The ‘green shoots’ theory is cloaked ironically in black humour as the shoots in the fields will probably not blossom with the nation being in the midst of a drought. Industrialists are talking of how industry is immune to this phenomenon, even though a drought means more poverty and cattle death. The issue is whether these green shoots are for real or whether they are hyped, imaginary visions.The excitement over a recovery is palpable across the globe where analogies are drawn from the English alphabet, with the recoveries being debated as being U, V or W shaped. The true picture really is dynamic because every time we think we have spotted the rainbow lining to the U (we have not reached the V as yet), there is a downside making the so-called W more plausible in small rather than capital letters. To take an impassioned view, the two sides to the argument may be laid down.First, the green shoots can be spotted from increasing industrial growth rates in the last four months and come against the background of negative growth rates, which really means that things have changed. Growth appears to be sanguine in case of basic, intermediate and consumer durable goods, which is encouraging as it gives hope that if sustained, it can actually forge the strong backward linkages. Cement, coal and electricity segments of infrastructure are looking up, which means that something must be happening.The above is partly reinforced by the numbers on traffic carried in terms of coal by the railways, which has been increasing. The capital markets are up, not in terms of the secondary market indices but plain capital issues as companies are raising more capital through both the debt and equity routes, which must be for investment. There is hence reason to believe that industry is going to invest more, which would not have been the case if they were not very optimistic of production.To a certain extent this story is supported by growth in production of passenger cars and two-wheelers, which implies that contrary to the gloom in the white collar job market, people are spending more, which has probably—and not with certainty—been supported by the banks (the overall picture tells a different story).The other side of the arguments has a longer list. The first is that growth in credit, which is the foremost leading indicator of industrial activity, is slack. Growth in credit for the period April-July has been lower at 1.1% (2.6%) and even the YoY number is lower at 15.8% (25.6%). Second, while industrial growth has been showing a recovery, cumulative growth for the first quarter is still lower than that last year—3.7% as against 5.3%. Third, production and sales of commercial vehicles including tractors are down, indicating that the drought will cast a shadow on this segment. Fourth, corporate performance continues to provide an ambivalent picture. While net profits have been growing, top line growth is missing. Sales have declined and are in the negative territory. Profit growth is more due to sharper decline in costs, which means the sector is becoming efficient, though not really growing.Fifth, while trade deficit has improved due to softer crude oil prices, both exports and imports growth are less than that last year. This is also seen from the port traffic statistics where less cargo is being handled for exports. Sixth, investment in mutual funds, which is a quick indicator of retail participation in the capital market, is lower in the first four months of the year relative to last year. This means that the shine being seen at times in the stock market is more due to foreign institutional activity and not really from within. Finally, WPI inflation numbers are in the negative zone for non-food manufactured products, which have to turn positive to support the turnaround hypothesis.The arguments are tilted against the motion that the green shoots are flowering. The drought is serious and while negative growth in agricultural production in the past does not mean lower overall growth (correlation with industry and services is 26% and 31%), it will call for various policy actions on both monetary (increase in loans, higher NPAs) and fiscal (loan waivers, subsidies) fronts. The so-called green shoots that we are conjuring may last for a longer while as the statistical low base of 2.3% growth in the IIP last year cannot get worse.Also, the predominance of the services sector of which around 40% is in the unorganised sector (such as transport, restaurants, retail trade, etc) may help to deliver good numbers by March 2010.
Thursday, August 27, 2009
Monday, August 17, 2009
Banks: too much capital, little lending: Financial Express: 17th August 2009
The performance of the banking sector in the first quarter of this year has been quite impressive in terms of growth in the top and bottom lines. However, there are two interesting facets which emerge from the numbers presented by them. The first is that there is a difference in the performance of the public sector and private banks and the second is that there is some concern in the areas of impaired assets and, ironically, excess capital. Overall performance was impressive with profits surging by 64.4% for a set of 40 leading banks—25 public sector, 6 new private and 9 old private banks. There are some interesting features. The first is that total income has been aided mainly by the surge in other income, which is primarily treasury income as fee based activity has been on the downswing ever since the financial crisis of 2007. The ratio of other income to interest income increased from 14.3% to 18.8% showing hence a higher reliance on other income. Secondly, net interest income had come under pressure with interest expenses rising faster than interest income. This has been a major concern for banks as they have had to lower their PLR with successive reductions in the reverse repo and repo rates and CRR cuts. This has not been compensated by lower deposit rates, which have been benchmarked to the small savings rate which still delivers 8% nominal return, which could be tax exempt. The third is that the most impressive performance has been put up by the public sector banks in all the top line indicators relative to the private banks. The new private banks, excluding ICICI Bank, have done better than the old private banks. The fourth is that ICICI Bank has adopted a different approach to banking. It has shrunk its balance sheet. This is a conscious policy pursued by the bank, which is also visible when one visits the bank branch. The staff encourages customers to withdraw deposits and invest in insurance products. This has been done on both the deposits and credit sides. The expense bill too has come down with both salary and non-salary based expenses coming down in this quarter.
The fifth is that non-performing assets have increased quite steeply in all banks both at the gross and net levels. It is significant as the rate of growth of the impaired assets is higher than that of the lending portfolio. The gross non-performing assets ratio has remained unchanged for public sector banks at 2.09 while it has increased for new banks to 3.06 from 2.65% and from 2.6% to 2.64% for old private banks. This is a worry because it reverses a trend observed earlier of a decline in this ratio over the years. In fact, Development Credit Bank (2.84% to 10.86%), ICICI Bank (3.72 to 4.63%) and Kotak Bank (3.17% to 4.95%) were the ones with high ratios. The public sector banks had controlled this ratio to less than 3%. For all banks put together, this ratio increased in 9 of the 25 public sector banks, 5 out of 6 new private banks and 4 of the 9 old private sector banks. Growth in non-performing assets is linked with overall performance of the borrowers, industry in particular. With low growth in industry there is an inherent tendency for delinquencies to increase, which is also possible this year with the drought and a possible slowdown in industry lingering. Another feature of the performance is the capital adequacy ratio. Banks have tended to increase this ratio, which is both a blessing and a concern. It is a blessing to know that the banks are well-capitalised and hence future expansion is possible without there being any impediments. However, it is also a concern because high ratios indicate that capital is not being efficiently utilised. Against the Basel norm of 9%, there were several banks which had a ratio of over 15%— 5 out of 6 new private banks and 1 old private bank. The public sector banks had ratios in the double digit range. This is also reflected in the growth in loan portfolio (where the NPA ratios and amount have been used to extrapolate the asset size). Public sector banks have been more active in increasing the loan portfolio relative to the private banks. Therefore, the overall picture when looked at from beyond profits is a bit disconcerting with net interest income being under pressure, too much dependence on other income, non-performing assets growing across banks and banks being over-capitalised —not the way the ideal results profile should look like.
The fifth is that non-performing assets have increased quite steeply in all banks both at the gross and net levels. It is significant as the rate of growth of the impaired assets is higher than that of the lending portfolio. The gross non-performing assets ratio has remained unchanged for public sector banks at 2.09 while it has increased for new banks to 3.06 from 2.65% and from 2.6% to 2.64% for old private banks. This is a worry because it reverses a trend observed earlier of a decline in this ratio over the years. In fact, Development Credit Bank (2.84% to 10.86%), ICICI Bank (3.72 to 4.63%) and Kotak Bank (3.17% to 4.95%) were the ones with high ratios. The public sector banks had controlled this ratio to less than 3%. For all banks put together, this ratio increased in 9 of the 25 public sector banks, 5 out of 6 new private banks and 4 of the 9 old private sector banks. Growth in non-performing assets is linked with overall performance of the borrowers, industry in particular. With low growth in industry there is an inherent tendency for delinquencies to increase, which is also possible this year with the drought and a possible slowdown in industry lingering. Another feature of the performance is the capital adequacy ratio. Banks have tended to increase this ratio, which is both a blessing and a concern. It is a blessing to know that the banks are well-capitalised and hence future expansion is possible without there being any impediments. However, it is also a concern because high ratios indicate that capital is not being efficiently utilised. Against the Basel norm of 9%, there were several banks which had a ratio of over 15%— 5 out of 6 new private banks and 1 old private bank. The public sector banks had ratios in the double digit range. This is also reflected in the growth in loan portfolio (where the NPA ratios and amount have been used to extrapolate the asset size). Public sector banks have been more active in increasing the loan portfolio relative to the private banks. Therefore, the overall picture when looked at from beyond profits is a bit disconcerting with net interest income being under pressure, too much dependence on other income, non-performing assets growing across banks and banks being over-capitalised —not the way the ideal results profile should look like.
Parched Economy: DNA 17th August 2009
The prospect of a monsoon failure and a drought is scary not just because it means the obvious pain caused to people who derive a living from it. A monsoon failure actually affects every segment of the economy. The stress it causes calls for policy actions that would once again upset the apple cart. It goes beyond those numbers shown on the calculators or the back of envelopes.Agriculture per se accounts for around 18 per cent of GDP which means that all those who derive their income from this sector would face declining incomes. Around 60 per cent of our workforce is employed here which means that these families will have to face hardships for the entire year until the next season if they were solely dependent on farming for a livelihood which would be so in over half the families. The meltdown caused by a drought can be traced from the time the harvest is impacted.First, the incomes of the farmers get affected as the kharif crop provides at least 60 per cent of the income to farmers, even those who follow dual cropping covering the two seasons. A loss of income affects their consumption power which gets reflected in lower demand for goods. The limited income earned is used for sustenance. White goods and rural housing (and by implication cement, steel and machinery) will see a fall in demand. A related fallout is unemployment, which can only partly be compensated for by the National Rural Employment Guarantee Schemewhich again provides income for sustenance but cannot start a spending spiral. A more serious fallout is urban migration which has already been prompted by the relative unattractiveness of farming to manufacturing and service jobs (such as unskilled labour, coolies, running small retail outlets, road labour) in cities. This has medium-term implications for agriculture as there will gradually be less labour available to cultivate land.Industry will also be affected in a dual manner. The first is low demand from farmers starting from October onwards when the harvest begins. On the supply side, the food industries will be affected in terms of supply of inputs such as oilseeds, cereals, sugarcane which will increase costs while putting pressure on availability. While industrial growth is still possible at an elevated path notwithstanding this slowdown if the non-rural middle and upper classes continue to spend, that growth would have been smoother with support from the farm sector.Intuitively one can smell higher inflation this year as food prices will continue to be under pressure. The fuel price hike has already increased cost of transportation of farm products and limited supplies will accentuate it. It may just be a goodbye to the 5 per cent inflation number. Typically government's reaction to a drought is to increase the Minimum Support Price (MSP) of all farm products at harvest time which has high latent inflation potential.In the past the government has acted proactively, albeit with a characteristic delay, to supplement domestic production with imports when production falters. It happened with wheat in 2007 and sugar this year. Interestingly, whenever the Indian government plans to import food products, there is a ratcheting of global prices. The trade balance will be affected as imports will increase thus putting pressure on the rupee even if other conditions remain constant.Droughts always invariably lead to higher government subsidies and outlays which mean further pressure on the fiscal deficit. Programmes have to be introduced to provide more employment to the unemployed, increased quotas for those covered by the Public Distribution System, outlays on fertilisers and other inputs. The fiscal deficit level of Rs4.5 lakh crore will be surpassed depending on the extent of government intervention. Therefore, fiscal policy will come for further review in these circumstances which will once again raise questions on government borrowing and movement in interest rates.Lastly, the Reserve Bank of India will have to get active. Anecdotal evidence shows that farm failures invariably lead to interest rate subvention, loan waivers (we are just trying to put to an end the earlier scheme which cost more than Rs70,000 cr) and public sector banks being forced to lend more to farmers through various resuscitation packages.Therefore, the impact of a drought is all-pervasive and all sectors intertwined in some way or the other would have to brace up to face the challenge. Even with its small share in GDP, the farming sector could influence the way in which the entire economy conducts its operations. Unfortunately, there is no solution for avoiding drought -- the only common-sense hint being that we need to spruce up our attempts at providing irrigation to more farm land -- against the low 20 per cent that is covered today. There is really no alternative if we do not want to hear the replay of this story again in the future.
Monday, August 10, 2009
For another Green Revolution: Mint 10th August 2009
A deficient monsoon and rising food prices will continue to be troublesome till demand and supply are resolved
The agriculture saga in India gets repeated almost every year. The two triggers are a delayed or deficient monsoon and higher food prices. This year, there is a combination of the two, which has made the issue even more acute. The official view was that there was no need to panic as the granaries were full, even though the stocks were of only wheat and rice. Imports of foodgrains were banned and we were assured that the monsoon would catch up, which it has somewhat done in July. We probably will end up with a satisfactory aggregate harvest and will soon forget about the problem until next year. And the same saga will start all over again.
There are two sides to this problem. The first is on the supply side. While foodgrain production has increased continuously in the last three years, the performance has been skewed by rice and wheat, while pulses remain neglected. We remain net importers of pulses and higher production in any year merely means that we import less.
The policy thrust has been on rice and wheat; production has been propelled by providing incentives to farmers. The minimum support price (MSP)—the price floor at which the government buys food—of wheat has been increased from Rs630 per quintal in 2003-04 to Rs1,080 in 2008-09, while that of paddy has been increased by Rs300 per quintal during the same period. Production is further bolstered by the presence of the open-ended procurement programme of the Food Corporation of India (FCI).
There have been two consequences. First, farmers prefer to produce these two crops, which in turn reduces the water table level—these crops need relatively more water. Second, the open-ended procurement scheme squeezes private traders. The marketable surplus of rice is around 70%, while that of wheat is 55%. Therefore, when we talk of production of around 80 million tonnes (mt) of wheat this year, only 44 mt enters the market, of which FCI has claimed around 24 mt. This leads to an anomaly where there is surplus production and prices still increase on account of the shortage being inadvertently created. The solution would be to release this stock, which is not being done—ostensibly to retain public confidence!
The second side of the problem is demand: Here, one must realize that with our population growing by 1.4% per annum, individual products need to grow by this level. This has not been so in the case of pulses and oilseeds; this has exacerbated the problem. Shortfall in oilseeds production can be substituted with imports of edible oils; this, however, comes at a price, as international prices respond to India’s demand, given the sheer quantity of imports. In the case of pulses, the conundrum is that we cannot import them easily as there are limited sources of imports and the harvest season in other nations isn’t the same.
The other important factor working towards increasing the demand for food in general is the declining poverty ratio. The Economic Survey 2008-09 has reported that the poverty ratio has come down by almost 9 percentage points between 2000 and 2005. This actually means that around 100 million people have moved out from utter “wretchedness” to a better standard of living, which translates immediately into higher demand for food items beyond the staples of rice and wheat. Therefore, thanks to such economic mobility, demand would be increasing at a faster rate than the population growth and will, hence, have to be matched through higher production or imports.
However, the bigger problem is the cyclical nature of production, which has been alternating between highs and lows. This is because, first, the area under cultivation is not keeping pace with increasing demand. This can partly be explained by the gradual shift of agricultural labour to urban areas, due to the uncertainty in farming. Second, the dependence on the monsoon is still very high. Less than half of cereals production is supported by irrigation, while 85% of pulses are still dependent on the monsoon. Also, just around 30% of oilseeds come under the irrigation belt. The absence of irrigation facilities has contributed further to alienating farmers from their land. Alternatively, they keep changing their cropping pattern, which, in turn, affects the crop output.
What are the solutions? Quite clearly we need to have in place a comprehensive agricultural policy which starts from landholding, inputs, credit, marketing, subsidies and distribution—all of which should be internally consistent. The roles of the state and the private sector should be clearly delineated and adhered to without ad hoc intervention.
We need to improve acreage and yields so that there is a self-sustaining production stream in place—the second Green Revolution. Further, we should seriously consider our pricing policies. MSPs and procurement have caused certain distortions which can be corrected by letting the market forces play a role through futures trading. This way, the procurement process could be capped and targeted primarily at the buffer stock and MSP would be the last resort rather than the first choice for the farmer. Given the shortages that occur in pulses and oilseeds, we could consider buffer-stocking these until we have attained stable production levels. Moreover, we can also conceive of having a system of providing tax incentives to companies, so as to make farming in non-MSP crops more attractive.
Pursuing such a policy will do away with the approach we are taking today, one that myopically looks only at the very short term.
The agriculture saga in India gets repeated almost every year. The two triggers are a delayed or deficient monsoon and higher food prices. This year, there is a combination of the two, which has made the issue even more acute. The official view was that there was no need to panic as the granaries were full, even though the stocks were of only wheat and rice. Imports of foodgrains were banned and we were assured that the monsoon would catch up, which it has somewhat done in July. We probably will end up with a satisfactory aggregate harvest and will soon forget about the problem until next year. And the same saga will start all over again.
There are two sides to this problem. The first is on the supply side. While foodgrain production has increased continuously in the last three years, the performance has been skewed by rice and wheat, while pulses remain neglected. We remain net importers of pulses and higher production in any year merely means that we import less.
The policy thrust has been on rice and wheat; production has been propelled by providing incentives to farmers. The minimum support price (MSP)—the price floor at which the government buys food—of wheat has been increased from Rs630 per quintal in 2003-04 to Rs1,080 in 2008-09, while that of paddy has been increased by Rs300 per quintal during the same period. Production is further bolstered by the presence of the open-ended procurement programme of the Food Corporation of India (FCI).
There have been two consequences. First, farmers prefer to produce these two crops, which in turn reduces the water table level—these crops need relatively more water. Second, the open-ended procurement scheme squeezes private traders. The marketable surplus of rice is around 70%, while that of wheat is 55%. Therefore, when we talk of production of around 80 million tonnes (mt) of wheat this year, only 44 mt enters the market, of which FCI has claimed around 24 mt. This leads to an anomaly where there is surplus production and prices still increase on account of the shortage being inadvertently created. The solution would be to release this stock, which is not being done—ostensibly to retain public confidence!
The second side of the problem is demand: Here, one must realize that with our population growing by 1.4% per annum, individual products need to grow by this level. This has not been so in the case of pulses and oilseeds; this has exacerbated the problem. Shortfall in oilseeds production can be substituted with imports of edible oils; this, however, comes at a price, as international prices respond to India’s demand, given the sheer quantity of imports. In the case of pulses, the conundrum is that we cannot import them easily as there are limited sources of imports and the harvest season in other nations isn’t the same.
The other important factor working towards increasing the demand for food in general is the declining poverty ratio. The Economic Survey 2008-09 has reported that the poverty ratio has come down by almost 9 percentage points between 2000 and 2005. This actually means that around 100 million people have moved out from utter “wretchedness” to a better standard of living, which translates immediately into higher demand for food items beyond the staples of rice and wheat. Therefore, thanks to such economic mobility, demand would be increasing at a faster rate than the population growth and will, hence, have to be matched through higher production or imports.
However, the bigger problem is the cyclical nature of production, which has been alternating between highs and lows. This is because, first, the area under cultivation is not keeping pace with increasing demand. This can partly be explained by the gradual shift of agricultural labour to urban areas, due to the uncertainty in farming. Second, the dependence on the monsoon is still very high. Less than half of cereals production is supported by irrigation, while 85% of pulses are still dependent on the monsoon. Also, just around 30% of oilseeds come under the irrigation belt. The absence of irrigation facilities has contributed further to alienating farmers from their land. Alternatively, they keep changing their cropping pattern, which, in turn, affects the crop output.
What are the solutions? Quite clearly we need to have in place a comprehensive agricultural policy which starts from landholding, inputs, credit, marketing, subsidies and distribution—all of which should be internally consistent. The roles of the state and the private sector should be clearly delineated and adhered to without ad hoc intervention.
We need to improve acreage and yields so that there is a self-sustaining production stream in place—the second Green Revolution. Further, we should seriously consider our pricing policies. MSPs and procurement have caused certain distortions which can be corrected by letting the market forces play a role through futures trading. This way, the procurement process could be capped and targeted primarily at the buffer stock and MSP would be the last resort rather than the first choice for the farmer. Given the shortages that occur in pulses and oilseeds, we could consider buffer-stocking these until we have attained stable production levels. Moreover, we can also conceive of having a system of providing tax incentives to companies, so as to make farming in non-MSP crops more attractive.
Pursuing such a policy will do away with the approach we are taking today, one that myopically looks only at the very short term.
Roti. chawal, dal, sabji and a question: Financial Express August 6, 2009
After inflation and agflation, the new economic phenomenon is foodflation: prices of food items increasing sharply across major product groups. An interesting aspect of foodflation today is that it is not captured by the conventional WPI, and CPI numbers only touch the periphery of the issue. Disaggregated WPI data shows that prices of cereals have increased by 10.9%, pulses by 16.9%, vegetables by 26.1% and sugar by 33.4% (as of July 18th). If retail prices at various centres are tracked over the last few months, the jump in prices seem even sharper. What is happening? And what can be done? There are three parts to the answer to the first question. The first pertains to foodgrains, where production has been higher than last year. However, an inherent upward bias in prices has been provided by the higher MSPs which increased by 30% for paddy and 8% for wheat last year. These two cereals constitute 80% of total cereals production and 70% of total foodgrains. An increase in the MSPs automatically pushes up their market prices. Also with changes in income mobility there has been a tendency for shifting preference to rice and wheat from coarse cereals, which has pushed up demand for these grains. With progressively higher procurement of rice and wheat by the FCI, there has been a squeeze in the private market, thus bringing about this anomaly of coexistence of rising prices and excess stocks of 50 mn tonnes of wheat and rice. The second story pertains to pulses, which have witnessed abnormal increases in prices. The basic problem is that July-September is the period when there are no fresh arrivals in the market. The kharif crop of tur, urad and moong arrives from late September onwards and hence, present consumption has to be met from the stocks of last year. Now, in FY09, there was a fall in production of tur, urad and moong. Unlike rice and wheat where there are buffer stocks which can be used, there is no such option for pulses. One way of augmenting supplies is through imports; but in case of pulses there are limitations in terms of harvest timings in countries like Myanmar and Canada, and supplies will continue to be squeezed until then.
There have been two associated issues here. The first pertains to the impact on rabi crops like chana and masoor, where prices have been volatile, albeit to a lower... extent due to substitution in the consumption of pulses. Further, the months of August till November are the festival season in India, when typically demand for food products increase. The second is that inflation expectations have been heightened by the news of the subnormal monsoon this year. Conjectures are that output will be affected across crops, especially rice, tur and urad on account of deficient monsoon, late sowing and probably late harvest. Hence, monsoon-related inflation expectations have added to the price increase that we are witnessing today. The third part of this story of foodflation is in the area of vegetables and sugar. Vegetables prices have increased due to lower output on account of delayed monsoon and higher transport costs due to the increase in fuel prices announced in June. It must be pointed out that even as the WPI shows a decrease in fuel prices of around 12% due to the impact of high base year, higher diesel prices have fed into the price of transportation, which is irreversible for some time now. The indirect impact of a fuel price increase is more significant than the direct increase and will impact prices of all food products which are primarily transported by road. The higher price of sugar witnessed this year has been brought about by low production and a mess-up in policy. Production declined by over 50% in FY09, and indications are that there could be problems this year too given the possible lower production of cane this year. More importantly there are low carry-over stocks which will exert pressure on the prices this year too. In hindsight it may be said that the policy to export surplus sugar of almost 5 mn tonnes in 2007-08 has perhaps led to the problem of high prices today. Foodflation in India is serious because it affects the real standard of living of all households. So, what can be done? There unfortunately appears to be no immediate solution except imports wherever it is possible. With a slightly longer perspective, we need to revisit our policies to ensure that MSPs, procurement or excess procurement, absence of buffer stocks concept in non-rice and wheat products, export-import of farm products are all looked at as part of a comprehensive policy rather than as adhoc measures, which are the norm.
There have been two associated issues here. The first pertains to the impact on rabi crops like chana and masoor, where prices have been volatile, albeit to a lower... extent due to substitution in the consumption of pulses. Further, the months of August till November are the festival season in India, when typically demand for food products increase. The second is that inflation expectations have been heightened by the news of the subnormal monsoon this year. Conjectures are that output will be affected across crops, especially rice, tur and urad on account of deficient monsoon, late sowing and probably late harvest. Hence, monsoon-related inflation expectations have added to the price increase that we are witnessing today. The third part of this story of foodflation is in the area of vegetables and sugar. Vegetables prices have increased due to lower output on account of delayed monsoon and higher transport costs due to the increase in fuel prices announced in June. It must be pointed out that even as the WPI shows a decrease in fuel prices of around 12% due to the impact of high base year, higher diesel prices have fed into the price of transportation, which is irreversible for some time now. The indirect impact of a fuel price increase is more significant than the direct increase and will impact prices of all food products which are primarily transported by road. The higher price of sugar witnessed this year has been brought about by low production and a mess-up in policy. Production declined by over 50% in FY09, and indications are that there could be problems this year too given the possible lower production of cane this year. More importantly there are low carry-over stocks which will exert pressure on the prices this year too. In hindsight it may be said that the policy to export surplus sugar of almost 5 mn tonnes in 2007-08 has perhaps led to the problem of high prices today. Foodflation in India is serious because it affects the real standard of living of all households. So, what can be done? There unfortunately appears to be no immediate solution except imports wherever it is possible. With a slightly longer perspective, we need to revisit our policies to ensure that MSPs, procurement or excess procurement, absence of buffer stocks concept in non-rice and wheat products, export-import of farm products are all looked at as part of a comprehensive policy rather than as adhoc measures, which are the norm.
Tuesday, July 14, 2009
Unfounded fiscal deficit fears : Mint 14th July 2009
Concerns that the government borrowing programme will crowd out private investment have been overstated
A view normally held is that higher government borrowing tends to put pressure on interest rates—which, in turn, affects the private sector’s ability to invest, and, hence, probably growth. The rationale is that there are fixed sums of money available with banks which have to be deployed as credit or investments. When the government borrows more, then there are fewer funds available for the private sector and there is a crowding out phenomenon. Further—even if funds are available—the cost goes up as yields on bonds rise, which sets the pitch for the deposit and credit rates as they indicate the risk-free rates that have to be adjusted with the premium to be charged. Intuitively, when more government paper floods the market, the price of government bonds decline due to oversupply conditions which, in turn, push up yields. Also See The fiscal deficit for the year is around Rs4 trillion and the borrowing level in net terms is around the same level. Government officials have maintained that there is not going to be any significant crowding out because there are surplus funds in the system to the tune of Rs1-1.5 trillion presently that are being invested by banks in the reverse repo auctions. Therefore, while interest rates are not expected to come down, they would also not move up significantly to cause disturbances. What, then, is the true picture? The accompanying table provides a peep into the past to show how these numbers have tallied when borrowings were high. The first column provides information on the difference between incremental deposits and credit every year, which is the unadjusted surplus (before accounting for the cash reserve ratio, or CRR) that banks could invest in government paper. The difference between these surpluses/deficits and the net government borrowing programme is seen in the next column as the “system’s deficit”. This gives the deficit that was created on account of the government’s borrowing programme after considering the surpluses that were available with banks from their incremental deposits. Different interest rates, such as the prime lending rate, deposits rate for one year, reverse repo and repo rates and the 10-year bond rate, have then been juxtaposed to discern the reaction of interest rates to this situation. It’s not wrong to say that interest rates have been influenced more by policy rates than by existing liquidity Now, the deficit in funds has been present in eight of the 10 years, with the deficit being very high in fiscal 2005 and fiscal 2006, which has now peaked in fiscal 2010. However, interest rates have shown a continuous decline up to fiscal 2004 and fiscal 2005 and then increased subsequently before declining in fiscal 2010. The rate of increase or decline in interest rates has not been related to the quantum of the system’s deficit increasing or decreasing, and appears to be more a part of a trend. In fact, it would not be incorrect to say that interest rates have been influenced more by policy rates than existing liquidity. Government securities (G-Sec) rates were relatively marginally more related with liquidity when the deficit was high. There is evidently a conundrum here, where we are witnessing large borrowings that are not being financed by the banks, leading to a deficit. Yet, there are surplus funds in the banking system as evidenced in the reverse repo auctions. And interest rates are not in sync with the liquidity trends. How does all this add up? To begin with, it must be pointed out that banks are one set of entities that purchase government paper. Reserve Bank of India (RBI) data for March shows that banks hold around 40% of government paper, followed by insurance companies with 23%, RBI with 10% and primary dealers and provident funds with around 10% each. Therefore, while banks are the most important supplier of funds, the same flows from other entities too. Two, the market stabilization scheme (MSS) of RBI helped to absorb surplus funds a couple of years ago, and these funds have been used astutely to finance the government borrowing programme in the form of unwinding of the same. Three, RBI has been reducing CRR at regular intervals to provide more funds. Since September, for example, a reduction of 400 basis points in CRR meant a supply of at least Rs1.5 trillion. Lastly, key bank interest rates have been guided, though not dictated, more by policy rates than implied liquidity. In fact, even the G-Sec rates which should be most affected by liquidity have a countervailing force that works in the government’s favour. When deposits growth is tardy, savings get channelled into other avenues such as insurance or provident funds which, in turn, invest in government paper. Hence, as long as the gross domestic product is growing and the marginal propensity to save is increasing, there will always be funds for the government—unless there is a major shift to the capital markets. Besides, bank deposits are rarely substituted with equity, as the class of investors is different, as is the risk profile. All this means that we really may not have to despair of the large government borrowing programme for the year, and the system may just be able to tide over this hurdle with minimum pain.
A view normally held is that higher government borrowing tends to put pressure on interest rates—which, in turn, affects the private sector’s ability to invest, and, hence, probably growth. The rationale is that there are fixed sums of money available with banks which have to be deployed as credit or investments. When the government borrows more, then there are fewer funds available for the private sector and there is a crowding out phenomenon. Further—even if funds are available—the cost goes up as yields on bonds rise, which sets the pitch for the deposit and credit rates as they indicate the risk-free rates that have to be adjusted with the premium to be charged. Intuitively, when more government paper floods the market, the price of government bonds decline due to oversupply conditions which, in turn, push up yields. Also See The fiscal deficit for the year is around Rs4 trillion and the borrowing level in net terms is around the same level. Government officials have maintained that there is not going to be any significant crowding out because there are surplus funds in the system to the tune of Rs1-1.5 trillion presently that are being invested by banks in the reverse repo auctions. Therefore, while interest rates are not expected to come down, they would also not move up significantly to cause disturbances. What, then, is the true picture? The accompanying table provides a peep into the past to show how these numbers have tallied when borrowings were high. The first column provides information on the difference between incremental deposits and credit every year, which is the unadjusted surplus (before accounting for the cash reserve ratio, or CRR) that banks could invest in government paper. The difference between these surpluses/deficits and the net government borrowing programme is seen in the next column as the “system’s deficit”. This gives the deficit that was created on account of the government’s borrowing programme after considering the surpluses that were available with banks from their incremental deposits. Different interest rates, such as the prime lending rate, deposits rate for one year, reverse repo and repo rates and the 10-year bond rate, have then been juxtaposed to discern the reaction of interest rates to this situation. It’s not wrong to say that interest rates have been influenced more by policy rates than by existing liquidity Now, the deficit in funds has been present in eight of the 10 years, with the deficit being very high in fiscal 2005 and fiscal 2006, which has now peaked in fiscal 2010. However, interest rates have shown a continuous decline up to fiscal 2004 and fiscal 2005 and then increased subsequently before declining in fiscal 2010. The rate of increase or decline in interest rates has not been related to the quantum of the system’s deficit increasing or decreasing, and appears to be more a part of a trend. In fact, it would not be incorrect to say that interest rates have been influenced more by policy rates than existing liquidity. Government securities (G-Sec) rates were relatively marginally more related with liquidity when the deficit was high. There is evidently a conundrum here, where we are witnessing large borrowings that are not being financed by the banks, leading to a deficit. Yet, there are surplus funds in the banking system as evidenced in the reverse repo auctions. And interest rates are not in sync with the liquidity trends. How does all this add up? To begin with, it must be pointed out that banks are one set of entities that purchase government paper. Reserve Bank of India (RBI) data for March shows that banks hold around 40% of government paper, followed by insurance companies with 23%, RBI with 10% and primary dealers and provident funds with around 10% each. Therefore, while banks are the most important supplier of funds, the same flows from other entities too. Two, the market stabilization scheme (MSS) of RBI helped to absorb surplus funds a couple of years ago, and these funds have been used astutely to finance the government borrowing programme in the form of unwinding of the same. Three, RBI has been reducing CRR at regular intervals to provide more funds. Since September, for example, a reduction of 400 basis points in CRR meant a supply of at least Rs1.5 trillion. Lastly, key bank interest rates have been guided, though not dictated, more by policy rates than implied liquidity. In fact, even the G-Sec rates which should be most affected by liquidity have a countervailing force that works in the government’s favour. When deposits growth is tardy, savings get channelled into other avenues such as insurance or provident funds which, in turn, invest in government paper. Hence, as long as the gross domestic product is growing and the marginal propensity to save is increasing, there will always be funds for the government—unless there is a major shift to the capital markets. Besides, bank deposits are rarely substituted with equity, as the class of investors is different, as is the risk profile. All this means that we really may not have to despair of the large government borrowing programme for the year, and the system may just be able to tide over this hurdle with minimum pain.
Why should anyone farm? 3rd July 2009 Financial Express
The Union Budget is normally seen as a policy package or concessions to be given to India Inc while paying formal obeisance to the common man by giving a few concessions. Agriculture and rural development keep getting allocations that have never really been analysed; and with the exception of the NREG, which has been successful, there has been no concerted action taken to boost agriculture. The Economic Survey, which is a precursor to the Budget, shows that even though agriculture plays a vital role in the prospects of industry besides sustaining employment to a large number of households, its share in GDP has declined from 21.7% in FY04 to 17.8% in FY09. Also, its share in capital formation has been declining over the years. As the recent monsoon forecast is not too favourable, we need to address this issue head-on in the Budget. The government’s reactions to droughts, low harvests and suicide deaths have followed a fixed pattern. To begin with, we delay the acceptance of the problem. When the problem arises, we brush it aside as being atypical and not pandemic. Then we panic and look for the causes. While trying to apportion the blame, we decide to import the product. When India decides to import, we push up global prices and end up paying more. The solution is in terms of increasing MSPs quite mindlessly —mindless because while this helps to reward the farmer better for one crop, it leads to crop shifting which solves the problem of one crop but transfers the same to another one. Also, once increased, prices cannot be rolled back. Budgets react to an agrarian crisis by going in for loan waivers and interest rate subventions that transfers the problem to banks. When they cry foul over their NPAs and lower profits, the amount then gets into the fiscal deficit of the government. Intuitively the question that should be posed is whether or not it is possible to eschew this chain of agony by simply budgeting for practical numbers in a phased manner based on a firm policy. In simple terms, this means that we need to have a comprehensive farm policy that tackles the issues of land under cultivation, inputs for farming and improving yields. The Economic Survey has highlighted that food grains production in FY09 was just about at the same level as FY08. Also, the area under cultivation has come down for food grains and oilseeds and increased marginally for sugarcane. Not much progress has been witnessed in area under irrigation except for oilseeds in the last decade, while productivity remains stagnant at best. With output levels remaining uncertain, farming is not an attractive proposition today and there has been a tendency for migration to the urban centres where unskilled labour still finds jobs that provide a sustainable income stream. Hence, we have a situation where demand for farm products has gone up and supply is erratic. The results are seen in constant price spikes for consumers and desperation for farmers who have been driven to extreme action at times when crops fail in the face of indebtedness. Under these conditions, there is the need to usher a new Green Revolution where we have a comprehensive package of quality of seeds, irrigation facilities, pesticides and fertilisers that is spread across the country and the crop spectrum. The funds have to necessarily emanate from the government if they are to come on a large scale as this is analogous to contract farming or corporate farming schemes, which however are restricted to the choice made by the company concerned. Assuming a cost of Rs 15-30,000 for a small pump set, the government could upfront provide the same to a fixed set of farmers every year. Providing 1 million such sets would amount to up to Rs 3,000 crore, which can be provided by the Budget. To make this work, there is of course the need to continue supplying free power to the farmers. The same could be done for seeds, fertilisers and say pesticides so that we are able to have a broad-based strategy for growth in agriculture. The basic point is that we need to provide the inputs gratis to the farmers if we are to encourage them to remain in business. MSPs and credit are only supplements that cannot solve the problem. More importantly, we need not always be reactive to agriculture as we are well aware of the cycles and amplitudes of farm growth. Planned growth in agriculture is doable and will eschew a crisis and hence be more pragmatic.
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