Month: March 2015 | Page 5

14 March, 2015

The mess in public sector banks will not be easy to sort out

The finance minister Arun Jaitley met the chiefs of public sector banks yesterday for a quarterly review of performance. Media reports suggest that among other things the banks were also asked to cut interest rates on their loans.
The Reserve Bank of India (RBI) has cut the repo rate by 50 basis points to 7.5% during the course of this year. Repo rate is the rate at which the RBI lends to banks. But banks haven’t passed on this cut to their end consumers.
There are multiple reasons for the same. Typically when the RBI increases the repo rate, the banks match the increase very quickly. But the same thing is not seen when it comes to a scenario where the RBI cuts the repo rate. Banks are normally very slow to pass on cuts to consumers.
As Crisil Research points out in a research note: “Lending rates show upward flexibility during monetary tightening but downward rigidity during easing. Between 2002 and 2004, while the policy rate declined by 200 basis points, lending rates dropped by just 90-100 basis points. Conversely, in 2011-12, when the policy rate rose by 170 basis points, lending rates surged 150 basis points.”
But there is a little more to it than just this. The balance sheets of public sector banks are in a big mess. As thelatest financial stability report released by the RBI in December 2014 points out: “PSBs [public sector banks] continued to record the highest level of stressed advances at 12.9 per cent of their total advances in September 2014 followed by private sector banks at 4.4 per cent.”
What this clearly shows is that public sector banks are not in great shape. The stressed asset ratio is the sum of gross non performing assets plus restructured loans divided by the total assets held by the Indian banking system. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank) by increasing the tenure of the loan or lowering the interest rate.
What this means in simple English is that for every Rs 100 given by Indian banks as a loan (a loan is an asset for a bank) nearly Rs 10.7 is in shaky territory. For public sector banks this number is even higher at Rs 12.9.
Also, as the following table from Credit Suisse shows, 46% of public sector banks have a tier I capital of less than 8% and un-provided problem loans greater than 100% of their networth.

62% of PSU banks have Tier-I < 9% and
Un-provided problem loans > 100%

Source: Company data, Credit Suisse estimates

What this clearly tells you is that banks many public sector banks do not have enough money to cover their losses. The public sector banks are hoping to recover some of these losses by cutting their deposit rates but staying put on their lending rates. And this leads to a situation where even though the RBI has cut the repo rate once, it hasn’t had much impact on the lending rates of banks.
Further, banks do not have enough capital going around. Take the case of Tier I capital mentioned
earlier. It is essentially sort of permanent capital that the bank has access to andincludes equity capital and disclosed reserves.As the RBI master circular on this points out: “Tier I capital consists mainly of share capital and disclosed reserves and it is a bank’s highest quality capital because it is fully available to cover losses.”
As the following table shows the average tier I capital of public sector banks is less than 8%. While this is the more than 6% tier I capital that banks are required to maintain under current norms, it is very close to the 7% tier I capital that banks will have to maintain under the Basel III norms, which need to be fully implemented by March 31, 2018.

Average Tier-I for PSU banks is less than 8%

This lack of capital has and will continue to constrain the ability of the public sector banks to lend and keep growing. The PJ Nayak committee report released in May 2014, estimated that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.”
The report further points out that “assuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.50 lakh crores.” In the next financial year’s budget the finance minister Arun Jaitley has committed just Rs 7,940 crore towards this.
As analysts Ashish Gupta, Prashant Kumar and Kush Shah of Credit Suisse point out in a recent research note: “The amount allocated is almost the same as our estimate of total dividend likely to be paid by all PSU banks to the government in FY16. This indicates that government capital infusion going forward could be a function of only the profit generation ability of PSU banks.”
Also, by allocating a very small amount to towards public sector banks recapitalization, the message that the government seems to be giving the banks is that they are on their own. This in a way is good, given that the government clearly is not in a position to commit the kind of money required to recapitalize the public sector banks.
Nevertheless, many public sector banks are not in a position to raise money on their own, given the mess their balance sheet is in. As the Credit Suisse analysts point out: “Smaller/weaker PSU banks with limited ability to raise capital from markets will be worst affected as there is very little likelihood of getting capital next year as well.”
So what is the way out? The only way out for the government is to sell off the weaker banks. There is no reason that the government of India should be running more than 20 banks. It simply doesn’t make any sense. Mergers of the weaker banks with the stronger ones is not a feasible option for the simple reason that it will tend to pull down the well performing banks as well.
Of course politically this will be difficult to implement. But that is the kind of strong governance that Narendra Modi promised the people of this country. It is now time to deliver.

The column originally appeared on The Daily Reckoning on Mar 12, 2015

11 March, 2015

Why all deodrant ads commodify women and diamond ads don’t

Vivek Kaul

This is another column which is different from the usual stuff that I write. Over the last few years I have been observing a few advertisements that tend to commodify women and few which don’t and have been wanting to understand, why things are the way they are. This column is a result of that.
Take the case of deodorant advertisements. These ads are like item numbers in films. They titillate and present women as one dimensional objects of sexual desire.
The only difference is that at the end of the deodorant advertisement the hero usually gets the girl because he has had the foresight to spray the deodorant on his well built body. The woman gets attracted by the smell of the deodorant and is hooked on to the guy.
One such advertisement was that of Wild Stone deodorant which featured the out of work but still stunningly beautiful actress Dia Mirza. As the formula for such advertisements goes, Mirza is seen getting attracted to a well sculpted male model who has applied the Wild Stone deodorant.
In real life it would be foolish to think that beautiful women are attracted to men on the basis of just a brand of a deodorant. But this ad, like most deodorant ads, is not targeted towards women. It is targeted towards men.
As brand guru Martin Lindstrom writes in Brandwashed –Tricks Companies Use to Manipulate Our Minds and Persuade Us to Buy: “in general women tend to more easily persuaded by ads that are more romantic than sexual… Men, on the other hand, respond to sexual innuendo and women in bikini.”
In fact when it comes to deodorants a lot of research and thinking has been done to arrive at these clichéd advertisements. As Lindstrom told me in an interview when I asked him what the ultimate male fantasy was: “A man sitting in a hot-top-spa with two naked ladies on each side – popping a bottle of Champagne. Unilever, the manufacturer of AXE discovered this very observation based on thousands of interviews and observations of men worldwide – realising that this very fantasy indeed seems global – and today explaining why AXE uses this very imagination as the foundation for all their ads.”
And that explains to a large extent why all deodorant advertisements are one and the same. Geoffrey Miller, a professor of evolutionary psychology has an explanation for this in his book Spent –Sex, Evolution, and Consumer Behaviour. He writes “Biology offers an answer. Humans evolved in small social groups in which image and status were all-important, not only for survival but for attracting mates, impressing friends, and rearing children. Many products are products are signals first and material objects later.”
Deodorant ads work on this evolutionary trait and tend to project the smell of a deodorant as a sexual mating signal from the male to the female. This is primarily because biologically the best strategy for a man is to be promiscuous and try and attract as many women as possible. “The more women with which he mates, the greater number of children containing his genes are possible… Thus, a man’s biological criteria can be simple: 1) she must be healthy; 2) she must be young; 3) she must be receptive; 4) and she must be impregnable,” writes Richard F. Taflinger in You and Me, Babe: Sex and Advertising.
While a man may want to be promiscuous it may not be always possible for him to do so because of societal pressures. But even with that a subconscious need may still remain. And that is what marketers who commission sexually loaded ads, play on. A great example is the chocolate man ad of Axe Body Spray, which had multiple women swooning over one man.
The other product that has taken on to sexually loaded advertising is the male ganji. A typical ad shows a guy wearing a ganji (these days chances are that this could be a filmstar) always getting the girl in the end. What is true about ganjis is also true about the male underwear.
An ad that went overboard with sexual innuendo was the Amul Macho underwear ye to bada toing hai. The ad showed a woman, who was probably newly married, going to the village river to wash her husband’s underwear. And in the process the other women around her were shown to get sexually turned on. The ad again played on the promiscuous nature of men even though it did not feature a man and ended up demeaning women through its one dimensional projection.
In fact automobiles are another area which tend to get sexually loaded advertising. This phenomenon is still to take off in India where most car advertising tends to concentrate on the family and if not the family, then the double income no kid couple.
But in the developed countries this mode of advertising has been around for a while. Lindstrom points to a Volvo ad showing a silhouette of a Volvo’s driver’s seat with its parking brake extending in the air – precisely like an erect penis – over the tagline, “We’re just as excited as you are”.
One thing that is common to this track of advertising is that they tend to project women as bimbos. As Madhukar Sabnavis of Ogilvy & Mather puts it “Do Axe commercials project women as bimbos, or are they a light-hearted take on the man-woman relationship? I would prefer to think it’s the latter…The judgement is subjective and qualitative, and so it cannot be cast in stone.” While the advertising industry might say that they are not projecting a stereotype, the evidence is clearly to the contrary.
But what about women? Why don’t they take to direct sexual advertising and tend to be swayed more by romantic advertising?
A few years back Tanishq released an advertisement featuring Adil Hussain and Tisca Chopra which had all the settings of romance—a couple in a restaurant with the candles lit, saxophone playing in the background and a man getting ready to gift a solitaire to his wife of ten years.
So why do these kind of advertisements work well with women? As Taflinger puts it “Women…have a far greater physical, physiological and temporal stake in producing children. This means she must be highly selective in her choice of men if she wishes to produce the highest quality children in her reproductive lifetime. If she selects just any man that comes along, she could waste all that time and energy that pregnancy and rearing require on a possibly weak or nonviable child. She thus aims her biological criteria at getting the best possible man. The sex act, and his participation, being so brief, doesn’t have to be of any particular interest to her. What is important is the quality of genes he brings and the help, if any, she will have while carrying, bearing and rearing the children.”
Now that does not mean that the sexual desires are strong only in men. As Taflinger explains “She also has sexual desires as strong as a man’s. However, she will often subordinate that desire. That is, she may desire a physically attractive man, but she will not actually have sex with him until he has satisfied more than physical criteria.”
Hence, women are more careful than men when it comes to entire ritual of mating. But that does not mean they don’t send out sexual signals. They do that, but not in a way as direct as men. The entire cosmetics business is built on this insight. As Miller puts it: “The whole cosmetics business is focused on helping women appear younger, more fertile, healthier, and thus better able to bear offspring. The evolutionary background of cosmetics is that in most primate species,sexual selection focuses very heavily on facial appearance. In assessing women’s ages, men apparently evolved to pay close attention to facial and bodily cues of being in the young-adult phase of peak fertility. So women could evolve to fake their fertility all the way from around age twelve to around age twelve to around age sixty.”
And how cosmetics help? “One way of faking fertility across a broader age range is to apply cosmetics that amplify facial fertility cues that peak in young adulthood, such as plump lips, large eyes, prominent cheekbones, smooth and radiant complexion, thick and glossy head hair, and minimal facial hair,’ writes Miller.
This explains why you will see more deodorant ads stereotyping women in the time to come. But you will never see a diamond ad doing the same.

The column originally appeared on The Daily Reckoning on Mar 11, 2015

10 March, 2015

E is now mc2: The changing face of Indian ecommerce

This is a slightly different column from the ones that I usually write, given that it has no hard core economics in it for a change.
In February earlier this year I was in Bangalore at a literature festival, moderating a discussion titled old retail versus new retail. And this discussion along with some recent family experiences and reading leads me to believe that some interesting things are happening in the Indian ecommerce space.
I first discovered ecommerce when I started ordering books on Rediff.com(of all the places) sometime in 2007 or 2008 (I don’t remember when). I found the process very convenient and ended up finding a large number of books which weren’t available in book stores. During those days the discount phenomenon hadn’t really caught on.
While ordering yet another book on Rediff I discovered a small advertisement (if my memory serves me right) of a website which offered discounts on books. I had never heard of the website before and was sceptical ordering from it.
But the discount finally did the trick and I placed a order. The book was delivered a few days later. And that’s how I discovered Flipkart.com. In the days to come I discovered other book websites like Infibeam.com, Uread.com and so on.
All my book shopping moved online and I stopped going to bookstores like Oxford(at Churchgate in Mumbai), Landmark(at Phoenix Mill in Mumbai) and Crossword(at Kemps Corner in Mumbai). This is how things stayed in the years to come.
My tryst with Indian ecommerce was limited to buying books. Nevertheless, the Indian ecommerce scene has changed dramatically over the last six years. The kind of goods that are now available (and are being bought) online, was absolutely unthinkable six years back. I came to realize this after I saw my mother buying everything from towels to cup-plates-spoons from e-commerce sites, using the cash on delivery option. This gave me the confidence to buy a water filter online, which was delivered within 24 hours. I even ordered a pair of spectacles online recently. The process was extremely convenient.
Everything from furniture to electronics to shoes to clothes, is now available online. The feeling prevailing in 2008 was that people needed to touch and feel a lot of things before buying them. Hence, ecommerce would never move beyond selling books and a few other goods. But that is not how it has turned out.
So, the question is why are people now comfortable buying those goods online which nobody thought they would six years back? I feel there are two major reasons for the same. The first is of course price. Professor Rajiv Lal of Harvard Business School who has studied the retail business all over the world explained this to me in an interview when he said: “Basically the margins that are build up because some of our retail chain are inefficient. Think about the amount of inventory that is being held in the Indian apparel business. It is humongous. Stores are full of inventory and most of them don’t even know how much inventory they are holding. All that stuff is being reflected in the prices that we pay.”
The e-commerce companies don’t have to maintain huge inventories. If they manage to build up an efficient supply chain network, they can keep ordering goods as they go along. Hence, they do not to have maintain a large inventory like the offline players. This helps keeps costs down.
Also, like offline players they do not need to maintain a huge physical infrastructure like showrooms, godowns etc., to sell their goods. They can also buy goods directly from companies producing them and get a better deal in the process. These goods can be then directly sold to prospective consumers without having to go through an elaborate distribution channel.
As Lal told me: “even situations that we think that it doesn’t make sense for people to buy things on the internet because of the inefficiencies in the Indian retail system, the price is so appealing that people are willing to compromise on other things.”
Further, the second reason for the success of ecommerce companies in India is that they follow a very flexible return policy. This allows consumers to touch and feel the product that they want to order. Let’s say a consumer wants to order a pair of shoes. Instead of ordering just one pair, he can order four pairs, see which one fits and looks the best, keep that, and return the other three.
While this is a logistical nightmare for ecommerce companies it has become an important part of the business model that has evolved, allowing the consumers to touch and feel the product.
Ecommerce companies can reach all parts of India even where old retail does not. A friend of mine narrated an interesting story about ordering diapers online for his newly born child. The ones that he wanted were not available in the small town that he lives in.
In Bangalore while moderating the discussion, the CEO of an ecommerce company which specializes in women’s inner wear told me that they deliver to all pincodes in India. It wouldn’t be possible for an old retail company to have that kind of reach through physical stores.
Also, as people get used to ordering stuff online, the ticket sizes of what they order are going up. “The biggest solitaire we have sold was priced at Rs 20 lakh,” the CEO of an ecommerce company which sells jewellery online told me in Bangalore.
Interestingly, Indian ecommerce now needs to be rechristened as mcommerce. Akhilesh Tilotia of Kotak Institutional Equities makes this point in a recent research note titled e is now mc²: “India’s new internet users [are] coming primarily via mobiles…Flipkart said that ~70% of its transactions take place on mobiles across all categories (from electronics to fashion) and freecharge indicated that this number was ~90%.”
And in case you wondered why every ecommerce(oops I should be saying mcommerce) company keeps advertising their mobile apps, you now know the reason.
In fact, ecommerce companies now even want to set up physical stores. I came to know about this at Bangalore. Tilotia suggests the same in his note: “Online channel players (especially in high-value or experiential verticals such as furniture, jewelry, and beauty products) pointed out the challenges that they face in bringing the correct and complete experience to the customer. Issues such as the need to touch and feel a product, trust, dispute resolution, and handholding and demonstration need a physical outlet. Companies that started as online-only portals are now developing an omni-channel strategy.” Such stores should take care of the need of a consumer to touch and feel a product to some extent.
But that’s the good part. What nobody seems to be talking about is whether the ecommerce companies are actually making any money? Or when will they start making money? Right now, with money available at low interest rates in the developed world, private equity and venture capital firms are falling over one another to invest in Indian ecommerce. The question is for how long will that continue?

The column originally appeared on The Daily Reckoning on Mar 10, 2015

5 March, 2015

Inflation targeting will only work if govt keeps its end of bargain

The finance minister Arun Jaitley’s budget was slightly high on the policy front. One of the things that Jaitley announced in the budget was: “To ensure that our victory over inflation is institutionalized and hence continues, we have concluded a Monetary Policy Framework Agreement with the RBI…This Framework clearly states the objective of keeping inflation below 6%. We will move to amend the RBI Act this year, to provide for a Monetary Policy Committee.”
This strategy essentially involves a central bank estimating and projecting an inflation target, which may or may not be made public, and then using interest rates and other monetary tools to steer the economy toward the projected inflation target.
In the Indian case the target has been made public. As per the agreement between the Reserve Bank of India(RBI) and the government, the RBI will aim to bring down inflation below 6% by January 2016. From 2016-2017 onwards, the rate of inflation will have to be between 2% and 6%.
One of the popular theories going around(especially in the social media among Narendra Modi bhakts) is that by doing this the government has managed to clip the wings of the RBI governor Raghuram Rajan.
Nothing can be far from truth as this. Rajan has been an active advocate of central banks following inflation targeting as a strategy, over the years. He believes that the RBI should be concentrating on controlling inflation, instead of trying to do too many things at the same time.
As Rajan wrote in a 2008 article (along with Eswar Prasad): “The central bank is also held responsible, in political and public circles, for a stable exchange rate. The RBI has gamely taken on this additional objective but with essentially one instrument, the interest rate, at its disposal, it performs a high-wire balancing act.”
By trying to do too many things at the same time, RBI ends up being neither here nor there, the RBI governor feels. As Rajan and Prasad put it: “What is wrong with this? Simple that by trying to do too many things at once, the RBI risks doing none of them well.”
Hence, Rajan felt that the RBI should focus on controlling inflation. As he wrote in the 2008 Report of the Committee on Financial Sector Reforms: “The RBI can best serve the cause of growth by focusing on controlling inflation.”
The agreement chalked out by the government and the RBI is in line with the recommendations of the Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework (better known as the Urjit Patel committee report) which was released in January 2014. The Committee had recommended that the RBI be set an inflation target of 4%, with a band of +/- 2 per cent around it.
Also, the way the RBI is currently structured, it is another remnant of the British Raj. World over central banks are essentially run by monetary policy committees. In India setting the interest rate is the personal responsibility of the RBI governor. This should change with Jaitley saying that the RBI Act will be amended to put a monetary policy committee in place, this year. From the point of view transparency and clear goal setting this is a good move.
Nevertheless, the question though is, is inflation targeting the right strategy to follow? First and foremost, the agreement between the government and the RBI is about maintaining inflation as measured by the consumer price index(CPI) between 2% and 6%, starting in 2016-2017. Before this, the RBI needs to ensure that inflation stays below 6%.
Every six months, the RBI is supposed to publish a document which explains the sources of inflation and forecasts inflation for a period of six to eighteen months from the date of publication of the document.
The thing is that food and beverages constitute 54.18% of the CPI. Food inflation in India is typically caused by disruptions in supply (majorly due to the weather). Take the recent case of rains hitting North India. This has had a dramatic impact on vegetable supply in New Delhi, and led to higher prices.
The RBI cannot do anything in a situation like this. Further, the government policy of the day also has a huge impact in determining which way the food prices go. The government through the Food Corporation of India(FCI) buys wheat and rice at minimum support prices (MSPs). The previous Congress led United Progressive Alliance(UPA) government increased the MSP of rice and wheat dramatically over the years, which in turn led to higher food prices.
As the Economic Survey released a day before the budget points out: “High MSPs result in farmers over-cultivating rice and wheat, which the Food Corporation of India then purchases and houses at great cost. High MSPs also encourage under-cultivation of non-MSP supported crops. The resultant supply-demand mismatch raises prices of non-MSP supported crops and makes them more volatile. This contributes to food price inflation that disproportionately hurts poor households who tend to have uncertain income streams and lack the assets to weather economic shocks.”
This is something that the RBI has no control over. And in situations like these, monetary policy is more or less useless.
What this also means is that the RBI alone cannot ensure that inflation stays less than 6% (or between 2-6% from 2016-2017 onward). The government will also have to follow a responsible fiscal policy. Getting the RBI to sign to an agreement of maintaining low inflation clearly does not mean that only the RBI is responsible for inflation and the government can do whatever it wants to on the fiscal front.
As Rajan said in the monetary policy statement released yesterday: “The central government has signed a memorandum with the Reserve Bank setting out clear inflation objectives for the latter. This makes explicit what was implicit before – that the government and the Reserve Bank have common objectives and that fiscal and monetary policy will work in a complementary way.” I hope, the government keeps its end of the bargain.

Postscript: The RBI cut the repo rate yesterday by 25 basis points (one basis point is one hundredth of a percentage) to 7.5%. Honestly, I was not expecting this and I had more or less said so in the column that appeared on March 2, 2015.
One thing the rate cut tells us is that Rajan hasn’t bought into the new GDP growth number of 8.1-8.5% in 2015-2016. Jaitley had talked about India soon hitting double digit economic growth in his speech.

The column appeared in The Daily Reckoning on Mar 5, 2015

4 March, 2015

The great Indian govt Ponzi scheme is here to stay

Vivek Kaul

In the budget speech that he gave in July 2014, while presenting his first budget, the finance minister Arun Jaitley had said: “My Road map for fiscal consolidation is a fiscal deficit of 3.6 per cent for 2015-16 and 3 per cent for 2016-17.” Fiscal deficit is the difference between what a government earns and what it spends. It finances the deficit through borrowing.
In the budget speech that Jaitley gave on February 28, 2015, he put fiscal consolidation on the back burner, when he said: “I will complete the journey to a fiscal deficit of 3% in 3 years, rather than the two years envisaged previously. Thus, for the next three years, my targets are: 3.9%, for 2015-16; 3.5% for 2016-17; and, 3.0% for 2017-18.”
This is a worrying trend. Finance ministers want to increase government expenditure but they do not have much of an idea about how to increase its income. In the process, they end up running higher fiscal deficits, which leads to the government borrowing more.
As can be seen from the table that follows the Ponzi ratio of the Indian government has gone up over the years. In 2009-2010, it was at 0.70, and in 2015-2016, it will be at 1.23. Before I go about explaining what this means, it is important to go back in history and talk about a certain Charles Ponzi.

Year	Interest payment	Repayment of principal	Total debt servicing	Fiscal Deficit	Ponzi ratio
2015-2016	4,56,145	2,25,574	6,81,719	5,55,649	1.23
2014-2015	4,11,354	2,00,955	6,12,309	5,12,628	1.19
2013-2014	3,74,254	1,62,976	5,37,230	5,02,858	1.07
2012-2013	3,13,170	1,15,218	4,28,388	4,90,190	0.87
2011-2012	2,73,150	1,11,933	3,85,083	5,15,990	0.75
2010-2011	2,34,022	1,47,793	4,68,044	3,73,591	1.25
2009-2010	2,13,093	81,764	2,94,857	4,18,482	0.70

Sometime in 1919, Charles Ponzi, an Italian immigrant into the United States, promised investors in the city of Boston that he would double their money (i.e. give them a 100% return on their investment) in 90 days.
Ponzi had hoped that to make this money through a huge arbitrage opportunity that he had spotted among the international postal reply coupons being sold across different countries. But due to various reasons both bureaucratic as well as practical, he could never get around to executing the scheme he had come up with.
But by the time Ponzi realised this, big money was coming into his scheme and he had got used to a good lifestyle. At its peak, the scheme had 40,000 investors who had invested around $ 15 million in the scheme.
Ponzi kept his investors happy by using money brought in by the new investors to pay off the old investors who wanted to redeem their investment. And that is how the scheme operated up to a point. On July 26, 1920, the Boston Post ran a story questioning the legitimacy of the scheme.
Within a few hours, angry depositors lined up at Ponzi’s door, demanding their money back. Ponzi asked his staff to settle their obligations. The anger subsided, but not for long. On Aug 10^th, 1920, the scheme collapsed. The auditors, the newspapers and the banks declared that Ponzi was definitely bankrupt.
Ponzi was not the first individual to run a Ponzi scheme, just that his name stuck to it. A Ponzi scheme is essentially a fraudulent investment scheme in which money brought in by new investors is used to redeem the payment that is due to existing investors.
Governments also degenerate into Ponzi schemes over the years, though there is no intention of fraud. This happens when governments do not earn enough and issue new debt to repay old debt as well as pay interest on it.
Take a look at the table shared above. In 2009-2010, the interest payment on the total debt of government of India stood at Rs 2,13,093 crore. Over and above this, the government had to repay around Rs 81,764 crore of debt that was maturing. The total debt servicing cost came to Rs 2,94,857 crore. This amount divided by the fiscal deficit of Rs 4,18,842 crore was around 0.70. This ratio I refer to as the Ponzi ratio.
In 2015-2016, the interest payment on government debt will be at Rs 4,56,145 crore. The maturing debt that needs to be repaid is at Rs 2,25,574 crore. This leads to a total debt servicing cost of Rs 6,81,719 crore. The fiscal deficit for the year has been projected to be at Rs 5,55,649 crore. This means a Ponzi ratio of 1.23.
Hence, the entire fiscal deficit or the difference between what a government earns and what it spends, and which is financed through borrowing, is being used to pay interest on existing debt as well as repay the debt that is maturing. In fact, this is eating into the government revenues as well. Hence, because of the burgeoning debt the Indian government is spending more and more of its money on servicing debt. This is clearly not a good sign as it leaves a lesser amount of money to be spent on other things.
In the July 2014 budget speech, Jaitley had said: “The Government will constitute an Expenditure Management Commission, which will look into various aspects of expenditure reforms to be undertaken by the Government. The Commission will give its interim report within this financial year.” The Commission led by former Reserve Bank of India governor Dr Bimal Jalan, submitted its report in January earlier this year. Nevertheless, the recommendations of the Commission do not seem to have made it into the budget.
The one big-ticket expenditure item that Jaitley had to deal with in this budget were the recommendations of the 14th Finance Commission which increased the states’ share of central taxes from 32% to 42%. The other big-ticket item that Jaitley should have done something about, he chose to more or less ignore.
The public sector banks need a huge amount of capital in the years to come. The PJ Nayak committee report released in May 2014, estimated that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.”
The report further points out that “assuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.50 lakh crores.” In the next financial year’s budget Jaitley has committed just Rs 7,940 crore towards this.
Further, as Jaitley said in his speech: “uncertainties that implementation of GST will create; and the likely burden from the report of the 7th Pay Commission.” This will make expenditure management even more difficult in the years to come. This means that the government Ponzi scheme will only get bigger than it currently is. Let’s see how this goes.

The column appeared on The Daily Reckoning on Mar 4, 2015