The Orwellian Economics of Indian Banking

George Orwell towards the end of his brilliant book Animal Farm writes: “There was nothing there now except a single Commandment. It ran: All animals are equal but some animals are more equal than others.”

Nowhere is this more visible these days than at Indian banks, in particular the government owned public sector banks, and the way they treat their different kind of borrowers. As is well known by now, Indian public sector banks have a massive bad loans problem. This basically means that borrowers who had taken loans over the years are now not repaying them. The bad loans of Indian banks are now among the highest in the world, only second to that of Russia.

The borrowers who have defaulted on their loans primarily consist of large borrowers i.e. corporates, who have taken on loans and are now not repaying them. As per the Economic Survey of 2016-2017, among the large defaulters are 50 companies which owe around Rs 20,000 crore each on an average to the banking system. Among these 50 companies are 10 companies which owe more than Rs 40,000 crore each on an average to the banking system.

These are exceptionally large amounts. Typically, when a borrower defaults the bank comes after him with full force, in order to recover the loan, by selling
assets offered as a collateral against the loan. But this force is not felt by the large corporates. It is felt by the small entrepreneurs who borrow from banks or people like you and me who take on retail loans like home loans, vehicle loans, credit card loans etc.

As former RBI governor Raghuram Rajan said in 2014 speech: “Its full force [i.e., of the banking system] is felt by the small entrepreneur who does not have the wherewithal to hire expensive lawyers or move the courts, even while the influential promoter once again escapes its rigour. The small entrepreneur’s assets are repossessed quickly and sold, extinguishing many a promising business that could do with a little support from bankers.”

Given that they have access to the best lawyers and are close to politicians, the large borrowers don’t feel the heat of the banking system.

In fact, the large borrowers given that they are large, get treated with kids gloves. In some cases, the repayment periods of their loans have been extended. In some other cases, the borrower does not have to pay interest on the loan for a specific period. But all this hasn’t really helped and the banking mess continues.

The Economic Survey of 2016-2017 has recommended based on the data for the year ending September 2016 that “about 33 of the top 100 stressed debtors would need debt reductions of less than 50 percent, 10 would need reductions of 51-75 percent, and no less than 57 would need reductions of 75 percent or more.”

This basically means that banks will have to take on what is technically referred to as a haircut. Let’s say a corporate owes Rs 100 to a bank. A haircut of 51 per cent would mean that he would now owe only Rs 49 to the bank. The bank would have to take on a loss of Rs 51.

The Economic Survey offers multiple reasons why haircuts will be required. The first and the foremost is that the borrowers simply do not have the money to repay. Secondly, large corporates owe money to many banks and these banks need to agree on a strategy to tackle the defaults. That hasn’t happened.

Of course, what the Economic Survey does not tell us is that the large borrowers are politically well connected. It also does not get into the moral hazard haircuts would create. Once corporates are bailed out this time around, why would they go around repaying loans the next time around? They simply won’t have the economic incentive to do so.

And finally, the Survey does not tell us anything about why only the large corporates are being treated with kids gloves? I guess it does not need to because that was something Orwell explained to us many years back.

The column originally appeared in Bangalore Mirror on March 29, 2017.

Why Real Estate Prices are Going Down at a Slow Pace

A few days back an email popped up, asking us, why had we stopped writing on real estate. We would like to assure the reader that we haven’t stopped writing on real estate, just that we have taken a break from writing on the topic.

It’s just that it is very difficult to write new things about Indian real estate in a scenario where very little data is available. But yesterday while reading a book we came across a concept from behavioural economics which weaves in beautifully with the real estate scenario that prevails in India currently. So, let’s discuss that in today’s edition of the Diary.

In his book A Man for All Markets—From Las Vegas to Wall Street, How I Beat the Dealer and the Market, Edward O Thorp discusses the concept of anchoring in real estate. As he writes: “Anchoring is a subtle and pervasive aberration in investment thinking. For instance, a former neighbour, Mr Davis (as I shall call him), saw the market value of his house rise from his purchase price of $2,000,000 or so in the mid-1980s to $3,500,000 or so when the luxury home prices peaked in 1988-1989. Soon afterward, he decided he wanted to sell and anchored himself to the price of $3,500,000.

And this is when the troubles of Mr Davies began. Luxury home prices started to fall pretty soon. But Mr Davies was anchored to a price of $3,500,000. While the price of $3,500,000 had meaning to Mr Davies, it did not have any meaning to the market in which he was trying to sell his house because the prices had come down. In fact, that is exactly how anchoring is defined. As John Allen Paulos writes in A Mathematician Reads the Stock Market: “We… become attached to any number we hear. This tendency is called the “anchoring effect”.

Anyway, getting back to the story of Mr Davies. As he hung on to his “anchored” price, he didn’t find any buyers for his house. As Thorp writes: “During the next ten years, as the market price of his house fell back to $2,200,000 or so, he kept trying to sell at his now laughable anchor price. At last, in 2000, with a resurgent stock market and a dot-com-driven price rise in expensive homes, he escaped at $3,250,000.”

In the end Mr Davies ended up selling the house at more or less his anchored price. Of course, what he forgot or perhaps ignored in the process of being anchored to the price that he was, was that there is a certain time value of money. As Davies writes: “In his case, as often happens, the thinking error of anchoring, despite the eventual sale price he achieved left him with substantially less money than if he had acted otherwise.

The point being that if Davies had sold at a price slightly lower than his anchored price and invested the money somewhere else, he would have ended up with more money by 2000, than the $3,250,000 he managed for the house.

Now how is this concept of anchoring relevant in the Indian context? In a weak real estate market the dangers of anchoring are faced by the seller of a house. This is precisely what is happening in India right now. Over the last few years, in many markets in the country, real estate prices have fallen. Despite this, many sellers are still anchored on to the peak price their home had achieved a few years back. I see this phenomenon play out very well in and around Delhi.

And given this, they aren’t ready to sell at the current market price. In some other cases, the home prices have been stagnant over the last few years. And investors are anchored to a higher price at which they are likely to make a good return on their real estate investment. I see this phenomenon play out in cities like Pune. These investors are also not in a mood to sell.

This has essentially led to a situation where real estate transactions have crashed across many markets in the country but the prices haven’t. This isn’t good for the real estate market because unless homes that have already been built are sold to buyers who want to live in them (and not invest), the huge inventory of built up homes with no one living in them, won’t clear.

Unless this inventory clears, no new homes will be built or homes will not be built at the same pace as they were in the past. And the new homes that will be built will only add to the inventory of homes that is already there. Clearly, we have a problem here. Also, with the home owners anchored on to a price, they will lose money in the years to come, given that it is highly unlikely that real estate prices will go up or even if they go up, they will not go up at the rate that they did in the past.

Meanwhile, the home owners will have to bear the cost of maintenance, property tax etc. Hence, overall, they will lose money on their real estate investment. In fact, they might just be better off by selling their home and investing the money even in a fixed deposit.

But that of course is not going to happen given that the idea that real estate prices only go up, is highly ingrained (or should I say we are anchored to it) in us Indians. And that is not going to change anytime soon.

The column originally appeared on Equitymaster on March 23, 2017

 

Why Waiving Off UP Farm Loans is a Bad Idea, Nevertheless…

In the run-up to the assembly elections in Uttar Pradesh, the Bhartiya Janata Party had promised that it would waive off crop loans taken by the small and marginal farmers of the state.

Political parties promising to waive off crop loans is nothing new. Before the 2009, Lok Sabha elections, the Congress led United Progressive Alliance government had carried out a similar exercise.

The question, as always, is how much is it going to cost and where is the money going to come from? The State Bank of India in a research report expects the cost of waiving off crop loans to small and marginal farmers to come at around Rs 27,419.7 crore. How have they arrived at this estimate? The total loans given by banks to the agriculture sector in Uttar Pradesh stands at Rs 86,241 crore.

As the SBI report points out: “According to RBI data (2012), 31% of the direct agriculture finance went to marginal and small farmers (landholdings upto 2.5 acres). Taking this as a proxy for Uttar Pradesh as well, approximately Rs 27,419.70 crore will have to be waived off in case loan waiver scheme is implemented for the small and marginal farmers for all banks (scheduled commercial banks, cooperative banks and primary agricultural cooperative societies).”

The SBI estimate suggests that the loan waive off will cost around Rs 27,420 crore. The banks which had given these loans will have to be compensated for this waive off. The union agriculture minister Radha Mohan Singh in a series of tweets on March 17,2017, made it clear that the union government wasn’t picking up the tab. In one of the tweets he said that, if any state government waives off the loans of small and marginal farmers using the state treasury, the move should be welcomed. Hence, from the looks of it, if the loans are waived off, the Uttar Pradesh government will have to pick up the tab.

Take a look at Figure 1. It shows the fiscal deficit of the Uttar Pradesh government over the years. A government is said to run a fiscal deficit if its revenue is less than its expenditure. This difference the government makes up through borrowing money.

As can be seen from Figure 1, the fiscal deficit of the state has risen at a much faster pace than its gross domestic product over the years. While, the state GDP has jumped by 59.3 per cent between 2011-2012 and 2015-2016, the fiscal deficit has jumped from 2.13 per cent of the state GDP to 5.57 per cent of the state GDP, at a much faster pace.

Figure 1:

YearGross Fiscal DeficitState GDP at current prices (in Rs crore)Fiscal Deficit as a percentage of GDP
2016-2017*49,96112,36,655^^4.04%^
2015-2016**64,31711,53,7955.57%
2014-201532,51310,43,3713.12%
2013-201423,6809,441462.51%
2012-201319,2408,22,9032.34%
2011-201215,4307,24,0492.13%

*budget estimate
**revised estimate
Source: /or GSDP, the RBI’s Database on Indian Economy.
For deficit, budget.up.nic.in and RBI Reports on State Finances
^Source: www.business-standard.com
^^ Calculated on the basis of 4.04 per cent and Rs 49,961 crore fiscal deficit estimates.

In 2016-2017 which is the current financial year, the fiscal deficit of the state government is expected to be at 4.04 per cent of the state GDP. In absolute terms it was expected to be at Rs 49,961 crore. If the Uttar Pradesh government waives off the loans during the course of this financial year, then the fiscal deficit in absolute terms would shoot to Rs 77,381 crore (Rs 49,961crore plus Rs 27,420 crore of the waive off), assuming that expenditure and revenue assumptions made at the beginning of the year, hold true. This works out to 6.26 per cent of the state’s gross domestic product and is a really high figure.

So, the question is can Uttar Pradesh government afford this? The answer clearly is no. Can the union government in Delhi afford it? The answer is yes. Rs 27,420 crore is not a large amount for it. But if it goes ahead and finances this write off, similar demands will be raised by other states as well. And given that the Bhartiya Janata Party governments now govern large parts of the country, it will be very difficult for the union government to say no.

Over and above the one-time cost to the state government, there is also the question of moral hazard. The economist Alan Blinder in his book After the Music Stopped writes that the “central idea behind moral hazard is that people who are well insured against some risk are less likely to take pains (and incur costs) to avoid it.”

This basically means that once the farmer sees a loan being waived off today, he will wait for elections in the future for the newer loans he takes on to be waived off as well. Essentially, he will see little incentive in repaying loans that he takes on in the future.

As the SBI Chairperson Arundhati Bhattacharya said recently: “We feel that in case of a (farm) loan waiver there is always a fall in credit discipline because the people who get the waiver have expectations of future waivers as well. As such future loans given often remain unpaid… Today, the loans will come back as the government will pay for it but when we disburse loans again then the farmers will wait for the next elections expecting another waiver.”

All this makes tremendous sense. But given that we live in the age of whataboutery, you, dear reader, may comeback and ask us: “But what about the fact that banks have written off lakhs of crore of loans that they gave to corporates? If they can do that, why can’t they waive off Rs 27,420 crore?”

This is a very good question for which I really don’t have a straightforward answer. In situations like these I suggest, dear reader, that you read George Orwell. As he famously wrote in the Animal Farm: “All animals are equal, but some animals are more equal than others”.

The point is that if there is a moral hazard for the farmer, there is also one for the corporates.

For today, we will leave it at that.

The column was originally published on March 22, 2016

The Perils of Too Much News

In my early teens, there were only two sources of news in India, the daily newspaper and the late evening news on Doordarshan, the only channel in town. Hence, the news wasn’t a 24 by 7 affair like it is now, especially with the advent and the rise of the digital media over the last few years.

The rise of the digital media has ensured that news gets to people faster. One doesn’t have to wait for the morning newspaper or the evening news to know what has happened. Also, with more and more news sources hitting the market, censoring the media isn’t as easy as it was in the past. Hence, to that extent it is a good thing.

Nevertheless, the rise of 24 by 7 news media brings with itself other sets of problems. As Alain de Botton writes in The News—A User’s Manual: “The modern world is teaching us that there are dynamics far more insidious and cynical still than censorship in draining people of political will; these involve confusing, boring and distracting the majority away from politics by presenting events in such disorganized, fractured and intermittent way that a majority of the audience is unable to hold on to the thread of the most important issues for any length of time.”

The point being that proliferation of the media and the rise of the social media has essentially ensured that the audience keeps getting bored and needs more and more new issues to agitate or at least feel agitated about. In the process, the most important issues of the day, actually get lost.

Take the Indian case. One of the most important issues which barely gets discussed in India is the fact that close to one million individuals are entering the workforce every month. This means around 1.2 crore individuals are entering the workforce every year. This is likely to continue at least for the next decade and a half. Further, the number can turn out to be an underestimate if more women enter the workforce.

While, 1.2 crore Indians are entering the workforce every year, there aren’t enough jobs going around for them. Many of these individuals are educated i.e. at least they have gone to school. Nevertheless, they don’t have any employable skills. There are economic and social repercussions that this is going to have.

As Thomas Sowell writes in Wealth, Poverty and Politics: “People who have acquired academic degrees, without acquiring many economically meaningful skills, not only face personal disappointment and disaffection with society, but also have often become negative factors in the economy and even sources of danger… In many poorer countries, especially, the “educated unemployed” are often numerous enough to be not only a major disappointment but a social and political danger.”

Also, what happens is that the only institution ready to employ them is the government. As Sowell writes: “Even many of those with academic credentials, but no economically meaningful skills, who are in fact employed are often employed in government bureaucracies, since they are unlikely to be much in demand in competitive markets where employers are spending their own money, rather than spending the taxpayers’ money.” This is what explains a whole host of engineers, MBAs and PhDs applying for government jobs of sweepers and peons.

The question is, when was the last time you saw anything in the media analysing this issue. We were busy arguing whether a film star couple should have named their son what they did. Until we moved on to something else.

The point, as Botton writes, is that “news organisations broadcast a flow of random-sounding bulletins, in great numbers but with little explanation of context, within an agenda” that keeps changing, and “without giving any sense of the ongoing relevance of an issue that had seemed pressing only a short while before.” This is interspersed with constant antics of film stars.

And this, as Botton writes, “would be quite enough to undermine most people’s capacity to grasp political reality – as well as any resolve they might have summoned to alter it.”

Indeed, this is something that we should worry about.

The column was originally published in the Bangalore Mirror on March 22, 2017

Is the RBI Telling Us Something That the Govt Isn’t?


One of the things that we have learnt in the business of economic forecasting is to highlight the forecasts that we get right and tom-tom about it. The new Reserve Bank of India deputy governor Viral Acharya said something two weeks back that we seemed to have missed (you know with the media expanding at the rate it has, it is difficult to keep track of everything).

Nevertheless, here we go. Acharya said on March 6, 2017, a few days after his birthday: “I think everyone should keep in mind that the remonetisation is taking place at a very fast pace. We have some way to go, but I think we expect that within two to three months we will reach full currency in circulation. It will be slightly lower, but it is in that ballpark (number).”

What Acharya was basically saying was that by May 2017, the currency in circulation will come to a level around what prevailed before demonetisation rendered Rs 500 and Rs 1,000 notes useless. This is something we have maintained from the very beginning, even though we have been ridiculed about it more than once, as we have gone along. (You can read the pieces here and here).

In fact, if the Modi government is to be believed there was never any problem because of demonetisation. In fact, the finance minister Arun Jaitley, said in early February: “At no point of time, not for a single day, was the currency inadequate.” Around the same time the economic affairs secretary Shaktikanta Das, who reports to Jaitley, said something along similar lines when he said that the remonetisation process was complete. Remonetisation essentially refers to the process of printing money and pumping it into the financial system.

We live in Mumbai and not in Delhi. And we don’t know Das. But if we did, we would have definitely asked him, if the remonetisation was almost complete in February, why is the RBI deputy governor, who knows a thing or two about such things, saying that remonetisation will be completed only in May 2017.

Now let’s get back to look at what Acharya is saying. Take a look at Figure 1. It shows the currency in circulation every week, through late January 2016 to March 10, 2017, the latest data point that is available.

Figure 1Figure 1

What does Figure 1 show us? It shows us that the currency in circulation fell dramatically in the aftermath of demonetisation. This is not surprising given that more than 86 per cent of the currency in circulation was rendered useless overnight. And it has been rising since early January 2017, as the RBI prints and pumps more new currency into the financial system. The average increase in currency in circulation per week since January 6, 2017, has been Rs 38,645 crore.

At this pace of increase, over a period of 10 weeks, i.e. two and a half months (the average of two to three months that Acharya said), the total currency in circulation by May 19, 2017 (10 weeks after March 10, 2017), will stand at Rs 16.32 lakh crore (Rs 12.46 lakh crore as on March 10, 2017 + Rs 3.86 lakh crore added over the 10 week period). If we go for the full three months, then the total currency in circulation as on June 2, 2017(12 weeks after March 10, 2017) will stand at Rs 17.10 lakh crore.

The currency in circulation before demonetisation was announced stood at Rs 17.98 lakh crore (as on November 4, 2016). If we end up with a currency in circulation of Rs 17.10 lakh crore after remonetisation is complete, the total currency in circulation would have fallen by around 4.9 per cent. If we end up at Rs 16.32 lakh crore, then the currency in circulation would have fallen by around 9.2 per cent.

If the currency in circulation is expected to come down by around 5-9 per cent, then what was the point in disrupting the economy in such a big way, is a question worth asking. Of course, the way things are these days, we won’t get answers. All we will be told is that in the long term, demonetisation will be beneficial.

Further, in this age of relentless media, people have forgotten by now that going digital wasn’t on the original list of aims of demonetisation. It was subtly introduced only once the original aims of tackling black money and fake notes, went out of the window.

What does Acharya’s comment and our analysis accompanying it, tell us? It tells us, something we have been saying recently, that Indians are going back to cash. The brief spurt in digital transactions has been reverted and this shall become more and more obvious as we go along. It also means that the RBI will have to print and remonetise a greater portion of the demonetised currency. If it does not do that then there is the risk of not enough currency going around in the economy and that will have an impact on the total number of economic transactions.

The RBI of course recognises this. It recognises the fact that an adequate amount of currency is needed in the economy. It also recognises that digital transactions despite all the hype around them haven’t really taken off. In this scenario, more and more new currency will have to be introduced into the economy.

Having said that the RBI, under the new dispensation of Urjit Patel, can’t say this in a very direct way. Nevertheless, sometimes we do have to read between the lines to understand the real message behind what is being said.

The column originally appeared in Equitymaster on March 21, 2017.