Thursday, July 19, 2007
More transparency needed in NPAs: Economic Times 19th July 2007
Transparency in accounts is pertinent for banks since they deal with public money. The stakeholders involve a large number of individuals starting from the owners and staff to the borrowers and deposit holders. The quickest indicator of the health of a bank is the ratio of non-performing assets to total assets. Assuming that prudential accounting practices are pursued, this number indicates the strength of a bank. If this ratio increases, then one can smell trouble. In the US, where the accounting norms are strict and transparency mandatory, there are some good chapters that should be incorporated in our systems. The first is that these health indicators should be announced more frequently with less scope given for window dressing. The second is that a simple number for the ratio is not really adequate and we must strive to have a drill down of this number. To see how this can be tackled, we can borrow what the Fed does. The first table (Heavy Burden) drills down the delinquent assets of various categories of banks and bank assets. Five major findings emerge from this table. Firstly, delinquency rates are higher for the larger banks compared to the smaller ones; which is the result when larger banks are more aggressive in building their asset portfolio. The second highlight is that consumer loans have higher delinquency rates with credit cards being the most vulnerable section. This is significant given that the focus of banking is on the retail end, where the consumer loan segment is being targeted aggressively by banks. The rates charged here are normally higher than the median rates charged on other loan categories. Thirdly, real estate loans, especially residential, have higher rates than the commercial real estate loans, meaning thereby that individuals tend to be the larger defaulters. This finding gels well with the earlier observation that the consumer loan segment is more vulnerable than other categories of loans. Fourthly, industry in particular is better at servicing their loans; and also agriculture loans have lower rates of default. Lastly, the larger banks are more vulnerable, when it comes to consumer or real estate loans, implying that they would tend to be more aggressive when dealing with individuals where the default rates are higher. For the other banks, the challenge is more at controlling the growth in industrial defaults since there would be a tendency for the lower-rated companies to access them since the larger ones would be more stringent with their lending norms. Now this is important for us since there has been a tendency for consumer loans to increase in our context. The table alongside shows the broad composition of bank loans in the US and India, and some of the categories of loans are equally important in India. The two sets of data may not be strictly comparable as the definition of segments is dissimilar in some places. However, the important point here is that the non-mortgage consumer segment, which is of an equal dimension in the two countries, has the same share in total credit for both sets of banks. Real estate, in our context, is the mortgage portfolio while it also includes commercial real estate in the US. The fact that the real estate (or mortgage in our case) segments are dominant in the US, and are beginning to dominate in our case is indicative of the problems that could beset our system in the years to come. The RBI has taken note of the same, but there is a need for close monitoring of the data and trigger points should be drawn so that prompt corrective action may be taken as these proportions rise. Also, as in the case of the US, this information needs to be revealed on a quarterly basis under standardised definitions so that there is equal access to this information. The absolute numbers of NPAs as well as ratios need to be mentioned to eschew any kind of camouflage which is resorted to by some banks by inflating the loan book when the NPA levels increase. This will strengthen the prudential processes that have been instituted and pursued assiduously by RBI for the last decade and a half.
Friday, June 29, 2007
How the west views India: Hindustan Times 27th June 2007
Aerosmith is an ugly rock group which brings out equally disgusting music. They are not known for intelligent talk. But, what was significant when they were interviewed on their visit to India was that they were keen to see the ‘elephants on the roads’. This was quite surprising considering that we are now living in an era where India is considered to be one of the fastest growing economies which has potential for greater things as was predicted by Goldman Sachs sometime back. But, the common man in the west still thinks of India as a land of elephants and snake charmers. Have we really arrived?
We as Indians do tend to think that we are progressing well with malls springing up in every suburb of urban India and large size vehicles blocking the narrow road-infrastructure which cannot keep pace with them, and probably never will. Economic numbers are great to view as they compete with only China. Our GDP growth has been over 9% for sometime now, which is surely impressive. This is notwithstanding the fact that ‘The Economist’ in one of its recent issues feels that growth cannot be sustained without inflation and that loose monetary policy has enabled to a large extent this growth. Industry is booming at a double digit level amidst burgeoning forex reserves. The savings and investment rates are now over 30% and inching closer to the levels which were attained by the East Asian economies prior to the crisis in 1997-98. What more can the critic ask for?
Yet, China is a force while India remains a land of mysticism for many. Mark Tully has remained optimistic about India while both Edward Luce (In Spite of the Gods) and Christopher Kremmer (Inhaling the Mahatma) are vaguely sympathetic to the economic progress but are amused by our leaders and our way of living. What is it that appeals to the west about India?
China has definitely found its way in the lives of the western audience physically through toys, electronics, engineering goods, and even fruits. India’s progress appears to be more peripheral in contrast which has scratched probably only the surface with the IT industry making a mark, and affecting mainly the elitist groups of the west. Foreign investment flows are impressive by our own standards but China still gets in 5 times more funds with ease. The much touted ‘Made in India’ branding is still in its infancy. Despite exports growing to cross $ 125 billion, Indian goods have not really made a decisive impact on the lives of the west. Exports still dominate in the traditional segments like textiles and handicrafts. India remains a poor country in the eyes of the west, which though growing fast still has a large number of starvation deaths and over 250 mn on the precipice of this deprivation. And neither does India rank high in terms of standard of living, bribery index, ease for investment, infrastructure development, fiscal austerity, disease, hunger, human rights etc.
While economic progress may appear to have been exaggerated by us, there is definitely potential for a transformation a la BRICs Report, which expects India to be in the top 5 league by 2050. The vast consuming potential in India keeps interest alive as the western nations; especially USA has looked at Indian markets for expansion. This is more so given the saturation in consumption levels in the west, where Chinese goods are substituting domestic production in all spheres. Given the so called large consuming class in India which is upwardly mobile, the sheer number of 250 mn is a dream to be pursued. What started ostensibly as awarding the Miss Universe titles to Indians, to provide a fillip to their beauty products, has now culminated with the Walmarts making a forceful entry. To top it, the WTO, which is a mouth piece of the US has argued for opening up of the services sector i.e. banking and insurance in particular, which is reinforcing the unequal trade practices that are propounded by all such treaties. Hence, whenever the US looks at the Indian economy, they never fail to point out that we are still closed to foreign investment to the extent that even our own analysts chide successive government for being slow on this score.
Politically, India makes a lot of sense to the west as it is strategically well placed to provide a moral anchor amidst the Islamic militant zones around. Being a democracy is an advantage and even though governance is missing in our political fabric, we still do well in terms of having elections at the centre and state levels – even though we get rogue governments at times. It is no wonder that George Bush has made concessions on the nuclear papers while taking a harder stance against the other recalcitrant nations on this issue.
The politics and economics of India are therefore of interest to the more informed people which would include investment bankers, parliamentarians, and academics. But, for the common man, India will remain the land of mysticism dominated by philosophy and centred on karma, which is the majority way of life, where people find happiness in their squalor and seek solace and salvation in religion. This had brought the likes of George Harrison to India decades back while the likes of Madonna and Richard Gere also put up occasional pretences of being influenced by the cosmic attraction provided by this nation. When will this change?
We as Indians do tend to think that we are progressing well with malls springing up in every suburb of urban India and large size vehicles blocking the narrow road-infrastructure which cannot keep pace with them, and probably never will. Economic numbers are great to view as they compete with only China. Our GDP growth has been over 9% for sometime now, which is surely impressive. This is notwithstanding the fact that ‘The Economist’ in one of its recent issues feels that growth cannot be sustained without inflation and that loose monetary policy has enabled to a large extent this growth. Industry is booming at a double digit level amidst burgeoning forex reserves. The savings and investment rates are now over 30% and inching closer to the levels which were attained by the East Asian economies prior to the crisis in 1997-98. What more can the critic ask for?
Yet, China is a force while India remains a land of mysticism for many. Mark Tully has remained optimistic about India while both Edward Luce (In Spite of the Gods) and Christopher Kremmer (Inhaling the Mahatma) are vaguely sympathetic to the economic progress but are amused by our leaders and our way of living. What is it that appeals to the west about India?
China has definitely found its way in the lives of the western audience physically through toys, electronics, engineering goods, and even fruits. India’s progress appears to be more peripheral in contrast which has scratched probably only the surface with the IT industry making a mark, and affecting mainly the elitist groups of the west. Foreign investment flows are impressive by our own standards but China still gets in 5 times more funds with ease. The much touted ‘Made in India’ branding is still in its infancy. Despite exports growing to cross $ 125 billion, Indian goods have not really made a decisive impact on the lives of the west. Exports still dominate in the traditional segments like textiles and handicrafts. India remains a poor country in the eyes of the west, which though growing fast still has a large number of starvation deaths and over 250 mn on the precipice of this deprivation. And neither does India rank high in terms of standard of living, bribery index, ease for investment, infrastructure development, fiscal austerity, disease, hunger, human rights etc.
While economic progress may appear to have been exaggerated by us, there is definitely potential for a transformation a la BRICs Report, which expects India to be in the top 5 league by 2050. The vast consuming potential in India keeps interest alive as the western nations; especially USA has looked at Indian markets for expansion. This is more so given the saturation in consumption levels in the west, where Chinese goods are substituting domestic production in all spheres. Given the so called large consuming class in India which is upwardly mobile, the sheer number of 250 mn is a dream to be pursued. What started ostensibly as awarding the Miss Universe titles to Indians, to provide a fillip to their beauty products, has now culminated with the Walmarts making a forceful entry. To top it, the WTO, which is a mouth piece of the US has argued for opening up of the services sector i.e. banking and insurance in particular, which is reinforcing the unequal trade practices that are propounded by all such treaties. Hence, whenever the US looks at the Indian economy, they never fail to point out that we are still closed to foreign investment to the extent that even our own analysts chide successive government for being slow on this score.
Politically, India makes a lot of sense to the west as it is strategically well placed to provide a moral anchor amidst the Islamic militant zones around. Being a democracy is an advantage and even though governance is missing in our political fabric, we still do well in terms of having elections at the centre and state levels – even though we get rogue governments at times. It is no wonder that George Bush has made concessions on the nuclear papers while taking a harder stance against the other recalcitrant nations on this issue.
The politics and economics of India are therefore of interest to the more informed people which would include investment bankers, parliamentarians, and academics. But, for the common man, India will remain the land of mysticism dominated by philosophy and centred on karma, which is the majority way of life, where people find happiness in their squalor and seek solace and salvation in religion. This had brought the likes of George Harrison to India decades back while the likes of Madonna and Richard Gere also put up occasional pretences of being influenced by the cosmic attraction provided by this nation. When will this change?
Do we need a president? Indian Express 29th June 2007
Today the selection of the president of India is dominating our television screens and morning headlines. But before we decide who we want as president, have we stopped to ask ourselves a more fundamental question: do we need a president?
Our civics books in school told us that the president was only a ‘nominal head’. The less charitable books, the guide books even at the level of civil services examinations, called the president a ‘rubber stamp’. If one goes through the powers of the president, the post does resemble a rubber stamp. The president can, at best, meekly refrain from endorsing a decision — and that, too, only for the first time.
So why does such an ornamental post prove so attractive? Superficially speaking, the president gets to occupy the Rashtrapati Bhavan, which is quite a palace to say the least. He gets a retinue of servants and can house a number of relatives. It is said that one of our presidents did, in fact, have several dozens of his relatives living on the premises throughout the year. Presidents also get high level security wherever they go and free medical treatment — usually in the US. There is also a lot of foreign travel thrown in, and presidents get to meet a frightful number of lower level dignitaries of lower level countries and, occasionally, more prominent heads of state.
They have their speech writers doing all the hard work of writing the stuff that needs to be read out on public occasions, and there is always the photostat to help in the recycling of lofty thoughts and aspirations. It is, generally, a fairly non-controversial job, because you do not have to take important decisions anyway. Even if ticklish issues come up — like the dismissal of a legitimate state government — no one really cares since it is accepted that the president is, anyway, only a rubber stamp.
Politically, of course, getting one’s chosen candidate into the office is highly desirable, leading to a show of strength, based on a formula that takes into account a party’s seats in the Parliament and the state legislatures. Presidents also, whether they like it or not, tend to get identified with a particular party.
But that is also why the process of selecting a candidate for this post has become so acrimonious. We therefore seriously need to decide whether or not we need this post. It is similar to British royalty, which is maintained at considerable public expense but for no good enough reason.
And if we want to persist with it, we need to give the president more powers to keep the government of the day under check. Are we prepared to do this? Probably, not. In which case, we should seriously consider dispensing with this post.
Our civics books in school told us that the president was only a ‘nominal head’. The less charitable books, the guide books even at the level of civil services examinations, called the president a ‘rubber stamp’. If one goes through the powers of the president, the post does resemble a rubber stamp. The president can, at best, meekly refrain from endorsing a decision — and that, too, only for the first time.
So why does such an ornamental post prove so attractive? Superficially speaking, the president gets to occupy the Rashtrapati Bhavan, which is quite a palace to say the least. He gets a retinue of servants and can house a number of relatives. It is said that one of our presidents did, in fact, have several dozens of his relatives living on the premises throughout the year. Presidents also get high level security wherever they go and free medical treatment — usually in the US. There is also a lot of foreign travel thrown in, and presidents get to meet a frightful number of lower level dignitaries of lower level countries and, occasionally, more prominent heads of state.
They have their speech writers doing all the hard work of writing the stuff that needs to be read out on public occasions, and there is always the photostat to help in the recycling of lofty thoughts and aspirations. It is, generally, a fairly non-controversial job, because you do not have to take important decisions anyway. Even if ticklish issues come up — like the dismissal of a legitimate state government — no one really cares since it is accepted that the president is, anyway, only a rubber stamp.
Politically, of course, getting one’s chosen candidate into the office is highly desirable, leading to a show of strength, based on a formula that takes into account a party’s seats in the Parliament and the state legislatures. Presidents also, whether they like it or not, tend to get identified with a particular party.
But that is also why the process of selecting a candidate for this post has become so acrimonious. We therefore seriously need to decide whether or not we need this post. It is similar to British royalty, which is maintained at considerable public expense but for no good enough reason.
And if we want to persist with it, we need to give the president more powers to keep the government of the day under check. Are we prepared to do this? Probably, not. In which case, we should seriously consider dispensing with this post.
Monday, June 25, 2007
Big Money Stakes: DNA, 25th June 2007
The success of mega IPOs should not blind us to some vital concerns
The spectacular success of the DLF and ICICI Bank IPOs is significant for more than one reason. The companies represent two booming sectors, which quite coincidentally share a symbiotic relationship, with the banking sector providing the finance for the real estate sector, while the real estate sector has been swelling the loan book of banks and hence their profit lines.
But why is there such a rush for oversubscription of these IPOs? There are essentially three categories of investors here: domestic investors, corporates and foreign investors. IPOs have a psychological influence on investors as they normally set a floor price for a share, below which it is not expected to go in the medium to long run. Therefore, companies price their IPOs at a premium to the past prevailing prices which is then accepted as a base rate under normal market conditions.
Individuals and mutual funds are the domestic investors, who are lured with a rising Sensex and assume that there will be no looking back now. This sentiment by itself keeps the market in the upward direction. The capital market today provides the best after-tax returns to investors — high nominal returns and low tax rates.
The corporate interest in the IPOs cannot be just for investment purposes as the yield per se is low. Theirs is a strategic investment in terms of getting hold of the company at a later date. It has been mentioned that some of the corporates have invested in the ICICI Bank IPO, which is interesting because it indicates that when regulation permits, they would be interested in having a say in the financial sector too. Such investments in companies may also be viewed as the starting point of M&A (merger and acquisition) activity at a later date.
The third interest is from foreign investors who still feel that the price-earnings (P-E) multiples of 15-20 in India can be improved. Typically we would have expected these funds to slow down in India given that interest rates in the West are improving, as are the markets. The fact that they are investing in India means that they believe that the India growth story is there to last and therefore their investments would continue to give good returns.
However, it must be remembered that this is the story in other Asian markets too where portfolio investors are rushing in, such as Indonesia, Russia, Malaysia and Latin American countries. Given the increase in the overall size of such portfolio investment it is but natural that India will receive progressively larger allocations.
The success of these IPOs raises three broader issues. First, where is this money coming from? Second, is all this money accounted for, especially as such IPOs fuel a secondary market multiple? Lastly, how long can this optimism last?
The high growth witnessed in the last three years could be the reason for the channeling of these funds into the IPOs, which count as savings officially, unlike funds in the secondary market. The savings rate in India has now gone past the 30 per cent mark, which means that it is on the upward trajectory.
Nine per cent growth and a 30 per cent savings rate is the ideal platform for the capital market where IPO money is used for capital investment either in fresh land, buildings and machinery, or loans if raised by financial companies. There is, however, no evidence of any substitution taking place in the household portfolio of savings and investments.
The second question raises an apprehension about how much of such money is black money. It has been observed in India that stock market booms, along with the real estate sector, invariably churn out a lot of black money which may be difficult to track.
As for the last question, investor interest in IPOs today is primarily because of the gains to be made in the secondary segment. The stock market does not mimic economic performance and the fall of the NDA government in 2004 was a classic example where the market fell even though the economy performed well. Also, at the present high levels being witnessed, the maintenance of such volumes will be a challenge as large quantities of money has to continuously flow in to ensure that the bullish trends continue.
Stock market returns closely resemble a Ponzi scheme where good money has to keep coming in to ensure that the apple cart is not upset. And therein lies the rub.
The spectacular success of the DLF and ICICI Bank IPOs is significant for more than one reason. The companies represent two booming sectors, which quite coincidentally share a symbiotic relationship, with the banking sector providing the finance for the real estate sector, while the real estate sector has been swelling the loan book of banks and hence their profit lines.
But why is there such a rush for oversubscription of these IPOs? There are essentially three categories of investors here: domestic investors, corporates and foreign investors. IPOs have a psychological influence on investors as they normally set a floor price for a share, below which it is not expected to go in the medium to long run. Therefore, companies price their IPOs at a premium to the past prevailing prices which is then accepted as a base rate under normal market conditions.
Individuals and mutual funds are the domestic investors, who are lured with a rising Sensex and assume that there will be no looking back now. This sentiment by itself keeps the market in the upward direction. The capital market today provides the best after-tax returns to investors — high nominal returns and low tax rates.
The corporate interest in the IPOs cannot be just for investment purposes as the yield per se is low. Theirs is a strategic investment in terms of getting hold of the company at a later date. It has been mentioned that some of the corporates have invested in the ICICI Bank IPO, which is interesting because it indicates that when regulation permits, they would be interested in having a say in the financial sector too. Such investments in companies may also be viewed as the starting point of M&A (merger and acquisition) activity at a later date.
The third interest is from foreign investors who still feel that the price-earnings (P-E) multiples of 15-20 in India can be improved. Typically we would have expected these funds to slow down in India given that interest rates in the West are improving, as are the markets. The fact that they are investing in India means that they believe that the India growth story is there to last and therefore their investments would continue to give good returns.
However, it must be remembered that this is the story in other Asian markets too where portfolio investors are rushing in, such as Indonesia, Russia, Malaysia and Latin American countries. Given the increase in the overall size of such portfolio investment it is but natural that India will receive progressively larger allocations.
The success of these IPOs raises three broader issues. First, where is this money coming from? Second, is all this money accounted for, especially as such IPOs fuel a secondary market multiple? Lastly, how long can this optimism last?
The high growth witnessed in the last three years could be the reason for the channeling of these funds into the IPOs, which count as savings officially, unlike funds in the secondary market. The savings rate in India has now gone past the 30 per cent mark, which means that it is on the upward trajectory.
Nine per cent growth and a 30 per cent savings rate is the ideal platform for the capital market where IPO money is used for capital investment either in fresh land, buildings and machinery, or loans if raised by financial companies. There is, however, no evidence of any substitution taking place in the household portfolio of savings and investments.
The second question raises an apprehension about how much of such money is black money. It has been observed in India that stock market booms, along with the real estate sector, invariably churn out a lot of black money which may be difficult to track.
As for the last question, investor interest in IPOs today is primarily because of the gains to be made in the secondary segment. The stock market does not mimic economic performance and the fall of the NDA government in 2004 was a classic example where the market fell even though the economy performed well. Also, at the present high levels being witnessed, the maintenance of such volumes will be a challenge as large quantities of money has to continuously flow in to ensure that the bullish trends continue.
Stock market returns closely resemble a Ponzi scheme where good money has to keep coming in to ensure that the apple cart is not upset. And therein lies the rub.
Tuesday, June 19, 2007
RBI governors: Continuing the reforms storyline : Financial Express: 18th June 2007
RBI governors: Continuing the reforms storyline
The RBI governors are celebrities today. The visual media goes behind the "pause made by the governor in the speech when the issue of inflation came up" or the "smile which accompanied the same", and even have coined the term "hawkish" to reflect the tone. Their proclivities to tinker with interest rates or CRR and focus on growth or inflation lead to conclusions that the RBI governors are anti-inflation or pro-growth. The purpose here is to examine ex post the economic environment under which past governors have operated and the tools used to conduct monetary policy.
The governors we looked at are S Venkitaramanan, C Rangarajan, Bimal Jalan and YVR Reddy. The economic environment as well as monetary actions taken by these governors have been juxtaposed with their tenures. The governors normally move in and out during December and it has been assumed that the governor in charge up to this point of time operates in the economic environment for the entire year, while their actions have been looked at as per their tenures.
Three facts emerge from the table. The first is that GDP growth has been rising progressively in the time periods associated with change in governors.
The second is that inflation has simultaneously come down having more than halved between the early ‘90s and contemporary times even though it has risen in the last period.
And lastly, monetary policy direction has been almost unidirectional—although there have been contrarian movements during certain time periods.
The profiling of the governors shows that Venkitaramanan was in charge in the pre-reforms period and actually operated in a regulated set-up. Therefore, the benefits which came from reforms were missing. His era was typified by low growth and high inflation. Banking was extremely regulated and there was limited flexibility in monetary policy. There was hence little scope for innovation. Double digit inflation was not something new. At the time of his exit we had the Narasimham Committee Report just being brought in.
Rangarajan had the most interesting phase where reforms were introduced and the economy had to be lifted to better heights. His actions hence were on all fronts. The SLR was lowered only during his regime and came down to 25%. The CRR was reduced as was the bank rate. The challenge was really to control inflation while bringing about higher growth. Growth was to be brought about by the overall series of economic reforms and monetary action was to support this process. His actions were actually gradual and became pronounced in 1996-97 when the CRR was reduced by 4% and bank rate by 3%.
With there being spare capacity, it was the ideal situation to push for high growth without inflation.
Jalan came in at a time when consolidation was needed and while policy was accommodative, inflation was the primary target. This was the first time that the policies emphasised the concept of growth with stability. This was also the period where the globalisation impact was first noticed and reinforced and the US Fed actions had an influence on domestic policy.
There was also the critical Asian crisis to be dealt with and while the CRR was raised to begin with to 11%, he continued with reforms to bring down the CRR to its lowest level by the time he exited. The bank rate was raised but then lowered to 6%. He had also brought in the concept of the ‘repo’ to control liquidity and interest rates and used the repo rate as an effective tool of monetary policy from 2000-01 onwards. Again the focus was on lowering of the repo rate to 7% from 9.5%.
Reddy inherited an economy which was poised for higher growth with most of the reforms in place and hence could boldly go ahead and move in the direction of financial liberalisation. Higher growth and low interest rates have typified his regime until last year, when inflation has become a worry. This has caused a reversal in interest rate and CRR movements with the idea being to ensure that the economy does not overheat. This is understandable given that industry is operating at near full capacity utilisation today.
The significant point here is that inflation at 5.4% in the last period is not acceptable while a double digit inflation accompanied by low GDP growth was acceptable at that time.
The overall picture gotten here is that the RBI governors have, in general, followed an accommodative monetary policy over the last 15 years or so.
They have used a mix of interest rate (bank rate and repo rate) and CRR changes to control the overall supply of money in the economy. While inflation targeting is the major concern, in the medium-term, the focus has been on GDP growth.
And more importantly, all of them have performed exceedingly well in continuing the story line which was laid down in 1992 when reforms were introduced.
The RBI governors are celebrities today. The visual media goes behind the "pause made by the governor in the speech when the issue of inflation came up" or the "smile which accompanied the same", and even have coined the term "hawkish" to reflect the tone. Their proclivities to tinker with interest rates or CRR and focus on growth or inflation lead to conclusions that the RBI governors are anti-inflation or pro-growth. The purpose here is to examine ex post the economic environment under which past governors have operated and the tools used to conduct monetary policy.
The governors we looked at are S Venkitaramanan, C Rangarajan, Bimal Jalan and YVR Reddy. The economic environment as well as monetary actions taken by these governors have been juxtaposed with their tenures. The governors normally move in and out during December and it has been assumed that the governor in charge up to this point of time operates in the economic environment for the entire year, while their actions have been looked at as per their tenures.
Three facts emerge from the table. The first is that GDP growth has been rising progressively in the time periods associated with change in governors.
The second is that inflation has simultaneously come down having more than halved between the early ‘90s and contemporary times even though it has risen in the last period.
And lastly, monetary policy direction has been almost unidirectional—although there have been contrarian movements during certain time periods.
The profiling of the governors shows that Venkitaramanan was in charge in the pre-reforms period and actually operated in a regulated set-up. Therefore, the benefits which came from reforms were missing. His era was typified by low growth and high inflation. Banking was extremely regulated and there was limited flexibility in monetary policy. There was hence little scope for innovation. Double digit inflation was not something new. At the time of his exit we had the Narasimham Committee Report just being brought in.
Rangarajan had the most interesting phase where reforms were introduced and the economy had to be lifted to better heights. His actions hence were on all fronts. The SLR was lowered only during his regime and came down to 25%. The CRR was reduced as was the bank rate. The challenge was really to control inflation while bringing about higher growth. Growth was to be brought about by the overall series of economic reforms and monetary action was to support this process. His actions were actually gradual and became pronounced in 1996-97 when the CRR was reduced by 4% and bank rate by 3%.
With there being spare capacity, it was the ideal situation to push for high growth without inflation.
Jalan came in at a time when consolidation was needed and while policy was accommodative, inflation was the primary target. This was the first time that the policies emphasised the concept of growth with stability. This was also the period where the globalisation impact was first noticed and reinforced and the US Fed actions had an influence on domestic policy.
There was also the critical Asian crisis to be dealt with and while the CRR was raised to begin with to 11%, he continued with reforms to bring down the CRR to its lowest level by the time he exited. The bank rate was raised but then lowered to 6%. He had also brought in the concept of the ‘repo’ to control liquidity and interest rates and used the repo rate as an effective tool of monetary policy from 2000-01 onwards. Again the focus was on lowering of the repo rate to 7% from 9.5%.
Reddy inherited an economy which was poised for higher growth with most of the reforms in place and hence could boldly go ahead and move in the direction of financial liberalisation. Higher growth and low interest rates have typified his regime until last year, when inflation has become a worry. This has caused a reversal in interest rate and CRR movements with the idea being to ensure that the economy does not overheat. This is understandable given that industry is operating at near full capacity utilisation today.
The significant point here is that inflation at 5.4% in the last period is not acceptable while a double digit inflation accompanied by low GDP growth was acceptable at that time.
The overall picture gotten here is that the RBI governors have, in general, followed an accommodative monetary policy over the last 15 years or so.
They have used a mix of interest rate (bank rate and repo rate) and CRR changes to control the overall supply of money in the economy. While inflation targeting is the major concern, in the medium-term, the focus has been on GDP growth.
And more importantly, all of them have performed exceedingly well in continuing the story line which was laid down in 1992 when reforms were introduced.
Thursday, June 7, 2007
The Commodity Futures Conundrum: Economic Times: 7th June 2007
The commodity futures conundrum [ THURSDAY, JUNE 07, 2007 12:02:21 AM]
The story of futures trading in India has been more than an enigma. Members of the committee that recommended the reintroduction of futures trading feel that the markets should not have been opened up. The minister who was instrumental for its resurrection has expressed regret for his action. The Leftists firmly believe that futures trading are responsible for high inflation today. The more moderate opinion leaders are willing to accept the efficacy of futures trading provided farmers have gotten the benefits. And lastly, the more ardent opponents are not willing to accept the market unless ‘only’ genuine users of the commodities participate and that the speculators are shown the door. In this milieu, the government went ahead and banned trading in two pulses and cereals in January and February. It appears that everyone has a different expectation from futures trading. How is one really to view these markets considering that it is not a panacea for some of our deep-rooted agrarian problems? Futures trading are reflective of the prices of commodities which are driven by expectations of demand and supply. While theoretically the futures price is the spot price plus the cost of carry, in practical terms it is a reflection of what the markets expect from the harvest. An expected supply shortfall gets reflected in higher futures prices while the converse holds in case of a surplus. Futures are hence an efficient real time monitoring mechanism of crop expectations. An efficient futures market is intended to discover the right price based on fundamentals while ensuring that there is discipline in the market and that there is no case of either hoarding or price manipulation. If this is taken care of, then it should not matter whether the price is rising or falling. What is important is that the price is the true reflection of fundamentals. The track record in the last three years has been very satisfactory. Rising wheat futures prices in November 2005 correctly predicted that there would be a shortfall in output in 2006. Later in the same year, futures prices indicated that there would be a shortfall in tur production, which was borne out by the ministry of agriculture estimates. Ironically, the ban on urad came when the futures prices were falling as they mirrored the arrivals of the rabi crop as well as imports in February and March. Therefore, there is a lot of merit in the futures markets provided regulatory processes are in place. Large-scale participation of members across various geographies and stringent position limits imposed at the member- and client-level as well as low, overall open interest to availability of the commodity are some of the measures being taken by the exchanges with the regulator FMC to ensure that there is market discipline
Now logically it should not matter whether prices are determined by majority hedgers or speculators or investors or market makers as long as the rules are obeyed. One must realise that even speculators are rational. When a supply shortfall is expected, then prices cannot be driven down, or will not be driven unreasonably high unless there is a counter-party who believes the same. Information symmetry and strong internal regulation, as explained earlier, ensure that there is a self-regulating force in the system. If prices reflect the economic fundamentals, and we are committed to the market mechanism, then it may not be proper to talk about benefits to either the farmer or consumer. The market cannot really play favourites to any part of the value chain. It is akin to interest rates where the market cannot be judged on whether the savers are to be assuaged or borrowers encouraged. Therefore, the issue is not whether the farmer is receiving a higher price or the consumer paying a lower price, but whether the price is the right one and whether farmers have knowledge of this price when taking their selling decisions. It follows that the futures market cannot be held responsible for either crop failures or institutional barriers along the way. If markets are efficient, as was the case in wheat, then as an extension, these prices could be used for cogent policy formulation. The minimum support price (MSP) programme of the government for wheat is a good example where the futures market can play a very important role. The MSP should take into account the prevailing futures prices to be more credible. The futures price is an indicator of the market price and if the MSP reflects the same, then it would be much easier for the Food Corporation of India to procure wheat and avoid the problem we are facing presently. The issue today is that the farmers have become more aware of the situation and are holding back their produce to sell at a later date. Therefore, sans futures and restraints on private procurement, the FCI is still facing problems in procuring. As the futures markets evolve, one can also think of the FCI considering operations on the futures exchanges to ensure that the procurement takes place. If done in advance in smaller quantities (to ensure that there is no distortion in the market), the procurement process is assured. Also, if the FCI can hedge on overseas exchanges then it could do the same on domestic exchanges. If these arguments are acceptable, then it follows that there is a need to permit futures trading in the banned commodities and encourage the same with the regulatory processes in place. Prices in any market send valuable signals: be it forex, money and commodity markets. We must not lose this very important tool as this will take us back several steps, which is acceptable in a closed economy set-up, but sounds anachronistic in a market driven economy.
The story of futures trading in India has been more than an enigma. Members of the committee that recommended the reintroduction of futures trading feel that the markets should not have been opened up. The minister who was instrumental for its resurrection has expressed regret for his action. The Leftists firmly believe that futures trading are responsible for high inflation today. The more moderate opinion leaders are willing to accept the efficacy of futures trading provided farmers have gotten the benefits. And lastly, the more ardent opponents are not willing to accept the market unless ‘only’ genuine users of the commodities participate and that the speculators are shown the door. In this milieu, the government went ahead and banned trading in two pulses and cereals in January and February. It appears that everyone has a different expectation from futures trading. How is one really to view these markets considering that it is not a panacea for some of our deep-rooted agrarian problems? Futures trading are reflective of the prices of commodities which are driven by expectations of demand and supply. While theoretically the futures price is the spot price plus the cost of carry, in practical terms it is a reflection of what the markets expect from the harvest. An expected supply shortfall gets reflected in higher futures prices while the converse holds in case of a surplus. Futures are hence an efficient real time monitoring mechanism of crop expectations. An efficient futures market is intended to discover the right price based on fundamentals while ensuring that there is discipline in the market and that there is no case of either hoarding or price manipulation. If this is taken care of, then it should not matter whether the price is rising or falling. What is important is that the price is the true reflection of fundamentals. The track record in the last three years has been very satisfactory. Rising wheat futures prices in November 2005 correctly predicted that there would be a shortfall in output in 2006. Later in the same year, futures prices indicated that there would be a shortfall in tur production, which was borne out by the ministry of agriculture estimates. Ironically, the ban on urad came when the futures prices were falling as they mirrored the arrivals of the rabi crop as well as imports in February and March. Therefore, there is a lot of merit in the futures markets provided regulatory processes are in place. Large-scale participation of members across various geographies and stringent position limits imposed at the member- and client-level as well as low, overall open interest to availability of the commodity are some of the measures being taken by the exchanges with the regulator FMC to ensure that there is market discipline
Now logically it should not matter whether prices are determined by majority hedgers or speculators or investors or market makers as long as the rules are obeyed. One must realise that even speculators are rational. When a supply shortfall is expected, then prices cannot be driven down, or will not be driven unreasonably high unless there is a counter-party who believes the same. Information symmetry and strong internal regulation, as explained earlier, ensure that there is a self-regulating force in the system. If prices reflect the economic fundamentals, and we are committed to the market mechanism, then it may not be proper to talk about benefits to either the farmer or consumer. The market cannot really play favourites to any part of the value chain. It is akin to interest rates where the market cannot be judged on whether the savers are to be assuaged or borrowers encouraged. Therefore, the issue is not whether the farmer is receiving a higher price or the consumer paying a lower price, but whether the price is the right one and whether farmers have knowledge of this price when taking their selling decisions. It follows that the futures market cannot be held responsible for either crop failures or institutional barriers along the way. If markets are efficient, as was the case in wheat, then as an extension, these prices could be used for cogent policy formulation. The minimum support price (MSP) programme of the government for wheat is a good example where the futures market can play a very important role. The MSP should take into account the prevailing futures prices to be more credible. The futures price is an indicator of the market price and if the MSP reflects the same, then it would be much easier for the Food Corporation of India to procure wheat and avoid the problem we are facing presently. The issue today is that the farmers have become more aware of the situation and are holding back their produce to sell at a later date. Therefore, sans futures and restraints on private procurement, the FCI is still facing problems in procuring. As the futures markets evolve, one can also think of the FCI considering operations on the futures exchanges to ensure that the procurement takes place. If done in advance in smaller quantities (to ensure that there is no distortion in the market), the procurement process is assured. Also, if the FCI can hedge on overseas exchanges then it could do the same on domestic exchanges. If these arguments are acceptable, then it follows that there is a need to permit futures trading in the banned commodities and encourage the same with the regulatory processes in place. Prices in any market send valuable signals: be it forex, money and commodity markets. We must not lose this very important tool as this will take us back several steps, which is acceptable in a closed economy set-up, but sounds anachronistic in a market driven economy.
Monday, May 28, 2007
Not a Bankable Idea: DNA, 28th May 2007
Not a bankable idea
May 28, 2007
The Reserve Bank of India (RBI) has recently announced that bank lending to minorities would be considered as priority sector lending. It has been further notified that if a minority community is in a ‘majority’ in a state, then it would not qualify for this status. This ruling is, in fact, a sweetener from the original demand that banks keep aside a certain part of their total loans for the minorities. Will this work?
The RBI, decades back, had decided that if banks were to lend money to borrowers based on their own priorities, they would tend to lend to those who are more likely to repay the money. Therefore, while large industry and other affluent sectors would readily receive loans, certain vulnerable sectors which are needed for the growth of the country would be left out of the credit stream and would have to rely on the local moneylender for finance.
Therefore, banks were asked to ensure that 40 per cent of their total lending goes to what was called the priority sector. The priority sector includes, inter alia, agriculture, small scale industry, and weaker sections of society (small and marginal farmers, landless labourers, tenant farmers, scheduled tribes, among others). Within this limit, 18 per cent had to be kept aside for agriculture and 10 per cent for weaker sections. In this manner the RBI ensured that given the social aspirations of banking, funds would be evenly distributed across all sectors. The sectors, mind you, have been defined in terms of either those which are critical for development as they have both growth and employment potential, or sections of society which are economically backward. Hence, this sectoral classification enables channelling of funds to all segments. We have had a report on financial sector reforms in 1992 called the Narasimham Committee Report which recommended that we dilute this pre-emption as it goes against the fibre of liberalisation. Now, this ruling of the RBI, which has political undertones, will take reforms a few steps back.
The problem of now including minorities under priority sector lending, has practical and ideological implications. Let us look at the practical side first. Banks can now lend to minorities such as Muslims, Sikhs, Christians, Parsis and so on and have it included as lending to priority sector. To meet their targets now, they could actually lend to rich Sikh farmers in states other than Punjab and hence get away from lending to the marginal farmers who carry higher risk. Also, hypothetically, loans to Nusli Wadia and Azim Premji, who belong to the minorities, would further help banks to meet their targets. The notification hence is quite easy to circumvent and banks may find this a convenient route to come closer to the 40 per cent target without diluting the quality of their asset portfolio. In this process, the truly needy could get left out.
Also, at the ideological level, can lending to a person by virtue of birth be good enough to be classified as a priority for banks? Let us take an example here. Suppose a banker who has limited funds gets two applications for loans, one from a Hindu and another from a minority category individual with a similar economic background. There would be an incentive for the banker to lend to the latter to meet the target, which would place the former at a disadvantage. The second issue is that once we accept such rulings without opposition, there is nothing to stop the RBI from bringing in the caste factor at a later date. Let us not forget that similar logic was behind the theory of reservations in the past where social and not economic factors proved to be the clinching factor.
The third issue goes back to the question of reforms: should banks be mandated to lend to anyone for that matter? Banks today are commercial entities which are driven by profit and are answerable to shareholders. They need to run their business based on business judgment and not government concerns. In fact, priority sector lending is soon going to become an anachronistic concept as banks such as ICICI Bank are willingly rushing into the agriculture sector as they see a great business opportunity. Taking into account both the practical and ideological aspects of treating lending to minorities as priority lending, this move of RBI needs to be looked at with a certain degree of reservation.
May 28, 2007
The Reserve Bank of India (RBI) has recently announced that bank lending to minorities would be considered as priority sector lending. It has been further notified that if a minority community is in a ‘majority’ in a state, then it would not qualify for this status. This ruling is, in fact, a sweetener from the original demand that banks keep aside a certain part of their total loans for the minorities. Will this work?
The RBI, decades back, had decided that if banks were to lend money to borrowers based on their own priorities, they would tend to lend to those who are more likely to repay the money. Therefore, while large industry and other affluent sectors would readily receive loans, certain vulnerable sectors which are needed for the growth of the country would be left out of the credit stream and would have to rely on the local moneylender for finance.
Therefore, banks were asked to ensure that 40 per cent of their total lending goes to what was called the priority sector. The priority sector includes, inter alia, agriculture, small scale industry, and weaker sections of society (small and marginal farmers, landless labourers, tenant farmers, scheduled tribes, among others). Within this limit, 18 per cent had to be kept aside for agriculture and 10 per cent for weaker sections. In this manner the RBI ensured that given the social aspirations of banking, funds would be evenly distributed across all sectors. The sectors, mind you, have been defined in terms of either those which are critical for development as they have both growth and employment potential, or sections of society which are economically backward. Hence, this sectoral classification enables channelling of funds to all segments. We have had a report on financial sector reforms in 1992 called the Narasimham Committee Report which recommended that we dilute this pre-emption as it goes against the fibre of liberalisation. Now, this ruling of the RBI, which has political undertones, will take reforms a few steps back.
The problem of now including minorities under priority sector lending, has practical and ideological implications. Let us look at the practical side first. Banks can now lend to minorities such as Muslims, Sikhs, Christians, Parsis and so on and have it included as lending to priority sector. To meet their targets now, they could actually lend to rich Sikh farmers in states other than Punjab and hence get away from lending to the marginal farmers who carry higher risk. Also, hypothetically, loans to Nusli Wadia and Azim Premji, who belong to the minorities, would further help banks to meet their targets. The notification hence is quite easy to circumvent and banks may find this a convenient route to come closer to the 40 per cent target without diluting the quality of their asset portfolio. In this process, the truly needy could get left out.
Also, at the ideological level, can lending to a person by virtue of birth be good enough to be classified as a priority for banks? Let us take an example here. Suppose a banker who has limited funds gets two applications for loans, one from a Hindu and another from a minority category individual with a similar economic background. There would be an incentive for the banker to lend to the latter to meet the target, which would place the former at a disadvantage. The second issue is that once we accept such rulings without opposition, there is nothing to stop the RBI from bringing in the caste factor at a later date. Let us not forget that similar logic was behind the theory of reservations in the past where social and not economic factors proved to be the clinching factor.
The third issue goes back to the question of reforms: should banks be mandated to lend to anyone for that matter? Banks today are commercial entities which are driven by profit and are answerable to shareholders. They need to run their business based on business judgment and not government concerns. In fact, priority sector lending is soon going to become an anachronistic concept as banks such as ICICI Bank are willingly rushing into the agriculture sector as they see a great business opportunity. Taking into account both the practical and ideological aspects of treating lending to minorities as priority lending, this move of RBI needs to be looked at with a certain degree of reservation.
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