What will the banking architecture look like going forward? MInt 28th December 2022

 Banks have been the fulcrum of the India growth story as they are the main channel for funding owing to the limited presence of alternative channels. As demand for credit from industry has been fairly tepid this year, the focus has changed to the retail segment where the appetite has revived notwithstanding rising interest rates. This change in focus is significant as the quantum of risk involved comes down significantly.

During the year, banks witnessed several changes which will set the tone also for 2023. First, the sector looks healthier than ever, with the pandemic induced slowdown giving time for banks to clean up their balance sheets and almost all PSBs are back to normal. Second, PSBs look better capitalized than before and hence when the FM draws up the budget, there will be less pressure on making provisions for capital. Third, two significant initiatives were taken up by banks and implemented that were part of the Budget. This was in the area of setting up digital banking units and the introduction of CBDC.

The former is a big step as this could be the way forward where brick-and-mortar structures will be complemented by the digital route to achieve financial inclusion. Along with this is the digital currency introduced by the RBI in both the wholesale and retail segments where banks have played a lead role.

The major challenge for banks was asset-liability management, which will persist in 2023, too. Ever since the RBI changed its approach from doing everything to preserve growth to fighting inflation, liquidity has been the challenge.

The stance of “withdrawal of liquidity" has had far-reaching consequences. As liquidity has dried up with credit growth outpacing deposits, banks have had to continuously fine tune the interest rates on both sides to ensure that mismatches were reduced. This has meant seeking recourse to bulk deposits and certificates of deposits at times. Given that this situation will persist in the first half of 2023, too, before RBI changes its stance and lowers rates, banks will have to be alert all the time.

2023 will probably be a little more predictable from policy standpoint with the RBI pausing post February (when it will still be confronting inflation of above 6%), and then changing the stance while keeping the repo rate unchanged, and probably lowering it by the end of the year. A positive fallout for banks is that a rising interest rate scenario means higher net interest margins, which is good for the bottomline, though treasury gains would be minimal or could also be negative.

However, what would be of interest is how structures and institutions evolve. First, the focus will be on the landscape of banking with a distinct focus on technology. The advances made in digital payments has been phenomenal and we would need to work on this mode for exponential growth in the banking business. In terms of structures, banks would tend to look at expanding business—both through the collaborative mode of leveraging the strengths of fintechs as well as independently working on furthering business in the digital space.

The second area of interest would be how NABFID evolves. The new financial institution for infrastructure would crystallize and hopefully be operative in 2023. Being headed by a pioneer in banking, who had actually sought to free the system by merging DFIs with commercial banks to form universal banks, is now going to show the way for the new FI. The market conditions have not changed much as the corporate debt market is still a restricted space for AA and AAA-rated companies. Therefore, something exciting can be seen in this space and banks will be watching this development closely as it affects the infra lending portfolio.

How much will cloth barricades hide? Free press Journal 24th December 2022

 Cloth partitions hiding evidence of poverty are not new – they were seen as far back as January 1978, when President Jimmy Carter became the fourth US President to visit India. He landed in Delhi and was there for a couple of days. The Janata Party under Mr Morarji Desai was in power. To ensure that the right picture was presented, the Government had evicted all beggars from the streets that would be traversed in these three days; and all signs of poverty were covered with the erection of white cloth barricades. This was the time when India would be called an underdeveloped country because we were still eligible for loans from the International Development Association, which gave loans to poor countries for long tenures at less than 1% interest.

Fast forward almost 45 years where India is a dominant economic power which has just hosted the G-20 Summit. It is a repeat of what one saw in Delhi. As Mumbai is a not too nice-looking city with slums everywhere and people still defecating on the roads (though not to the extent that Naipaul had overemphasised in his description of a wounded civilisation), the Government has painted the road dividers, put up lights along all roads that the delegates would travel; and put up the cloth partitions to ensure that the true India cannot be seen. Some may call this typical of a Potemkin state where there is a distinct ambivalent picture. For one who resides in Mumbai, the irony will not be lost when one views the rather long Andheri flyover, which was illuminated for festivity but houses hundreds of beggars permanently below the unintended shelter.

The approach of hiding the true state of the city and country is now a habit. The country has made great progress in terms of constructing highways at breakneck speed. But city roads continue to be plagued by continuous digging, leading to potholes that are never filled. There are fantastic malls which have come up even in Tier 2 cities but getting to these structures takes a lot of time due to the congestion. The picture outside these places is similar — beggars straddling the entrances and exits hoping to make money. This scene cannot be missed even at traffic signals. The reason for the picture remaining the same is not hard to guess. The growth process in India has been lopsided, being focused on the top echelon. In the true capitalist spirit a lot of reliance has been placed on the trickle-down approach. This was especially true after 1991 when we went in for free markets reforms. This has made India a globally comparable economy when it comes to width and quality of manufacturing and services, but scant regard has been paid to the bottom of the pyramid. The World Inequality Report states that the bottom 50% of population owns 13.1% of income and 5.9% of wealth while the numbers for the top 10% is 57.1% and 64.6% respectively. The numbers say it all

The trickle-down process has worked, albeit slowly. This is why we observe that even when it comes to begging, which is a flourishing business in metropolitan cities, it is typified by the beggar community owning mobile phones but having no house and probably unsure of a meal. The situation is more distressing when one moves to the interiors. The reaction of the Government has been to indulge quite aggressively in terms of providing cash transfers and cheap/free food, through a variety of programmes. While this is commendable, the broader challenge is to ensure that they have a sustainable income going forward. Having PM Kisan, PM-GKAY, NREGA etc. are good fillers but cannot be made permanent. Even the West is lamenting the liberal dole system which provides incentives for remaining unemployed. The problem is that not enough jobs have been created.

We also have a distinct economic transformation which has seen the economy moving from agriculture to services, without having an industrial revolution as such. This is a major slippage because industry creates jobs that are sustainable. Also, while the composition of GDP has changed — services dominating with a share of 65% — agriculture still accounts for 60% of the workforce. This lopsidedness has resulted in the dualistic structure of the economy. Agriculture has witnessed limited improvement in productivity but is the epitome of disguised unemployment. There have been pressures to ensure that commercialisation is thwarted at all stages (remember the farm laws which aim to give power to the farmers). Jobs that are created in the services sector are not quite of the skilled variety. The boom in retail and hospitality sectors has created a large workforce that is involved in lowpaying jobs like delivery agents or service staff in the commercial complexes. Construction is another large employer, but the employment provided is temporary and involves relatively low wages.

This leads to the larger issue of employment linked with education. Today, whether one likes it or not, an English education is essential for anyone who hopes to enter the corporate world and earn better. This is something that is left out in the New Education Policy which has made it mandatory to have preliminary education in the mother tongue. Culturally it is good, but practically those who do not have an English education find it more difficult to get into professional colleges where competition is intense.

It may be time to introspect quite seriously on all these issues when policies are framed, so that there is a synchronised growth process which is more inclusive.

Crystal gazing for 2023: Financial Express 23rd December 2022

 Year-ends are for ruminating over what transpired during the year, and the lessons learnt. In this world of uncertainty, forecasting the next 365 days would be interesting, as the coming year will be crucial for us, considering India will, at least statistically, continue to present better growth numbers than most countries. But let’s see what forces will work through the year 2023.

First, no one knows when the war in Ukraine will end, but this may not matter as 2022 showed that, even as the war rages, economic surprises are minimal.

Countries have adjusted to commodity flows and supply-chain disruptions, with prices returning to normal. While the world is against Russia’s invasion, the power the nation holds over supplies of oil and gas has helped it keep its own in the economic arena.

Second, the Fed’s stringent tightening of interest rates, followed by other central banks, is now a known factor, with the direction being clear. The Fed will be taking the rate to around 5%, and will then take a pause as it would need to wait for these rate hikes to work on inflation (which happens only with a lag). While a reduction in Fed rate looks unlikely in 2023, a long pause is expected during the year.

Third, the dollar is already reverting to its normal, and the appreciation seen in 2022 will be a thing of the past. The dollar had crossed the parity level this year, with the US economy becoming stronger by the day—which called for Fed action. This will be comforting for the world as all currencies fell against the dollar; the adjustments were fairly volatile. In 2023, fundamentals are more likely to drive currencies.

Fourth, as the days of easy money are over, unless the Fed starts QE under a different brand name (unlikely as of now), investment flows would be restricted and more discerning. For India, which depends on FPI and FDI to a considerable extent to steady the balance of payments, this will be something to watch.

Fifth, RBI will be taking a breather first, followed by a change in stance on accommodation, before finally looking at lowering rates. A rate hike in February looks likely as inflation will be above the 6% mark. But with the inflation rate moving down post March, one may expect RBI to consider lowering rates in the second half of the year.

Sixth, the government will hold an important lever when the Budget is announced. The fiscal deficit for FY24 will be more or less in range, helped by higher revenue earned as well as a larger base of nominal GDP, which will make up for the higher expenditure on account of food and fertiliser subsidies. The government is expected to go along the fiscal deficit prudency path and could target a deficit of 5.5-6% for FY24. Additional capex will be limited and in alignment with the growth in the overall size of the budget. In FY24, nominal GDP growth would be expected to be lower due to both real GDP and inflation (GDP deflator) being lower.

Seventh, the external scene for India will be under pressure. The trade deficit will be wider with exports slowing down further, but imports rising (India will still be the faster growing economy, which necessitates more non-oil imports). This, combined with a possible slowdown in software flows, can keep the current account deficit in the range of 3-3.5% for another year.

Eighth, the currency will be largely stable, with the average depreciation being replicated, possibly between 3-4%. In 2022, the strengthening dollar caused substantial chaos in the market. This external factor will be less potent this year.

Ninth, the banking sector will be more robust in terms of business, especially since the two major challenges of capital and quality of assets will be behind us. The focus will be more on furthering digitisation and lending. Here, we may expect the new financial institution to take some shape so that another tap opens for finance for infrastructure.

Lastly, the capital market will probably continue to witness buoyancy in both segments. As the economy grows, the IPO market will tend to look positive, with companies seeking to raise capital. The secondary market should ideally reflect the generally stable fundamentals of the economy and maintain the upward path.

While Sensex at 65,000 looks possible, anything above would be bordering on optimism as there will be phases when the global economic developments have an impact on domestic markets.

It would be a gradual movement to normal in 2023, with guarded monetary and fiscal policy that supports growth. This could be the appropriate platform for the economy to move to a higher trajectory in 2024.

All the world’s a stage and economic talk played its part" December 26th 2022

 All the world’s a stage and we are mere players. So said the Bard. The economics stage has had its share of events that will be remembered for some time. As 2022 draws to an end, it’s time for a light-touch rewind of all that occupied the media and conference discussions during the year. One can list several dramas from the domestic and global arenas.

The domestic stage had a big part played by the high-decibel epithet “fastest growing economy". India’s economic growth rate of 6.8%-7% estimated for 2022-23 got projected as a signal of our arrival on the global stage. We have taken on presidency of the G20 as well. But all agree that growth will slow down further in 2023-24. Yet, we have euphoria, which is good. But where are the jobs and why has investment stagnated at 28-29% of GDP since 2015-16? Don’t worry, say pundits, as production-linked incentives will deliver ₹40 trillion in additional output. All’s well that ends well, then? Clearly, it has been a good year for humour too.

Second, the spotlight on a $5 trillion economy has moved on to $10 trillion, as the former is passé. With so many great things happening around us, the goal has enlarged and shifted further away. It does not matter that we have been talking of the former since 2018 and are still at around $3.25 trillion now. Besides, this is nominal GDP, not real, so high inflation can make it achievable. A mid-summer’s night dream?

Third, in the arc lights was India’s retail inflation rate, which has been the cornerstone of all arguments on the economy or policy. We don’t like it when rates of interest are increased, even though our savings get a more respectable return. We argue for lower rates so that industry, which is yet to take advantage of the low-rate regime which held for over six years now, benefits. Much like Beckett’s Waiting for Godot. But that was theatre of the absurd.

Fourth, one would have heard economists use the term ‘base effect’ almost every time data is released. This pops up whichever way the number goes, up or down, as the base is driving the direction. Clumsy explanation, but statistically cannot be contested. But what, really, is the situation: Is GDP of 9.7% in the first half good or bad? Does 5.9% CPI inflation mean it has finally come down, or is it high? As you can never really tell, it comes down to as you like it.

Fifth, the Global Hunger Report, which placed India low down the pecking order, evoked umbrage and was rubbished. We were at No. 101 last year and No. 107 now. It did not matter then, but matters now. We cannot be hungry if the country is growing the fastest and on the verge of becoming a $10 trillion economy. The study’s methodology was dissected and found to be flawed. Besides it spoke only of children being stunted and malnourished, not adults. That cannot be a true hunger report. Much ado about nothing, really.

At the global level, it was the same. First were sanctions which meant that one could not deal with Russia except if one were buying oil or gas, which Europe continues to do. Duplicity is the word that resounds here. Russia was cut off from Swift payments, which had a positive collateral effect in terms of countries working out trading arrangements in domestic currencies. All this did not quite work as Russia continues to do what it wants to. But the world suffered from high commodity inflation, which affected each and every country. Why did we have sanctions in the first place? A comedy of errors?

Next, global inflation made Jerome Powell a superhero. Everything the US Fed’s chief said affected all leaders of central banks. The view held earlier that monetary policy was a domestic phenomenon was a thing of the past. Everything the Fed did had to be taken seriously because it affected every country as investment flows became ever so volatile. So it was measure for measure.

Linked to the above was the US dollar, which for the first time crossed the parity level reflecting American economic strength that the Fed wanted to suppress. This meant that all other currencies went down together, diluting the export advantage of depreciation and pushing central banks to use forex reserves to steady currencies. It’s what happens when an apple cart is upset, a subject George Bernard Shaw alerted us to long ago.

Fourth, the crypto boom ended in a bust, with the FTX fiasco as its last gasp. As this involved an entrepreneur with the name of Bankman-Fried, irony was not lost. Crypto was always an enigma with perils, given that it was unregulated. High returns was its temptation, and in India, the government and regulators smelt trouble, though did not ban it. Conceptually, cryptocurrency is a Ponzi-like scheme, with no underlying value. So it was a tempest that was brewing.

The last was this year’s Nobel Prize, which former Fed chief Ben Bernanke shared for his contribution to finance. Helicopter Ben, as he was called, had propagated showering the economy with money in a crisis, as was done via ‘quantitative easing’, which was followed by other central banks. But taking it back is always a challenge, one left for successors to take on. ‘Quantitative tightening’ is what is being spoken of, but how does one do it, especially with a world disrupted by covid and moving towards a recession as the Fed fights high inflation? Can we ever get out of this conundrum? Remember the great epic Mahabharata and its famous chakravyuh? It’s easy to enter, difficult to exit. A Nobel Prize should be awarded to whoever can provide a solution for it. Happy New Year!

Economic crisis: Where are the jobs? Free Press Journal 19th December 2022

 

For an economy like ours which takes pride in the demographic dividend, it is essential to create meaningful jobs to ensure there are no social repercussions. For this we need the manufacturing sector to expand and provide more opportunities

mazon, Microsoft, Meta, Twitter, OYO, Zomato, BYJUs, Udaan, Ola, Vedantu, Salesforce, Unacadmey, Ola, Cars24 are now household names and everyone knows about them. There is a commonality across all these brands. And this is not that they are coming closer to all of us, but they are in the process of downsizing their staff. Some of them are global decisions but the repercussions will be in India too as young professionals who joined these firms with stars in their eyes will now have to try and ensure they don’t fall into depression.

Actions taken by Indian and global companies have different motivations. At the global level, it is more a case of companies reacting to the recession which has enveloped the developed world, especially the US where business models are being revisited. Change in ownership at Twitter has caused large-scale layoffs, the effect of which is being felt here in our country too. This is the power of globalisation where India may be insulated from recessions in the west in terms of GDP growth (we still will be the fastest growing large economy), but will face the wrath of a slowdown through layoffs and loss of business (IT firms will face the heat here as export of services will get impacted).

The domestic story is different. Startup Tracker speaks of almost 18,000 jobs being lost in 2022 so far and this number will only rise. Start-ups as a rule, based on global experience, point to failure where 80% wind up within 3-5 years. This is because the models are not scalable and hence cannot be sustained. Start-ups generally tend to be in the fintech space and use technology to run their business. Online food delivery and education were big ideas that worked very well during the pandemic where it was felt that people will live life differently. The ultimate victory was online education and this is where there was proliferation in the number of players. Prima facie it appears to be a smart and efficient model; it works as long as there are business volumes. When children were at home and could not attend school or college, online education was the panacea. But with return to normal, things have changed, and from a hybrid model, most activities are moving back to the physical mode. This is where the business models need to change.

Several businesses like online retail and food delivery have worked well in the past where discounts were offered. Rates were lower than what the manufacturer or restaurant was charging, and with added advantages of returns (for retail), it went down well with consumers. But at the end of the day it is a zero sum game and the companies or start-ups took the discount on their books. It is little wonder that a large number of start-ups which went for an IPO had only losses to show besides a bright future, and got good valuations which failed subsequently. This has led to considerable downsizing and will be the way in the future too.

This highlights the serious problem of employment in India. With manufacturing down for almost 6-7 years now most jobs have been created in the low-income service sector where shopping malls and online delivery offered a plethora of low-paying jobs. The commissions offered to these staffers, or agents/associates as some were called, has come down sharply as companies are making consumers pay more and absorbing less of the losses. Those employed will find it hard to get other jobs and will continue doing delivery rounds on bicycles instead of scooters due to the absence of alternatives. The private sector while dishing out salaries of above Rs 1 crore to several fresh recruits will be balancing their head counts with employee cost. After Covid, most companies have shifted to greater use of technology through artificial intelligence and machine learning (AI and ML) which is a direct threat to future employment generation.

The Government is evidently cognisant of this problem. Notwithstanding the data provided by EPFO which shows more people employed, in October there was a rollout of 75,000 employment letters to various categories of staff by the government. This is part of the plan to provide 10 lakh jobs which was promised earlier. Interestingly the head count of Government departments has also undergone a transformation, where the focus was on austerity all this while. As of March 2019 there were 36.16 lakh central Government employees which has come down to 34.65 lakh in March 2022. The central bank has also lowered the head count from 18,132 in 2011 to 12,856 as of December 2021. Hence there has been a move towards bringing in higher efficiency with existing staff, and wider access to technology.

For an economy like ours which takes pride in the demographic dividend, it is essential to create meaningful jobs to ensure there are no social repercussions. For this we need the manufacturing sector to expand and provide more opportunities. Besides the social concerns of having less people employed, there is need to have more spending power to drive the economy. For this jobs have to be created on a sustained basis. Without income there will be less spending, which will keep investment at bay as no company will invest unless it sees future demand. This is the main reason why manufacturing stagnated outside the infra space even before the pandemic struck. The onus is on the private sector as Governments can only supplement the effort. Also, there may need to be less reliance on start-ups for creating jobs as the story so far has been more hype and less content.

Discussion on World Bank on Economy etc. on ETNow 7th December 2022

 https://twitter.com/ETNOWlive/status/1600158431364919297?t=Y8gVE2Mj0luXXxAUkIRerg&s=08

On Buisness Standard: The morning show talking on credit policy. 8th December 2022

 https://www.business-standard.com/the-morning-show/video/full-show/tmsep320-rbi-policy-and-inflation-a-warmer-winter-markets-and-elss-1872.htm

RBI policy on expected lines, but clarifies a lot: Financial express 8th December 2022

 

A green tax will help augment government revenue: Mint 8th December 2022

 

India Inc can step up investment: Business Line 7th December 2022

 A suggestion which is made by almost everyone to the government is to increase capex allocation in the Budget. In FY23 the government had budgeted for ₹7.5 lakh crore which was roughly 19 per cent of total outlay. In FY22 it was around 16 per cent. Is this really a panacea for our investment problem?

In FY22, total gross fixed capital formation was ₹68 lakh crore and Centre’s capex was ₹6 lakh crore. Can ₹6 lakh crore of funding drive ₹68 lakh crore of capital assets? A lot of government capex is actually carried out by private players, with the former acting as a financier, generating a stream of downstream investments. Despite this interdependence and the prevalence of PPP funding, government capex cannot replace private investment; it can only supplement it. Hence when there is a clarion call from India Inc to the government to increase capex, it indicates some helplessness on the part of the private sector to perform its role.

In fact, if the overall allocation of ₹7.5 lakh crore of capex for FY23 is looked at closely, some interesting insights can be obtained. This includes ₹1.11 lakh crore of transfers to the States which in turn also show a similar amount of capex. States normally have budgets for capex of an equivalent amount as the Centre; and in FY22 ₹6.67 lakh crore was targeted as against ₹5.54 lakh targeted by the Centre.

Govt, a catalyst

Governments, it should be remembered, provide finance for specific projects like roads or railways or irrigation. For the Centre, of the balance ₹6.4 lakh crore that was to spent in FY23, defence (₹1.52 lakh crore), roads (₹1.88 lakh crore), railways (₹1.37 lakh crore), telecom (₹0.54 lakh crore) and housing (₹0.27 lakh crore) accounted for ₹5.58 lakh crore. Therefore, the canvas for big ticket investment is restricted to five sectors.

Quite clearly the heavy lifting for capex has to come from the private sector, led by corporate India. The NSO data for FY21 is useful here where the contribution of various sectors can be gauged for gross fixed capital formation. The table gives the shares of various sectors in total gross fixed capital formation in FY21. There are indications that the share of SMEs in capital formation, included in the household component in the NSO data, has taken a hit on account of the Covid impact.

There is therefore a need for the private sector to ramp up its investment. In 2015-16, that is just before the NPA issue surfaced post AQR, the share of private non-financial companies was as high as 40.3 per cent. This position has to be restored, but that is perhaps easier said than done.

The first reason for that is private sector investment in infrastructure has slowed down substantially with funding as well as risk aversion being the two main factors. Profit margins have taken a hit in the wake of commodity inflation. Banks have preferred to cherry pick their customers and changed focus to retail lending. At the same time companies evaluated risk before venturing into areas like power or telecom.

Besides, consumption has not been growing at a fast pace to improve capacity utilisation rates which is required for fresh investment to be considered. Capacity utilisation rates have been capricious. After peaking at 75.3 per cent in March 2022, it has dipped again to 72.4 per cent in June 2022 going by RBI data. It does look like that investment has been more sector specific rather than broad based. The environment has to change.

The PLI scheme

The government has been pragmatic on the PLI scheme which has an outlay of ₹2 lakh crore spread over around 15 sectors. The idea is to enthuse them with incentives of 4-6 per cent of value of turnover provided certain norms on investment and turnover are met. The response has been good in terms of applications and intention and it needs to be seen as to how much of this fructifies given that there are time lines of at least three years provided for most of the sectors.

The other issue with government capex is that while the Centre is able to largely meet its commitment because it is not bound by a sacrosanct fiscal deficit number, States do not have such liberty. States tend to wait and watch till the end of the year before putting in their money. The reason is simple. As the fiscal deficit ratio of 3-3.5 per cent is something that cannot be compromised, if revenue pick up is slow, they tend to cut back on capex which is the discretionary element in the budget.

In FY21 for example, States had budgeted for ₹5.98 lakh crore of capital outlay but ended up spending just ₹4.59 lakh crore mainly due to the fiscal constraints.

Hence while there is a lot of attention paid to government capex, the core issue being missed is the role of the private sector here. The low interest rate regime especially in the Covid years helped the government keep its cost of borrowing down, which helped in capital formation. The response of the private sector was weak on this score though admittedly the uncertainty in the economic environment hindered the revival of animal spirits.

Government capex can hence be a good starting point for roads for instance but for manufacturing and other infra segments like airports, ports, power, telecom, the private sector has to take the lead to have an impact. The economy has to get back to the ratio of 33-34 per cent of GDP for gross fixed capital formation. Banks are in a better shape to provide finance, now that the books have been cleaned up.

But the real push has to come from India Inc.

Counting the poor: Indian Express: 6th December 2022

 

Time for noise cancellation: Economic Times 28th November 2022

 

A fresh look at municipals is needed: Free Press Journal, 26th November 2022

 

The RBI has recently brought out a study on municipal finances and has recommended that they should be borrowing more in the market. However, for such activity to take place, several reforms are needed to ensure that they are run on sound lines.

Gokhale Bridge is a name that has been in the news and is now familiar to all residents of Mumbai, and it speaks a lot about how municipalities are run and why they fail. The bridge connects the Eastern and Western sides of Andheri on the Western line, and the storyline goes like this.

During the monsoon in 2018 a part of the bridge collapsed, resulting in casualties. The bridge was under renovation for four years, during which time only half the bridge was operational for traffic moving on both sides. Simultaneously another flyover was commissioned from the highway to the start of Gokhale Bridge which is now in a precarious state. The side roads, which saw traffic crawl for four years, deteriorated with potholes and were never repaired. Curiously, post the collapse of Morbi Bridge in Gujarat, a report was flashed to say that the bridge is dangerous and cannot be used. It has been shut down. A new one is to be built now by September 2023. And more recently, VJTI and IIT have been asked to submit reports on whether the same should be open to light vehicular traffic because of public umbrage.

This story is both hilarious and serious. Wasn’t Gokhale Bridge under renovation for four years? If it could not be done in four years how it can be done in less than a year? Who takes responsibility for nothing being done all along? Why are authorities enthusiastic in getting new bridges built where the contract sizes are large, but never take responsibility for repairing roads? How can a decision to build a new connecting flyover be taken without being sure of the viability of Gokhale Bridge? Till the issue came up, no one was even sure whether it was the responsibility of the BMC or the Railways to break, renovate or construct the bridge. How can a bridge which has been certified by experts to be unsafe again be open to opinion over being selectively operational?

This is the problem with most municipal corporations in the country which are inefficient in terms of delivery of services. The stories of Bengaluru and Gurugram are well known where due to unplanned concretisation of roads, monsoon leads to flooding of magnitudes never witnessed in these cities as the drainage systems have not been provided.

The problems with municipal bodies are manifold. They are run by political parties which win popular vote. The officials are bureaucrats who move the files. Most projects are outsourced to contractors. Maintenance is outsourced. Construction and plan designs are outsourced. Consultants with the best pedigree are appointed to guide. If all the practical work is being done by outsiders, does it then make sense to privatise them? This question is far-fetched, because municipal bodies are part of the federal structure enshrined in the Constitution.

The RBI has recently brought out a study on municipal finances and has recommended that they should be borrowing more in the market. However, for such activity to take place, several reforms are needed to ensure that they are run on sound lines. The problems of the large municipal corporations is not about finance as they are cash-rich (the BMC has over Rs 90,000 crore in fixed deposits). The problems are on the operational side.

First, the governance structures are fragile as there is a lot of politics mixed with administrative and financial subjects. The link with state Governments is strong and there could be other Government agencies involved in carrying out specific functions. Second, the process of charting out responsibility is not clear. This means that while funds are allocated, there is no way of ascertaining how the money is spent and whether the terms of engagement with contractors are being enforced. Third, there are no efficiency benchmarks that are monitored on a day-to-day basis, like the case of potholes being addressed during monsoons. Fourth, given the system of governance, accounts are not available on time and are hard to understand as the systems used differ between states and the Centre. Hence, even statistical evaluation is a challenge with data coming with big lags. Budget numbers are aspirations and come long after the year begins for most local bodies.

In such a situation there will always be a trust deficit when it comes to investing in municipal bonds, as the chain of responsibility is not known. Also investors would always judge municipal corporations not entirely on their finances but also what they see around them. The case of Gokhale Bridge (and there are many such projects in different cities) is an example of how projects are undertaken and probably abandoned at times.

It will be useful to get credit rating agencies to do a detailed evaluation of how these municipal bodies are run and provide a rating which goes beyond what is revealed in outdated budgets and financial reports that are presently available. The CRAs should be empowered to have access to all possible data on the subject (which is not easily available today). Agencies like CARE, CRISIL, ICRA have had a very good track record of rating of municipals and would have to extend the approach to cover the physical side of their operations. This would mean moving around the cities and observing whether or not the basic functions of a local body are being carried out, and evaluate the status of projects when awarding a rating.

This can be extended to also use this rating as a basis for additional funding being provided to the body. Alternatively a performance-based reward can be given to the staff of the municipal body, based on this rating. We need to think differently.

Have the markets turned around? Financial express, November 23 2022

 The last Fed meeting was a turning point as things have changed across countries almost in harmony. The Fed did what it wanted to do, which was expected, with an increase in rates by 75 bps. But the indication given is that its action will become tempered, which means that it will be less aggressive in the future, though rates will probably still go towards the 5% mark next year. The signals, however, have been quite strong across all the markets, and India, too, has benefited a lot. The rupee, it may be remembered, had moved towards the 83 to the dollar mark, and forecasters did not feel shy to even talk of 85. However, with the Fed’s announcement, the dollar has started weakening with the dollar index moving down. Collateral benefits have been witnessed across most currencies. The rupee, too, has now moved to the 81-82/$ range and the question asked now is whether this will be a phase of appreciation that can go below 80/$.

The rupee has been guided by two sets of factors. The first is the external one which had the strong dollar driving all currencies down. The rupee did better compared to other currencies. Now with the dollar weakening somewhat, the rupee has gained. And this will continue as the dollar gets softer as the economy slows down. The second relates to fundamentals. The trade deficit has been widening primarily because exports are declining, which is expected due to the slowdown in the global economy. Imports growth has receded due to commodity prices easing, but it is still higher than that of exports, thus widening the trade deficit. Software receipts, too, would slowdown as demand for such services, particularly from the US, would be impacted. A lot now depends on how the FPI flows behave. They have been positive from the last week of October and all through November, which has helped to firm up the rupee on a daily basis. But for how long will this last? Normally, the FPIs square up their positions towards December when they repatriate their profit. In case they do so, the net inflows can turn negative, in which case the rupee will be impacted in the reverse direction.

The Fed action also had a salubrious effect on the stock markets, and the Sensex has been on an upward trajectory aided by the FPI inflows. This is quite surprising because the corporates that have announced their results for the second quarter have, in general, shown a smart increase in turnover though a decline in profits. In fact, this has been the paradox across most non-financial sectors where turnover recovered due to pent-up demand, but profits came down due to higher input costs. Clearly, the profit logic of today does not work in evaluating value tomorrow, as the stock market has brushed these results aside as being only transient. The long-term story remains intact.

The other consequence of the Fed tempering its commentary is that the bond yields have come off highs, even in the USA and European markets. The US 10-year treasury yield was closer to the 4% mark as long as there was uncertainty regarding the Fed’s move. But now, things have changed, and the softer stance has brought the yields down. This has also worked through the Indian market where the 10-year yield, which had been displaying rather volatile tendencies, has moderated to less than the 7.3% mark. It may be recalled that the earlier Fed action and tone had driven the yield past the 7.6% mark. It was moderated when there was news of the Indian bonds being included in global indices. The deferment of this inclusion drove the rates up to the 7.4-7.5% range, and now the trajectory seems to be downwards toward the 7.2% mark.

Therefore, while there is a lot of talk and speculation on RBI action, which can provide forward guidance for the market, it has been observed that the Fed’s action has an equivalent impact on domestic markets. And this can be felt even before RBI takes a call. In fact, the RBI rate hikes have not quite brought about a similar reaction in the bond market, though liquidity considerations have impacted the lower maturity yields. But the benchmark 10-year bond has been more or less resilient to RBI action. Similarly, RBI’s actions in the forex market were not able to do what the Fed announcement did, as it does appear that our fundamentals may not be that strong to warrant an appreciation. However, the global spillover effect has been impactful.

The power of globalisation has hence been more evident in the three markets like never before. The global slowdown or the action taken by Jerome Powell leaves an indelible mark for sure and cannot be brushed aside. It is not surprising that in the last monetary policy meeting, the RBI governor highlighted the importance of the announcements of the central banks of advanced economies.

Ours is the fastest growing major economy: How come? Mint 23rd November 2022

 A statement made in various conferences and investor calls is that India is the fastest growing major economy today at 7%, and while the world will sleep through a recession, we will be awake and have plenty of opportunities to leverage. The tone assumed is one of pride as well as schadenfreude. Are we really in this sweet spot? Are we really disconnected from the world?

Numerically, there’s no contesting the number, just as our economy clocked high growth in 2017-18 despite demonetization. Also, going by most forecasts, including those of the International Monetary Fund, growth will slow down in 2023-24, but will be in a range of 6-6.5%, which will still be higher than that in all other major economies. So, the Indian growth story will be a winner all the way. The curious part of this 7% expected growth of ours in 2022-23 is that our economy will slow down in the year’s second half. If one goes by Reserve Bank of India (RBI) forecasts, we see a sequential slowing down from 13.5% in the first quarter to 6.3% in the second, and then to 4.6% each in the third and fourth quarters. The last two quarters will be disturbing because in 2021-22, growth was just 5.4% and 4.6%, which should have ideally provided a statistical low base for higher growth this year. But this will not be the case, which is why it is necessary to evaluate what is not right in our economy.

The first issue relates to corporate profitability, which shows how inflation has affected balance sheets. Second-quarter results present a picture of robust growth in sales of non-finance companies by as much as 25-30%, thanks to pent-up demand. However, almost universally profits have declined and the reason is that companies have witnessed high growth in input costs that could not be passed on completely. This also means that the affliction will persist through the rest of the year, as inflation will remain high for the next 3-4 months. The solution is to keep working to bring down inflation.

Second, data once again shows that high inflation (and its mirage of higher consumption) has had a negative effect on savings, which have been under pressure this year. In 2021-22, financial savings came down as per RBI data. The fact that consumption has been steady, yielding good GST collections and boosting company toplines, has been at the cost of savings. It’s the impact of inflation again. This is not good news, given that banks confront the challenge of slower growth in deposits relative to credit. We need to revive savings through suitable tax incentives. The savings decline also means that we will run a large current account deficit (CAD), defined ex-post as the difference between savings and investment. This deficit can be in the region of 3-3.5% of GDP in 2022-23.

Third, exports have been impacted by recessionary conditions in the West. Textiles, engineering, jewellery, chemicals, etc, are some sectors impacted sharply by the slowdown, as demand has come under pressure with a Western combination of low growth and high inflation hurting our exports. While inflation will probably come down in the West too next year, recession-like conditions will persist. Therefore, exporters need to be prepared for a prolonged slack. We need to think differently and take a hard look at the composition and destination of our exports.

Fourth, a sluggish West is a red flag for the software industry. We are already seeing layoffs at Big Tech companies which will get reflected in outsourcing. This is important because both software inflows and remittances support our current account. Our trade deficit will surely widen, as with 7% growth, import demand will hold steady. Exports will remain low key until such time the world economy recovers. Annual software receipts of over $ 120 billion in the past have supported our current account, but a slippage here will be hard to avert.

Fifth, as India’s finance minister pointed out, the private investment cycle needs to pick up. The picture so far is that it’s concentrated in few sectors, like steel and telecom, and is not broad-based. A wider recovery is likely to take time.

Sixth, consumption growth could be an inflation-backed mirage, as several marketers of consumer goods have flagged low rural demand as a concern. Kharif output will be lower for rice and pulses this season, which will impact farmer incomes. Hence, one must be cautious in interpreting signals here.

Seventh, the employment question still hangs in suspension. There is constant debate on whether it is going up or not. The fact that several new-age firms, especially startups, have gone in for layoffs is bad news. Post-covid, many companies have embraced technology for routine processes. Now with profitability under pressure, jobs would be at stake even on the domestic front. We need more openings in the skilled market space, rather than mere delivery jobs at the lower end, to keep consumption ticking.

While we have ambitious goals of joining global supply chains, being relatively aloof has helped us this time, as ours remains the world’s fastest growing major economy. This epithet would not hold once India’s growth gets linked to the fortunes of other countries. Presently, only foreign portfolio and direct investments are vulnerable to external factors, while exports are growth supplements.

In conclusion, we should interpret the title of ‘best growing economy’ with caution. There is still a lot to be done by the government and RBI in providing the right policy environment. But the steering wheel will be in the hands of private investment.

Banks left to juggle with rates: Business Line 21st November 2022

 Economic discussions these days are invariably related to financial markets and ultimately come back to the banking sector’s doorstep. The latest cause for worry is that deposits are not rising at the same pace of credit. Meanwhile, there are concerns over rising repo rate hitting investment.

The increase in deposits since the beginning of the year to November 4 is around ₹9.04 lakh-crore while credit is up ₹10.34 lakh-crore. At the same time the central bank is concerned that while the repo rate has gone up by 190 bps, the deposit rates have remained rather sticky (weighted average rate changed by 35 bps between May and September) which in turn has caused deposit growth to slow down. The weighted average lending rate on new loans has increased by 108 bps while the same for the entire portfolio by 51 bps. What does one make of this situation?

Theoretically, when the central bank increases the repo rate or the monetary policy rate, growth in credit has to slow down as the cost of borrowing goes up and people borrow less. If this does not happen there is a problem with monetary policy efficacy.

Therefore, when we talk of the Fed raising rates to slow down the economy, it can be effective only in case firms borrow less leading to fewer homes being bought. It is expected to lead to cautious investment by companies given the high borrowing costs. This holds good for India too.

Rate hike impact

Hence if the RBI has been raising rates, economic activity should slow down as borrowing comes down. Logically, then growth in credit has to slow down to vindicate monetary policy decisions. The RBI has made this transmission partly automatic by linking certain loans to an external benchmark which is largely the repo rate and at times the treasury rates. And this will carry on until inflation comes down.

Theory says that by raising rates, demand comes down for homes and tepid investment will lower demand for steel, cement, use of credit cards, plastics, chemicals etc, that will slow down price increases and hence inflation. This should play out in the system.

The transmission process deserves some thought. By having some loans linked to the external benchmark the transmission of repo rate hikes becomes automatic. However, bank deposits are based on fixed contracts. Thus even if deposit rates rise, they would apply only to future deposits and the existing deposits don’t get impacted.

Once they come up for renewal, they would be repriced at the new rate. Therefore, there will always be sluggishness in upward movement of bank deposit rates. Customers are rarely flexible when it comes to switching banks and tend to remain with the existing bank. New deposits, however, could be in new banks offering higher rates.

Now, loans which are not linked to the external benchmark would be reckoned at the MCLR which is calculated as marginal cost of new funds. Here the critical aspect is how banks change deposit rates. Banks need to constantly look at the asset and liability maturity profile while pricing deposits.

Further, there has to be an informed decision taken on future of interest rates. Are we sure that the RBI will keep increasing the repo rate or will there be a reversal once inflation comes down?

It is likely that after inflation falls below 6 per cent the repo rate will be lowered. In such a case the loans at repo rate will yield lower returns. It has been seen that banks are selectively increasing deposit rates in certain maturity buckets and not making it a general increase. This way they would not lock in deposits at high rates for long-term deposits.

The MCLR, which is driven by a formula, automatically does not show a commensurate increase in cost. Therefore, the MCLR increase is lower again. The anomaly here is that the retail segment and SMEs borrow normally at the repo based rate and end up paying a higher price. Corporate loans are linked to the MCLR and do not get impacted that much. This explains the transmission conundrum.

Under normal conditions, in the next couple of months the gap between deposits and credit growth should decrease as the former increases and the latter slows down.

But the fundamental problem is the state of financial savings in the economy.

Today it has been observed that consumption has been rising for the first seven months of the year as evidenced by the growth in GST collections.

But inflation has been relentlessly high for the last 10 months. This means that as households keep spending on consumption which is at a higher price, less is left for savings. Here allocation of resources into different channels is important. The stock market has done well since the pandemic. Mutual funds offer a balance between direct and indirect investment in the market.

Indian ‘QE’

Since the pandemic set in the RBI policy has focussed on maintaining growth and so the repo rate was set at a low level of 4 per cent over an extended period of time, deposit rates had come down to the range of 5-5.5 per cent when inflation had been ruling at over 6 per cent. So households naturally moved away from bank deposits to other avenues to protect their real returns.

This has been the fallout of our version of monetary easing where the savers bore the brunt of low interest rates. The low interest rate environment did not lead to higher offtake of credit as demand was selective and banks were cautious. Now with conditions normalising the contradictions are playing out. This is the pain involved in moving back to a new equilibrium.

So the combination of unusual monetary policy followed during the pandemic combined with high consumption at the cost of savings has contributed to the present disruption which will get ironed out as monetary policy works through the system. This can take some time.

Six years on, cash still rules: Free Press Journal 12th November 2022

 

Clearly, the appetite for currency has been on the rise. And given that the RBI revealed that neither black money nor an abnormal amount of counterfeit currency was unearthed, it can be assumed that the demand is genuine and people like cash.

Nov 8, 2016, was a chilling evening and will be remembered by the entire nation. This was when the infamous demonetization exercise was announced, which literally brought the economic system to a standstill with high denomination notes of Rs500 and Rs1000 being demonetized. The ostensible reasons for announcing the move was to get hold of black money, curb terrorism and identify counterfeit currency.

Along the way, as individuals and bankers struggled to meet the norms for exchange, which changed by the day, it was argued that demonetization would help in digitization. While this argument appeared to be an afterthought, several changes have taken place in the way in which business is transacted.

The curious thing about demonetization was that the logic of big denomination notes being responsible for black money was defied when the Rs2,000 note was introduced, as it makes it easier for black money to be stored.

There were other reforms brought in like GST, which sought to ensure that all businesses were registered, rules put in place on the maximum amount of currency that can be used for purchase transactions, and so on. Simultaneously, the Government propagated the trinity of JAM, which included a Jan Dhan account, Aadhaar card, and mobile phone which helped in making direct transfers.

The UPI system for payments has now become a household term which has been made popular through incentives rather than threats, as the consumer so far does not pay for the transaction made. This has led to multiple-level growth in the volume of transactions both in terms of number as well as value. Clearly there is a revolution taking place at a pace never seen anywhere in the world. And the reason is definitely not demonetization.

With six years now having passed, the apologists for demonetization use the proliferation in use of digital payments as vindication of the process. If that were the case, then are we holding less currency today than we did in 2016? This is pertinent, because if everyone is using the digital mode, then logically the RBI should be printing less currency than it did earlier. In this context it would be instructive to look at some data.

As of Nov 4, which was just before the announcement was made, currency in circulation was Rs17.74 lakh crore. As old notes were exchanged and limited quantities were made available by the RBI, it came down to a low of Rs9.92 lakh crore in January 2017.

In January 2022, which is a five-year period, it had grown to reach Rs30.04 lakh crore and rose further to Rs31.82 lakh crore by October 2022. The average compound annual growth rate for the period January 2017 to January 2022 was 24.8%.

The growth rate of currency in circulation in the five years preceding Nov 4, 2016, was 12.2%. Clearly, the appetite for currency has been on the rise. And given that the RBI revealed that neither black money nor an abnormal amount of counterfeit currency was unearthed, it can be assumed that the demand is genuine and people like cash.

Interestingly if the CAGR is reckoned for the first three years, which was before Covid-19 struck and the lockdowns were imposed, the growth rate was as high as 32%. This means the demand for currency was increasing at a greater pace immediately after demonetization.

However, after the lockdown, when people perforce could not move out at various points of time and going to banks was arduous, digital modes became more popular. For the two-year period from January 2020 to January 2022, growth averaged 14.7%.

Why is it that even while people are using digital modes of transactions, currency is still in demand? The first reason is that people are just more comfortable using cash and this has a generational bias.

Second, after the pandemic, the precautionary motive has become important and everyone would like to keep a certain amount of currency at home for emergencies. In fact, even today surgeons charge separately in cash for high-level operations even in top starred hospitals.

Third, several enterprises in the unorganised sector, which include the kirana stores, prefer cash because once they come under the composition scheme, GST filing is not required. Here they would prefer business transactions to be kept opaque.

Fourth, most real-estate transactions of the non-corporatised entities are conducted partly in cash as the argument given is that the seller has normally paid cash when acquiring land or the house and hence needs an offset through partial cash payment.

Fifth, small, unbranded jewellers deal primarily in cash and prefer not to accept digital payments. Often when digital payment is permitted, a premium is charged.

Sixth, professionals like doctors, lawyers and accountants often accept only cash to have control over their taxable income. Lastly, even today people have to pay bribes in cash when dealing with any state department, whether it be a simple police verification for a passport or any dealing at the housing counter. Therefore there will be an ambivalent structure in the country where currency and digital modes of transaction will coexist.

The RBI has already introduced its digital currency (CBDC) at the wholesale level and while it will permeate the retail layer at some point of time, it may become a substitute for UPI/e-wallets rather than for currency.

Digital transactions look large because the new generation has taken to these alternatives with ease and will continue to do so. The volumes are large because even small transactions of less than Rs100 can be done through UPI. But businesses that are opaque will continue to deal in cash as it is a win-win situation.