India can mark a turning point & re-energise G20: Free Press Journal: 1st April 2023

 

Given India’s clout on the global stage, there are expectations that this summit will make a difference and that members do fall in line and help to foster policies which are mutually beneficial given that all nations are not ideologically tuned in one direction

What does G20 mean to the common man? First, it must be something big as India is hosting the top 20 countries in the world which can be seen in the banners posted across the country along with the flags of the member nations. Second, all the cities that are being visited by the delegates have been spruced up making them look nice. Third, there has been a lot of business for the businesses like cloth, paints, banners, plant suppliers, conference halls, hotels, transport operators, guides etc. as there would be over 200 meetings held across almost 30 centres during a year, with the big one being in September in Delhi. Last, on the other side, there would be a host of inconveniences for the public every time the delegates arrive and depart as it involves ‘seamless’ travel.

What exactly is the G20 and how relevant is it? As the term suggests there are 20 nations involved where 19 are countries and European Union is the 20th entity. These nations together account for 80% of world GDP and 75% of exports covering 60% of the population. But ironically there is no formal office or secretariat and hence it is a formal get together of 20 entities to have informal discussions. The Presidency is by rotation which means that every member will get it chance and this has been the way since the financial crisis in 2008 though the forum was established in 1999. Last year it was driven by Indonesia and in the next two years will move to Brazil and South Africa. There are hence equal opportunities given to all the nations which strive to make a difference. We have taken up this challenge at a time when the world is in a phase of turmoil with political tensions and possible recession being topped by the recent banking crisis in the USA.

Hence unlike the WTO or IMF where there is a website linked with the organisation, in case of G20 the country which assumes Presidency does all that is needed to spread the word. The G20 will deliberate issues on climate change, finance, health etc. In fact, the separate chapters that exist range from anti-corruption to culture and infrastructure. But the twist here is that while there can be agreement, no country is forced to implement what is decided. Hence it can end up being just sharing of ideas, which may not be a bad thing given that these nations are the dominant ones.

Given India’s clout on the global stage, there are expectations that this summit will make a difference and that members do fall in line and help to foster policies which are mutually beneficial given that all nations are not ideologically tuned in one direction. For example, Donald Trump was vehemently against free trade, migration and climate change deliberations. In such a case arriving at a consensus would always be a challenge. Similarly while health is one issue which will dominate the proceedings, it is accepted that the G20 failed to do anything significant to alleviate the Covid situation as all countries followed their own policies. There was never a case of countries working together for a solution. Better communication across these nations could have helped to firm up a solution that could be used across the world - not just a case of preventing the spread but also ensuring that the vaccination drive was uniformly implemented.

At the political level, it is fairly impotent as the group has China and Russia as members, but will never be able to work out a solution on Ukraine as this issue will fall outside the perimeter. The distancing of nations from China’s political ambition in Taiwan or even the rise of extremism in Turkey make the Group quite irrelevant on the political front.

It would be interesting to also see if the countries can arrive at any agreement on elements which are eroding the concept of globalisation. There has been a move towards de-globalisation of late with all countries focusing on their domestic economies which has come in the way of freer trade. This is one reason as to why WTO, which is a larger formal organisation with 164 members, has failed. The challenge is in getting this core team to agree on a formula that can take the world economy back on the path of globalisation. Here we will have to reconcile this goal with our stance of Atmanirbhar India which has had Make in India at its core. USA would have to take a harder look at the concept of ‘Make America Great’ again. In fact of late the ‘Make in America’ doctrine has gained in weight as the government gives direct subsidies to encourage investment.

Such forums are platforms for discussing issues where any single party is not directly affected (like Russia conversing on Ukraine). But the challenge is to get on the same page on the economic front. This is where we need to display our influencing skills to drive home the point. One can hope that there are firm decisions which are taken especially in the areas of investment, health, inclusion, agriculture, and sustainable development. In the light of the recent developments in the banking system in USA, financial stability would be one issue that would occupy the centre stage as it is not just not about institutions that have jolted but also the fallout of the crypto maze which has affected markets.

This would be a turning point as far as we are concerned in influencing global leaders to move towards a stronger economic commitment. While there are other forums which address specific issues, we can be optimistic of being more effective this time given the rapid strides made in several of these fields. Our example can be a template to be followed by others.

Heavier tax on debt funds will hit our corporate bond market hard : Mint 27th March 2023

 

The withdrawal of India’s capital gains tax benefit on debt mutual funds is significant for various reasons. The first is that it seems aimed at the country’s overall goal of a tax structure that is simple, with few exemptions and benefits. Second, following from the first, it indicates that over the next few years, just as all debt is taxed in a similar manner, equity sops may also end. Already dividends are taxed at the slab rate and no capital gains are tax-free. The ₹1 lakh limit may also go at some point. Third, while the market absorbs these announcements, it should be prepared for further such changes that withdraw tax benefits. Alternative structures are presently being offered for income tax and corporate tax. One may expect convergence in the next few years.

Is this a good move? For the government, it is evidently good as tax revenue increases, which is what it needs, given that today’s structure offers limited buoyancy. The economy is stuck in a 6-8% growth band and a 10% rate that can generate more revenue looks like a long journey. Therefore it is a winning situation, as returns on savings held in debt will draw slab-rate revenue.

For mutual funds, this is a setback because debt funds account for around a third of total assets under management (AUM). So the withdrawal of a tax benefit that is probably their main allure will mean a shift of funds away to either equity/hybrid schemes or fixed deposits and directly bought bonds. Even within debt funds, schemes loaded with, say, government securities had been giving lower returns of 6-7% but looked better with the tax benefit. In fact, an anomaly was that if one purchased corporate bonds giving an 8% return, the interest earned was taxed at the slab rate. However, in the hands of a mutual fund, after adjusting for fund expenses, one could pay just 20% tax on an indexed value if held for at least three years.

For individuals, this is a big blow. The only balm applied is that it would hold for investments made post 1 April 2023, unlike the last time when the ‘long term’ definition was changed from 1 to 3 years where it was imposed retrospectively. Logically, if the government earns higher tax revenue, it has to be paid by unit holders, whether corporates or retail investors. As the economy has been hit with relentless inflation of 6% plus for three successive years, the capital gains sop helped to partly protect returns. Form now onwards, this benefit disappears.

Banks and NBFCs would be better off now. In fact, they had been arguing for the same capital gains benefit on deposits kept for 3 years and above as was the case with debt mutual funds. Now a level playing field has been provided, as that benefit has been altogether abolished. More funds are likely to flow into deposits now; and after assessing the situation, banks could also lower their rates as there are no risk-free alternatives for savers.

 

That said, the biggest blow is for India’s corporate bond market. There have been several attempts made to grow this market by the government, Sebi and RBI. Now two things will push the market back significantly. First, the ability of mutual funds to invest is limited by final investors opting for such schemes. If they migrate away from them, then demand for corporate debt will come down.

Second, at the retail level, this move is quite detrimental. Individuals as a rule should not get directly into the debt market because it is hard to understand the dynamics of bonds. Unlike equity, where a company’s share is easy to identify and hence buy and sell, bonds pose challenges. Bonds have a coupon rate and a tenure, and as time elapses, their implicit yield is hard to grasp. Besides, there is not much trading that takes place for most, which means they cannot be bought and sold easily.

Presently, investors buy units of a mutual fund scheme which in turn invests the money. Now with their net returns coming down sharply, it does not make sense to invest in debt funds. While RBI has been trying to get retail investors to invest directly in government securities, it made more sense for people to invest through a mutual fund window, not just for returns but also access to liquidity. Now, one has to think hard before entering this market, as it is not easy to sell securities that do not trade on a daily basis.

The setback to India’s market for corporate bonds is probably the most significant impact of this latest move. Companies with a lower rating of, say ‘A’, which could hope to attract mutual fund money, will now find it harder to find investors. At the retail level, there is risk aversion for lower-rated bonds. The ability of mutual funds to invest in debt depends on how savers deploy their funds. While corporates would still consider such deployment, retail investment, which accounts for 55-60% of the sector’s total AUM, would surely draw back from the debt segment.

Given the way in which Indian tax laws have evolved over the past 10 years, one could see the change announced on 24 March coming. Equity market gains would also be taxed at the slab rate once the logic of a level playing field comes to determine tax policy. The rationale offered would be that providing equity-gain sops has not moved the needle of private investment.

Money matters: Here’s a hard-hitting commentary on state of capitalism, inflation and policy: Book Review in Financial Express 26th march 2023

Rethinking Money and Capital is quite an interesting book that looks at the subject in a novel manner. Author Swapnil Pawar takes a rather unconventional approach and comes up with some rather far-reaching and hard-hitting commentary on the state of capitalism, inflation, policy, etc. For a non-economist to convincingly argue out logically his themes is quite refreshing, though he does use the economist’s tools to put things down for easy understanding. Hence there are several equations drawn up to explain his methods for reaching the conclusions.

For instance, he does argue that the invisible hand is not quite that powerful and may not lead to optimal solutions. Therefore, one cannot seek solace in the markets taking care of problems because they are basically inefficient. As an extension, he has a chapter which explains how laissez faire leads to aggravation of inequality, which is something that can be seen not just in countries like USA but also India, where everything is controlled by capitalists. This also leads to what he calls a quasi-feudal society, and depending on the way one defines feudalism, the argument is worthy of consideration. When the means of production are controlled by the elites, who also have the power to control policy making, then one does drift gradually to a tiered society where the rich are the strong and are the ones who control everything. This can be said as being typical even in our country.

Blank vertical book template.

The author treads different territories while writing on money and capital. We talk a lot of money and finance, which he feels are not resources like labour or capital. It is a means of transaction but not a resource that should come in the way of consumption or capacity expansion. Money, as per the author, has now transcended the conventional central bank-controlled components with the proliferation of capital markets, and, more recently, cryptocurrency. This also means that the power of monetary policy gets restricted because what the central bank controls is how the financial system that it oversees operates. The other sections are outside and can work in a different direction.

These conclusions are debatable, but are pertinent arguments that can be discussed. In fact, Pawar stretches these arguments to also show that fiscal policy is more effective than monetary policy because of its direct effect on spending either through expenditure or taxation.

He also puts forth the view that the limits being put on fiscal deficit may not be justified. His proposition is that as long as the debt is in domestic currency it should be okay and a default will never take place. He also pitches for an independent government body or board which oversees expenditure of the government. In a way the Finance Commission and the FRBM rules are already in place and perform a similar role. While the concept is good, ensuring that it is truly independent which can say ‘no’ to the government is difficult.

Here it may be counter-argued that the inflationary consequences are dire even when the debt is domestic as has been witnessed in some of the Latin American or African nations. Such a theory would hold in a country like the USA where the dollar is the global anchor currency. But at any rate the idea of the government playing a more important role when the economy is down is worthy of consideration.

The author also has some suggestions for rapid growth in the same vein. He speaks of not being obsessed by the fiscal deficit. This may not have support from economists, as his view is that governments have to come in when private sector is on the sidelines. The problem, however, in India is that most of the deficit goes into financing revenue, which is not what it should be. He also talks of having a wider inflation band for targeting. Here, too, this thought of having a band of 5-10% which is suggested may not mean much, because it becomes too flexible for interpretation.

He gets a bit into a knot when he asks for more tax breaks for investment to the private sector. At other places he cautions how the laissez faire model leads to semi-feudalism. Therefore, when his suggested roadmap talks of giving concessions to this structure, the reader may be a bit confused.

In a way one can interpret the author’s views as coming from a layman who knows what should be done, with the economists being left to work out how they can be implemented. There is talk also of universal basic income, higher government spending, export promotion, keeping interest rates low (goes against his concern of dissaving in the economy), etc. These ideas that have been put forth here may be at odds with one another, but are interesting nonetheless.

Rethinking Money and Capital: New Economics for QE, Stimulus, Negative Interest, and Cryptocurrencies

Swapnil Pawar

Leadstart

Pp 359, Rs 399 

The economics of employment and growth looks upside down : Mint 23rd March 2023

 

Bankable move. Lessons from global banking crisis: Business Line 22nd March 2023

 Silvergate Bank, Silicon Valley Bank, Signature Bank and Credit Suisse are names that have caught the headlines in the last few weeks. While Credit Suisse is a well-known name in India, the other three are not too familiar as they operate mainly in the US. Yet, the way in which these stories unfolded sequentially is unsettling.

The question raised is how secure is the banking system? Post Lehman, the Bank for International Settlements (BIS) strengthened capital norms, with Basel III laying down the guidelines. Yet, this has not prevented a crisis from erupting. This raises the question: Is this the end of the meltdown or are there other banks in line which are waiting to explode? This is notwithstanding the fact that the factors driving these banks to a crisis state are different.

These stories are probably not directly related to banks in India. Silvergate is a bank which was involved with crypto trading which is now no longer a favoured activity. In fact, the concept of crypto will fade in the next few years as it has been realised that the model is not sustainable.

SVB collapsed not because of an asset quality issue but on account of a rather unique model that focused on start-ups. Deposits came mainly from start-ups, and while there was some lending again to start-ups, the bank invested most of its funds in government paper (our own payments bank model, where funds are invested in G-Secs and T-bills). Signature Bank was into start-ups and crypto, which naturally caused panic. A rescue in the form of New York Community Bancorp buying it is on the cards.

Last, Credit Suisse, a Swiss bank, had its challenges in terms of its lending portfolio which had caused some controversy last year. But the losses incurred due to its varied business activity which spanned wealth and investment banking besides commercial banking now has a bailout by the Swiss National Bank and a takeover by UBS. These episodes, some of which are related to one another, will go down in history as the next financial crisis coming as it is post-Covid, during the Ukraine war and recession in the West.

The difference from the Lehman crisis is that all the regulators have stepped in immediately, which makes a difference. The RBI too has given assurance that the Indian banking system is strong. In Europe, central banks are evaluating the spillover effects of the Credit Suisse debacle to ensure that similar strains are not in evidence in their systems. So what are the lessons or implications for us in India?

The first lesson is that the SVB story shows that while the focus is often on the asset portfolio, the liabilities structure is equally important. There are prudential guidelines on exposure levels when it comes to lending, to ensure that there is no concentration of risk. But the idea that there is risk carried when there is concentration on the deposits side is quite novel.

Having start-ups as major sources of deposits engendered the crisis as a sudden withdrawal created panic. Banks in India need to look at their deposits to ensure that such a structure has not developed. This would hold more for smaller banks which could see such concentration.

Second, the travails of having a large investment portfolio is another message from this episode. Holding on to US treasuries appeared to be a safe bet. But with interest rates going up, the revaluation of the portfolio and booking of losses can be significant. Clearly,banks must review their risk management and treasury practices keeping in mind this development.

Third, it has always been argued that banks need to ensure that they specialise in commercial banking and lodge other activities in subsidiaries with their independent capital structures. The problem with Credit Suisse is that losses made on investment banking and the withdrawal of funds in the wealth management business led to a threat on the commercial banking balance sheet, which was steady when viewed independently.

In India, this weakness was recognised earlier itself and hence all other activities like investment banking, merchant banking, insurance, mutual funds, etc., are operated through other arms. This ensures that there are strong risk walls across different businesses.

Crypto has anyway not been recognised in India, which keeps it insulated from the impact of the failure of the other two banks. In fact, post these incidents, there is a strong case for banks across the world to ensure they keep business away from crypto-related activity as the downside from a collapse is substantial.

No direct impact

While  prima facie it appears that the Indian banking system is not going to be directly impacted by these episodes, there is a need for introspection. Individually, banks would need to go back to their balance sheets and evaluate the concentration levels in deposits and loans. The treasury departments need to work with the risk team to ensure that the investment portfolio is handled prudently. Further, the vulnerabilities of companies with respect to their debt service coverage ratios need to be evaluated on a continuous basis to gauge the risk carried on their portfolios.

There is also a case for the RBI to review the limit on deposits insurance, which is presently ₹5 lakh; this could be raised to ₹10 lakh. Maybe one can consider categorising banks into those more vulnerable, where the insurance level is increased. Banks incidentally have to pay the insurance premium to Deposit Insurance and Credit Guarantee Corporation.

At the global level, there may soon be discussion on whether there is need to create special buffers for such contingencies — Basel IV, probably? This can lead to higher capital requirements for banks. Also, there would be a need for more stress tests covering both market and credit risk as part of the learning.

Anchoring expectations: Financial express 22nd March 2023

 Quantitative ‘tightening’ was always considered to be a tough job for the Federal Reserve once the Lehman crisis seemed to be behind us. After keeping interest rates close to zero for too long and pumping in funds by buying government securities, the Fed did everything possible to protect the system. During the pandemic, the preferred solution, once again, was to lower the interest rate and open the taps. The Reserve Bank of India too did everything possible to protect growth by lowering the repo rate. Rolling back the same was, however, always going to be a challenge.

In the US, the Fed has increased rates by 450 bps with the possibility of more rate hikes. The story of the Silicon Valley Bank (SVB) is relevant here because when a bank buys safe securities (when interest rates are low), it also means that their prices are high. Now, with the Fed raising rates, the prices have come down, and if a bank wants to sell bonds it holds, it will face financial loss. In this situation, are US treasuries safe or ‘toxic’? SVB had invested in treasuries on the assumption they were safe assets!

This is interesting because almost all countries hold their forex reserves partly in dollars. While the exact amount is not revealed, given the total stock of forex reserves in the world, one can guess that countries could be holding anything between 60-70% of their reserves in dollars. These reserves are normally used to sort out balance of payments. But if any country were to sell these securities to get dollars, they would have to sell at a loss in an era of rising interest rates. For example, the 10-years bond gave a yield of 1.51% in 2021 and now averages around 3.60% in 2023. Therefore, the value of such securities has gone down significantly over two years.

The second part of the story of ‘easing followed by tightening’ pertains to the targeted Fed rate. Bringing it to zero had a rationale. But when things normalise, what should the market expect the rate to be? Should it be 1% or 2% or 3%? This part of the picture is not yet painted. 

Would the same apply to India? True, the repo rate has been increased from 4% to 6.5%, but the bond yields have been sticky and increased by just around 40-50bps. Therefore, while there would be a decline in the value of bonds that have to be revalued, the hit on the profit and loss account will be buffered to that extent. Further, given that these valuations are made every quarter, losses are booked along the way so that when the final sale is made, the shock is minimal. 

But, the process of tightening has had an impact on the lending rates quite perceptibly, as ever since the external benchmark concept has come in, loans like those for housing have been linked to this benchmark. This worked in the borrower’s favour when the repo rate came down to 4%. Now, with an increase of 250 bps, the transmission is instantaneous and it is not surprising that such borrowers are unhappy.

The lesson at the country level is that very easy monetary policies should have a short time-frame and not be continued for a long period of time. This is so because when the unusual situation that led to low interest passes, customers are used to the teaser rates and expect the same to continue forever. And this can never happen. There is hence more pressure on the central bank from industry bodies as well as the government to lower the repo rate or not increase the repo rate, because the base rate of 4% is always at the back of the mind. 

There should be signals to foretell that things will ‘mean revert’ in terms of policy rate. The question would be what would be this ‘mean’? Ideally, when the MPC rules of engagement were drafted—under which, inflation was targeted at 4+/-2%, there could have been some indication given on the normal repo rate in the form of a range as well. By not giving such a range, the normal repo rate is open to interpretation or conjecture. When the repo rate was lowered to 4%, it was known that this was an extraordinary measure. But, to now look at a normal repo rate at something above this mark would be logical. 

Hence, what is necessary is to anchor the repo rate or the Fed rate to a normal. Data on repo shows that over the last 20 years before the pandemic (when it started at 4.4%), it was only in 2009-2010 that the policy rate was at 5%. A level of around 6% appears to be a fair value going by the median and mean. The Fed funds rate would average around 1.5%. But can the past be a good measure for looking at the future?

One way out would be to have an indicative real interest rate for the policy benchmark. There is again nothing sacrosanct about such a number, but talking of one can temper expectations. Hence, targetting a real repo rate of 1 or 1.5% will anchor expectations. If it is stated that a particular level of real interest rate is targeted, just like the inflation rate with the band, then it would be easier to anchor expectations in future. This will hence serve as signals of how the central bank may behave given the inflation trajectory.

A lesson from the losers: Financial Express 19th March 2023

 There have been several books written on successful corporate honchos. They tell us how these leaders did things right. But in life, everything does not go right; and there can be patterns in failure. Hence, we need to also know what not to do. This can be known from experience of leaders who failed, and here Nandini Vijayaraghavan makes a difference with her book Unfinished Business. She looks at four corporate failures which involved leaders who were larger than life but came down in ignominy. Their case studies should be useful for students, as well as aspiring leaders. It is a book written with objectivity and backed by hardcore facts and incisive research.

The author has chosen four businessmen who were household names for all the wrong reasons. These are VG Sidhartha of Café Coffee Day, Vijay Mallya, Naresh Goyal and Anil Ambani. While their stories followed a similar pattern, the curious part is that no one raised a flag when their models ceased to work. This is probably the advantage of being a corporate celebrity where even brash actions are overlooked or justified on grounds of believing in the bigger picture.

There was a commonality among them. All of them had flashy lifestyles, which was part of the persona that they built for themselves. As long as the going was good, they were not just style icons, but also market gurus. The fall has reversed this view as they are now untouchables.

How did this happen? The problem started with buildup of large quantities of debt to finance businesses which were loss making. Yet there were grandiose actions of investing or buying other companies in different fields. The author attributes this to absence of acumen required to keep a business afloat in tough times.

The specifics of the book are extremely interesting as she starts from scratch. For example, the author takes us through the history of the aviation industry, which begins with Air India and Indian Airlines. There was politics involved even before the skies were opened up. Reading this section one would ask the question as to why should businessmen be interested in an industry where volatile fuel costs, abnormal operating costs, competitive pricing prima facie make the enterprise potentially less viable. It is always a struggle to survive.

Here, both Mallya and Goyal made all the wrong moves when they went in for expansion through consolidation as they had eyes on the overseas market. She also raises a pertinent point on the models pursued in the industry. One can run a low-cost or a full-service airline. According to Nandini, one cannot combine the two, which is what Jet and Kingfisher did, which brought about their downfall. This is quite a deep thought because it is relevant even today, as the new Air India and Vistara Airlines are looking like pursuing the same model. And if this being done strategically in the market, they should be aware of the possible pitfalls. In contrast, the author explains the Indigo model which is the low cost carrier. It works very well not just from the point of view of optimisation of aircraft use, but also in terms of using an approach of purchase-sale-lease of aircraft.

Interestingly, she points out that all these protagonists were empire builders who built ‘memorable brands’, which cannot be denied. They also had good relations with those in power, which helped them get closer to lenders. It is a different thing that this money finally was in jeopardy as these enterprises failed. Mallya and Ambani were MPs, while Sidhartha was related to a former chief minister. Goyal had clout at the ministry level to formulate policy and also had ties with the underworld. With such strong brand names, banks loosened their purses and failed to do due diligence, probably because of political patronage.

Now having political connections and bank backing also gave them abundant access to the equity market, and hence got investors to put in their money. Low investor awareness reflecting naiveté allowed them to raise money at substantial premium. The pitfalls of promoter financing became all-encompassing when this equity was used as collateral with banks and mutual funds joined the bandwagon.

Another commonality was that they focused a lot on scale rather than sustainability, which made it hard to meet debt commitments. The problem with such high leverage was that three out of four, which excludes Mallya, were not able to generate enough cash to finance their operations. Mallya had a good cash cow in the UB group, but this was not adequate to sustain the debt levels.

The author also has some very interesting stories that are narrated at the right place. These include Mallya and his partner carrying seven pieces of luggage and calmly flying out of New Delhi in a Jet Airways flight.

There is another on Dhirubai Ambani’s early life of how he converted coins to metal and made a fortune. The wars between the Ambani and Wadia family is also touched upon and the role of lobbying with the government by Dhirubai is quite revealing. She also points to the differences in the Ambani brothers in terms of competence.

Unfinished Business: Evolving Capitalism in the World’s Largest Democracy has very useful insights on how failed companies came to be what they became. Will these be a lessons for others is the pertinent question.

Unfinished Business: Evolving Capitalism in the World’s Largest Democracy

Nandini Vijayaraghavan

Penguin Random House

Pp 364, Rs 599s

Spectrum: Lessons India can take away from the SVB crisis: Free Press Journal 18th March 2023

 

The problem can be if start-ups in India have set up subsidiaries in the USA which have dealings with SVB. A collapse of the SVB will mean that the subsidiaries can be affected negatively and if the liability falls on the parent company, then the issue will get localised.

The SVB episode is now over a week old and one is better positioned to assess the impact. In terms of being a well-known bank to the general public, SVB would not feature in the list. But it is important to the world of start-ups. The model followed was quite rudimentary and there did not seem to be anything amiss here. The bank had mainly start-ups as its customers. They would put in the funds they received from venture capitalists to run their business. SVB in turn would use these funds for lending or invest in bonds which could be owned by the government or private sector. It would also be extending loans to the start-ups. 

The second part was the tricky one. As interest rates rose in the USA, the low coupon rates on bonds which were issued when interest rates were low in 2020-21 meant that there would be losses on valuation. Therefore the bank shifted the bulk of its bonds portfolio to what is called the HTM part, which means ‘held to maturity’. These bonds carried no revaluation losses as they were not traded and could be taken at face value on their books. The AFS, or ‘available for sale’, bonds were the ones which had valuation issues. 

SVB's fall

Now with the recession in the USA and the Fed raising rates there was a tendency for venture capitalists to stop funding the start-ups. Besides the days of easy money were over as the Fed has been tightening rather than easing the strings. The start-ups now found that they had a problem running their business and hence wanted to withdraw their deposits. SVB had not bargained for this situation and started selling the bonds in the AFS category to garner funds to repay deposits. 

This meant that they were sold at a lower price, thus making losses. It spurred panic across the market which was felt even on the Indian bourses. The Fed has said that while deposit money would be saved the investors would not, which means that the bank can collapse. The point put forward is that unlike the Lehman crisis, when there was intervention from the top, there would be no such provision made for this episode. 

How is India positioned here?

First, Indian banks do not have dealings with SVB directly and hence should not be affected. Second, the start-ups run by Indians which have deposits in SVB are those which are based in USA and not in India. Therefore a ripple effect on Indian banks looks unlikely. Third, the Indian banks do not have concentration of liabilities in one sector and hence do not even remotely resemble this bank. Fourth, the asset side of the books are diversified as regulation ensures that there are limits to large exposures on companies and groups. Therefore, the risk is in general low. 

Where can there be apprehension? The problem can be if start-ups in India have set up subsidiaries in the USA which have dealings with SVB. A collapse of the SVB will mean that the subsidiaries can be affected negatively and if the liability falls on the parent company, then the issue will get localised. And if the parent company has dealings with Indian banks, then there can be issues. Given that some of the big banks have stated that their exposure is virtually non-existent there seems to be less of a concern here. 

However, just like how Lehman started with one bank and then spread to others, it needs to be seen as to how things pan out in the USA. If there is a meltdown across all such banks which have niche customers, then even the larger ones would be impacted. The picture so far is that it is more of a micro rather than a macro issue. 

While the financial system stands strong and will come out unscathed, the challenge would be for start-ups. Most of them get venture funding which will be coming in a trickle with all this apprehension. Further it has been seen in India that most of the IPOs of start-ups have not quite done well in the market, which means equity funding will also be a challenge. The Indian government is working out a module which will enable them to park their deposits in IFSC which will address their immediate needs. 

At the institutional level a lesson learnt is that even on the liabilities side there is need for banks to have diversification. So far the focus is more on assets where normally problems emanate. Concentration in a certain industry or ownership group poses risk to the bank and is hence regulated by the RBI. But on the deposits side, so far attention has never been paid. SVB’s problem was that deposits were kept mainly of start-ups leading to substantial concentration. Also, on the assets side, having a large investment book runs the risk of valuation all the time. This fact is known. However, a situation like this where the bank had to sell its investments to get funds to repay deposits is quite unique. There would be greater introspection in the US in particular where there are niche banks catering to the demands of specific industries. This episode also offers a lesson to regulators to also look at the liabilities side when drawing up prudential rules.

Weather report. Shadow of El Nino over growth: Businessline, 11th March 2023

 El Nino is a term which sends jitters across the world. The reason is simple. El Niño is described by the FAO as “a naturally occurring phenomenon characterised by the abnormal warming of sea surface temperature in the central and eastern equatorial Pacific Ocean. On average, it occurs every two to seven years and can last up to 18 months”.

During these phases one can expect normal precipitation patterns to get disrupted, leading to extreme climate events. This can be in the form of droughts or even flooding. Experience in the past shows that globally agricultural production is affected; the impact is not localised to specific countries. Therefore, governments get concerned when there is talk of El Nino developing.

The last strong El Nino event was in the period 2014-16. There have, however, been less severe ones in this century after the strong event in 1997-98. We had a smaller event last in 2018-19. Given that the frequency can be between 2-7 years, the fact that it seems to be developing in the Pacific Ocean raises a red flag as it is around seven years since we had the last severe event.

Kharif crop prospects

The immediate issue of concern is the prospects of the kharif crop during an El Nino event. This is so because on an average around 60 per cent of the crop is rainfall dependent, and hence any deviation can harm prospects. This tends to be more significant for crops like pulses and oilseeds besides cotton where prices too tend to add to the vulnerability.

Rice could still be managed as the northern States of Haryana, Punjab and Uttar Pradesh do have access to irrigation. But not so for other States. As the kharif crop is approximately 50 per cent of total agricultural output, the magnitude is serious.

The accompanying table shows how agricultural production (as per GDP data) has moved when there have been episodes of El Nino, 2015-16 being the larger one.

It is clear that if there is an El Nino event, there is a significant likelihood of a decline or deceleration in agricultural production. In the last big event there was a decline in one year and low growth in the next one, hence impacting two years’ growth in value added in agriculture.

Foodgrains production remained largely flat in the years 2012-13, 2013-14 and 2014-15 at 128, 128.6 and 128 million tonnes respectively. Meanwhile, the fears of slowdown loom large; growth is expected to be in the region of 6-6.5 per cent in FY24.

Under normal monsoon conditions, it is assumed that agricultural growth would be at the trend rate of 3.5 per cent. If there is a shortfall, it will affect both supplies of farm products as well as demand from rural households thus pushing back overall growth.

The kharif season attains more prominence as the timing coincides with the festival season when typically there is higher spending on consumer products including automobiles post-harvest. So a poor kharif crop tends to slow down festival spending. Therefore, close monitoring of El Nino is important and the government should be prepared with a contingency plan.

Today, inflation is a tough nut to crack with core inflation being high. Food inflation has come down due to prices of horticulture products and edible oils easing significantly even while cereals have registered high inflation numbers. This trend can get exacerbated in the event of a sub-normal monsoon with pulses and oilseeds crops being affected. Further, concerns on the prospects of the wheat crop remain at this point of time, even though there has been a spell of rain in north India.

An unrelenting heat wave at this time in north India last year led to wheat output dipping to 107.7 million tonnes as against 109.6 million tonnes in 2021. This resulted in a sharp spike in the prices of wheat and wheat products. Wheat inflation has been high at 23 per cent going by the WPI for January with average inflation for the 10 months period being 15.9 per cent. Similar trends were witnessed in the CPI inflation numbers.

Government response

What can the government do in such a situation? An El Nino event is not a certainty, yet the government should be prepared for it. The IMD could study the past patterns and indicate the regions that would be most vulnerable. States should provide consultancy services to the farmers to be prepared for such an adversity and advise on cropping action.

Continuous weather and price signals need to be provided on a real time basis. For this to be effective, the ban on futures trading in certain farm products like rice, pulses, oilseeds needs to be removed so that proper signals are received. The market is the best indicator of perceptions and futures prices will indicate how much the crops would be affected. Or else one will have to rely on futures prices on global exchanges which is probably not the best option.

Further, to buffer against a possible shortfall in output of some prime commodities, there should be contingency plans in place such as sourcing imports. And finally the government needs to ensure that banks are sensitive to this issue so that credit flow to farmers remains uninterrupted.

The noise in the economic data: Financial Express 11th March 2023

 

Rollercoaster! In the bankers’ vault: Financial Express 12th March 2023

 Banking discourses are always serious and focus on areas such as capital adequacy, asset quality, and fintechs more recently. But what goes on behind the banking walls and bankers? This is something we know little of; and it is here that Tamal Bandyopadhyay tells us all in a book, curiously titled  Rollercoaster. The title can be misleading as it can convey the impression that the book is all about various crises in the banking sector, especially as the history of banking in India is replete with several episodes. But Tamal has a different spin as he talks about bankers in general and his experiences in this world.

Tamal is probably one of the most respected journalists in the field of banking and gains entry to all offices of bank CEOs quite easily. If this is not impressive, he also manages to talk to those on Mint Street. Add to this his continuous monitoring of these big stars; he has gotten to know about not just how they operate but also their eating habits or fascination for footwear.

He is able to provide the reader with several stories, exposing along the way the idiosyncrasies of the characters. So what does he do?

He starts off in a rather dry manner on how he started his journey as a regular journalist, and while the reader may wonder what is going on, he takes us to the cupboard of the publication he worked with, which had copies of board papers of a public sector bank. Yes, these papers used to leak out through photocopies as the board comprised a member from the unions in the Eighties. From this point, he takes us through three main sections and ends with stories of bankers through different time periods and their travails.

Tamal provides some insights on the relations between PSBs and the members of the joint parliamentary committee (JPC). His take is that members of the JPC are those whom the government cannot accommodate as ministers. But being in the JPC gives them the status of a minister. Hence, when a meeting is convened, a PSB becomes the sponsor and has to provide hospitality. The members are normally not interested in the proceedings and prefer to go sightseeing or meet friends when the meetings are on. Their level of awareness can be gauged from an incident where a PSB head of a Tokyo branch was asked as to what was he doing to spread  ‘rajbhasha’ in Japan.  

We all have strong views on demonetisation. The advocates talk of it as being a visionary step, while the other side thinks it was not an intelligent idea at all to begin with. But bankers have their story of trauma, and here Tamal narrates a story. Bankers had a harrowing time trying to manage customers with varied emotions. There was no protection for them against fraud, and they had to manage this transition with little staffing. The author writes it would have been fair for the government to have rewarded all bankers. The incident of a banker who found rules had been changed in the short window of his bio break will make the reader smile.

Tamal has three interesting sections on public sector bankers, private bankers and RBI governors. He talks of the misuse of power of unnamed PSB chiefs and the rather feudal structure followed here. He talks of a lot of interference from the top, which, however, has stopped since the middle of the last decade. Also, he writes quite a bit about how the positions at the top are rigged, which means not just currying favour from politicians, but also payments being made through brokers. (Brokers had a big role to play in getting clients too and took a cut in the interest rate charged). These brokers are also called merchant bankers. He admits that all this stopped when the BBB—Banks Board Bureau—was constituted, which streamlined the appointments process.  

Interestingly, he does not have any good stories to share about public sector bankers. It is possible that they were less willing to engage in conversations with the author or they just lacked gravitas to attract attention. But he has a lot to talk of private bankers and doesn’t shy away from taking their names. The two disgraced bankers of ICICI Bank and Yes Bank have already had their stories told, which are distasteful. But could this be happening in other private banks, stories that have not yet come out, is the question that the reader may ask?

Blank vertical book template.

There is a lot of eulogy for chiefs of HDFC Bank (on which the author has written a book earlier), IDFC Bank, Axis Bank and Kotak Bank. The author mentions some quirks of these people, like the second in line of a bank being forced by the CEO to take his ferocious dogs for a walk in Lonavala, or another one making them walk on hot coal as part of leadership training. These could be surprising to the reader.

Tamal is bang on when he concludes his chapter on private bankers by saying that some of them never encourage a second line to foster. This stems from the fact that they are keen to carry on forever. While the author does not name these star CEOs, one can know whom he is alluding to if one studies the tenures and history of those mentioned.
The third section on RBI is also insightful. One gets to know what happens on those high floors as he writes about various governors and their personalities. Some of them as deputy governors would be nervous when they were called by the governor. Also, the reader gets a sense how governors in general maintain a distance from even the deputy governors, and protocol is followed for entry and exit to the governor’s cabin. There are some stories on the wives of governors who were obsessed with the garden on Carmichael Road or held regular bhajans to keep the gods pleased.

This is a book that provides for interesting reading. One is never disengaged and the style of storytelling keeps the reader hooked. Interest in this book will extend beyond the banking community to the corporate world. While the title may not be quite appropriate for the subject, the book is definitely a different proposition.

Rollercoaster: An Affair with Banking

Tamal Bandyopadhyay
Jaico Publishing House
Pp 340, Rs 499