited, then the following can be considered, assuming that it is accepted that monetary policy can influence CPI (which is debatable as about 85 per cent of the weight is not affected by interest rates).

The first is the inflation target per se, which was fixed at 4 per cent. Is this the most suitable number? If one looks at the trend in inflation, based on the 2012 series, CPI on an average was 7.54 per cent between 2012-13 and 2015-16 — which was the last year before the mandate became law. Subsequently, it has averaged 3.84 per cent.

While the MPC can be happy with the number during its tenure, the basis of 4 per cent may have been a bit ambitious given the past readings. In fact, CPI inflation for industrial workers (2001) for the 10-year period prior to October 2016 was 8.53 per cent which came down to 4.22 per cent subsequently. Interestingly, in none of the 10 years was inflation lower than 4 per cent and the lowest reading was 5.65 per cent in FY16. For the new series too, the sub-4 per cent number was registered in FY18 and FY19.

Therefore, if headline inflation is to be revisited, clearly, the 4 per cent number needs to be changed as it does appear that the lower readings have been more due to serendipity than structural reasons.

 

Core or headline?

The second is whether we should be looking at core inflation or headline inflation? The argument is that monetary policy cannot affect food and fuel inflation which are supply-side factors and hence, targeting core inflation makes sense. Here too the numbers are interesting. Prior to formally launching the MPC, the core inflation numbers were above 4 per cent and have been above this mark for all the years as shown in the Table.

Non-core inflation had moderated overall inflation post MPC in all three years with lower readings. Therefore, if the MPC targeted the core CPI index which showed higher numbers relative to headline inflation in all the three years, the recommendations could have been different.

A clearer inflation target would help the markets as at times when rates were lowered, it was a case of core inflation going up but non-core coming down while of late, it has been the opposite where core has come down but non-core increased.

Third is how should policy response be poised? This is important because the MPC meets six times a year and the decision is based on monthly y-o-y inflation numbers which is combined with the outlook for the future. The outlook has been for half years or quarters in the coming months and may not be necessarily aligned with the decision taken.

The market always wants to know that if inflation moves from 4.5 per cent to 4 per cent, does it warrant a cut in interest rates or stance. Alternatively, if it moves from 4.1 per cent to 4.6 per cent should rates be increased and stance changed? This is presently left to the discretion of the majority decision of the members which leads to the next issue on growth.

Fourth, should MPC be looking at growth and inflation or just the latter? The MPC presently targets inflation but also looks at growth and talks a lot on the output gap and the weakness in demand which has to be stimulated through some interest rate action. If this is the stance, then the mandate should change and also incorporate a growth target.

Just like how the FRBM talks of an escape clause if GDP growth slips 2 per cent lower than that of the past four quarters, the MPC should be asked to consider growth as an objective in case GDP slides by 1-2 per cent points lower in the preceding two quarters. This would make it easier to take a decision and reduce volatility in the market.

Policy effects

Fifth, should the MPC be evaluating the efficacy of past actions in every meeting? Models often show that policy effects are seen with lags of 4-6 quarters which clouds the picture as several developments take place in both other policies as well as economy.

There is need for the MPC to also specify a time-frame within which the rate action should work in terms of not just transmission but also impact on inflation.

If inflation comes down due to onions becoming cheaper, the causal effect is missed when the repo rate is linked to the price movement. Therefore, self-evaluation reports would also be useful to the market on a periodic basis.

Last, all MPC reports have never touched on the issue of savings being impacted and while there is a lot of talk on growth, this aspect has been given a miss. In this context, a view is that the size of the MPC should be expanded — at present it consists of three members from the central bank and three academicians.

The new members can represent industry (which can highlight concerns), a banker (to put forward the sector perspective), and a member to represent the public (which affect savings).

This will help bring in diverse opinions which can go into decision-making. The tenure of the existing economists should be fixed and members rotated to bring in fresh approaches.

As the process of monetary policy is always evolving, these thoughts could be incorporated in the framework.

Harmonise revisions in GDP estimates: Financial Express March 7 2020

The CSO releases on GDP have tended to be controversial given the back series that was brought out, and which changed the course of debate. However, from the point of view of a user of such data, there is growing concern over the constant revisions made to these numbers. Such revisions are inevitable given that a large part of our economy is unorganised, leaving several imputations to be made. Even for the organised segment, data flow is not regular and lacks consistency, making estimating GDP challenging. For example, the IIP used for the unorganised sector, to arrive at GDP growth, is susceptible to revisions that automatically change the GVA. The WPI indices, used as deflators, are also susceptible to change.

In the latest release, the GDP growth forecasts for Q1 and Q2 for FY20 have been revised quite significantly, from 5% and 4.5%, respectively to 5.6% and 5.1%, respectively. Against these two numbers, the Q3 forecast is now at 4.7%, which indicates a slowdown rather than an increase given that 4.5% was the Q2 number as revealed in November. In fact, it was widely believed that Q3 should be better than Q2 due to the festive demand phenomenon, and low base year advantage. However, this did not happen. But, an upward revision cannot be ruled out, as was the case for the first two quarters.

These numbers lead to some confusion because when the first advance estimate is put out in early January, it is based on the extrapolation of Q1 and Q2 numbers. This annual projection would then be used for all the calculations and forecast made in the Economic Survey, the Union Budget, and by RBI. Now, with higher revised estimates for Q1 and Q2 of FY20, the full year forecast should have gone up, but has been taken to be unchanged in the second advance estimates released on February 28.

Interestingly, these revisions for the first half involve an addition of Rs 42,000 crore in a total increase of Rs 3.63 lakh crore in the first half of the year. This revision is around 12% of the total increase. This is quite significant as it indicates a forecast error of just over 10%. In fact, after revising these two numbers, the CSO has an unchanged estimate of 5% for FY20. This is surprising given that there is no reference made to corona virus, and there is a sharp positive base effect expected in Q4, which should ideally prop up the Q4 and full year growth numbers.

Quite clearly, there is need to revisit the process of data collection and dissemination. In our attempt to provide high frequency data, the probability of providing information that is amenable to constant revisions increases. The accompanying graphic shows how different CSO releases have projected these data points from FY16 onwards.

Starting from the bottom—the starting point of the first estimate provided—to the top, the latest number, shows some interesting patterns. Growth for FY16 has moved from 7.6% to 8.2% over two and a half years, after which it stabilised. In FY17, the year of the infamous demonetisation process, the initial forecast was 7.1%—lower than that of FY16, but then increased sharply by 1.2%, and stabilised in the January 2020 release. This changed the narrative from one which said that 0.5% growth in GDP got shaved off due to demonetisation to one which showed that the economy bloomed like never before to reach the highest mark in seven years! But, this was revealed almost two years after the event.

For FY18, the increase was from 6.6% to 7%, and came down from 7.2% in between. Here, too, the narrative changed from initially saying that GST impacted the economy in a negative manner to one that said it was not too bad.

Though GDP growth for FY19 can still be revised, so far, the forecast has stepped downwards from 7.2% to 6.1%. The sharp fall came in January 2020. Hence, in three of the four years, there were upward revisions, and a downward one in the fourth. For FY20, it needs to be seen if the 5%forecast will hold or be revised upwards. Typically, the final number should be out within a span of a year and a half to two years.

While revisions may be a part of the process of forecasting, the CSO numbers become a part of all business planning as the present GDP growth number is always taken by companies to forecast future GDP growth, which is then linked with business targets and goals. While the absolute numbers that are put out, and which enter all planning models, tend to overstate or understate projections, it gets stickier when the direction of growth changes.

During demonetisation, the initial indicator was that growth had slowed down, which would have been used to give a positive thrust to almost all corporates when planning for FY18. However, the revised number for FY17, which was higher, would have shown most plan forecasts to be conservative. Similarly, all macro targets benchmarked to the GDP number (usually, nominal)—fiscal deficit, current account deficit, investment ratio, etc—would get distorted. It can be seen that frequent revisions of such magnitude lead to asymmetrical forecasts for companies, and upsets plans.

The question to be posed is whether it makes any sense to release numbers in what can be called a hurry if there are, consistently, significant revisions to be made. While the prevalent view is that it is preferable to have some information rather than no information, the fact that there are a plethora of decisions being taken based on these numbers calls for introspection. Today, the demand for all industries—steel, coal, metals, automobiles, consumer goods, etc—are based on projections of GDP, which is the standard variable used globally as it tends to give the best results over a longer period of time.

A suggestion would be to stop making extrapolations in January based on H1 numbers, and have only the May figures, which are based on more facts. There would still be major revisions as the data pockets are fragile. Also, the sectors responsible for these divergences need to be reworked. Understandably, this will be an evolving process, but reducing the noise caused by constant revisions is a necessity.

Book Review: Who Blunders and How? The Dumb Side of the Corporate World: Financial Express March 1 2020

OvOver-leveraged companies have had a history, albeit a negative one, with the bankers and shareholders and this has led to their collapse.

Who Blunders and How? is a book that is hard to stop reading and is written by a man at the top of a company, Robin Banerjee, who has experience working in some of the best companies such as Hindustan Unilever, Thomas Cook, Suzlon Energy and Essar Steel, besides Caprihans India, which he currently heads. He builds his narrative on various stylised blunders made by firms that can be traced to those in power, like CEOs, founders and other members of the top management. It is, hence, a first-hand analysis of how things go wrong in organisations and how companies should avoid these traps.

The book is in various sections or chapters, with each one talking of a blunder that is committed. Quality failure is his first take, where several companies fall or lose credibility on this score. This is backed by extensive research and analysis, which the author draws from across the world and showcases how companies have fallen in this trap.

The Toyota story is well known and he adds such tales from India and the world to make the essay really engaging. In fact, this trait can be traced to cultures of the organisation and the leadership as it all starts from the top. As Banerjee takes us through this maze, he quite rightly points out that one common reason for failure in owner-driven companies is the inherent tendency to hand over the reins to family members, who can be siblings or children and may just not be made for running an organisation. Professional leadership is required and while some founders understand this, others don’t. This is why several empires have collapsed or degenerated over the years. This is a tough call for any head of the family, as it’s always assumed that the baton will be passed on to a family member. The examples given here are quite relevant and the reader would be able to relate to several of these cases.

Being a managing director of a company, Banerjee is able to clearly talk of the roles of the CEO and the governance structures when building or destroying an organisation. Errors will always be made by CEOs, but the way we react to them and counter the perception is important. Here, he rightly points out that the three most difficult words for any leader to say are, “I am sorry”. By just uttering these words, the world becomes forgiving and the intensity of criticism comes down. This is rarely admitted and either companies tend to push the problem under the carpet (as Indigo has done) or even ridicule customers (Ryan Air). When publicity goes awry, it is largely damaging for any company and the reputation hit is severe.

Banerjee takes us through all kinds of blunders where human beings are involved, which tells us a lot about the personality of the CEOs or owners. Certain corporate actions like those involving M&A activity have also been highlighted by the author on why companies decay. Globally, too, it is accepted that merger activity has had more misses than hits and, hence, should be done very carefully. Times Warner and AOL is the best-known large M&A that went bust. We have seen that, often, the savings in cost don’t work and that the logic of one plus one being greater than two can become less than one. Yet there have been several cases of bold acquisitions by Indian companies in other countries that have destroyed value. And when mergers fail, it is hard for companies to revive because, often, this gets related to another corporate activity that presages a downfall, which is debt.

Over-leveraged companies have had a history, albeit a negative one, with the bankers and shareholders and this has led to their collapse. There is evidently a need to get the right mix of debt, in terms of quantum, if the project (which could be a merger) does not work, as it can bring down the main business too.

There are, hence, a series of such blunders that are discussed in detail by the author and it is quite amazing that most of them seem so obvious that the reader can probably say, ‘How could the management not have seen it coming?’ This is especially true when the author talks of the importance of innovation for growth, which companies seem to miss.

Often, one feels that Kodak or Nokia should have seen the change in technology taking place and prepared for it. These changes in a competitive arena rarely happen at a particular point of time, but take a couple of years. In such a situation, it seems logical that anyone can see it happening, but firms do not. The reason is that often they are in denial of such changes affecting them.

The author believes that the CEO or MD or someone at the top is responsible for these bloopers because most corporate cultures discourage dissent and naysayers, and the heads like to surround themselves with sycophants who say what they want to hear. Having contrary views is normally brushed aside, if not punished.

That’s why companies fail. The author does argue that organisations need to be flexible, have diversity in workforce, chalk out a career path for thinkers, inspire creativity, institutionalise innovation and, more importantly, be prepared for failure. While everyone likes to say that they pursue these tenets, few actually do so in practice.

Banerjee has a knack of writing with panache and is quite direct in his approach. Never mincing words or using innuendo, he has provided appropriate examples for each blunder, which make the book worth keeping on the shelf.

Are you paying more? Tax rates across the world and how India taxes: Financial Express 29th Feb 2020

ax systems in countries differ, and it is difficult to ascertain the ideal tax rate as this would vary depending on the political economy and levels of inequality. All governments try to lower tax rates, but there are always fiscal pressures that come in the way of policy. In this context, it is useful to see how our tax rates compare globally.

Rarely does a country have a singular tax rate. The principles of public economics are based on the ability to pay, with the state taking on the job of redistribution. Therefore, one can look at the highest tax rate as an indication of a regime’s obtrusiveness. In the case of corporate tax rate too, various models are pursued—even in India, companies can follow alternative regimes—and companies receive several exemptions; hence, tax rates per se may not be strictly comparable. The same holds for taxes on goods—GST, while now a staple in most countries, has different structures. For instance, it may not always be applicable at a single rate, with governments differing on nature of goods and services and some taxing necessities at a lower rate.

To make a meaningful comparison, the data here is sourced from Trading Economics to maintain homogeneity. Comparison is made between the corporate tax rate, highest income tax rate, and sales tax rate of 10 countries (five developed countries, and the BRICS nations) to see where India stands.

The accompanying graphic shows that Russia has the lowest tax rates—for individuals as well as corporates. However, at 20%, the goods tax remains on par with that in other countries. The developed countries have rates significantly higher than India’s when it comes to personal income, reflecting the relative friendliness of our tax regime. Corporate tax rate in India is lower than that in half the countries considered, and hence, comes at the median level. Evidently, the government has made efforts to rationalise tax rates on both counts, and while the issues of exemptions can be debated, it is significant that India is well-aligned with global standards.

As for taxes on goods, India’s 18% rate is at the lower end—South Africa, China, Japan, and Brazil do better. GST rates are not cast in stone, and in the last couple of years, several changes have been made to them, and over a period of time, these rates can be expected to reach equilibrium. Therefore, India appears well-positioned on the tax curve.

Interestingly, barring Brazil and Russia, in all countries considered, the corporate tax rate is lower than the personal tax rate, implying industry is favoured. This is significant because when profitable corporates pay lower taxes than individuals, the surplus goes back to shareholders, who constitute the elite.

The other issue on budgets relates to deficits and government debt. Here, too, there are problems with defining what constitutes deficit and debt given that all countries have the concept of off-balance-sheet activity, which get aligned to the accounting standards. Yet, based on the commonly accepted definitions, these two variables have been plotted in the accompanying graphic to give an idea of how much our budgets are aligned with those of other countries.

This quite revealing because it again shows that India is well-placed in the global context. The fiscal deficit at 3.3% (excludes states) is on par with most countries, and is sixth on the list. USA has the highest deficit among the developed nations. While such levels can be justified given that the dollar is the world economy’s anchor currency, the fact remains that the government is definitely spending more than it earns. Germany runs a surplus, as does Russia, which has the benefit of oil money. China, too, has a deficit of 4.2%, which reinforces the rather aggressive role governments play in emerging markets as this is during a slowdown in the world economy.

India’s debt-to-GDP ratio includes state liabilities, and, at 69.6%, is at the median level. The developed countries, enjoying the benefit of international currencies, have higher debt ratios—USA and Japan are above 100%, and the UK, backed by the pound, has a ratio of 81%. The ratio for France is also close to 100%. For the Euro currencies, these ratios have been moderated since the Euro crisis, which led to substantial restructuring and has only stabilised recently.

India can take comfort in the fact that its debt ratio is denominated in rupees and hence poses no contagion risk in extreme situations. The government, too, has shown character in following the FRBM path. The 3.3% number—3.5% for FY21—combined with states’ deficits of not more than 3% would amount to 6.5%, which the system can support.

Hence, while there has been a call for fiscal stimulus, the government has been prudent in not allowing fiscal numbers to go overboard. At the same time, the tax reforms have worked towards aligning rates with global standards. While there is still scope, given the highly diversified tax paying class, for tinkering with rates, the principles of public economics have largely been adhered to. Critics may highlight the inclusion of contingent liabilities, but to make a fair assessment, government assets would also have to be included in the calculation. Often, this point is missed, and liabilities of PSUs are pointed at without looking at their assets, which have significant value.

LTRO, the new flavour of RBI: Free Press Journal 28th Feb 2020

The long term repo operation called LTRO is quite a fascinating tool that has entered the monetary arena. The latest monetary policy introduced this concept by which banks can borrow from the RBI at the prevailing repo rate for a period of 1 or 3 years as may be the case in the announced auction. The limit for such operations was put at Rs 1 lakh crore and so far, there have been two auctions with two more in the pipeline. What exactly does this mean?

LTRO is an operation where banks can take money from the RBI at the repo rate which is 5.15% today against collateral of G-secs held and repay the amount after the stated time period. The interest rate does not change during this tenure and hence there is stable cost for the bank. Presently the system is in surplus position where banks are lending to the RBI through the reverse-repo auctions and getting 4.90% at the overnight window or a little more for term reverse repo. They are now borrowing at 5.15% from the RBI and locking into the price for a year or 3 years. How exactly should this make sense?

Banks will look at the average cost of funds, which broadly speaking is the cost of deposits and other borrowings. Today around 10% of deposits come at zero cost being demand deposits. Another 30% is in the form of savings deposits which can cost 3.5% while the balance would be term deposits which cost around 6.5%. The average cost of deposits would be around 4.9-5% while borrowings would be 50 bps higher. With deposits having a share of over 90% in funds, the average cost of funds would work out to just a little above 5.15%. But this may not be the over-riding reason for banks to borrow at a rate which is close to their cost of funds.

It is expectations of the future which matter. Banks would expect rates to be higher especially when the tenure is 3 years. Here it makes sense for them to lock in a price of 5.15% so that the cost gets fixed.

The risk which is taken here is that if the repo rate goes down in the next couple of months, then this would work out to be an expensive proposition for banks as the overall cost on incremental funds would have come down. Therefore, it looks like that the banks which have been bidding for these funds must be the ones which have a significantly higher than repo rate cost of funds. For both the auctions held so far, the bids were 5 times than the amount that was offered at Rs 1.25 lakh crore. Quite clearly both the cost as well as expectations of future movements in rates has gone into the calculation for the concerned banks.

The LTRO also would be a winner for the RBI because it is borrowing at 4.90% from banks through the reverse repo window and lending the same at 5.15% which is 25 bps higher. On a sum of Rs 1 lakh which would have been disbursed through these 4 operations by March 9th, the RBI would have made Rs 250 crore on an annualised basis. These levels could also be increased during the course of the year which will help both the banks as well as the central bank.

This new method of infusing more permanent liquidity is quite novel as it also kind of sets benchmarks for the tenures of other securities in this bracket.

While the amount of Rs 1 lakh crore is too low presently to influence the yields on 1 or 3 years paper, as the amount increases, there will be a tendency for 5.15% becoming another benchmark that will be considered by the market. While this would also assist banks in lowering rates to borrowers in an environment when rates remain stable or likely to increase, it may not have the same effect if the policy rates are lowered in future, as this cost becomes higher.

Presently it does look like that the banks which have bid for the LTRO would be the ones that have a higher cost of funds than the repo rate because in the current environment it does look like there would be further rate cuts during the year with inflation likely to come down amid sluggish growth. There are expectations that the RBI will further lower rates, though the timing is a matter of conjecture. Besides, interest rates hikes are ruled out for sure and hence the cost of funds would be the primary factor driving banks to these auctions.

Hold on, for the long haul: Economic Times 21st Feb 2020

There is considerable ambivalence on the real state of the economy today. While green shoots — signs of economic recovery — have been spotted by some economists, such sights have turned out to be, more often than not, mirages. At times, a positive growth number in the index of industrial production (IIP) is interpreted as the ‘start of a turnaround’, which may not be the case. The high purchasing managers’ index (PMI) in manufacturing registered in January 2020 has added to this sentiment.

These ‘sightings’ were visible in FY2019, too. But they did not quite turn out the way expected.It is now clear that growth in FY2020 will not be more than 5% of GDP. Now, if green shoots are seen, and have to fructify, the result, based on existing official estimates, may not be very strong. Growth estimates in the budget as well as Economic Survey point to 6-6.5% in FY2021, which is also the view of the Reserve Bank of India (RBI). The International Monetary Fund (IMF) and World Bank also aver that this can be lower at 5.8%. But one can assume that there will be movement by one percentage point this year.

However, a significant pointer in the budget, which may have missed our attention, is that the fiscal deficit would be 3.5% in FY2021 and 3.8% in FY2020, against 3.3% targeted at the beginning of the year. But it was stated clearly that the fiscal deficit for both the years would still be within the Fiscal Responsibility and Budget Management (FRBM) Act framework —and, more significantly, the exerciseleveraged the escape clause of extra 0.5% deficit when the economy was going through extreme conditions.

This means that the economy was on adecline in FY2020 and will also be in a similar state in FY2021, notwithstanding the higher growth rate.

In fact, FRBM talks of extreme conditions of drought or natural calamity or political-related issues for invoking such a clause. But as these situations do not prevail, the economy is downbeat, which has evoked this clause. In fact, the FRBM talks of growth being 3% lower than the average of the last four quarters may not hold for FY2021, as overall growth is expected to be higher than FY2020. So, caution may need to be exercised when interpreting these green shoots.

Statistically, growth in FY2021 would be better than FY2020 due to the base effect, which is more of a numerical explanation, as growth across sectors would be reckoned on lower base numbers of FY2020. But, prima facie, it does not look like that significant acceleration is expected in FY2021.

At the start of any year, one could assume that there would be a normal monsoon. This is a necessary condition for rural demand to revive during harvest time, which coincides with the festival and marriage season starting end-September and moves through till January. But this theory has faltered, as a good monsoon and high supplies may not mean good income for farmers, who have been battling declining prices with ineffective support from the minimum support price (MSP) scheme, which is selectively active for rice and wheat alone.

Here, the Economic Survey has also spoken of growth picking up in the second half, which means that the first half won’t be too exciting. This is reiterated by the RBI forecast, which looks at a higher growth rate of 6.2% in Q3 and 5.5-6% in H1. Therefore, there will also be tepid growth during the first half of the year.

While official indications are that the growth path will be gradual, there are some interesting takeaways from RBI’s Financial Stability Report.

In its projections on non-performing assets (NPAs), the view is that the baseline scenario looks at gross NPAs increasing from 9.3% in September 2019 to 9.9% in September 2020. This has been ascribed to both the macroeconomic situation, as well as to lower growth in the denominator effects.

This is comforting in a way, as it means that the asset recognition conundrum is now behind us. But macro effects would again indicate some pressure building on account of a less-than-robust economy. This, however, doesn’t take into account the restructuring of small and medium enterprises (SME) loans entering this bucket.

While growth in FY2021 may be expected to be better than in FY2020, it may lack the zing required to reflect any kind of acceleration. A gradual upward path looks reasonable, though the risk factors, especially on the demand side, will still hold the clue. GoI has shown character by not going beyond the FRBM perimeter, which has already been extended by using the escape clause. FY2021 will, hence, be more a period of consolidation than of acceleration.

Looking beyond repo rate: Financial Express 18th Feb 2020

The architecture of monetary policy has changed over the years, where central banks go beyond the reference rate to influence the monetary situation. It started with the quantitative easing (QE) process, which involved large-scale purchase of private bonds such as mortgage-backed securities (MBS) and asset-backed securities (ABS) by the Federal Reserve to provide liquidity to the market. This was when the interest rate was lowered to the extent that it ceased to matter, as banks were not willing to lend to one another following the Lehman crisis due to issues of trust. This was reminiscent of the Keynesian liquidity trap where the supply of money became flat and the only way to improve the situation was to move the money supply curve upwards through QE.

The Reserve Bank of India (RBI) has been at the same job for quite some time now, where it has worked hard to bring interest rates down to lower the cost of funds for industry. While the repo rate was the tool used to begin with, there has been a gradual move over to other systems to influence both liquidity and interest rates. Let us see how this situation has evolved, of late.

The first option is the conventional repo rate, which is the benchmark that has been used to lower the cost of funds for banks, which then feeds into the base rate that is used by banks when calculating their benchmarks. When this did not work, given that not more than 1% of NDTL (net demand and time liabilities) was available at this rate—which was quite small in quantitative terms to influence the base rate—the concept of MCLR (marginal cost of funds based lending rate) came in, where the marginal cost was reckoned. Yet the transmission was sluggish.

Second, in FY19, RBI induced a record Rs 3 lakh crore in the form of OMOs (open market operations), where it bought government securities from banks. In a way, this is what QE was all about where liquidity is provided by the central bank to lower yields in the market. The difference is that QE also deals with private bonds that were large in quantum, while OMOs pertain to G-Secs (government securities) only. Hence, liquidity infusion has been another move used quite aggressively by RBI to ensure that yields soften and funds are available to the market.

Third, RBI went in for the purchase of dollars from banks so that liquidity is provided to them. This was done in 2019 where a sum of $10 billion was purchased by RBI in two tranches. This was a rather innovative measure brought in to enhance liquidity at a time when bank deposits were not increasing at the desired pace. A sum of Rs 70,000 crore was hence made available through this route. However, there are limitations to the extent to which this can be used as it depends on the quantum of forex with commercial banks. As long as forex comes in, banks would be able to sell the same to RBI under such operations.

Fourth, since December 2019, RBI had gone in for what informally was called ‘operation twist’, which was one where central banks bought and sold an equal quantum of G-Secs but of varying tenures to ensure that liquidity was not affected but yields were guided in the desired direction. The focus was on buying 10-year paper, which pushed up demand and hence price, which, in turn, brought down yields on this tenure. At the same time, by selling securities of a shorter duration of 1-year, yields went up and hence there was a narrowing of the yield gap between the longer and shorter ends of the maturity spectrum. A sum of Rs 40,000 crore was swapped so far. While bank lending rates do not get touched by this move, market rates tend to move in sync and the corporate bond spreads, which can vary between 70 bps and 450 bps depending on the rating of the debt paper, move in accordance with the new yield curve.

Fifth, RBI has introduced the concept of linking specific loans like SME and retail to pre-announced benchmarks. This is significant because as banks fix these benchmarks, any change in these indicators due to monetary policy would lead automatically to transmission to loans, which use these as anchors. Hence, if loans are linked to a treasury bill yield or repo rate, the changes in the latter will get reflected automatically here. This measure will work as long as the market-based benchmark changes. However, if linked with the repo rate, then the impact would be restricted to the extent to which RBI lowers this rate. One can think of such norms being introduced for other segments too, which ensure that the transmission of policy is swifter.

Sixth, more recently, RBI has announced that it would no longer have a fixed repo rate auction on a daily basis, and would move over to targeting the weighted average call rate. This automatically makes the market more vibrant as the call rate will drive yields more than the repo rate. Hence, while repo and reverse repo rates would still be fixed at auctions, the market will be looking at the call rate to take clues. Yields on G-Secs would also be guided indirectly by what happens to short-term liquidity in this market.

Seventh, the LTRO (long-term repo operation) is a novel concept where banks can borrow money at a fixed rate for a longer period of time. While judgement on future rate movements will be important here, there will be a tendency for the 1-year and 3-year papers to also get aligned to these term repos that would be prevalent in the market. This is a unique way of providing funds to banks, while also influencing G-Sec yields as when banks bid in these auctions the price will tend to equalise with the corresponding 3-year security. However, there would be anomalies in case rates start moving up and the 3-year G-Sec trades at a higher rate than the 3-year term repo issue.

Last, the concept of having exemption of CRR (cash reserve ratio) for incremental loans to SMEs and retail for a fixed time period is another novel measure used by RBI to enhance the flow of funds to these sectors, while also simultaneously bringing down the cost of funds that will get reflected in the base rate/MCLR as the cost of CRR comes down. Intuitively, one can see this mode being used for sector-specific loans too, and while the overall level of CRR is not touched, the exemptions will afford additional space.

Hence, RBI has brought in a lot of innovation when conducting monetary policy so that it is better able to guide the quantum of liquidity in the system as well as manage the same across sectors. With the repo rate becoming progressively less potent as a tool to influence lending rates, alternative measures have been used to bring down rates through market forces. One can expect more such steps being taken by RBI that make monetary policy more effective.

Why individuals don’t like Budgets: Business Line 11th Feb 2020

The changes in the tax system that are introduced in every Budget — the latest examples being the DDT abolition and new tax slabs sans exemptions — leave individuals scrambling to adapt and plan their financials for the future

There is an argument that Budgets are generally framed keeping in mind the lower income groups — which is ‘populist’ — and corporates, on the assumption that they bring about growth. Arguably, there could be some merit here.

Individual taxpayers are at the receiving end of tax reforms, which tend to be skewed against them. In the last five years or so, the changes in the tax structure that affect individuals have been quite demanding; and with the tax environment increasingly becoming volatile, it is also hard to take a decision on savings and investment. Most of these changes have been justified as following the principle of a ‘level playing field’, which is the clinching argument.

Change in criteria

First, individuals had to face the wrath of the imposition of LTCG on debt investments, where the fixed maturity plans (FMPs) were affected. From a situation where one year considered as long term, overnight, the criterion was changed to three years. As a result, there was a high tax outflow; and since the tax was imposed with a retrospective effect, it impacted past decisions taken.

Second, the LTCG on equity was introduced with the one-year condition, but an imposition of 10 per cent tax on gains. This time, however, there was a grandfathering clause which provided some relief to investors. There was also a condition that if LTCG was less than ₹1 lakh in a year, the gains would be exempted. Given the way tax rules are changing, it is a matter of time before this will be withdrawn, as the logic of the ₹1-lakh cap can be questioned at any time. Also, on grounds of a level playing field, there is nothing to stop future budgets to extend the time period of LTCG to three years for equity, as was the case with debt.

Structural reforms

Third, the biggest blow for individuals is the change in the dividend distribution tax (DDT). By abolishing the DDT, companies are better off, but it is very unlikely that they will pay higher dividends on the savings from this score. Now with the dividend being taxed at the level of the individual, it would generally mean a higher outflow. While it is said that the lower income groups will benefit, it would be naïve to accept that they are the big investors in the mutual funds or equity markets.

While this is the first loss for households, the second is in terms of planning for the future. Individuals who go in for dividend schemes do so on the premise that there will be a steady flow of income in future. The DDT was a notional loss for them, as higher tax, when paid, enters the financial ratios of the company but does not affect the shareholder in the real sense. Ideally, such a rule should apply for fresh investments made post-April 2020, like the grandfathering clause allowed for LTCG on equity gains.

Fourth, the new lower income tax slabs announced, which go with the removal of around 70 of the 100 exemptions that are currently available, is optional today. However, in subsequent interviews it has been clarified that this would soon cover all individuals, with all the exemptions removed. The ‘choice’ given today can be looked at as temporary. This raises an interesting question on the exemptions.

Exemption logic

All exemptions have been provided for a rational economic purpose. Interest on home loans was to enable people to borrow money to buy a house; Section 80C was to encourage savings for the long run, like with PPF or certificates; those on pension were to fill a lacuna for the absence of a social safety net in the country; health insurance is to ensure that individuals protect themselves, and so on. By removing these exemptions, all plans of individuals are disrupted and their purpose that was to be served.

The argument all along is that there has to be a level playing field and that tax laws have to be steered towards the direction of ability to pay. Higher income groups can pay higher tax and do not require benefits. In fact, even during debates on small savings, it is stated that as long as their returns are high, banks cannot lower their deposit rates. This has also been expressed in the Credit Policy Statement on February 6.

Interestingly, the size of the deposit component of small savings was around ₹6 lakh crore as of March 2019, of which time deposits were ₹1.2 lakh crore; bank deposits amounted to ₹129 lakh crore, of which ₹110 lakh crore were time deposits. Clearly, the argument that deposits would move from banks to small savings is not convincing.

The curious part here is that as people move away from small savings once exemptions are withdrawn, the government may find itself in trouble, as the NSSF provides a lot of support to maintain the government’s fiscal deficit. If people stop saving in these instruments, then the government will be forced to borrow from the market. Hence, small savings are important not just from the point of view of individuals, but also for the fiscal ecosystem. The government relies on this source (which will contribute 30 per cent in FY21) to ensure that there is no turbulence and crowding out in the financial market due to excessive market borrowings.

The main takeaways here are that individuals have consistently been at the receiving end of budget after-effects; this is one category which never can ‘manage’ the tax system as there is an audit trail for every transaction and there are no ‘escape clauses’, like the ones available for corporates. Second, it is hard to plan for the future when the tax regime changes continuously — it is a kind of regulatory risk. Third, rather than just withdrawing exemptions in a robotic manner, the ethos behind each one needs to be analysed before taking a decision. This would be a more just way of handling tax systems.

LIC disinvestment: Blending ideology with the market Financial Express Feb 13 2020

With LIC being out for disinvestment via an IPO, this means the institution would become a company that will require needed regulatory changes.

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LIC has as asset base of Rs 36.7 lakh crore, and involves 22 lakh agents and a staff of 2.85 lakh. It has 11,280 branches across the country.

The Union Budget may not have transcended the fiscal clichés that go with such announcements, but the point made on disinvestment of the Life Insurance Corporation of India (LIC) will go down as the big story to track during the year. LIC has been the star of government-owned institutions, and has continuously been the bastion of security and assurance for a myriad of policyholders. In fact, it cannot be denied that when a policy is due for redemption, no other company makes the effort to trace the policyholder as much as LIC does! Such is the reputation of LIC that any talk of any kind of disinvestment makes for a big story.

There are evidently arguments on both sides on whether such a disinvestment is required or not, but that is not really the point here. It may be assumed that this has been worked out by the finance ministry and an informed decision has been taken based on such evaluation. As it has been stated that there will be disinvestment, the storyline that develops would be important.

The next is whether this would be a one-shot affair, or if this would be of the crawling variety where the government will lower its stake till 51% and reap the benefits of providing support to future budgets? Logically, it should mean further such measures over the years, or else the motivation would look like as being only garnering revenue and not moving towards a changed business model. This has been the case for several PSUs where buyers have been found even while the government nature of the company remains. Therefore, it is possible that this could also be the case with LIC.

Third, with LIC being out for disinvestment via an IPO, this would mean that the institution would become a company that will require the needed regulatory changes. But the focus would automatically change—once a company is listed, the financial performance will matter and the profitability ratios as well as capital and NPAs will surface for discussion. In fact, the quarterly syndrome of continuously reporting higher earnings will become a goal in itself, and the nature of the business can change gradually in tandem with private ownership share from being a company run for the ‘policyholder’ to one ‘for the shareholder’. Benchmarking with other private firms cannot be eschewed, and there will be greater focus on disclosures and transparency.

Fourth, the amount being spoken of would be very high and could be anywhere in the range of Rs 70,000 crore to Rs 80,000 crore, assuming the balance would be for the other financial institution. The question is, can the market absorb such a large stock of capital? The highest amount raised so far was Rs 3.13 lakh crore in FY18. If Rs 90,000 crore has to come from the market along with a part of the balance Rs 1.15 lakh crore of other disinvestment for this year (a total of Rs 2.1 lakh crore has been budgeted), the demand on the market would be immense. There would also be the issue of FPIs being allowed here, which would add another dimension. FPIs have been quite dormant in the equity segment since 2014-15 when around $18 billion came in (or Rs 1.25 lakh crore). But this rather large amount from one issue will challenge the market for sure, and the timing has to be right to be successful.

Fifth, from the point of view of the government, it will continue to be the owner at this stage with all policyholders having the sovereign guarantee. For interest in the IPO, investors may see what the future plan would be like, especially so in terms of control. This is important because LIC has always played the role of investor of last resort in the disinvestment programmes of the government in the past. Therefore, whenever the government wanted to disinvest in a PSU where there were limiting factors such as timing, valuation, type of sale, etc, LIC was always there to buy the stock and transfer the funds to the government. Once LIC gets listed, this flexibility may not remain as shareholders would question every such investment, especially of PSUs that are not doing well in terms of profitability. The puzzle will unfold when LIC is listed, because even if the government has a majority stake, the market will not take kindly to such investment that become big news. This is something the government has to be prepared for.

Sixth, the timing of this announcement has a bit of irony because the recent Union Budget has brought in a new personal taxation system that will be without any exemptions of certain savings, which include insurance. The peculiar part of insurance is that while life cover is the main goal, it is often taken for two major reasons, besides the contingency of death. The first is to get a steady return periodically as per the policy, which goes with tax benefits even if it is not too attractive. The second is tax benefits under Section 80C. In fact, the latter actually pushes up the effective return on insurance products. With the finance ministry indicating that in due course of time the ‘option’ to join the new income tax scheme will not be there, the new scheme does militate against savings and insurance—both life and non-life can get impacted as people do not get the tax incentive.

Last, given the track record of large disinvestments, the practical question is whether or not this can be accomplished in 2020-21 as there are several processes to be followed before coming out with the issue? Also, given that it would be the first of its kind, there could be opposition from various quarters, leading to delays. Several large disinvestments have gotten held up on account of these factors. As the amount expected from this sale is large, non-accomplishment would mean a significant impact on fiscal balances as these account for about 3% of total receipts that have to be compensated through other measures. Considering that there have been sharp tax shortfalls in the last two years and that the economy is expected to gradually improve and not register a V-shaped recovery this year, the budgetary implications can be serious.

Disinvestment in LIC is a very big story that will lay the template that can be followed for other such great institutions. It does seem as if a blending ideology that caters to the people with market flavour will be the new offer at the disinvestment parlour for sure