Indian economy

How to Run Public Sector Banks Well Without Privatising Them. And Why That’s Not Going to Happen

As of March 31, 2020, the total bad loans of public sector banks stood at Rs 6,78,318 crore. This is a drop of 24.3% from a peak of Rs 8,95,600 crore as of March 2018. Bad loans are largely loans which haven’t been repaid for a period of 90 days or more.

So how did bad loans of public sector banks come down by nearly a fourth? First and foremost, as of March 31, 2018, IDBI Bank, the worst performing bank when it comes to bad loans, was a public sector bank. From January 21, 2019, the bank was categorised to be a private bank. Accordingly, its bad loans moved to the overall bad loans of private banks. But we need to remember IDBI Bank is owned by the Life Insurance Corporation of India, that makes it as close to being a private bank, as Indian Chinese food is close to the real Chinese food.

As of March 31, 2020, the overall bad loans of IDBI Bank were Rs 47,272 crore. If we add this to the bad loans of public sector banks, the real bad loans of public sector banks work out to Rs 7,25,590 crore (Rs 6,78,318 crore + Rs 47,272 crore). This means that the real fall in bad loans of public sector banks in the two-year period has been around 19% and not 24.3%, as we originally calculated.

So, bad loans worth Rs 47,272 crore came down, simply because IDBI Bank got recategorised as a private bank.

Let’s move to the next point. Take a look at the following chart, which basically plots the bad loans of public sector banks over the years. The bad loans of IDBI Bank are included in this chart.

India’s Manhattan

Source: Centre for Monitoring Indian Economy and Indian Banks’ Association.

As I elaborate in detail in my book Bad Money, the RBI practiced regulatory forbearance between 2011 and 2014 and did not force public sector banks to recognise their bad loans as bad loans, even though they had started to appear by then. In simple English, regulatory forbearance, essentially means the central bank looking the other way from the problem.

An asset quality review (AQR) was launched in mid 2015 and this forced banks to recognise their bad loans as bad loans. As you can see in the chart, the overall bad loans of public sector banks take a huge jump post 2014-15. This was the AQR at work.

Now loans which have been bad loans for four years can be dropped from the balance sheet of banks by way of a write-off. Hence, many loans which had been categorised as bad loans in 2015-16 would have spent four years on the balance sheet by 2019-20.

Accordingly, they got written off from the balance sheet of banks. Of course, before such bad loans are written off, a 100 per cent provision needs to be made for these bad loans. This means that banks need to set aside money to meet the losses arising from these loans. This essentially led to the overall bad loans of banks coming down as well.

And over and above this, the banks would have managed to recover a portion of the bad loans (which includes bad loans that have been written off as well). The overall recovery rate for banks through various recovery channels during 2018-19 was around 15.5% of the amounts involved. (Numbers for 2019-20 aren’t currently available or at least I couldn’t find them anywhere).

In fact, a bulk of the current accumulated bad loans will disappear from the balance sheets of public sector banks over the next two to three years, thanks to the fact that bad loans can be written off after they have spent four years on the balance sheet.

Nevertheless, the question is: even after this can the public sector banks operate in a healthy way where they don’t need to be constantly recapitalised. In fact, once public sector banks get around to identifying post-covid bad loans early next year, their balance sheets are likely to come under stress again.

But the basic problem of public sector banks remains interference by the government. This interference can take several forms. As Viral Acharya and Raghuram Rajan write in a research paper titled Indian Banks: A Time to Reform?: “Interference, including appointing favoured candidates to management, expanding lending just before elections, or directing banks to lend to favoured borrowers is obviously harmful.” (Again, something I discuss in great detail in my book Bad Money).

To ensure that public sector banks do not face this kind of interference it has been suggested that they need to be privatised. Over and above this, there have been news reports which suggest that the government is looking to privatise public sector banks.

This remains a difficult decision politically. Also, in an economic environment like the one prevailing, there will be fairly limited number of firms looking to buy government banks saddled with a huge amount of bad loans and a section of employees not used to the idea of working.

Further, unlike other public sector enterprises, the government has to be even more careful while selling a bank. As Acharya and Rajan write:

“The experience in other countries with allowing corporations to own banks is that it increases the possibility of self-dealing within the group – the bank is used to make risky loans to failing group entities, and the bill is paid by the tax payer when the bank is eventually bailed out.”

They further say that the Indian industry is already heavily concentrated. As a recent McKinsey Knowledge Centre report titled India’s turning point An economic agenda to spur growth and jobs points out: “Our analysis shows that just 20 of the country’s roughly 600 large firms contribute 80 percent of the total profit of large firms.” The report defines large firms as firms with an annual revenue of more than $500 million.

If India’s large corporates end up buying its banks, the industry is likely to get even more concentrated. Hence, while privatisation of public sector banks remains a good idea over a long-term, currently, the government can initiate the reform process through the Axis Bank model, wherein the government is an investor in banks rather being a promoter.

The Committee to Review Governance of Boards of Banks in India (better known as the Nayak Committee, after its chairman, PJ Nayak) which presented its report to the RBI in May 2014, suggested the Axis Bank model.

Axis Bank was originally called UTI Bank. It was set up in 1993. It was owned by the Unit Trust of India (UTI) and a clutch of public sector banks. Even though ownership was 100 per cent in the public sector, the bank got a licence to operate as a private sector bank. The bank was listed on the stock exchanges in 1998. UTI Bank was later renamed Axis Bank.

Even at that point of time, the public sector shareholding continued to be the majority shareholding. In early 2000s, when the Unit Trust of India ran into trouble, the government broke it down into two parts. One part became the UTI Mutual Fund and the other was the Specified Undertaking of the Unit Trust of India (SUUTI).

In February 2003, the shareholding of UTI in the bank was transferred to SUUTI. UTI Bank was later renamed Axis Bank.

As the Nayak Committee Report pointed out:

“The Government-as-Investor stance has characterised the control of the Bank, with SUUTI acting as a special purpose vehicle holding the investment on behalf of the Government. The CEO is appointed by the bank’s board, and because the bank was licensed in the private sector, it sets its own employee compensation, ensures its own vigilance enforcement (rather than being under the jurisdiction of the Central Vigilance Commission), and is not subject to the Right to Information Act. SUUTI appoints the non-executive Chairman and up to two directors on the Board, and there is no direct intervention by the Finance Ministry.”

This means that the bank has been run as a proper banking business, without much intervention from the government. Between March 2003 and March 2014, the share price of Axis Bank rose thirty-two times. Over the years, the government has been able to sell its stake in the bank to raise a decent amount of money.

The point being that even though, as per its shareholding, Axis Bank ‘was for many years a public sector bank’, but ‘fortuitously, the bank was licensed at the commencement of its business as a private sector bank’.

The Nayak Committee Report suggests that the government should look at public sector banks as an investment and not as a business it has to run, and follow the Axis Bank model. This essentially means the government reducing the stake in these banks to less than 50 per cent, and letting the bank’s management and its board do their job, like in the case with private sector banks.

But then as the oft-repeated cliche goes, public sector banks are not just about making money. They also need to keep the social objectives of the government in mind. This is something that even Prime Minister Narendra Modi had suggested at the First Gyan Sangam in 2015 (a meeting of bureaucrats, bankers and insurers). As Modi had said on that occasion, while “government interference was inappropriate, but government intervention was needed to further public objectives”.

It’s this line of thought has driven India’s public sector enterprises for seven decades now and gotten them nowhere in the process.

R C Bhargava, the current Chairman of Maruti Suzuki, who was also an IAS officer for a very long time, writes the following in his book Getting Competitive: A Practitioner’s Guide for India:

“The USSR was the pioneer in attempting industrialization along with creating a communist society. It did not succeed. On the other hand, Japan became a highly competitive and industrialized nation and has a high degree of equality and social justice. The policies for regulating and promoting industrial growth do not have any social content in them [emphasis added]. Social equality was a result of the political and industrial leadership understanding that manufacturing competitiveness would be enhanced if there was greater equality and the bulk of the people were enabled to become consumers of manufactured goods.”

What Bhargava, who has worked for long periods of time, both for the government and the private sector, is basically saying is that social objectives of the government shouldn’t become objectives of its enterprises.

This does not mean that the government should do away with meeting its social objectives. Not at all. But what it should do instead is incentivise banks on this front.

As Acharya and Rajan write:

“Perhaps a better approach would be to pay for the mandates (such as reimbursing costs for maintaining branches in remote areas or opening bank accounts for all) so that both private banks and public sector banks compete to deliver on them. This will distance the public sector banks a little from the government. While public sector banks may be given a slightly different set of objectives than private banks (for example, they may put more weight on financial inclusion), their boards should have operational independence on how to achieve the objectives.”

Competition and incentivisation goes a much longer way in delivering services than a government diktat.

The question is, where will the money for all this come from? Allow me to throw a few numbers at you, before I answer this question.

The market capitalisation of the State Bank of India, India’s biggest bank and the biggest public sector bank, is Rs 1.67 lakh crore. The total assets of the bank as of March 2020 were at Rs 41.97 lakh crore. Now compare this to Kotak Mahindra Bank. Its market capitalisation is at Rs 2.53 lakh crore. The total assets of the bank as of March 2020 stood at Rs 4.43 lakh crore.

Hence, in comparison to the State Bank of India, the Kotak Mahindra Bank is a very small bank. But its market capitalisation is almost Rs 86,000 crore more. Why? Simply because Kotak Mahindra Bank is run like a proper bank and the stock market gives it a proper valuation for the same.

Or take the case of HDFC Bank, which has a market capitalisation of Rs 5.80 lakh crore, which is more than all public sector banks put together. Both these well-run banks have much lower bad loans than public sector banks. The overall bad loans of private banks, Yes Bank notwithstanding, are significantly lower than public sector banks even after adjusting for their size.

The point I am trying to make here is that if public sector banks end up being much better run than they currently are, the stock market will give them a higher market capitalisation. And the government can then finance its social objectives by gradually selling the shares it owns in these banks.

Of course for anything like that to happen, the Department of Financial Services in the Finance Ministry which controls the public sector banks, needs to take a backseat. As Rajan writes in I Do What I Do: “Unless PSBs are run like normal corporations, they will not be competitive in the medium term. I have a simple metric of progress here: We will have moved significantly towards limiting interference in PSBs when the Department of Financial Services (which oversees public sector financial firms) is finally closed down, and its banking functions taken over by bank boards.”

But as we all know, bureaucrats don’t take backseats.

Oh and politicians. Let’s not forget them here. Back in 2000, the Atal Bihari Vajpayee government tried to push through the move and dilute the government stake in PSBs to 33 per cent. And it failed. Why?

Vajpayee’s finance minister, Yashwant Sinha, had introduced a bill to reduce the government’s stake in PSBs to 33 per cent. It never saw the light of day. In a 2018 interview, Sinha said: “The parliament and the people were not prepared for such [a] kind of step”.

In fact, all these years down the line, we are still grappling with the same issue.

The more things change…

And I sincerely hope, I am proven wrong on this.

Propaganda 101: What the Indian Right has learnt from Big Tobacco

The Indian economy as measured by the gross domestic product (GDP) contracted by 23.9% during April to June 2020 in comparison to the same period in 2019. This contraction was huge.

But soon journalists, economists, corporate honchos and analysts, who are close to the current dispensation, started telling us that, so what if India has contracted by 23.9%, the American economy contracted by 32% during the same period. The point being that if India was in trouble, America was in bigger trouble. How did this lessen our trouble they didn’t bother to explain.

There was an even bigger problem with the 32% American contraction figure. It was wrong, when compared to India’s 23.9% contraction. The way India calculates GDP contraction (or growth for that matter) and the way America does it, are different.

So, what was the American contraction if we used the Indian method? It was 9.1% year on year and not 32% as was being suggested. (For those interested in the fifth- standard maths behind this, I suggest you Google it. It has been explained by multiple people, including me).

Also, none of the people who sincerely believed that the American economy had contracted by 32%, bothered to sit back and think the negative impact this would have had on the world at large.

Data from the World Bank suggests that in 2019, the American GDP (real GDP adjusted for inflation), had stood at $18.3 trillion.
This was around 21.7% or somewhere between a fourth and a fifth of the global GDP. Now imagine the American economy contracting by a third (which is what a 32% contraction almost means) year on year. This would have led the world into a second Great Depression.

America is the world’s largest source of consumer demand. If that demand contracts by a third, the global economy would have been in an even worse situation than it currently is. This simple thought did not occur to anyone who went around town telling people that the American economy had contracted by 32% and hence, had done much worse than the Indian economy. Or maybe it did occur to them, and they simply chose to ignore it.

The Indian GDP numbers for April to June were declared on August 31. This was almost four weeks back. The social media is still buzzing with this issue.

Do the people who spread the story of the US economy contracting by 32% to counter the Indian economy’s contraction of 23.9%, not understand basic fifth standard maths? Because a simple understanding of fifth standard maths would have told them very clearly that the US economy had contracted by 9.1%, if the contraction is calculated in the Indian way.

Obviously, this bunch of people is a smart lot and I don’t think there is any problem with their understanding of fifth standard maths. So, what were they up to then? They were basically borrowing a simple idea first used by Big Tobacco Companies in the 1950s.

In the early 1950s, research which linked the smoking of cigarettes to incidence of lung cancer, started to come out. Big Tobacco Companies met at the Plaza Hotel in New York, just before Christmas in 1953. Scientific research which was being published was making them look very bad. And they had to do something about it.

What did they do? As Tim Harford writes in How to Make the World Add Up: Ten Rules for Thinking Differently About Numbers: “They muddied the waters. They questioned the existing research; they called for more research; they funded research into other things they might persuade the media to get excited about, such as sick building syndrome or mad cow disease. They manufactured doubt. A secret industry memo later reminded insiders that ‘doubt is our product’.”

How did muddying the waters help Big Tobacco? It basically created confusion in the minds of smokers. Was the research linking smoking to lung cancer, right? Was there enough evidence of it? Aren’t correlation and causation two different things? These were the questions that the smokers were suddenly asking themselves.

As Harford writes: “Smokers liked smoking, were physically dependent on nicotine, and wanted to keep smoking if they could. A situation where smokers shrugged and said to themselves. ‘I can’t figure out all these confusing claims’ was a situation that suited the tobacco industry well.”

Big tobacco wasn’t trying to tell smokers that smoking was safe. They weren’t so blatant about it. All they were trying to do was to ‘create doubt about the statistical evidence that showed they were dangerous’.

The muddying of waters to create doubt has been a standard part of propaganda since then. It’s propaganda 101. As Harford summarises it: “Their answer [that of Big Tobacco companies] was – alas – quite brilliant, and set the standard for propaganda ever since.”

Something very similar happened in case of the Indian economy contracting by 23.9%, as well. The fact that the Indian economy contracted by close to a fourth, was something that the sympathisers couldn’t deny. It was official government data. And of course, that this contraction was bad for the average Indian, couldn’t be denied either.

But the waters could be muddied by getting the American angle in. The message was that so what if the Indian economy has contracted and Indians are suffering, the Americans are suffering more.

The sad part of all this is that many educated Indians fells for this spin. But that’s the thing with propaganda, even the educated fall for it.

This piece originally appeared in the Deccan Herald on September 27, 2020. 

Are Acche Din Here for Onion Farmers and Consumers?

Yesterday (September 22, 2020), the Rajya Sabha passed the Essential Commodities (Amendment) Bill, 2020. The Lok Sabha had passed the Bill a week back on September 15. The passage of this Bill essentially dropped cereals, pulses, oilseeds, edible oils, potatoes and onions, from the definition of essential commodities.

The government may regulate the supply of food items only under extraordinary circumstances like war, famine, extraordinary price rise and a natural calamity of grave nature.

In this piece we will concentrate on what this change means in the context of onions.

India grows 10% of the world’s onions. It is the second largest producer of onions in the world, after China. In 2019-20, the total onion production across the country stood at 251.46 lakh tonnes. But despite being the second largest producer in the world, the price fluctuations of onions within the country are huge.

In fact, on more than a few occasions in the past, the price of onions has crossed Rs 100 per kg, causing a lot of pain across households, with the onion being an important ingredient in different kinds of food all across the country. Elections have been lost on the price of onions going up, making it a politically sensitive vegetable.

Take a look at the following chart, which basically plots the inflation of onions as measured by the consumer price index. Inflation is the rate of price rise.

Up and Down


Source: Centre for Monitoring Indian Economy.

(The curve is broken towards the end because data for a couple of months wasn’t available due to the covid-pandemic).

The inflation of onions is all over the place. It just tells us how volatile onion prices are at the consumer level. It’s not just the consumers who face this volatility, even the farmers face volatility in the price they get for the onions that they grow.

All over the place

Source: Centre for Monitoring Indian Economy.

The above chart shows the volatility of onion prices at the wholesale level. And the way the curve goes up and down, tells us that onion prices move around quite a lot, even at the wholesale level.

What does this mean for the consumer and the farmer? The onion consumer doesn’t get to buy onions at a consistent price, the prices go up and down, quite a lot. On the other hand, the onion farmer doesn’t get to sell onions at a consistent price. There is always a chance that when the farmer goes out to sell the onions he has grown, there is a price crash. In that sense, growing onions for a living becomes a very risky profession.

The question is why are onion prices so volatile? This is where things get interesting. Take a look at the following chart (I know, I am throwing a lot charts at you, dear reader, but these are simple straightforward charts.) The chart plots the wholesale prices of onions through the months, over the years.

Rise in wholesale onion prices

Source: http://ficci.in/spdocument/23156/FICCI’s-paper-on-Onion-Crisis.pdf

What does the chart tell us? It tells us that the wholesale onion price start rising around May and they keep rising till around August-September. This is where the entire problem lies, both for consumers as well as farmers.

Why is that the case? The onion has three harvesting seasons; the Rabi season (March-May), the Kharif season (October-December) and late Kharif season (January-March). Close to 60% of the onion production happens during the Rabi season.

Also, the onions produced during the Rabi season are most amenable to storage. The supply of fresh onions hitting the market between May to September is simply not enough to meet the demand. Given this, a part of demand has to be met through stocks of Rabi onions maintained by traders and wholesalers.

When the supply from the Rabi season starts to run out, the price of onions tends to rise. If there are any rains it makes the situation worse. The rains not only destroy the early Kharif crop which starts hitting the market in late September-early October, but they also destroy the Rabi crop that has been stored.

In fact, this is precisely what has happened in 2019 as well as 2020. As the Economic Survey for 2019-20 points out: “Due to heavy rains in August-September, 2019, the kharif crop of onions was adversely affected leading to lower market arrivals and upward pressure on onion prices. This kharif crop usually caters to the demand during the period from October to December till fresh produce from late kharif crop comes in the market.” Something similar has happened this year as well, with rains destroying the onion crop in Karnataka.

Hence, as an economist would put it, there is a structural problem at the heart of the onion trade in India. The government notices this only when there is a price rise and the media starts splashing it. Hence, there is always a knee-jerk reaction.

The government has a fixed way of reacting. It either invokes the Essential Commodities Act (ECA), 1955, or bans exports of onions (and if not that, it makes exports unviable by increasing the minimum export price).

Last year, on September 29, stocks limits under the ECA were imposed. Retail traders could stock up to 100 quintals of onions and wholesale traders could stock up to 500 quintals. (One quintal = 100 kgs. This was later reduced to 20 quintals and 250 quintals, respectively).

The idea here being that as soon as stock limits are imposed anyone who has onions stocked beyond the limit will have to sell them in the open market and that will push down wholesale prices and in the process retail prices (at least, that is what the government hopes).

This year on September 14, onion exports were banned under the Section 3 of the Foreign Trade (Development and Regulation) Act, 1992. The trigger was the more than doubling in the average price of onion arriving at India’s biggest onion market at Lasalgaon near Nashik, between end of March and September 14.

The modal price of onion as of March 30 was Rs 1,301 per quintal. By September 14, the modal price had jumped to Rs 2,801 per quintal. After the export ban on September 14, on September 15 the wholesale onion prices crashed to Rs 1,901 per quintal. Obviously, this did not go down well with the onion farmers.

The third option that the government resorts to is the import onions. This does not bring immediate consumer relief because imports carried out through government institutions take time. Even after onions have been imported, there is trouble is storing, distributing and selling them, because government institutions involved in this process, really don’t have the expertise for it. Also, in the past, the taste of imported onions hasn’t really gone down well with the Indian consumers.

So, what’s the way out of this mess? Let’s take a look at this pointwise.

1) The ECA is a remanent of an era when India had genuine food shortage. The idea was to restrict activities of some agents who were indulging in black marketing and hoarding at that point of time.

As a July 2018 report titled Review of Agricultural Policies in India published by the Organisation for Economic Co-operation and Development, points out: “Orders issued by the centre or the states regulate the production, storage, transport, distribution, disposal, acquisition, use or consumption of a commodity.”

While, we do have our share of problems with some food products where the price volatility is very high (pulses and onions in particular), the days of food shortage are long gone. Also, over the years, the fact that ECA exists has undermined investments in India’s agricultural supply chain infrastructure.

As the Economic Survey of 2019-20 points out:

“ECA interferes with this mechanism by disincentivising investments in warehousing and storage facilities due to frequent and unpredictable imposition of stock limits. As stockholding limits apply to the entire agriculture supply chain, including wholesalers, food processing industries and retail food chains, the Act does not distinguish between firms that genuinely need to hold stocks owing to the nature of their operations, and firms that might speculatively hoard stocks.”

This fear of stock holding limits essentially leads to entrepreneurs staying away from creating supply chain infrastructure.

2) The lack of storage facilities adds to the price volatility of onions. As per a report titled A Report on the study of Onion Value Chain, published by the College of Agricultural Banking, Reserve Bank of India, 20-25% of onion production is lost due to post-harvest damages. This is because of the lack of storage infrastructure.

As the report points out:

“Nearly, 60% of the onion produced in Maharashtra during Rabi/ summer is available for storage i.e. 27 lakh tonnes out of total 45 lakh tonnes. The storage capacity created in the state through different government schemes is 8 lakh tonnes. These are scientifically built onion storage structures. Farmers store 5 lakh tonnes of onion in traditionally built local storage structures. Thus the total storage capacity in the state is 13 lakh tonnes.”

What this means that as of 2018, there was a need to create onion storage structures of additional 14 lakh tonnes, just in Maharashtra. Both the ECA and the lack of bank finance come in the way.

3) The ECA also leads to a situation where traders aren’t able to store enough and this creates problems. Let’s take a look at what happened last year. The ECA was invoked in end September. The onion inflation in the coming months just went through the roof (you can take a look at the inflation charts earlier). The stock limits basically ensured that traders couldn’t store onions beyond a point.

As the Economic Survey pointed out:

“Most of the kharif crop, which itself was lower, would have had to be offloaded in the market in October itself [thanks to the stock limits under the ECA]. Absent government intervention through ECA, traders would store a part of their produce to ensure smooth availability of a product at stable prices throughout the year.”

Of course, this does not mean that onion prices wouldn’t have gone up post September. They still might have gone up because of the lower kharif production, but the prices would have risen in a smoother way.

4) The government also resorts to export bans or increases the minimum export price of onions (where you can still export as long as the customer at the other end is ready to pay the higher price). The idea as mentioned earlier is to increase the supply in the domestic market.

In 2018-19, India exported around 22 lakh tonnes of the onions it produced. This was worth around $500 million. The total onion production during the year had stood at 228.2 lakh tonnes. Hence, less than 10% of the onion produced was exported. Also, the value of onion exports isn’t very big in the overall scheme of things.

As per a FICCI document, India’s export policy towards onions was changed 14 times between 2014 and 2019. This does no good to India’s image globally on the export policy front. It makes us look terribly unreliable.

Also, while prices in the Lasalgaon market fell on September 15, a day after the export ban, they have risen since then, and on September 23, the modal price of onion stood at Rs 3,600 per tonne. So much for the policy benefiting the consumer.

So where does all this leave us? The government has removed onions from the list of essential commodities in the hope that it leads to the development of storage infrastructure.

As Minister of State for Consumer Affairs, Food and Public Distribution Danve Raosaheb Dadarao told the Rajya Sabha:

“The stock limit conditions imposed through the law were hindering investment in the agriculture infrastructure… The move will boost investment in the agriculture sector and will also create more storage capacities to reduce post-harvest loss of crops.”

The move is also expected to increase the income of farmers.

The question is will this work out in the way the government is projecting it to be? Let’s look at this pointwise.

1) While, the government has removed onion from the list of essential commodities, its export continues to be banned. So, what kind of signal is being sent out to anyone who is interested in building agriculture infrastructure, including onion storage?

2) Even though onion is no longer a part of essential commodities, the government can still intervene, under extraordinary circumstances like war, famine, extraordinary price rise and a natural calamity of grave nature.

How is extraordinary price rise defined as?

“Any action on imposing stock limit shall be based on price rise and an order for regulating stock limit of any agricultural produce may be issued under this Act only if there is— (i) hundred per cent increase in the retail price of horticultural produce; or (ii) fifty per cent, increase in the retail price of non-perishable agricultural foodstuffs, over the price prevailing immediately preceding twelve months, or average retail price of last five years, whichever is lower.”

In the last three years, retail onion inflation has been more than 100% in eight months. Clearly, there is a good chance of high onion inflation in the time to come, given that any onion storage infrastructure isn’t going to be built overnight. Will the government intervene? Or will it sit tight and let the end-consumer pay?

The larger point here is that what the government does on this front in the time to come will determine how many entrepreneurs get interested in building agricultural infrastructure.

Just because onion is out of the essential commodities list doesn’t mean that the government cannot intervene. Any prospective entrepreneurs will like to see more evidence on this front.

3) There is great fear (as has been the case with the two main Farm Bills) of big business taking over. The question is if private enterprise is not allowed to operate in this sector, then what’s the way out? The government doesn’t have the money or the wherewithal to do much here. Central planning has been failure the world over and that it is a failure here as well, isn’t surprising.

Big business has built a lot of things since 1991, which most of us use and enjoy. Of course, along the way there has been crony capitalism as well. And that’s the fear here in the minds of people as well. (I don’t have a clear answer for this and I am saying so).

To conclude, taking onion out of the essential commodities list is just the first step. Many other things need to be done before the consumer can pay the right price and the farmer can get the right price.

In an ideal world, these are things that should have started in May 2014, when Narendra Modi was elected the prime minister for the first time. It would have been best to carry out small experiments in states and see how they go, before a nationwide plan was unleashed. There is always a gap between theory and practice and it’s best to correct that gap at a smaller level.

I would like to thank Chintan Patel for research assistance.

Why India is Not Buying as Many Cars as Carmakers Want

Yesterday morning, there was a news flash that the carmaker Toyota does not want to expand any further in India.

Shekar Viswanathan, vice chairman of Toyota’s Indian unit, Toyota Kirloskar Motor, told the news-agency Bloomberg: “The government keeps taxes on cars and motorbikes so high that companies find it hard to build scale.”

The company later released a statement saying: “Toyota Kirloskar Motor would like to state that we continue to be committed to the Indian market and our operations in the country is an integral part of our global strategy.” General Motors quit India in 2017.

In 2019, Ford Motor Company agreed to move a bulk of its assets into a joint venture with Mahindra and Mahindra. Whether Toyota wants to expand in India or not remains to be seen, but this sort of prompted me to look at car sales data over the years and it makes for a very interesting read.

Motown Slowdown

Source: Centre for Monitoring Indian Economy.

The car sales data is available from 1991-92 onwards, a year in which around 1.5 lakh units were sold. The actual jump in car sales came in the decade between 2001-02 and 2011-12, when the car sales jumped from 5.09 lakh units to 20.31 lakh units, an increase of 14.8% per year on an average.

The car sales in 2019-20 were at 16.95 lakh units and lower than the sales in 2011-12. Of course, some of this was on account of the spread of the covid-pandemic. But car sales had been slow even before covid struck. Let’s ignore the car sales for 2019-20 and look at car sales for 2018-19, which were at 22.18 lakh units.

The car sales between 2011-12 and 2018-19 grew at the rate of 1.3% per year, which basically means that they were largely flat.

If one looks at the increase in car sales over the decade between 2008-09 and 2018-19, when the sales jumped from 12.2 lakh units to 22.2 lakh units, it works out to an increase of 6.2% per year.

Irrespective of whether Toyota is leaving India or not it is safe to say that car sales haven’t been going up much in the last ten years or more. In fact, if we look at data a little more minutely, things get more interesting.

A bulk of the cars being sold are essentially mini and compact cars (3201mm to 3600mm and 3601mm to 4000mm). Data for this is available from 2001-02 onwards. Take a look at the following chart, which plots the number of mini and compact cars sold as a proportion of total cars sold.

Value for Money?


Source: Author calculations on Centre for Monitoring Indian Economy data.

In 2001-02, mini and compact cars formed 82.4% of cars sold. It fell to a low of 72.9% in 2012-13. It has largely risen since and in 2019-20 reached a high of 93.7%. The point being that over the years a greater proportion of car buyers have bought value for money cars, making it difficult for many foreign car companies, given that this end of the market is dominated by Maruti Suzuki and Hyundai.

In the last five years, the sales of cars of up to 4,000 mm in length has simply gone through the roof. This is a function of the fact that the economic growth and the income growth have both stagnated in comparison to the past. Take a look at the following chart, which plots the increase in per capita income over the years in nominal terms.

Show Me the Money


Source: Centre for Monitoring Indian Economy.

The per capita income growth has fallen over the years and that is reflected in the kind of cars people buy. There is a straightforward connect between the second chart and the third chart. Car sales have gone up at a fast pace whenever there has been a consistent double-digit growth in income. Between 2014-15 and 2019-20, the per capita income has consistently grown in single digits, except in 2016-17, when it grew at 10.4%. This reflects in the car sales as well.

This slowdown in income growth indicates an economy which has slowed down majorly over the last few years. And this shows in the slow growth in car sales.

Of course, this is not the only reason for slow growth in car sales. There is also the problem of higher taxes. And Viswanathan of Toyota is not the only one who thinks so.

As RC Bhargava, the current chairman of Maruti Suzuki, India’s largest carmaker, and the grand old man of India’s car industry, puts it in his new book Getting Competitive—A Practitioner’s Guide for India:

“In India cars have always been considered a luxury product and taxed accordingly till the present… [this] despite being one of the few globally competitive industries. Both the Central and state governments levy taxes and the total is 2–3 times the tax in the developed countries.”

Of course, these taxes make cars expensive and that leads to lower sales growth. The car industry has tremendous multiplier effect on the overall economy. As Bhargava puts it:

“It generates high volumes of employment and leads to the development of many technologies and industries whose products are used in the manufacture of cars. These include steel, aluminium, copper, glass, fabrics, electronics and electricals, rubber and plastics.”

Essentially, high taxes on cars have ensured a slow growth of the industry. Slow growth of this industry has contributed to the overall slow growth of the economy. And the overall slow growth of the economy and incomes have contributed to the slow growth of the car industry. This is how it links up.

Hence, lowering taxes on the automobile sector in particular (something I have written about in the past) and on cars in particular, will work well for the economy. It might lead to lower per unit tax collections for the government, but the increase in sales volume should gradually make up for this.

Also, as I explain here, an expansion in manufacturing creates many services jobs as well. But for all that to happen taxes need to come down. Nevertheless, as Viswanathan told Bloomberg: “You’d think the auto sector is making drugs or liquor.”

CONFLATION (Contraction + Inflation) is Here. And It Will Stay This Year.

The British politician Ian Macleod is said to have first used the word stagflation in a 1965 speech he gave to the Parliament, where he said:

“We now have the worst of both worlds—not just inflation on the one side or stagnation on the other, but both of them together. We have a sort of “stagflation” situation. And history, in modern terms, is indeed being made.”

The words stagnation and inflation came together to create the new word stagflation. The economic growth in United Kingdom in 1965 was 2.1%, falling to 1.6% in 1966. Consumer prices inflation during the year was at 4.8%. While, this might not sound much, it was the highest in more than half a decade. Inflation in United Kingdom would touch a high of 24.2% a decade later in 1975.

Hence, stagflation became a term which referred to a situation of slow economic growth or stagnation and high inflation.

Many economists and analysts are asking if India has entered a stagflationary scenario now, just like the British had in the mid 1960s. The consumer prices inflation for August 2020 was at 6.7%. The consumer prices inflation for April to August in the current financial year has been at 6.6%, higher than the Reserve Bank of India’s comfort range of 2-6%.

What is worrying is the food inflation level. Food inflation in August was 9.1%, whereas food inflation during this financial year has been at 9.6%. Within this, the inflation in the price of vegetables was at 10.9%, oil and fats at 11.8%, pulses at 18.2% and that of egg, fish and meat at 15%.

At the same time, the Indian economy as measured by its gross domestic product (GDP) contracted by 23.9% during April to June 2020, in comparison to a year earlier. Things are expected to slightly improve during the period July to September 2020, but the Indian economy will contract in comparison to last year.

Hence, during the first six months of 2020-21, India will see the economy contracting and high inflation. Stagflation doesn’t quite represent this scenario, for the simple reason that stagnation represents slow economic growth and not an economic contraction as big as the one India is seeing.

As Macleod put it in the 1960s: “History, in modern terms, is indeed being made.” What was true in the 1960s Britain is also true about the 2020 India.

Given this, it’s time to coin a new word to represent this particular situation of economic contraction plus inflation and call it CONFLATION (I considered Contraflation as well but somehow Conflation just sounded better and the word anyway means the merging of ideas, so, works that way as well).

What does this conflation really mean in the overall scheme of things for India for the remaining part of the year? Let’s take a look at it pointwise.

1) A high inflation, especially food inflation, during a time when incomes are contracting is going to hurt the economy badly. People are having to pay more for food while their incomes are contracting. This means that spending on non-food items is going to come down. This will impact overall consumer demand right through the remaining part of the year. It is estimated that poor households allocate up to 50% of their expenditure towards food. So, conflation will hurt.

Lower consumer demand also leads to a fall in investments simply because there is no point in corporates expanding production, when people aren’t buying things like they used to. This again will negatively impact the economy. (A contraction in investments has been negatively impacting the economy for close to a decade now).

2) High food inflation has primarily been on account of supply-chains from rural to urban India, breaking down. This means that the farmers are not the ones benefitting from the high food prices. Basically, the traders, as usual, are cashing in on the shortage.

This can be gauged from the fact that food inflation as measured by the consumer price index during the year has stood at 9.6%.

Food inflation as measured by the wholesale price index has stood at 3.1%. This clearly tells us who is benefitting from food inflation. It’s clearly not the farmers. If farmers need to benefit, the terms of trade need to shift in their favour, something that hasn’t happened in many years.

3) Some economists have been of the view that food prices will slowdown in the second half of the year, thanks to a bumper agricultural output. Anagha Deodhar of ICICI Securities writes: “We expect vegetable and pulses inflation to start moderating from September 2020 and October 2020 respectively due to base effect. These two items together account for almost one-fifth of food basket and hence meaningful decline in their inflation rates could keep a lid on headline inflation as well.”

While this is true, what this view does not take into account is the fact that covid is now spreading to rural areas. As Crisil Research put it in a recent report: “Of all the districts with 1,000+ cases, almost half were rural as on August 31, up from 20% in June.” This basically means that the supply chain issues when it comes to movement of food are likely to stay, during the second half of the year as well.

Also, the spread of the pandemic could impact the harvesting and the marketing of agricultural products. Hence, overall agricultural production may not grow along expected lines. Given this, food inflation may not fall as much as it is expected to and might continue to remain elevated. Again, a sign of conflation hurting the economy.

4) The medical facilities in rural India are nowhere as good as the ones in urban India (This is not to say that medical facilities in urban India are excellent). The spread of covid pandemic will mean that people will have to spend money treating the disease.

This will lead to the cutting down on spending towards other items. Also, more importantly, the spread of the pandemic will even have an impact on the spending of people who haven’t been affected by it. People will save more for the rainy day. So, conflation will continue to hurt the Indian economy.

5) Another factor that needs to be taken into account is the fact that the money supply* has gone up by more than 11.7% consecutively for the last four months. This hasn’t happened since 2014. What this tells us is that the Reserve Bank of India is really pumping in money into the financial system. If all this money keeps floating around in the months to come, then there is a real danger of this leading to a further rise in prices. (A piece on how the RBI has botched up the monetary policy remains due).

6) But all this remains valid only for 2020-21. Come 2021-22, and India will be back in growth territory again and hence, conflation will be out of the picture. This, as I had explained in an earlier piece, will primarily be because of the base effect.

Basically, the GDP figure in 2020-21 will turn out to be so terrible that it will make the GDP growth in 2021-22, look fantastic. But this won’t mean much because only in 2022-23 are we likely to go past the GDP figure of 2019-20. This means the Indian economy is likely to go back by two years and that will be the cost of conflation.

To conclude, the Indian economy will contract during the second half of the financial year. There is a slim chance of growth being flat for the period January to March 2021. Inflation, even though it might come down a little, is likely to remain high due to the spread of the covid pandemic. Hence, India will see conflation through 2020-21.

* Money supply as measured by M3.