Dear parents, the engineering bubble has burst

In my extended-family when a kid grows up, the parents push him towards getting an engineering degree. If I may generalise a little more this is largely true for the Kashmiri Pandit community my parents belong to.

Once a youngster gets into an engineering course, all is forgiven and it is automatically assumed that the future will now be bright. And this may have been largely true for the nineties and the noughties, when India’s information technology companies were taking off. But now we are in the teens and the story has changed.

Why? The “indifference principle” is at work. As Steven E. Landsburg writes in The Armchair Economist: “Unless you’re unusual in some way, nothing can ever make you happier than the next best alternative.”

Landsburg explains the indifference principle through an example. As he writes: “Would you rather spend a bright summer day at the shopping mall or the…Fair…If the Fair is more fun than the mall, people flock to the Fair, building up the crowd size until it’s not more fun than the mall.”

So, the Fair doesn’t remain fun anymore because way too many people turn up. Something similar has happened to the engineering degree in India. The country is producing way too many engineers. As analyst Akhilesh Tilotia of Kotak Institutional Equities writes in a recent research note titled How many graduates are required to change a light bulb?: “Engineering graduate output of Indian universities stood at 15 lakh a year in FY2015 [the period between April 1, 2014 and March 31, 2015], up from 3 lakh in FY2005 [the period between April 1, 2004 and March 31, 2005].”

Hence, over the last decade, the number of engineers being produced has gone up five times. In fact Tilotia in his book The Making of India writes: “India in 2016 will graduate more engineers annually (1.5 million) than China (1.1 million) and the United States (0.1 million) combined.” One impact of so many engineers being produced is that it has “reduced the importance of ‘capitation fees’”.

Nevertheless, the trouble is that the employment opportunities for engineers haven’t gone up at the same speed. Information technology companies which were taking in a bulk of the country’s engineering graduates, aren’t recruiting at the same pace as they were in the past. As Tilotia points out: “net hiring in the IT sector has remained stagnant at 2.5 lakh [per year] over the past five years until FY2015”.

In fact, if we leave out the individuals recruited by the BPO sector from these numbers, the number of employees recruited by the information technology companies in the financial year ending as on March 31, 2015, stood at 2.09 lakh. The number of engineers produced, as mentioned earlier, stood at 15 lakh. Hence, there is a clear disconnect between supply and demand. The engineering dream to prosperity has clearly broken down.

The fascination of Indian parents for pushing their children towards getting an engineering degree has been built on hearing too many “success stories” of Indian engineers working in information technology companies in the United States on dollar salaries and other parts of the world.

Even those Indian engineers who have settled in the country and started working for the information technology companies in the nineties and up to the mid noughties, have done well for themselves. And these success stories have had a lot of impact on the thinking of parents.

The trouble is that the story has changed. As Tilotia writes: “IT companies have publicly stated that they are looking to automate meaningful parts of service offerings…Automation of workflow can significantly impact the prospects of entry-level joinees – their work is more susceptible to being automated.” Nevertheless, stories take a long time to unravel.

To conclude, as Landsburg writes: “In order for one activity to make you happier than another, you must be unusual in some way.” Hence, dear parents, the engineering bubble has burst. And as far as children go— please let them be!

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared in the Bangalore Mirror on August 5, 2015

Banks have lent no new money to real estate this financial year

It is very difficult to get hold of numbers when it concerns the real estate sector in India. The numbers usually put out are by organisations and institutions close to the real estate companies. The one genuine set of numbers that are put out every month is related to the total amount of lending carried out by scheduled commercial banks to the real estate sector in India. These numbers are put out by the Reserve Bank of India (RBI) as a part of the sectoral deployment of credit data, which is released once every month.

The latest set of numbers were released by the RBI on July 31, 2015, and make for a very interesting reading, especially if you have had a long(and perhaps lost) dream of buying a home to live in. Why do I say that? Allow me to explain.

As on June 26, 2015, the total amount of lending carried out by banks to the commercial real estate sector stood at Rs 1,66,900 crore. As on March 20, 2015, three months earlier, the number had stood at Rs 1,68,000 crore. Hence, the total amount of lending by banks to real estate companies has actually come down by around 0.7%. What can safely be said is that in the current financial year (which started on April 1, 2015) on an aggregate basis, the banks haven’t lent a single rupee to real estate companies.

How did the scene look like last year? As on March 21, 2014, the total amount of lending by banks to real estate companies had stood at Rs 1,54,400 crore. By June 27, 2014, the total lending had gone up by 1.7% to Rs 1,57,000 crore. This year the total lending has fallen by 0.7% during a similar period.

How do the numbers look over a longer horizon of one year? The lending to commercial real estate by banks has slowed down considerably. As mentioned earlier, as on June 26, 2015, the total amount of lending to commercial real estate by banks stood at Rs 1,66,900 crore. Over a period of one year, it has grown by just 6.3%. The overall lending by banks grew by 7.3% during the same period.

This is the third month in a row when the lending to real estate by banks has grown at a much slower pace than the overall lending. In fact, we need to look at numbers in June 2014 to realise how much the situation has changed over the last one year.

As on June 27, 2014, the total lending by banks to real estate companies had stood at Rs 1,57,000 crore. It had grown by 17.2% over a one year period. The overall lending by banks had grown 12.8%. Hence, the lending to real estate companies by banks had grown at a much faster rate than overall lending.
Further, lending to real estate companies by banks had grown by 17.2% last year. This year it has grown by only 6.3%. Also, as mentioned earlier, since the beginning of this financial year, the lending to real estate companies by banks has actually fallen.

And all this should be good news for buyers.  Why? For the simple reason that the funding source of real estate companies is drying out. Real estate companies have to repay the interest on the loans they had taken on previously. They also need to pay interest on it. Over and above this, there are projects that are still being built and need to be delivered by a certain date. Money will be needed for all these things.

All these reasons will ensure that the companies will have to get around to selling the unsold apartments that they have built and have been unable to sell. The number of unsold homes in cities across the country is huge. As per an estimate made by the real estate consultant Knight Frank the number of unsold homes in National Capital Region stands at around 1.89 lakhs. In Mumbai Metropolitan Region it stands at 1.94 lakh. In Ahmedabad the number is at 42,000. In Bangalore the number is at 1.05 lakh. And so the situation is all across the country.

The only way these unsold homes can be sold is by cutting prices. While the real estate companies have resisted this so far, with the funding from banks almost coming to a standstill, they really have no more options left in the days to come.

Finally, acche din should be on their way for those looking to buy homes to live in.

The column originally appeared on Yahoo India on Aug 4, 2015

RBI monetary policy: Interest rates won’t come down unless bad loans are controlled

The third Bi-monthly Monetary Policy Statement for 2015 was released by the Reserve Bank of India (RBI) today (August 4, 2015). As was widely expected, the RBI led by Governor Raghuram Rajan did not cut the repo rate and let it stay at 7.25%. Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark for the interest rates that banks pay for their deposits and in turn charge on their loans.

The RBI did not cut the repo rate because the rate of inflation has been on its way up. As the monetary policy statement pointed out: “Headline consumer price index (CPI) inflation rose for the second successive month in June 2015 to a nine-month high on the back of a broad based increase in upside pressures, belying consensus expectations…Food inflation rose 60 basis points [one basis point is one hundredth of a percentage] over the preceding month, driven by a spike in prices of vegetables, protein items – especially pulses, meat and milk – and spices.”

Food prices are something that the RBI cannot do much about. But prices on the whole have been going up as well. As the monetary policy statement pointed out: “Excluding food and fuel, inflation rose in respect of all subgroups other than housing. The momentum of price increases remained high for education. Inflation pressures increased for personal care and effects and household goods and services sub-groups. Inflation in CPI excluding food, fuel, petrol and diesel has been rising steadily since April.” Non food and fuel inflation will continue to go up as the new (and higher) service tax rate of 14% comes into effect June 2015 onwards. All these reasons led to the RBI keeping the repo rate constant.

More importantly, there is an interesting data point that the RBI monetary policy statement reveals: “Since the first rate cut in January, the median base lending rates of banks has fallen by around 30 basis points, a fraction of the 75 basis points in rate cut so far.”

What this basically means is that even though the RBI has cut the repo rate by 75 basis points, the median interest rate at which banks lend money has fallen by only 30 basis points. At the same time, the deposit rate cuts carried out by banks have almost matched the repo rate cut of 75 basis points that has happened so far.

A report in the Mint newspaper points out: “Large lenders such as State Bank of India (SBI), ICICI Bank Ltd, Punjab National Bank, HDFC Bank Ltd and IDBI Bank Ltd started trimming their deposit rates across various maturity periods since October last year, and reduced them by 75-100 bps[basis points].”

If a bank is cutting its deposit rates much faster than its lending rate, it is obviously looking to increase its profit margins. Why is it doing that? The answer in the current case is the bad loans that have been piling up with the Indian banking sector in general and public sector banks in particular.

Data from the RBI’s Financial Stability Report released in June 2015 shows that the gross non-performing assets of scheduled commercial banks in India stood at 4.6% of their total advances, as on March 31, 2015. The number had stood at 4% as on March 31, 2014.

What is even more worrying is the fact that the total amount of stressed advances have jumped significantly over the last one year. As on March 31, 2014, the stressed advances stood at 9.8% of the total advances. A year later this had jumped to 11.1%. The situation in public sector banks is even worse with stressed advances jumping from 11.7% of advances to 13.5%, between March 2014 and March 2015.

The stressed advances number is arrived at by adding the gross non-performing assets (or bad loans) and restructured loans divided by the total assets held by the scheduled commercial banks. Hence, the borrower has either stopped repaying the loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan by increasing the tenure of the loan or lowering the interest rate. This entails a loss for the bank.

What this means is that for every Rs 100 that public sector banks have given out as a loan Rs 13.5 is in dodgy territory. The borrower has either defaulted or the loan has been restructured.

Hence, it is not surprising that banks have been cutting their deposit rates in line with the fall in the repo rate. But their lending rates have not fallen at the same pace. The idea is to increase the profit margin between the cost of borrowing and the cost of lending. This is to ensure that there is enough leeway to account for the bad loans that have been piling up.

If the banks cut their lending rates at the same pace as their borrowing rates, they will either end up with losses or with falling profit levels. Nobody wants that.
Also, banks on the whole have been using the restructuring route to postpone recognising bad loans as bad loans. What this means is that the bad loans of banks (particularly public sector banks) will keep piling up. And hence, the banks will not cut lending rates in line with future cuts in the repo rate as and when they happen.

As one of the deputy governors of the RBI SS Mundra had pointed out in a recent speech: “There has also been an increase in incidence of suits filed against defaulters and cases of wilful default- an unwillingness to pay, despite an ability to pay. These problems could have their genesis in a failure to exercise the right amount of prudence and due diligence on part of the banker or an ab initio intent of the borrower to defraud the bank.”

Also, because of this the trust needed for a banker-borrower relationship to work well has broken down. As Mundra said during the course of his speech: “Recent spurt in instances of forensic audit being conducted by bankers on their borrowers signifies a breakdown in the implicit trust…The banker-borrower relationship is essentially symbiotic as both need each other. Both have certain expectations from the other and when these don’t get fulfilled on account of a malafide or fraudulent intent on the part of either of them, the relationship gets strained.”

This needs to be set right if a meaningful fall in lending rates has to happen. And at the sound of sounding clichéd, this is easier said than done.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column was originally published on August 4, 2015, on Firstpost

With Rs 70,000 cr bailout of banks, Modi’s minimum govt vision has gone for a toss

The government of India has planned to put in Rs 70,000 crore into public sector banks over the next four years. “As of now, the PSBs are adequately capitalised and meeting all the Basel III and RBI norms. However, the government wants to adequately capitalise all the banks to keep a safe buffer over and above the minimum norms of Basel III. We have estimated how much capital will be required this year and in the next three years till financial year 2019,” a ministry of finance press release pointed out.

The press release further pointed that: “If we exclude the internal profit generation which is going to be available to PSBs (based on the estimate of average profit of the last three years), the capital requirement of extra capital for the next four years up to FY 2019 is likely to be about Rs.1,80,000 crore.  This estimate is based on credit growth rate of 12% for the current year and 12 to 15% for the next three years depending on the size of the bank and their growth ability.”
This theme of rescuing public sector banks is something I have discussed in the past. And honestly, I am disappointed with the government deciding to spend to so much money over them. There are number of reasons for the same.

The latest release by the ministry of finance suggests that public sector banks are going to need Rs 1,80,000 crore of extra capital over the next four years. Of this amount the government plans to plough in Rs 70,000 crore.

(i)Financial Year 2015 -16Rs. 25,000 crore


(ii)Financial Year 2016-17Rs. 25,000 crore


(iii)Financial Year 2017-18Rs. 10,000 crore


(iv)Financial Year 2018-19Rs. 10,000 crore


 Total Rs. 70,000 crore


Source: Press Information Bureau

These numbers are very different from the numbers put out by the PJ Nayak committee report released in May 2014. The committee estimated that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.” The committee further said 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.”

The difference between the number put out of by the ministry of finance last week and the number put out by the PJ Nayak committee is huge. The PJ Nayak Committee said that the government would need to invest Rs 3,50,000 crore by March 2018. The government is investing only Rs 70,000 crore by March 2019. If the PJ Nayak Committee number is the amount of money that is required then the money being put in by the government is basically small change.
In a research note titled A Growing Need for Indian TARP, Anil Agarwal, Sumeet Kariwala and Subramanian Iyer, analysts at Morgan Stanley estimate that an immediate infusion of around $15 billion (or Rs 96,000 crore assuming $1 = Rs 64) is needed in these banks. Either ways what the government plans to invest is too small in comparison to what may be required at this point of time.

Further, other than requiring a massive infusion of money, these banks continue to face a significant amount of bad loans. As the latest RBI Financial Stability Report released in June 2015 points out: “Five sub-sectors, namely, mining, iron & steel, textiles, infrastructure and aviation, which together constituted 24.8 per cent of the total advances of scheduled commercial banks, had a much larger share of 51.1 per cent in the total stressed advances. Among these five sectors, infrastructure and iron & steel had a significant contribution in total stressed advances accounting for nearly 40 per cent of the total. Among the bankgroups, public sector banks, which had the maximum exposure to these five sub-sectors, had the highest stressed advances.”

Around 30.5% of the stressed advances of public sector banks come from the infrastructure sector. Nearly 10.5% comes from iron and steel sector.
The stressed assets are arrived at by adding the gross non performing assets(or bad loans) 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 by increasing the tenure of the loan or lowering the interest rate.

The trouble is that many public sector banks have essentially been using the restructuring route to avoid recognising bad loans as bad loans.  The Morgan Stanley report referred to earlier points out: “The current managements’ policy of “extend and pretend” is causing banks to move further into problems.”
The banks have been kicking the can down the road by refusing to recognise bad loans upfront. In a research note published earlier this year, Crisil Research estimates that 40% of the loans restructured during 2011-2014 have become bad loans. Morgan Stanley estimates that 65% of restructured loans will turn bad in the time to come.

What this tells us actually is that any capital infusion will essentially not amount to much given that bad loans will keep piling up. In a research report titled Current Worries Crisil Ratings has estimated that “around 46,000 mw of power generation projects (36,000 mw coal-based and 10,000 mw gas-based) are in distress today. Loans to these projects are around Rs 2.1 lakh crore, with about two-thirds lent by public sector banks.”

Further, of these loans “as much as Rs 75,000 crore of loans – or nearly 15% of aggregated debt to power generation companies — are at risk of becoming delinquent in the medium term.”

So, along with putting money in public sector banks the government needs to come up with a plan on how to stop these banks from bleeding. Any capital infusion plan is incomplete without a plan on how to counter mounting bad loans. As S.S. Mundra, deputy governor of the Reserve Bank of India said in a recent speech: “The issue is how to deal with imprudent and non-co-operative borrowers, wilful defaulters or for that matter, fraudsters? It is important that the errant borrowers are quickly brought to book and recovery proceedings be completed as early as possible. A non-performing account of whatever origin and pedigree, is a drag on the banking system and increases the cost of intermediation, which pinches an honest borrower the most. It is important for the system to weed out the unethical elements at the earliest opportunity to ensure the credibility and the efficiency of the credit system in the country.”

Further, as I have pointed out in the past, why does the government need to own 25 public sector banks? There is clearly no point in continuing to own 25 banks, especially given that they require a massive amount of money to continue functioning.

The government plans to allocate Rs 25,000 crore to these banks during the course of this year. Of this around 40% (Rs 10,000 crore) the second tranche will be allocated to the top six banks (State Bank of India, Bank of Baroda, Bank of India, Punjab National Bank, Canara Bank and IDBI Bank). This will be done “in order to strengthen them to play a vital role in the economy,” the ministry of finance press release pointed out.

The question is why doesn’t the government concentrate on these six banks and sell off the remaining banks. Yes, it will be politically difficult. But why should the tax-payer keep bailing these banks out?

Further, as prime-minister Narendra Modi has said in the past: “I believe government has no business to do business. The focus should be on Minimum Government but Maximum Governance [the emphasis is mine].” This was his chance to implement this vision. But sadly that doesn’t seem to be happening.

The column was originally published on The Daily Reckoning on August 4, 2015