Whenever we talk of budgetary challenges, attention invariably turns to the expenditure side where we pontificate on whether the government should spend more on subsidies or project expenditure. This is so because, unlike individuals who have an income to spend, the government has a list of expenses, and has the prerogative to then see how this money can be raised. When all things fail, it can always borrow, which individuals cannot do. Should this thinking actually change?
Once we get into the FRBM framework, there is always pressure to perform and governments then walk the razor’s edge of balancing revenue with expenditure. Revenue generation is actually an extraneous concept because while the rates are fixed by the government, the assumptions made are on certain growth targets being realised. When they do not materialise, then problems start.
The main source of revenue is taxation. The ability to increase revenue depends on the taxable base increasing steadily, for if it does not, then the entire edifice stars cracking. Income tax, for example, showed an elasticity of 1.3 to growth in GDP in the last five years, meaning thereby that if our GDP in nominal terms grows by, say, 15% (sum of, say, 8.5% real GDP and 6.5% inflation), then income tax receipts could grow by 19.5%. Similarly, the elasticity of corporate tax collections is around 0.80 for the last 5 years while that of customs is 1.36 with respect to change in imports. Curiously, in FY09, when imports soared due to high imports of crude oil when prices had touched the $150 mark, the government reduced the tariffs sharply, which led to a fall in customs collections. Excise has not shown any clear trend, though low growth in industry has necessarily meant low collections. Quite clearly, the revenue collections for the government are, in a way, beyond its purview and the assumptions made could go awry.
Last year, the government based the budget on 9% GDP growth, which though in retrospect looked ambitious, seemed okay then as the economy had grown by 8.5% in FY11. Now that this has been scaled down to 7%, inflation has helped to maintain the growth in base. But the problem is that IIP growth has been lacklustre while corporate profits have shown signs of declining in the third quarter. Clearly, revenue has come under strain because the growth scenario has not materialised.
The point here is that the government should hence start off a different note and try and operate like an individual or corporate entity. As there is a move to manage public debt through the ministry and not RBI, the amount of borrowing should be capped with limited flexibility to deviate from this number. Alternative budget scenarios should be drawn up in terms of ‘conservative’ and ‘optimistic’ outcomes. The starting point hence for FY13 could be nominal GDP growth of 12% at a conservative level, including 7% real GDP and 5% inflation and, say, a higher number of 14%, which can go with IIP growth of, say, 6% and 8%, respectively. Revenue collections could then be drawn up on how various sectors including the service sector would behave during the year under these scenarios. The borrowing level could then be added here to have a feel of the maximum resources to be mobilised through conventional means.
The expenditure part is where the government would have to take a tough call. There are basically three kinds of expenditure. The first is mandatory, such as interest, over which there is no choice. The second is subsidy, where it should cap it on grounds that it will not spend more and, in case we are talking of fuel subsidy, the public has to bear the additional cost if global prices increase. The same holds for, say, food subsidy where the MSPs and issue prices are worked out with no flexibility for any further discussion once fixed. Intuitively, we are integrating the petroleum and agriculture ministries in this exercise. The third would be project expenditure, which is what is really required for growth. This would be a residual and will increase depending on the resources being garnered. Therefore, project expenditure becomes the last component and can actually be earmarked to, say, disinvestment. Disinvestment is a dicey component because it materialises only when the market does well. If it does not, then there is a reputation risk carried when it is undertaken. To eschew such controversy, the two may be linked.
Does this sound too simplistic? In fact, even today, the government invariably lowers project expenditure towards the end of the year once there are strains in terms of revenue collection. As interest, subsidies are non-negotiable; the onus does fall on capital expenditure. This model only makes an extension to capping all expenditures so that there are no slippages.
Do budgets work like this anywhere? The answer is no, but since we are in uncertain times when our macro projections have gone awry too often, we need to think differently. There could still be slippages on account of revenue falling in case the two scenarios we talk of do not materialise. But this will be an improvement. The downside is that the private sector has to play a larger role in investment and cannot really depend on the government for the big push. Is this acceptable?
Saturday, March 10, 2012
Why not MFI Banks: Financial Express: 2nd March 2012
Are there alternative ways of addressing the MFI issue, considering that the new proposed guidelines for priority sector lending earmark 9% of credit for this segment? Everyone wants this segment to benefit, though we are not sure of the structures that have to be created or modified. The fact that banks do not do non-collateralised lending means that it is outside their purview or else they would have been there given their expansive branch network. The existing structure of MFI lending appears to be flawed in terms of the cost of credit for the MFIs that have pushed up the lending rates, which makes non-repayment attractive.
One thought here is that we can think of creating new banks that are dedicated to micro-lending. This addresses the issue of cost of funds for the MFIs, as once they are allowed to garner deposits, their cost of operations comes down and they are better positioned to lend at lower rates, which could improve repayment schedules. Today, they are not allowed to collect deposits, which pushes up the cost of funds as they borrow from reluctant banks that charge anywhere between 14-20%, given the risk. By allowing specialised MFI banks, we can leverage their expertise in terms of dealing with non-bankable public.
The structure for such banks can be that either an existing MFI becomes an MFI bank, or new MFI banks come into being. They should be allowed to operate only in the rural areas, and lending can be to only the lowest income class that is not covered by banks. The maximum amount of money that can be lent to an individual (R25,000) can be fixed along with tenure (1 year) and repayments (weekly, fortnightly, monthly). A rural credit bureau should be set up simultaneously as it will help to spread the word about the creditworthiness of borrowers. As the UID scheme works out, it becomes easy to integrate the same. These MFI banks would need to bring in a minimum amount of capital; and to start with R200 crore that, with a capital adequacy norm of 12%, will enable lending of around R1,600 crore.
On the liability side, these banks should be allowed to raise deposits from the public and offer rates that could probably be lower than what a bank gives with fewer restrictions such as minimum account size and withdrawals. By allowing access to deposits, we can cap the lending rate in a manner that makes it less usurious and at the same time profitable. There should be the CRR and SLR norms too so that the integrity of the system is maintained. Lending, however, could be only micro-credit. The SLR will ensure that banks actually earn some revenue from these investments, and as they mature could be allowed to trade in GSecs. Therefore, with pre-emption of, say, 30%, the balance can be used for lending purposes. It will resemble crudely the concept of a narrow bank that focuses on micro-lending and investments.
Capital infusion will be important and there are two options. The first is to have new players who satisfy a financial and expertise criteria or we could have an existing MFI becoming an MFI bank. This can be either by the MFI going public or choosing to be bought by a bank owned by corporate entity. The latter option is of interest here. Banks generally do micro-credit lending indirectly and could use such subsidiaries to run these operations. With their financial strength, these models become scalable. Banks who acquire and run such outfits could further be incentivised by allowing them to include such lending which is indirect as priority sector lending, much like the way that it is being done through the NBFC route.
The entry of corporates is another option for an existing player. Companies such as ITC, Godrej, Mahindra & Mahindra, Amul, HLL, etc, have done a lot in the rural space in terms of integrating their operations at the grassroots. Owning an MFI bank would fit in with their business models as it strengthens their own base in these geographies. In terms of the borrowers, they get a complete solution once they start borrowing from an MFI bank, which simultaneously leads to access to other facilities like deposits and creates a new culture that can later be linked with other financial products such as insurance.
To make these models cost-effective, one will have to leverage technology, and while a brick-and-mortar structure is essential to inspire confidence to the populace, operations should be linked by technology so that costs are reduced. The use of local staff with strong local knowledge will be helpful for screening loan applications.
There is evidently need for us to do something more definite in the micro-credit space. The existing models worked well before running into barriers and the creation of new banks may just be the solution. Currently, securitisation of their loans appears to be taking off, which means that we are integrating this concept with commercial banking. The last mile becomes that much closer once we establish these specialised banks with strong regulatory control.
One thought here is that we can think of creating new banks that are dedicated to micro-lending. This addresses the issue of cost of funds for the MFIs, as once they are allowed to garner deposits, their cost of operations comes down and they are better positioned to lend at lower rates, which could improve repayment schedules. Today, they are not allowed to collect deposits, which pushes up the cost of funds as they borrow from reluctant banks that charge anywhere between 14-20%, given the risk. By allowing specialised MFI banks, we can leverage their expertise in terms of dealing with non-bankable public.
The structure for such banks can be that either an existing MFI becomes an MFI bank, or new MFI banks come into being. They should be allowed to operate only in the rural areas, and lending can be to only the lowest income class that is not covered by banks. The maximum amount of money that can be lent to an individual (R25,000) can be fixed along with tenure (1 year) and repayments (weekly, fortnightly, monthly). A rural credit bureau should be set up simultaneously as it will help to spread the word about the creditworthiness of borrowers. As the UID scheme works out, it becomes easy to integrate the same. These MFI banks would need to bring in a minimum amount of capital; and to start with R200 crore that, with a capital adequacy norm of 12%, will enable lending of around R1,600 crore.
On the liability side, these banks should be allowed to raise deposits from the public and offer rates that could probably be lower than what a bank gives with fewer restrictions such as minimum account size and withdrawals. By allowing access to deposits, we can cap the lending rate in a manner that makes it less usurious and at the same time profitable. There should be the CRR and SLR norms too so that the integrity of the system is maintained. Lending, however, could be only micro-credit. The SLR will ensure that banks actually earn some revenue from these investments, and as they mature could be allowed to trade in GSecs. Therefore, with pre-emption of, say, 30%, the balance can be used for lending purposes. It will resemble crudely the concept of a narrow bank that focuses on micro-lending and investments.
Capital infusion will be important and there are two options. The first is to have new players who satisfy a financial and expertise criteria or we could have an existing MFI becoming an MFI bank. This can be either by the MFI going public or choosing to be bought by a bank owned by corporate entity. The latter option is of interest here. Banks generally do micro-credit lending indirectly and could use such subsidiaries to run these operations. With their financial strength, these models become scalable. Banks who acquire and run such outfits could further be incentivised by allowing them to include such lending which is indirect as priority sector lending, much like the way that it is being done through the NBFC route.
The entry of corporates is another option for an existing player. Companies such as ITC, Godrej, Mahindra & Mahindra, Amul, HLL, etc, have done a lot in the rural space in terms of integrating their operations at the grassroots. Owning an MFI bank would fit in with their business models as it strengthens their own base in these geographies. In terms of the borrowers, they get a complete solution once they start borrowing from an MFI bank, which simultaneously leads to access to other facilities like deposits and creates a new culture that can later be linked with other financial products such as insurance.
To make these models cost-effective, one will have to leverage technology, and while a brick-and-mortar structure is essential to inspire confidence to the populace, operations should be linked by technology so that costs are reduced. The use of local staff with strong local knowledge will be helpful for screening loan applications.
There is evidently need for us to do something more definite in the micro-credit space. The existing models worked well before running into barriers and the creation of new banks may just be the solution. Currently, securitisation of their loans appears to be taking off, which means that we are integrating this concept with commercial banking. The last mile becomes that much closer once we establish these specialised banks with strong regulatory control.
Book review of : Transforming Capitalism: Business World 20th Feb 2012
For The People, Too
A collection of Arun Maira's previous writings, the book emphasises how the capitalist growth model must have a human face to be meaningful
Despite being an anthology of articles written over years, Arun Maira’s Transforming Capitalism is sheer brilliance. It is straight from the heart, and tells us that the capitalist growth model must have a human face to be meaningful. Maira, a member of the Planning Commission, demolishes several excuses for the existing inequality in the model of economic Darwinism. He questions nine myths. Here are some of them. We cannot grow the pie and wait for the trickle down effects to take place, saya Maira. The poor have to be taken along in the growth process. Also, saying the poor should try harder is a feeble statement given that initial conditions are different for them. And we cannot leave it to the private sector to address inequality.
The business of business cannot be only business, says Maira, as there are repercussions to be faced. We see this today in terms of hostility to private sector expansion. The approach of ‘just do it’ cannot be viewed in isolation and we need to take society with us. Finally, it cannot be just the left or right view, or being or not being with a principle, it has to be somewhere in between.
The capitalist has to think of the other party as a citizen and not just a consumer. We need to think of this citizen as not just having access to the product, but also owning it. This is really a cogent way of putting it. And that take is one of the reasons for saying this book should be read by every CEO. Even if 10 per cent of them act on Maira’s lines, our society will be better off.
A collection of Arun Maira's previous writings, the book emphasises how the capitalist growth model must have a human face to be meaningful
Despite being an anthology of articles written over years, Arun Maira’s Transforming Capitalism is sheer brilliance. It is straight from the heart, and tells us that the capitalist growth model must have a human face to be meaningful. Maira, a member of the Planning Commission, demolishes several excuses for the existing inequality in the model of economic Darwinism. He questions nine myths. Here are some of them. We cannot grow the pie and wait for the trickle down effects to take place, saya Maira. The poor have to be taken along in the growth process. Also, saying the poor should try harder is a feeble statement given that initial conditions are different for them. And we cannot leave it to the private sector to address inequality.
The business of business cannot be only business, says Maira, as there are repercussions to be faced. We see this today in terms of hostility to private sector expansion. The approach of ‘just do it’ cannot be viewed in isolation and we need to take society with us. Finally, it cannot be just the left or right view, or being or not being with a principle, it has to be somewhere in between.
The capitalist has to think of the other party as a citizen and not just a consumer. We need to think of this citizen as not just having access to the product, but also owning it. This is really a cogent way of putting it. And that take is one of the reasons for saying this book should be read by every CEO. Even if 10 per cent of them act on Maira’s lines, our society will be better off.
Growth, Sustainability and India's Economic Reforms: Book review in Business World 20th Feb 2012
Growth, Sustainability, And India’s Economic Reforms
By T.N. Srinivasan
Oxford Univesrity Press India
T.N. Srinivasan’s contribution to economics has been remarkable. And this book, a collection of four of his talks, reflects his key arguments. Tracing the progress of the economy over the past six decades, the book is a good commentary of how our doctrines evolved in tune with the times. Evidently, Srinivasan is against the controlled system of economic governance and supports reforms, which he feels is what we should be working on in future to move ahead. While the first phase of the economy (1950-80) was one of control typified by the licence raj, the second (1980-92) was of profligacy. But this was when the first seeds of liberalisation were sown. The third, 1992-2008, is Srinivasan’s favourite, where India moved towards consolidation and growth numbers were impressive until the financial crisis hit. This was the time for unshackling the economy. More importantly, it showed a lot of political will among all ruling parties.
The book also carries interesting commentaries from economists M. Narasimham, Y.V. Reddy, Sankar De and Rakesh Mohan. Mohan does not share the author’s view that ours was a “bullock-cart system” and uses his own experiences at the RBI to refute this thought. This adds interest in reading as the views are not always in agreement with the author’s.
By T.N. Srinivasan
Oxford Univesrity Press India
T.N. Srinivasan’s contribution to economics has been remarkable. And this book, a collection of four of his talks, reflects his key arguments. Tracing the progress of the economy over the past six decades, the book is a good commentary of how our doctrines evolved in tune with the times. Evidently, Srinivasan is against the controlled system of economic governance and supports reforms, which he feels is what we should be working on in future to move ahead. While the first phase of the economy (1950-80) was one of control typified by the licence raj, the second (1980-92) was of profligacy. But this was when the first seeds of liberalisation were sown. The third, 1992-2008, is Srinivasan’s favourite, where India moved towards consolidation and growth numbers were impressive until the financial crisis hit. This was the time for unshackling the economy. More importantly, it showed a lot of political will among all ruling parties.
The book also carries interesting commentaries from economists M. Narasimham, Y.V. Reddy, Sankar De and Rakesh Mohan. Mohan does not share the author’s view that ours was a “bullock-cart system” and uses his own experiences at the RBI to refute this thought. This adds interest in reading as the views are not always in agreement with the author’s.
Saturday, February 25, 2012
Testing times for the regulator: Financial Express 21st February 2012
The MCX IPO is an important development not just because it will be one of the bigger ones that will hopefully lift the market but also because it spurs debate on the public issue of a company that comes under what is called financial infrastructure. This has been discussed at length when the Jalan committee commented on the same with respect to stock exchanges in 2010. This would probably be a precursor to the listing of other exchanges, including stock exchanges, which can possibly provide some buoyancy to the respective markets.
To begin with, it should be stated that in a free market economy everything should be permitted and in case there are any apprehensions, they should be addressed through regulation rather than prohibition. If regulation is in place and the regulator is strong enough, then it should not really matter whether it is a stock exchange or a manufacturing company that is getting listed. There are global examples of listing of exchanges—the CME group, Intercontinental Exchange, NYSE Euronext and London Stock Exchange. The last two are listed on themselves. But it is nonetheless necessary to visit the debate once more.
Let us look at the more conservative set of arguments against such listing. Financial infrastructure companies serve a broader goal of public service for society and hence should not be motivated by profit as they are public goods. Once listed, their goal would be to maximise profits for the shareholders and for better valuation, which can lead to a conflict of interest with their own rules and regulations. Rules may be compromised to appease brokers and regulation may be flouted. This is but natural because when the idea is to increase profits that are also linked to the ESOPs offered to managers, then there is an attempt to be lenient.
They could also misuse their oligopolistic power to charge higher prices, which can then distort the market. The process of price discovery itself could, hence, be in danger in case there is insider trading, which can be perpetrated to increase business. Besides, since such business is typically a closed supplier group, entrepreneurs could come in, increase valuation and then exit, thus leaving behind weaker institutions as there is less commitment to the enterprise. Last, the existence of a dicey troika of owner, manager and broker, where each one is dependent on the other, sows the seeds for impropriety.
These arguments can actually be countered quite forcefully with the following. Does not this hold for any enterprise in any field? Second, if exchanges are financial infrastructure, then aren’t banks also the same? Don’t banks use public money (which exchanges do not) and, hence, carry greater risk at the bourse than the exchanges? Third, exchanges are not really public goods since those who use it make money and the promoter puts his own money to create it, unlike a public good where the government spends and everyone benefits. Fourth, even public sector companies are listed which are owned by the government, in which case the same should be permitted for exchanges. Also the government is earning a lot from disinvestment by virtue of this listing. Why not exchanges? Fifth, on the issue of the troika of relationships, it can be addressed by laying down prerequisites for such listings. This leads to the final counter-argument where the clue really is regulation. Exchanges should be allowed to list only if the regulator is strong and can ensure that the rules of the game are observed. All the issues raised earlier can be addressed by the FMC for MCX and Sebi for any stock exchange that could get listed in course of time.
Today there are various rules set for shareholding pattern and, to ensure interest in the project, there can be a minimum holding time period before divestment can be done. Further, market watch and surveillance has to become more important at both the exchange and regulator levels to ensure that trading takes place in an orderly manner. Also, broker dealings have to be examined even more closely in the commodity market by the FMC as well as Sebi once the listing takes place because any information or news on wrongdoing can create havoc in both the commodity and stock markets. The onus or test is really on regulation once such a listing takes place. Such listing, however, has not really created problems elsewhere in the world, and hence there is reason to believe that it should be similar here too.
Therefore, the listing of MCX is going to set the tone for more advanced versions of financial liberalisation where systems will be tested as this will logically provide opportunities for stock exchanges. The commodity market is relatively larger in terms of the number of players though, admittedly, it is still dominated by around 3-4 entities which is still more than the stock market. The FMC will have a job on its hand from now onwards and, going by its past record, can be depended on to ensure that trading is orderly, considering that in the last eight years or so ever since such trading was resurrected there has not been any trouble in this market, which tells a lot on its performance.
To begin with, it should be stated that in a free market economy everything should be permitted and in case there are any apprehensions, they should be addressed through regulation rather than prohibition. If regulation is in place and the regulator is strong enough, then it should not really matter whether it is a stock exchange or a manufacturing company that is getting listed. There are global examples of listing of exchanges—the CME group, Intercontinental Exchange, NYSE Euronext and London Stock Exchange. The last two are listed on themselves. But it is nonetheless necessary to visit the debate once more.
Let us look at the more conservative set of arguments against such listing. Financial infrastructure companies serve a broader goal of public service for society and hence should not be motivated by profit as they are public goods. Once listed, their goal would be to maximise profits for the shareholders and for better valuation, which can lead to a conflict of interest with their own rules and regulations. Rules may be compromised to appease brokers and regulation may be flouted. This is but natural because when the idea is to increase profits that are also linked to the ESOPs offered to managers, then there is an attempt to be lenient.
They could also misuse their oligopolistic power to charge higher prices, which can then distort the market. The process of price discovery itself could, hence, be in danger in case there is insider trading, which can be perpetrated to increase business. Besides, since such business is typically a closed supplier group, entrepreneurs could come in, increase valuation and then exit, thus leaving behind weaker institutions as there is less commitment to the enterprise. Last, the existence of a dicey troika of owner, manager and broker, where each one is dependent on the other, sows the seeds for impropriety.
These arguments can actually be countered quite forcefully with the following. Does not this hold for any enterprise in any field? Second, if exchanges are financial infrastructure, then aren’t banks also the same? Don’t banks use public money (which exchanges do not) and, hence, carry greater risk at the bourse than the exchanges? Third, exchanges are not really public goods since those who use it make money and the promoter puts his own money to create it, unlike a public good where the government spends and everyone benefits. Fourth, even public sector companies are listed which are owned by the government, in which case the same should be permitted for exchanges. Also the government is earning a lot from disinvestment by virtue of this listing. Why not exchanges? Fifth, on the issue of the troika of relationships, it can be addressed by laying down prerequisites for such listings. This leads to the final counter-argument where the clue really is regulation. Exchanges should be allowed to list only if the regulator is strong and can ensure that the rules of the game are observed. All the issues raised earlier can be addressed by the FMC for MCX and Sebi for any stock exchange that could get listed in course of time.
Today there are various rules set for shareholding pattern and, to ensure interest in the project, there can be a minimum holding time period before divestment can be done. Further, market watch and surveillance has to become more important at both the exchange and regulator levels to ensure that trading takes place in an orderly manner. Also, broker dealings have to be examined even more closely in the commodity market by the FMC as well as Sebi once the listing takes place because any information or news on wrongdoing can create havoc in both the commodity and stock markets. The onus or test is really on regulation once such a listing takes place. Such listing, however, has not really created problems elsewhere in the world, and hence there is reason to believe that it should be similar here too.
Therefore, the listing of MCX is going to set the tone for more advanced versions of financial liberalisation where systems will be tested as this will logically provide opportunities for stock exchanges. The commodity market is relatively larger in terms of the number of players though, admittedly, it is still dominated by around 3-4 entities which is still more than the stock market. The FMC will have a job on its hand from now onwards and, going by its past record, can be depended on to ensure that trading is orderly, considering that in the last eight years or so ever since such trading was resurrected there has not been any trouble in this market, which tells a lot on its performance.
Bring Farmers to the bourses: MInt 20th February 2012
With the commodity futures market reaching new levels, it is time to make this platform more meaningful
The commodity futures market has once again come into focus as it has become an interesting option for investors. However, the question to be posed is whether or not it has helped in fulfilling the objective of helping farmers to hedge, which was the motivation behind resurrecting this market.
The market had a turnover of over 1.5 times of the gross domestic product at market prices in FY11 while the equity futures market had a multiple of 1.3 and derivatives, including options, had a multiple of 3.8. However, curiously even today, the share of agri futures is just about 10%. India now has leading global volumes in bullion, comparable volumes in energy and non-precious metals, but not much in agri products. India by virtue of its size and population is a leading producer or consumer of all farm products, which sets the contours for potential of futures trading.
But the story has not quite gone the way it was conceived. There have been severe hiccups along the way with bans on trading in products such as tur, urad, wheat, sugar, soy oil and chana. The ostensible reason was that futures trading caused inflation—a theory that has been refuted. The Abhijit Sen committee showed that there was not enough evidence to prove that futures trading was related with inflation. The recent two years of inflation experience clearly points to the absence of such a relation as none of the traded products was part of the inflation numbers. This means that it is time to make this platform more meaningful with these preconceived notions being dispelled.
Presently, futures trading in farm products is predominantly on NCDEX and the most sought after products where price discovery takes place is the oil seeds complex (soya bean, soy oil, mustard), spices (pepper, cumin seed), chana, guar seed, sugar and wheat. Traders in commodities are hedging and given the efficient price discovery process futures have set benchmarks for the spot markets too. But the farmers are out of this scheme. Why?
First, there is absence of awareness. Second, they have limited access to these platforms. Third, their production levels are lower than that of the contract sizes. The exchanges can bring it down in case there is liquidity or else the contract flops. Presently, it is based on the economical size of delivery lots. Fourth, we do not have adequate warehousing facilities. Fifth, the warehouse receipt is not a negotiable instrument which can help in increasing lending to farmers who sell forward on exchanges. Sixth, there is limited liquidity in several products.
The approach, hence, has to be threefold. First, we have to enable farmers to trade for which we have to create structures and liquidity. To get in farmers we have to get in aggregators who pool the output of farmers and hedge on their behalf, which is not permitted by the prevalent regulation. Banks could pitch in as was recommended by the Reserve Bank of India (RBI) in 2005, but regulation does not allow for bank participation in this space. Banks are lending to farmers as part of their priority sector targets and, hence, it makes sense to hedge on their behalf as the ability of the farmer to repay loans depends on the ability to get the right price, which can be assured through hedging. Further, the warehouse receipt has to be made negotiable for banks to enhance lending. We need changes in the Forward Contracts (Regulation) Act, Banking Regulation Act and Warehousing Act.
Second, we need to create more warehouses because unless farmers have access to delivery centres, this will be a non-starter. Farmer awareness programmes are necessary, which the Forward Markets Commission (FMC) is doing along with the exchanges and should leverage the farmer clubs of Nabard, non-governmental organizations, cooperative banks, commercial banks, etc. Merely having programmes will not work, as there should be appointed nodal officers who take it forward. Hence, it has to be an initiative taken by the commodity market along with RBI and Nabard.
Third, liquidity is important and FMC should allow market-making, which has been successful in the capital and government securities markets. Next, we should get more retail participation, which can be done through enabling legislation that permits “commodity funds” much like mutual funds where individuals are able to invest through this route. Today, the collection of funds from the public comes under the purview of the Securities Contracts (Regulation) Act with Sebi as regulator. This needs to be resolved soon. Also the entry of foreign institutional investors into this field will help induce liquidity with corresponding riders placed on position limits and delivery.
Last, we need to allow options that are analogous to the minimum support price (MSP) of the government. Futures assures a price at the time of harvest and the seller cannot go back on this commitment. In case of options, one can exercise this right by paying a premium, which resembles a market related MSP offered by the Food Corporation of India where the farmer can choose to sell at this price.
We have reached a stage where the commodity futures market is positioned to move to a new level. But various laws have to be sewn together and regulators should start talking to one another.
The commodity futures market has once again come into focus as it has become an interesting option for investors. However, the question to be posed is whether or not it has helped in fulfilling the objective of helping farmers to hedge, which was the motivation behind resurrecting this market.
The market had a turnover of over 1.5 times of the gross domestic product at market prices in FY11 while the equity futures market had a multiple of 1.3 and derivatives, including options, had a multiple of 3.8. However, curiously even today, the share of agri futures is just about 10%. India now has leading global volumes in bullion, comparable volumes in energy and non-precious metals, but not much in agri products. India by virtue of its size and population is a leading producer or consumer of all farm products, which sets the contours for potential of futures trading.
But the story has not quite gone the way it was conceived. There have been severe hiccups along the way with bans on trading in products such as tur, urad, wheat, sugar, soy oil and chana. The ostensible reason was that futures trading caused inflation—a theory that has been refuted. The Abhijit Sen committee showed that there was not enough evidence to prove that futures trading was related with inflation. The recent two years of inflation experience clearly points to the absence of such a relation as none of the traded products was part of the inflation numbers. This means that it is time to make this platform more meaningful with these preconceived notions being dispelled.
Presently, futures trading in farm products is predominantly on NCDEX and the most sought after products where price discovery takes place is the oil seeds complex (soya bean, soy oil, mustard), spices (pepper, cumin seed), chana, guar seed, sugar and wheat. Traders in commodities are hedging and given the efficient price discovery process futures have set benchmarks for the spot markets too. But the farmers are out of this scheme. Why?
First, there is absence of awareness. Second, they have limited access to these platforms. Third, their production levels are lower than that of the contract sizes. The exchanges can bring it down in case there is liquidity or else the contract flops. Presently, it is based on the economical size of delivery lots. Fourth, we do not have adequate warehousing facilities. Fifth, the warehouse receipt is not a negotiable instrument which can help in increasing lending to farmers who sell forward on exchanges. Sixth, there is limited liquidity in several products.
The approach, hence, has to be threefold. First, we have to enable farmers to trade for which we have to create structures and liquidity. To get in farmers we have to get in aggregators who pool the output of farmers and hedge on their behalf, which is not permitted by the prevalent regulation. Banks could pitch in as was recommended by the Reserve Bank of India (RBI) in 2005, but regulation does not allow for bank participation in this space. Banks are lending to farmers as part of their priority sector targets and, hence, it makes sense to hedge on their behalf as the ability of the farmer to repay loans depends on the ability to get the right price, which can be assured through hedging. Further, the warehouse receipt has to be made negotiable for banks to enhance lending. We need changes in the Forward Contracts (Regulation) Act, Banking Regulation Act and Warehousing Act.
Second, we need to create more warehouses because unless farmers have access to delivery centres, this will be a non-starter. Farmer awareness programmes are necessary, which the Forward Markets Commission (FMC) is doing along with the exchanges and should leverage the farmer clubs of Nabard, non-governmental organizations, cooperative banks, commercial banks, etc. Merely having programmes will not work, as there should be appointed nodal officers who take it forward. Hence, it has to be an initiative taken by the commodity market along with RBI and Nabard.
Third, liquidity is important and FMC should allow market-making, which has been successful in the capital and government securities markets. Next, we should get more retail participation, which can be done through enabling legislation that permits “commodity funds” much like mutual funds where individuals are able to invest through this route. Today, the collection of funds from the public comes under the purview of the Securities Contracts (Regulation) Act with Sebi as regulator. This needs to be resolved soon. Also the entry of foreign institutional investors into this field will help induce liquidity with corresponding riders placed on position limits and delivery.
Last, we need to allow options that are analogous to the minimum support price (MSP) of the government. Futures assures a price at the time of harvest and the seller cannot go back on this commitment. In case of options, one can exercise this right by paying a premium, which resembles a market related MSP offered by the Food Corporation of India where the farmer can choose to sell at this price.
We have reached a stage where the commodity futures market is positioned to move to a new level. But various laws have to be sewn together and regulators should start talking to one another.
Monday, February 20, 2012
Curious developments in money markets: Economic Times: 15th Febuary 2012
The liquidity situation in the market is quite bizarre to say the least. The final number that comes out from this market is the net borrowing from the RBI through the repo window. This has been high at over Rs 1 lakh crore on a daily average basis, which is well over the comfort limit of the RBI that has so far maintained that 1% of deposits, which is aroundRs 60,000 crore, is the bearable amount.
When it remains consistently above this mark, then there is reason to worry. More so, because, we have also heard that the corporate sector is not really borrowing these days as the last two fortnights have witnessed a decline in credit. This time, however, there is a slowdown in growth in deposits, too, meaning people are saving less, ostensibly due to higher inflation, which is causing a squeeze on the supply-side for banks. It should actually not be a concern since growth in credit, too, is tardy with high interest rates deterring investment in general. Where then are the funds going?
Funds are actually being channeled into government paper and the investment-deposit ratio is currently 29%. Last year, one may recollect that the RBI had voiced a view that it feared that funds were being borrowed from the repo window and deployed in commercial lending, which could create severe destabilising of asset-liability mismatches.
Here, too, one is borrowing for one day and probably investing in a tenyear paper. But when it comes to investments, it does not matter since they can be sold anytime and tenure matches do not really matter. Therefore, things are not really amiss here. The curious development is how GSec yields have been behaving.
The 10-year G-Sec yields have come to a level of 8.15-8.30%, with average daily repo borrowings of over Rs 1 lakh crore. In November, the rate went towards the 9% mark with such equivalent amounts. Thus, the conundrum really is as to how come the rates have come down in an era of stringent liquidity and unchanged policy rates. One conjecture is that when liquidity crunch is due to the government and not commercial borrowings, then rates do not move in a rational manner because once funds move into G-Secs, then the true cost of funds get blurred.
The other action of the RBI that is taking place relates to OMOs, which is simultaneously infusing longterm liquidity even while funds are being drawn out through auctions of fresh paper. The announcement of OMOs and the expectations of further OMOs on its own has the power to keep rates down, which could be a strong factor working in making it self-fulfilling. Under normal circumstances, rates should be rising given the borrowing programme that has to be completed, which actually should drive down the price of government paper and correspondingly increase the yields.
But that is not happening. The RBI has already supplied over Rs 85,000 crore into the system in this form, which indicates that in case it had not done so, then repo borrowings would have touched the Rs 2-lakh-crore mark. Movements in corporate bond spreads in this market are no less puzzling.
The spread of a triple A-rated corporate is still ruling at just about 100 bps for a 10-year tenure, while the same for say commercial paper vis-avis 364 days treasury bills is above 200 bps. Clearly, there is greater premium on short term compared to long term. And this difference has been maintained across the CP-TBill yields in the 150-200 range bps.
Quite clearly, the financial markets have gone into a spin with theoretical axioms not really holding most of the time. The round tripping of funds through higher borrowings supported by bank investments, which is being supported by OMOs and repo borrowing, has grown to significant levels, which has made interest rates move away from the fundamentals. Given that government borrowing is still uncertain; such volatility may be expected for the rest of this financial year.
To the final question, how will yields move, one really does not have an answer. In fact, the correlation between repo borrowings and 10-year yield since October 1 is just around 50%, and statistically goes with a negative coefficient ie: higher borrowings leads to lower yields -which is not what the text book would say.
When it remains consistently above this mark, then there is reason to worry. More so, because, we have also heard that the corporate sector is not really borrowing these days as the last two fortnights have witnessed a decline in credit. This time, however, there is a slowdown in growth in deposits, too, meaning people are saving less, ostensibly due to higher inflation, which is causing a squeeze on the supply-side for banks. It should actually not be a concern since growth in credit, too, is tardy with high interest rates deterring investment in general. Where then are the funds going?
Funds are actually being channeled into government paper and the investment-deposit ratio is currently 29%. Last year, one may recollect that the RBI had voiced a view that it feared that funds were being borrowed from the repo window and deployed in commercial lending, which could create severe destabilising of asset-liability mismatches.
Here, too, one is borrowing for one day and probably investing in a tenyear paper. But when it comes to investments, it does not matter since they can be sold anytime and tenure matches do not really matter. Therefore, things are not really amiss here. The curious development is how GSec yields have been behaving.
The 10-year G-Sec yields have come to a level of 8.15-8.30%, with average daily repo borrowings of over Rs 1 lakh crore. In November, the rate went towards the 9% mark with such equivalent amounts. Thus, the conundrum really is as to how come the rates have come down in an era of stringent liquidity and unchanged policy rates. One conjecture is that when liquidity crunch is due to the government and not commercial borrowings, then rates do not move in a rational manner because once funds move into G-Secs, then the true cost of funds get blurred.
The other action of the RBI that is taking place relates to OMOs, which is simultaneously infusing longterm liquidity even while funds are being drawn out through auctions of fresh paper. The announcement of OMOs and the expectations of further OMOs on its own has the power to keep rates down, which could be a strong factor working in making it self-fulfilling. Under normal circumstances, rates should be rising given the borrowing programme that has to be completed, which actually should drive down the price of government paper and correspondingly increase the yields.
But that is not happening. The RBI has already supplied over Rs 85,000 crore into the system in this form, which indicates that in case it had not done so, then repo borrowings would have touched the Rs 2-lakh-crore mark. Movements in corporate bond spreads in this market are no less puzzling.
The spread of a triple A-rated corporate is still ruling at just about 100 bps for a 10-year tenure, while the same for say commercial paper vis-avis 364 days treasury bills is above 200 bps. Clearly, there is greater premium on short term compared to long term. And this difference has been maintained across the CP-TBill yields in the 150-200 range bps.
Quite clearly, the financial markets have gone into a spin with theoretical axioms not really holding most of the time. The round tripping of funds through higher borrowings supported by bank investments, which is being supported by OMOs and repo borrowing, has grown to significant levels, which has made interest rates move away from the fundamentals. Given that government borrowing is still uncertain; such volatility may be expected for the rest of this financial year.
To the final question, how will yields move, one really does not have an answer. In fact, the correlation between repo borrowings and 10-year yield since October 1 is just around 50%, and statistically goes with a negative coefficient ie: higher borrowings leads to lower yields -which is not what the text book would say.
Subscribe to:
Posts (Atom)
