Curbing bank loans to fight inflation : Economic Times: 30th August 2007

RBI’S monetary actions are primarily focused on countering the rapid growth of foreign exchange reserves and all measures tantamount to controlling growth in commercial credit, which in turn has raised other issues on future growth. This approach is quite different from the earlier one where the RBI had to accommodate the flow of funds to the government, which at times could mean curbing the growth in commercial credit. Either way, monetary policy appears to be targeting growth in commercial credit to control inflation. It has been observed that at times when growth in credit is buoyant and the RBI is keen to lower the lending power of banks, it becomes essential to use direct controls on credit growth. This is also suggested by an analysis of the components of incremental money supply in the last seven years. The changing structure of the components of incremental money supply suggests five major trends. The first is that the share of the government has come down quite rapidly between FY02 and FY05. This has happened in two stages with RBI initially placing less of government paper with itself. In fact, it has reduced the intake of private placements along the way before eliminating them. After offloading these bonds to commercial banks through open market operations, the next step has been for banks to off-load these securities and lower their investment deposit ratio. This has been more prominent in the last two years, where banks were able to increase their lending to the commercial sector with credit growing by an average of 33% amidst monetary tightening by the RBI. The second trend is that forex assets have actively taken over from the government in terms of dominance in the last three years. The average growth of net forex assets of banks has been around 24%, comparable with the growth in bank credit. Thirdly, bank credit has grown rapidly in the last three years by an average of 31% which has pushed up the credit-deposit ratio to 74% from 53% at the beginning of the century. Banks have shuffled their investment portfolios to secure funds even as RBI has increased the CRR. This has been prompted by the high industrial growth rate during this period where companies have borrowed notwithstanding higher interest rates.

Fourthly, credit policy is now trying to counter the large inflows of forex assets which are responsible for the higher growth in money supply. The preference has been on using direct measures such as the CRR to interest rates. Monetary tightening had started from 2004-05 and the CRR has been raised from 4.75% to 6.5%. This has been more effective than the reverse repo rate, which also has been raised from 4.5% to 6%. But, in general it has been observed that the RBI has used the reverse repo or repo rate to signal its desired direction of movement in interest rates, while it has used the CRR to have a direct impact on money supply growth through pre-emption of resources. Higher interest rates do not really work to curb growth in credit at a time when the industrial sector is booming. More direct action is needed to sterilise inflows from the forex channel. Lastly, the component of non-monetary liabilities of the banking system is quite worrisome as it is a large amount which distorts the picture. By definition this reflects amounts that do not add to money supply and are in the nature of RBI deposits with international agencies such as the IMF, contribution to national funds and superannuation funds, paid up capital, reserves, and provisions of commercial banks and so on. However, as this number is also a balancing figure drawn by calculating the money supply through the deposits route and subtracting these sources of funding on the credit side, there is need to reconcile these numbers. This is more so because the share of this component is very high at times. Quite clearly, the message is that we need to have a policy of tackling external capital inflows directly as monetary policy has become fairly inhibitive in the last quarter or so... the room for manoeuvre has also narrowed down.

Are You left holding the baby? Hindustan Times, 22nd August 2007

When I was a student in college, there was a lecturer who devised a scheme wherein a list was prepared with her name to begin with. It was sold to 20 people, who paid Rs 100 for the same. Rs 100 in 1983 meant a lot of money. Each of them sold the list to another 20 and so on. The rule was that whoever bought the list had to send Rs 100 each to all those on the list and then strike out the first name and include their own as the last. In the next round, they would be receiving money from a multiple of 20 persons and so on. This was a fool proof scheme as only like-minded people would join and the rules would be obeyed. The problem would arise when someone at the end could not find another 20 to sell to. Those people would be the losers and the scheme would crumble.

This is a kind of a Ponzi scheme which is fine as long as the direction is maintained. A break would mean a fall for lots of people with the early entries making the money and those holding the stock of lists being the losers. The stock market is similar to a regulated and organized Ponzi scheme where everything is good as long as all are buying and making money without any effort. But, when some big guys sells, then those left holding the stock suffer losses and there is a crash. Should one grieve for these losses? The answer is really no.

The stock market has been falling since the sub-prime specter has afflicted global markets. What happened was quite plain and simple. In the USA, when interest rates were low, people bought property and banks financed them at low interest rates (sub prime lending rates). The idea was that as real estate prices were rising, low rates were good enough and even if there were defaults, that would not matter since the property could be sold and the amount recovered. Now, the world of finance is a crazy one. Fancy models guide you as to how the future will be. To top it all there are new instruments such as securitization which made banks reorganize such assets and issue securities to others, including hedge funds. The risks are passed on or rather scattered among more risk-takers. These funds bought them for a song and knew that they were backed by rising real estate assets.

Now as we come to 2006, interest rates move up and the price of property comes down. This means that those holding on the estate backed securities realize that their collateral value has diminished. The borrowers are unable to repay their mortgages when rates rise, and the banks have sold these securities to hedge funds, which after a point of time cannot be identified. The result is mounting losses for these funds. Nobody wanted to lend to anyone and the commercial paper and call rates rose, which finally got the Fed and ECB to intervene.

The result was a collapse of global stock markets. After all if the financial sector is in jeopardy, the share market must reflect them and therefore share prices started tumbling. Funds are answerable to investors and need to sell assets elsewhere to pay the returns that are expected. So they start selling in overseas markets such as India which caused the Sensex and NIFTY to take a beating.

When the Bear Sterns crisis erupted and the Nifty and Sensex slid, it was called a correction waiting to happen. But, now it looks more serious even though there is nothing incorrect about our fundamentals. Our banking system is strong and has not been lending recklessly to real estate. It is an externality, which Thomas Friedman would be proud of, that has caused these travails.

There are irrational cycles in markets which are waiting to collapse - stock markets as well as sub-prime lending market. There is a perception to begin with which starts from positive things about the future leading to rising prices. It happened in the real estate sector and stock markets world over with credit pouring in. Fortunately our banking regulation ensures that prudence supersedes animal spirits. Then there is over-trading wherein everyone seems to be in the market. In case of the USA, people were borrowing money to buy property to sell it to others to make a quick buck. This euphoria is often cautioned as being a bubble, but is disparaged by the market moghuls – after all India is shining. And then there is the inevitable fall, and the experts are already predicting doomsday.

Now, stock market movements are always governed by ‘herding’ where everyone follows everyone in which ever direction the herd moves. There is little rationale or logic. The economy has always been strong in the last 3 years and has displayed no exceptional trait. But, this state of existentialism was used to justify the booming market, when funds poured in. But, such exuberance is not always rational as the words of Mr Alan Greenspan have been resonating for a few years now.

It is anecdotal that the legendary tennis star Arthur Ashe when detected with AIDS had a fan pleading with the Almighty as to why did he choose Sir Arthur Ashe for this punishment. Ashe’s reply was quite soul touching. There were thousands of people who played tennis, of which hundreds played in the Grand Slam tournaments. Of them some 60 odd played the Wimbledon while 4 made it to the semi finals and 2 to the finals. And ultimately only 1 won the tournament. When he won the Wimbledon in 1975, he never looked up to ask the Heavens as to why be he the chosen one. So it was the same with the AIDS attack.

Take this analogy to Dalal Street. When the Sensex zoomed, we never stopped to ask “but why”. Now that it is falling, just sit back and ruminate over your losses without; but don’t complain.

Sixty years and young and counting: Hindustan Times, 9th August 2007

Six decades back our leaders had made a tryst with destiny and had vowed to redeem their pledges. The Preamble of our Constitution had outlined the broad contours, which were to be fulfilled in the post-independence years. As we complete now 60 years of independence, it is appropriate to review these pledges and objectively evaluate whether or not we have redeemed ourselves properly.

The Preamble talks of 10 goals, each of which can be evaluated on a score of 1 and summed across to aggregate 10. We remain a ‘sovereign’ country and despite global turmoil and alliances our policies are dictated by Indians. This is saying a lot because developing countries have tended to slip into the former Soviet Bloc prior to 1990 or become a USA crony in return for favours. We have truly remained non-aligned and there is one point to be scored here.

We were to be a ‘socialist’ country, but have made limited progress here. While efforts have been on in the beginning to reduce inequalities through the public sector and mixed economy dictum, there has been a tendency for capitalist principles to predominate in the last decade and a half. There is nothing wrong in pursuing such policies except that there has been a tendency for the gulf between the rich and poor to widen. There have been policies espoused in the Plans to relieve poverty, but the implementation has been tardy. So it is half mark here.

India was to be built as a ‘secular’ nation. Unfortunately, secularism has been the most abused term used very often to divide society by our leaders. While secularism is a doctrine which gives equality to all religions in all respects, our polity has tended to use this term to garner votes, split society and create ill-will between people of different religions. This could be through either affirmative action or through plain bad-speaking of other religious doctrines. Either way, the nation remains polarized today on religious grounds as politicians. Conditions have been exacerbated by bringing in the caste factor, when religion is a non-issue. We have definitely failed here and there are no marks to be had.

The nation can take pride in being ‘democratic’ despite all the ups and downs that have been faced in the economic and social spheres. There has been just one minor aberration during the mid-seventies when democracy was subverted, but that did not last long. And given that we are one of the most populous nations, it is commendable that we remain a democracy with fair elections and no sign of a deviation from the processes. It is a different issue that we may not be voting in the right kind of people or vote for the wrong people time and again. But, holding free and fair elections in the country for 60 years deserves applause and one point further for this achievement.

The Preamble promised a ‘Republic’ where the leader is an elected person and not a monarch or part of a dynasty. We have again lived up to this spirit and can claim another point here. Often we mistake the Nehru family rule to be dynastic. This is misplaced because if a nation of 1 billion chooses on its own will a person in the same family, the fault lies with the people and not the system. Similarly, if parties end up propping up one surname for leader, it may reflect the paucity of ideas, but we cannot blame the system.

The Preamble also promised ‘justice’: social, economic and political. Out here the performance has been mixed. The judicial system appears to be very slow to dispense justice just as the recent rulings on the bomb blasts of 1993 demonstrate. The processes are so intricate that the common man can spend a life time making rounds of the courts searching for justice. Even today the underprivileged classes do not get social justice. But as the judicial system functions well and is known to be impartial, another half mark may be added.

The Preamble further assured us ‘liberty’ of thought, expression, belief, faith and worship. On this score, we would compare well with any western developed country. There are none or few controls imposed by the system. However, in the recent past we are seeing certain fundamental views which are being expressed not just in words but in destructive action by some intolerant political and religious groups. The reference is intolerance towards certain kinds of literature (Shivaji), art (MF Hussain), celebration of festivals (Valentine’s Day), conversions (Staines) dress codes and so on. These are some dangerous signs which need to be dealt with strictly by the judicial system before these Talibanistic tendencies spread and get ingrained in our social fabric. Three-quarter marks here.

The Preamble also guarantees ‘equality’ of status and opportunity. While we have had conscious affirmative action by the government to meet this objective, there have been problems in implementation of the reservations policy. Also the real under-privileged are not really receiving this benefit. But, to the extent that our laws have taken this objective seriously and made such provisions, we could give another three-quarter marks here.

Lastly, the Preamble talks of building ‘fraternity’ and the success has been quite remarkable despite all the problems that we have faced. People do stand up as one when it comes to the country with the nationalistic fervour prevailing. While this gives us one more point, the credit goes more to the people of the country rather than the system.

We have hence scored 6.5 points on a score of 10, which is quite good given the vastness of our country and the contradictions that lie in our society in terms of religion, caste, politics, social differences, education and conservatism. We need to consciously work on these factors to improve this score and should not let any extraneous elements get in the way.

Calling the call centre: Indian Express, 8th August 2007

They wish you a nice day... right after destroying every prospect of it


Hi-Tech banks claim that transactions carried out at a branch cost Rs 50. At an ATM, they come down to Rs 15, if they are through a call centre, they cost Rs 10, and it’s just Rs 2-4 if they are done on the internet. That is why customers are ‘encouraged’ to opt for cheaper modes.
Now call centres may sound like a good idea, but watch how they change your life — and mood. If the bank has a jingle, you are welcomed with a song. You are then provided with nine single-digit numbers corresponding to nine different banking options. If you forget what they stand for, you will have to wait for them to be replayed. You yearn for a human being on the other side, but that option is not easy to access. You start with choosing a language. Then you are asked to key in your 16-digit credit/debit card number. You do not have it on you so you either disconnect and try again or yell to someone to get you your card. You may be asked to key in your date of birth too, but before you get around to it, you are thanked for using the facility — the call is dropped.
You ring up again, go through the same process and this time manage to get through to the call centre staff. While the call is being transferred, you are politely told that your call is important and that someone will serve you “as soon as possible”. The jingle is supposed to keep you tuned in but makes you want to tear your hair out. Finally Rita, Vishal or Vinamra comes on the line and asks you to identify yourself. They will ask you for your address — and you better reel it off as it was typed in your particulars or else your call won’t be entertained. Your mother’s name will then be asked. What is the credit limit? What is the expiry date? When, and if, you finally break the barrier, you pose your question.
But your agony does not end there. If you are a ‘privileged’ customer you are transferred to a special division where the interrogation begins again. If you are lucky, your query gets answered at this stage. Otherwise, you are told that the system is down and that you will have to call back. Or you are told that you will get a response in four days’ time. Never mind if the call is about a lost credit card or something as urgent; the “four-days” answer is universal. Then comes the icing on the cake: “Sir/madam, is there anything else I can do for you? Have a nice day.”
But how can you have a nice day when your question has still not been answered? It makes you feel almost nostalgic for the days when you stood in the sweaty queue of your neighbourhood bank and waited for the person behind the counter to finish his cup of tea!

Has the ban worked? Business Standard, 29th July 2007

Futures trading was banned in four commodities in the beginning of the year ostensibly because it was felt that they were responsible for higher inflation. Five months have passed since the ban was imposed and it is essential to assess the impact of this ban on prices and the market — more so because there is a Committee that is looking into aspects of futures trading to provide a clearer perspective.

The inflation impact has not really been positive. The moderation in inflation from the 6 per cent mark to the 4.3 per cent mark witnessed today has been more due to a higher base effect as well as the aftermath of the rabi crop, which was good this year. Also this is the time when inflation is typically lower than in the latter part of the year, when demand picks up across the board.

Therefore, we have seen the prices of wheat and urad decline to begin with as the rabi harvest came in the months of March, April and May . However, ironically this was indicated by the futures prices at the time of the ban. But in the case of wheat, the story did not really end because the government has still not managed to procure the 15 million tonne target set for the FCI.

Either the production estimates of wheat, which is supposed to be close to 75 million tonnes, is not right or the farmers have become savvy and are not interested in selling to the government at a price of Rs 850/quintal especially since the landed cost of wheat could be anywhere up to Rs 1,200 per quintal at a minimum price of $263/tonne. The wheat chaff has yet to settle down and imports have been reckoned for the second successive year.

Tur was the other commodity which was banned, and its price continues to increase in the market, as output has fallen short of the target as indicated by the ministry of agriculture. This was also what the futures prices had indicated in January. In case of urad, the futures prices were falling anyway due to the rabi arrival as well as the imports which come towards the end of the first quarter from Myanmar. Quite evidently, the important signals provided by the futures market were incorrectly interpreted which resulted in what was euphemistically termed as a delisting of these commodities.

The consequences on the market have been fairly harsh. Firstly, market participants are apprehensive of trading in agricultural commodities as there is fear that the same kind of restrictions may be imposed on other commodities as well, in which case moving out of the market on satisfactory terms would be difficult. Therefore, participation in trading in agricultural commodities has come down quite significantly by between 10-20 per cent.

Secondly, the volumes of future starting in agricultural commodities have also come down and the commodity market appears to be buoyant only in non-agricultural commodities. The share of agricultural commodities in total traded volumes fell from around 55 per cent in FY06 to 35 per cent in FY07 and has further declined to 29 per cent in the first quarter of FY08.

Thirdly, diminishing volumes as well as participation in the futures markets have also affected the liquidity of contracts on the exchanges. Liquidity is important because an efficient market means there are large volumes, which is the prerequisite for efficient price discovery which, in turn, implies lower impact cost. This process has been set in motion in the last three years and has been quite competently established in an array of commodity groups such as cereals, spices, pulses and oils and oilseeds.

Fourthly, the very purpose of having futures trading has been defeated as it was proposed that futures trading would bring the benefit of fair prices to farmers when this market was resurrected in 2002. However, with diminished interest in futures trading, this bridge would get that much farther. While it is true that farmers are not trading today on the exchanges, there is enough evidence to show that in certain pockets of the country, the community is making use of the prices.

It is true that farmers would take time to actually trade as there are a number of enabling provisions in the regulatory structure that need to be put in place before this can happen. But before this can be embarked upon, we need to have a liquid market for agricultural commodities. The drying up of liquidity would automatically make the market that much less efficient and keep the farmers away from this system. There is a view that vested interest groups, who have seen their oligopolistic power diminished with the advent of futures trading, have been constantly trying to present an incorrect picture which could have influenced the decision to ban the trading of futures in four essential commodities.

The last consequence of a thin agricultural futures market is that a very important tool for taking economic decisions would be lost. Futures prices have, in the last couple of years, indicated well that crop harvests and prudential regulation from the FMC have ensured that price deviations have by and large reflected the fundamentals. This tool can hence be used at a more practical level by the government for fixing the MSPs as they will provide the market view of things.

At a different level, the ban has also affected the global view of the country in an age where markets are being liberalised; India appears to be dragging its feat. However, it is heartening that there are a number of foreign investors who are still interested in taking equity stakes in commodity exchanges with an equal interest being shown in trading.

The delisting logically needs to be removed to restore the equilibrium though it would take time for the market to restore its faith. This would be a pragmatic decision.

Carving out value: dna 25TH July 2007

It is not unusual to see a company separating one of its divisions into a new entity and getting a nod in the stock market for its action.
The share price goes up and the shareholders gain, thus vindicating the decision. This keeps happening in USA, Europe and Japan. In the last six years there have been a number of such actions in India which come under the umbrella of the synonyms of demergers, spin-offs, carve-outs, and so on.
There was a time when companies went in for diversification — very often in unrelated fields, either because it was trendy or because it came along with an alliance with a foreign collaborator.
After a while, the management realises that this business is a burden on the P&L account. Demergers then are the logical corollary, and the market applauds it with higher valuation for both the entities.
The basic premise here is that parts of the company get a better valuation than the single entity. The issue now is whether or not this can be a workable strategic proposition: Can we get superior valuations from demergers?
Companies such as Hindustan Lever, L&T, Tata Steel and Tata Motors have moved away from their non-core businesses using this route. Exiting from unviable businesses has been a common corporate strategy to address the challenges of competition.
Two aspects need to be debated: the motivations for such an action and the actual experiences of companies in this regard.
Spin-offs or demergers are definitely used to get better market valuations. That’s so because the market now gets more information on both the companies, thus reducing the information asymmetry, and investors are able to evaluate the companies in a better way.
A company would typically try and spin-off a unit or line of business which no longer adds value to the balance sheet.
Selling unwanted and surplus or unconnected parts in the business is a restructuring strategy to get rid of the sick parts of the company.
The other reason could be to return to its core competence and move away from unrelated fields. At times the better valuation helps it garner resources to finance an acquisition.
Such moves also help to make financial and managerial resources available for developing other, more profitable opportunities.
Take the case of L&T, which is primarily an engineering firm. It had capital locked in cement, which was driving the profit level down. So it made sense to demerge this unit so that the valuation of L&T improved. How did this happen?
The profit ratios improved as the balance sheet of the cement division was separated and the share price rose manifold.
Similarly, EID Parry was able to separate its sugar business from fertilizers, which went to Coromandel fertilizers. Now Reliance Communications is planning to hive off its towers business to unlock value at the bourses.
These success stories could be attributed to proper planning where there is better management focus and greater flexibility in operations.
While the results have been encouraging in terms of better valuation, the motivation was definitely restructuring of business lines. All spin offs have not been successful even when they’ve made theoretical sense.
This holds especially for the IT education business, where companies such as Aptech and NIIT separated software from education.

However, this could be attributed more to the diminishing importance of the education business where it was no longer the prerogative of these institutes to provide the service.
The question now is whether or not the value created through such separations is real. Most spin-offs are invariably of divisions that are not performing: rarely does a company find an unrelated business a burden if the profits are streaming in!
In the last 6 years or so, there have been more successes than failures. As long as the premises are right, the chances of success are greater. However, there are some preconditions.
The resulting business has to be a viable one (NIIT). Secondly, the business (to be spun-off) must be one which is bringing down the value of a company due to the absence of the required skills or management time for the same (L&T). Thirdly, the hived off unit must have a capable management.
Anecdotal evidence suggests that the market is mostly rational and awards a better valuation only if enhanced value is seen. Mere spin-offs do not guarantee better valuations. This critical point must not be missed.

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.