Month: June 2016

Why Raghuram Rajan had to go

ARTS RAJAN

Raghuram Rajan, the governor of the Reserve Bank of India(RBI), announced on Saturday evening (June 18, 2016) that he won’t be taking a second term, and would return to his teaching job at the University of Chicago.

In a letter to the RBI employees, which was released to the press, Rajan said: “I want to share with you that I will be returning to academia when my term as Governor ends on September 4, 2016.”

Since the letter has been released a small industry has cropped up, trying to figure out, why has this happened. Other than being the RBI governor, Rajan is also a public intellectual in his own right. Given this, he had things to say on a wide variety of issues and from the looks of it, some of these things haven’t gone down well with the government of the day.

More than one minister has publicly criticised Rajan for having an opinion on a wide range of issues. Take the case of a comment he made in April
this year. “I think we have still to get to a place where we feel satisfied. We have this saying — ‘In the land of the blind, the one-eyed man is king.’ We are a little bit that way,” Rajan told Marketwatch.com. Rajan was referring to India’s fast economic growth, in a slow growing world.

This did not go down well with the government and Nirmala Sitharaman, the commerce minister, told the press: “I may not be happy with his choice of words. I think whatever action is being taken by this government is showing results.”

Rajan perhaps forgot that he was working with a government which is extremely sensitive to criticism. He later clarified what he really meant in another speech, where he said: “My intent was to signal that our outperformance was accentuated because world growth was weak, but we in India were still hungry for more growth. I then explained that we were not yet at our potential, though we were at a cusp of a substantial pick-up in growth given all the reforms that were underway.” But by then the damage had already been done.

There were other similar occasions where his comments did not go down well with the government of the day, and that seems like the major reason for his early exit. It needs to be pointed out here that no RBI Governor since 1992 has had just a three-year term. C Rangarajan at four years and 334 days, has had the shortest term after Rajan. Bimal Jalan, YV Reddy and D Subbarao all got terms close to five years. In fact, Jalan’s term was close to six years.

So letting the RBI governor go in a period of three years, is clearly unprecedented. Something of this sort has not happened in close to 25 years. In the recent past, the maverick Member of Parliament, Subramanian Swamy, has run a rather slanderous campaign for his removal. That seems to have had its impact as well. Further, a section of the government has never liked Rajan, given that he was appointed by the previous Congress led United Progressive Alliance government.

Rajan’s tenure had many good things about it. First and foremost, as soon as taking over, he handled the rupee crisis very well. Inflation has been brought under control from the earlier double digit levels, though that was not only because of the RBI. The bad loans mess in the public sector banks has been brought into the open. And for the first time in India’s history, banks have gone aggressively after crony capitalists, who defaulted and are still defaulting on bank loans.

This is unprecedented. In the past, the show would have just gone on. Crony capitalists would have defaulted only to borrow again a few years later, and the taxpayers would have taken on the tab. This remains Rajan’s biggest achievement. It will be interesting to see if the next RBI Governor continues to be aggressive on this front. For now, India’s crony capitalists will be breathing a sigh of relief and opening champagne bottles for sure.

Over and above this, Rajan has an international stature. He is the only central banker who has openly spoken out against the massive amount of money printing that has been carried out by the Western central banks and the ill effects of the same.

Rajan’s outspokenness on issues, as many in India feel, is not a recent phenomenon. In August 2005, at a Federal Reserve of Kansas’s annual symposium at Jackson Hole, Wyoming, in the United States, Rajan had criticised the policies of Alan Greenspan, the then Chairman of the Federal Reserve of United States.

Greenspan was considered as god in banking circles at that point of time and the Jackson Hole symposium was supposed to be a sort of a send-off for him, before he retired in 2006. Rajan spoilt Greenspan’s party by saying: ““The bottom line is that banks are certainly not any less risky than the past despite their better capitalization, and may well be riskier. Moreover, banks now bear only the tip of the iceberg of financial sector risks…the interbank market could freeze up, and one could well have a full-blown financial crisis.”

Three years later, the financial crisis which the world is currently dealing with, started with Lehman Brothers, the fourth largest investment bank on Wall Street, going bust. The US government had to then come to the rescue of the American financial system. Rajan’s warning came to be true.

Of course, when Rajan spoke out against Greenspan, he was severely criticised by other economists attending the symposium. As he would later admit in his bestselling and brilliant book Fault Lines: “I exaggerate only a bit when I say I felt like an early Christian who had wandered into a convention of half-starved lions. As I walked away from the podium after being roundly criticized by a number of luminaries (with a few notable exceptions), I felt some unease. It was not caused by the criticism itself…Rather it was because the critics seemed to be ignoring what’s going on before their eyes.”

Something similar seems to have been happening in India as well, where the critics of Rajan seemed to have closed their eyes to the issues that the country is currently facing and want to hear good things about the Indian economy all the time.

There justification for Rajan’s removal is that India has enough good economists to fill his shoes. Of course, it does. But there is no one who has the same respect as Rajan has globally.

Further, is that really the point? When was the last time a board fired a well-performing CEO, because he did not agree with their views all the time?

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column originally appeared on BBC on June 20, 2016

India and the Fallacy of the Demographic Dividend

indian flag

At times it is very difficult to make sense of a country as complicated as India is. What complicates the situation further is the fact that we have very little data going around in many cases. But then there are broader trends, which one can comment on.

One such thing is the demographic dividend or to put it more precisely India’s demographic dividend. Nearly eleven years back, when I didn’t understand much economics or finance, this was one of the terms I heard people connected with the investment industry, continuously talk about.

India will do well in this decades to come because of its demographic dividend, they said. In fact, some of them are still talking about it.

So what is the demographic dividend? As country progresses it moves from being a largely rural agrarian society to a predominantly urban society. Along the way it changes from being a society with high fertility and mortality rates to a society which has low fertility and mortality rates.

As Ronald Lee and Andrew Mason write in an article titled What is the demographic dividend in the Finance and Development magazine of the International Monetary Fund: “At an early stage of this transition, fertility rates fall, leading to fewer young mouths to feed. During this period, the labour force temporarily grows more rapidly than the population dependent on it, freeing up resources for investment in economic development and family welfare. Other things being equal, per capita income grows more rapidly too.”

The infant mortality rate in India was 75 in 1996. It has come down to 38 in 2015, data from World Bank shows. The infant mortality rate is essentially defined as the number of infants who die before reaching one year of age, for every 1000 live births during the course of a given year.

Along with the infant mortality rate declining, the general technological advances as well as access to medical facilities have improved. This essentially means that in the coming years there will be a huge bulge in the number of young people in the country. In this stage, the workforce of the country will increase dramatically.

There are multiple estimates of what India’s workforce will look like in the years to come. Most of these estimates essentially suggest that India’s workforce is increasing at the rate of one million workers per month and will continue increasing at this rate in the years to come.

The Planning Commission, before it was disbanded by the Narendra Modi government, had made an estimate on India’s workforce in the years to come.

As the 12th Five Year Plan (2012-2017) document pointed out: “One hundred and eighty-three million additional income seekers are expected to join the workforce over the next 15 years.” This essentially means that a little over 12 million individuals will keep joining the workforce every year, in the years to come. This works out to around one million a month. And at this rate, the Indian workforce is expected to be larger than that of China by 2030.

And this is India’s demographic dividend. As these individuals enter the workforce, find work, earn money and spend it, the Indian economy is expected to do well. When economists and politicians talk about an economic growth of close to 10 per cent per year, they are essentially hoping that India’s demographic dividend will play out as it is expected.

But the question is how likely is this? How have things with other countries been in the past? Have countries which were expected to benefit from the demographic dividend benefitted from it?

As Ruchir Sharma writes in his new book The Rise and Fall of Nations—Ten Rules of Change in the Post-Crisis World: “The trick is to avoid falling for the fallacy of the “demographic dividend,” the idea that population growth pays off automatically in rapid economic growth. It pays off only if political leaders create the economic conditions necessary to attract investment and generate jobs. In the 1960s and ‘70s, rapid population growth in Africa, China, and India led to famines, high unemployment and civil strife. Rapid population growth is often a precondition for fast economic growth, but it never guarantees fast growth.”

Sharma then talks about the Arab world which despite being poised to, did not benefit from a demographic dividend. As Sharma writes: “The Arab world provides a cautionary tale. There between 1985 and 2005 the working age population grew by an average annual rate of more than 3 percent, or nearly twice as face as the rest of the world. But no economic dividend resulted. In the early 2010s many Arab countries suffered from cripplingly high youth unemployment rates; more than 40 percent in Iraq and more than 30 percent in Saudi Arabia, Egypt, and Tunisia, where the violence and chaos of the Arab Spring began.”

This is something that India and Indians need to be aware of. The demographic dividend benefits a country if the government of the day is able to create the right environment in which jobs are created. As Sharma writes: “In India, where hopes for the demographic dividend have also been sky high, ten million young people will enter the workforce each year over the next decade, but the lately the economy has been creating less than five million jobs annually.”

If this were to continue, there will be no demographic dividend for India.

The column originally appeared in the Vivek Kaul Diary on June 17, 2016

Here’s Why the Biggest Crib of Real Estate Companies is a Big Lie

India-Real-Estate-Market

Earlier this month, Raghuram Rajan, the governor of the Reserve Bank of India(RBI) presented the second monetary policy statement for 2016-2017. Rajan decided to keep the repo rate at 6.5%.  Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark to the interest rates that banks pay for their deposits and in turn charge on their loans.

The real estate lobby Confederation of Real Estate Developers’ Associations of India (CREDAI) wasn’t happy with this. As C Shekar Reddy, ex-president and national executive member of CREDAI told The New Indian Express: “Banks are charging 9.50 pc or more interest on home loans. People will be motivated to buy homes if the loan interest rates are lowered. All our representations to banks to cut the interests rates to give a fillip to the struggling housing sector have gone in vain. Whenever we approached the banks earlier, they said they would think of reducing interest rates if RBI did so with its policy rates.”

Similar statements were made by other CREDAI officials as well. As Geetambar Anand, the president of CREDAI told the Press Trust of India: “It was on expected lines. Now, banks should be advised to reduce interest on home loans by another 50 basis points.” One basis point is one hundredth of a percentage.

The basic point being made is that the RBI has kept the repo rate too high. As the repo rate is high, the interest rate charged by banks on home loans are high. As interest on home loans is high, people are not buying homes. As people are not buying homes, real estate companies are suffering. Or as SARE Homes MD Vineet Relia told PTI: “Since demand in real estate and allied industries remains sluggish, a rate cut could have improved liquidity and created renewed interest in property purchase.”

While all this sounds quite logical, it isn’t correct. Every month, the Reserve Bank of India releases the sectoral deployment of credit data. This data essentially gives out the total amount of lending carried out by banks to different sectors. And this includes home loans given out for the purchase of homes.

In the last one year (actually it’s a period slightly greater than a year, between April 17, 2015 and April 29, 2016), the overall lending of banks (i.e. non-food credit) has grown by just 8.4%. As I explained in yesterday’s column, this has happened primarily because banks have more or less stopped making fresh loans to industry.

Nevertheless, the retail loans of banks have grown at a very good pace, over the last one year. The retail loans include home loans, vehicle loans, education loans, credit card outstanding, loans against fixed deposits, loans against shares/bonds, and personal loans.

The overall growth of retail loans in the last one year stood at 19.7%. This had stood at 15.7% between April 2014 and April 2015. The home loans given out by banks have also seen a fairly robust growth. Home loans grew by 18.1% to Rs 7,58,203 crore, over the last one year. They had grown by 17.1% between April 2014 and April 2015.

Things become a little more interesting if we look at this data in a little more detail. The RBI gives also gives data on priority sector home loans. As per the Master Circular issued by the RBI in July 2014, priority sector home loans are essentially loans to individuals up to Rs 25 lakh in metropolitan centres with population above ten lakh and Rs 15 lakh in other centres.

The home loans given under the priority sector lending that banks need to carry out, grew by 7.6%, over the last one year. They had grown by 4.4% between April 2014 and April 2015.

As far as the non-priority sector home loans (home loans greater than Rs 25 lakh in centres with a population of above 10 lakh and greater than Rs 15 lakh in other centres), are concerned, they grew by a whopping 28.6%, in the last one year. The loans had grown by 33% between April 2014 and April 2015.

What does this tell us? The priority sector home loans are not growing because there are very few real estate markets in the country which banks service, where homes of up to Rs 15 lakh or Rs 25 lakh are available. The growth in priority sector home loan lending has been even slower than the overall bank lending growth.

In fact, in April 2014, priority sector home loans, made up for 56% of total home loans. By April 2015, this was down to 50%. And in April 2016, this stood at 45%. This is definitive evidence of the high real estate prices that continue to prevail in this country, despite what real estate builders keep telling us.

As far as non-priority sector home loans are concerned, they have grown by close to 29% over the last one year, after growing by 33% between April 2014 and April 2015. And that is a pretty good rate of growth, when overall lending growth is 8.4%, and retail lending growth is 19.7%. So what are the builders really complaining about?

I think what seems to be happening is that the home buyers are no longer buying under-construction homes. I have no way of verifying this through data. But that is what the data along with the builders cribbing all the time about the RBI, seems to suggest.

Over the last few years, many builders haven’t delivered homes on time. This has led to a situation where many individuals have had to pay the pre EMI along with the rent as well. Some people I know are even paying their EMIs along with their rents. (I don’t know how EMIs have started without possession of the home being taken).

Some builders have disappeared as well, after taking money from home buyers. Hence, homebuyers are staying away from under-construction property is what my analysis seems to suggest. It seems the buyers are now buying completed homes, which is where the home loans taken are basically going. This can mean that investors who had bought homes in the past are now selling out. It could also mean that builders who had completed inventory are selling it now.

This has hit the entire business model of the real estate developers, who raise money from prospective buyers, when they start building, without putting much of their own capital at risk. But then, for this, they have no one but themselves to blame.

The column originally appeared in the Vivek Kaul Diary on June 16, 2016

Big Govt is a Huge Negative for Economic Growth

nehru

These days, Jawaharlal Nehru, gets blamed for a lot of what is wrong with India. This includes the fact that many countries which attained independence around the same time as India did, grew much faster than India has.

The trouble is that this argument is not totally correct. These days Nehru tends to get blamed even for the economic mess created by his daughter Indira Gandhi. Between 1950-1965, the economic growth of India was 4.1% per year, on an average. Nehru was the prime minister between 1947 and 1964.

Between 1965 and 1981, the economic growth was 3.2% per year on an average. For most of this period, Indira Gandhi was the prime minister. As Arvind Panagariya writes in India—The Emerging Giant: “She [i.e. Indira Gandhi] nationalized the major banks, oil companies, and coal mines. She imposed tight restrictions on operations of foreign companies…She introduced tight ceilings on urban landholdings and effectively outlawed layoffs of workers…Many of the restrictions introduced during this era proved politically difficult to undo later, and some of them continue to harm growth today.”

All these things slowed down Indian economic growth considerably. As Rakesh Mohan and Muneesh Kapoor write in an IMF working paper titled Pressing the Indian Growth Accelerator: Policy Imperatives: “The slowdown in growth during the 1965-81 period, ‘the darkest in the post independence economic history of India’, can be attributed to the various restrictive policy actions put in place during this period that effectively closed the Indian economy and slowed down Indian economic growth, just when various East Asian countries were opening up and accelerating their growth.”

Long story short—as the government grew bigger, the economic growth of the country slowed down majorly. In fact, while the economic growth between 1965 and 1981, slowed down to 3.2% per year, the growth between 1965-1966 and 1974-1975 had been even slower at just 2.6%. This when the population growth was at 2.3%.

As Panagariya writes: “While the government understandably did not publicly acknowledge that it had gone too far in restricting industrial activity, it quietly began to ease up controls through administrative measures. These measures included capacity expansion, increase in the threshold level of investment below which no license was required, delicensing in selected sectors, and permission to change the product mix within existing authorised capacity.”

These changes started to happen in the mid-1970s and were expanded on between 1979 and 1984. The economic growth averaged at 4.8% per year between 1981-1982 and 1987-1988. Over the ten-year period of 1981-1990 it averaged at 5.4%.

The trouble was that in the second half of the 1980s, a good portion of the economic growth was financed by borrowing from abroad. This ultimately led to the economic crisis of 1991 and which finally led to economic reforms being initiated by the Narsimha Rao government with Manmohan Singh as the finance minister.

In fact, economic growth since then has been higher than 5% in almost all years. Next month, it will be 25 years since India saw the first wave of economic reforms. And 25 years after economic reforms were first initiated one lesson that we can draw is that big government hurts economic growth.

As the National Manufacturing Policy of 2011 pointed out: “On an average, a manufacturing unit needs to comply with nearly 70 laws and regulations. Apart from facing multiple inspections, these units have to file sometime as many as 100 returns in a year. This kind of compliance burden puts-off young entrepreneurs and they are not willing to take up an entrepreneurial role. As a result, a large number of people who could have been self employed and would contribute to further employment and enhance economic activity, end up accepting jobs much below their potential.”

This is something that needs to be corrected. The Modi government has taken a few steps on this front, but a lot more needs to be done to unravel the big government that India inherited from Indira Gandhi. This is necessary for job-creating economic growth to happen.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column originally appeared on Bangalore Mirror on June 15, 2016

Rajan’s Not Responsible for Slow Growth in Bank Lending

ARTS RAJAN

It is fashionable to criticise the Reserve Bank of India(RBI) governor Raghuram Rajan these days.

It is fashionable to say that the economy is not doing well, because Rajan hasn’t cut interest rates.

And because Rajan hasn’t interest rates, bank lending isn’t growing.

And because bank lending isn’t growing, the Indian economy is stuck in a quagmire. But didn’t the economy grow at 7.6% in 2015-2016? So how is the economy stuck in a quagmire?

The problem with such analysis is that while it makes for great copy, it is extremely simplistic. Let me tackle all the points being made by the Rajan baiters, one by one.

The lending by banks (i.e. non-food credit) has grown by 8.4% between April 2015 and April 2016. Indeed, this is slow and not as fast as it was in the past. But that is only if we look at the overall bank lending.

If we look at the bank lending numbers in a little more detail, the situation is nowhere as bad as it is being made out to be. Let’s first look at what RBI calls personal loans (i.e. home loans, vehicle loans, education loans, credit card outstanding, loans against fixed deposits, loans against shares/bonds, and what the general people call personal loans). In normal nomenclature such loans are referred to as retail loans and that is what we will call them as well.

In the last one year (actually it’s not exactly one year, but a little more than one year between April 17, 2015 and April 29, 2016) the retail loans of banks have grown by 19.7%. Between April 2014 and April 2015(between April 18, 2014 and April 17, 2015), these loans had grown by 15.7%. Hence, the retail loan growth has clearly picked up over the last one year. What is interesting is that in the last one-year retail loans have formed around 45.6% of the total loans given by banks (i.e. non-food credit).

Interestingly, between April 2014 and April 2015, retail loans had formed 32.4% of the total lending. What does this mean? It means banks are now giving out more and more retail loans.

Why is that the case? The answer is very straightforward. The banks are not in the mood to increase their lending to industry. Lending to industry has grown by just 0.1% in the last one year, against the 5.9% between April 2014 and April 2015.

In fact, lending to medium level industry has fallen by 14% and that to small and micro industries has fallen by 6.7%. Only lending to large industry has grown by 2.2%. This lending had grown by 2.7%, 10% and 5.4%, respectively, between April 2014 and April 2015.

This is primarily because banks are sitting on a huge amount of bad loans on money that they have lent to industry. Let’s take the case of the State Bank of India, the largest public sector bank in the country, as well as the largest bank. Take a look at the following table.

This table shows us very clearly that for the State Bank of India, lending to the retail segment (or what RBI classifies as personal loans) is by far the best form of lending. The gross non-performing ratio (or the bad loans ratio) for 2015-2016 was at 0.75% of the total loans given to the retail sector. This came down from 0.93% in 2014-2015.

Take a look at what has happened to lending to industry. The bad loans ratio of large corporates has jumped from 0.54% to 6.27%. The bad loans ratio of mid-level corporates has jumped from 9.76% to 17.12%. And the bad loan ratio of small and medium enterprises has remained more or less stable and increased marginally from 7.78% to 7.82%.

The State Bank of India is a very good representation of the public sector banks. In this scenario it is not surprising that banks are not in the mood to lend to corporates. Further, many corporates are also over-leveraged and are not eligible to borrow. In fact, this is one clear indicator of the fact that public sector banks are not being forced to lend money to crony capitalists, as was the case earlier.

This is a big thumbs up for the Modi government. The bad loan problem of corporates is not going to go away overnight. The RBI is trying to tackle it in various ways, including getting banks to go after bid defaulters. Meanwhile, banks will go slow on lending to corporates and given this overall lending will continue to remain slow irrespective of the level of interest rates.

Also, it is important to point out here that retail lending has grown big time in the last one year. This means banks are comfortable lending to individuals because of the low default rate on loans.

Let’s also take a look at lending to what RBI categorises as services (tourism, hotels, restaurants, shipping, retail trade, wholesale trade, transport operators, computer software, commercial real estate etc.). The lending to the services sector grew by 10.9% in the last one year. In comparison it had grown by 6.6% between April 2014 and April 2015.

Hence, like lending to retail, lending to the services sector has also grown at a much faster rate, over the last one year. It is only lending to industry that has more or less remained flat over the last one year. And that as I have explained has got nothing to do with interest rates.

In this scenario blaming Raghuram Rajan for the slow growth in overall bank lending is incorrect. The overall bank lending will revive once the lending to industry revives. And that will only happen once the bad loans are cleared up.

The column originally appeared in the Vivek Kaul Diary on June 15, 2016