Tag: Arun Jaitley | Page 19

12 December, 2014

Jaitley may end up doing a Chidambaram to meet fiscal deficit target

Vivek Kaul

In yesterday’s column I had explained how the fiscal deficit of the government of India between April and October 2014 was at its highest level since 1998. Fiscal deficit is the difference between what a government earns and what it spends.
This despite the fact global oil prices have been falling for a while now. This has not helped the government primarily because like his predecessors the current finance minister Arun Jaitley also assumed a low oil subsidy number at the time he presented the budget in July 2014.
When the previous finance minister P Chidambaram presented the budget for the financial year 2013-2014, he assumed that Rs 65,000 crore would be spent towards oil subsidy. The actual number came in at Rs 85,480 crore, which was 31.5% higher.
This has been standard operating procedure for finance ministers over the years, where they start with a low oil subsidy number at the beginning of the year and end up spending much more by the time the year ends. What this does is that it makes the fiscal deficit number look more respectable at the time the budget is presented.
Jaitley did the same thing as his predecessor by assuming that oil subsidy for the year would work out to Rs 63,426.95 crore. This despite the fact that subsidies worth Rs 35,000 crore which were to be paid in 2013-2014, had been postponed to this financial year. So, in effect Jaitley only had a little more than Rs 28,400 crore to play around with on the oil subsidy front.
Oil prices started falling a few months back. This wasn’t known at the time the budget was presented in July earlier this year. In the budget it was assumed that oil prices would average at $110 per barre during the course of this financial year. As on December 10, 2014, the price of the Indian basket of crude oil stood at $63.16 per barrel.
Given that, Jaitley assumed a lower number to start with, the government is not going to benefit on the fiscal deficit front, due to a fall in oil prices. As Neelkanth Mishra and Ravi Shankar of Credit Suisse write in a recent research note titled 2015 Outlook: Growth at any price?: “The…budgeted amount for fuel subsidies (Rs 63,400 crore, 0.5% of GDP)…may not change much for financial year 2014-2015, as Rs35,000 crore of the oil subsidy is already spent.”
The analysts also wrote that there won’t be much change in the fertiliser subsidy amount of close to Rs 73,000 crore, as well. Mishra and Shankar write that “it will be difficult for the government to reduce food subsidies”.
Given this, Jaitley isn’t really in a position to cut down subsidies. What he will have to do is to start cutting down on plan expenditure, like Chidambaram had done. As I had explained in yesterday’s piece, the government expenditure is categorised into two kinds—planned and non planned. Planned expenditure is essentially money that goes towards creation of productive assets through schemes and programmes sponsored by the central government.
Non-plan expenditure is an outcome of planned expenditure. For example, the government constructs a highway using money categorised as a planned expenditure. But the money that goes towards the maintenance of that highway is non-planned expenditure. Interest payments on debt, pensions, salaries, subsidies and maintenance expenditure are all non-plan expenditure.
As is obvious a lot of non-plan expenditure is largely regular expenditure that cannot be done away with. The government needs to keep paying salaries, pensions and interest on debt, on time. These expenses cannot be postponed. Hence, the asset creating plan expenditure gets slashed.
This is what the previous finance minister Chidambaram did in 2012-2013 and 2013-2014. In 2012-2013, he had budgeted Rs 5,21,025 crore towards plan expenditure. The final expenditure came in 20.6% lower at Rs 4,13,625 crore. In 2013-2014, the plan expenditure was budgeted at Rs 5,55,322 crore. The final expenditure came in 14.4% lower at Rs 4,75,532 crore.
This helped Chidambaram to cut down on the overall government expenditure majorly. Jaitley will have to do something similar, if he wants to achieve the fiscal deficit target of Rs 5,31,177 crore or 4.1% of GDP, that he has set.
As economists Taimur Baig, and Kaushik Das of Deutsche Bank Research write in a recent research note titled India 2015 Outlook: Turning the cycle and structure around: “The government’s 2014-2015 fiscal deficit target of 4.1% of GDP will likely be achieved, but by cutting capital expenditure for the third straight year in a row. We estimate that the government will have to cut capital expenditure by at least Rs 70,000 crore…to make up for the significant shortfall in tax collection and disinvestment target.”
Supporters of Jaitley say that Chidambarm left him with unpaid bills of more than Rs 1,00,000 crore. Fair point. But Jaitley knew about this at the time he presented the budget. So, what stopped him from taking these unpaid bills into account while presenting the budget earlier this year?
If he had done that he wouldn’t have been able to present a fiscal deficit number of Rs 5,31,177 crore or 4.1% of GDP. The number would have been much higher. Nevertheless, that would have been the real fiscal deficit number, instead of the unrealistic and fictional number that was presented at the time of the budget. It is not surprising that Jaitley will have a tough time in meeting this number.
As I said in yesterday’s piece, the first step towards solving a problem is acknowledging that it exists. Jaitley and the BJP had an excellent opportunity to do this. And they let that go.
Another reason for the government to worry is the disinvestment target of Rs 58,400 crore. With basically three months left for the financial year to get over, the disinvestment of shares that the government owns in government and non-government companies has barely started.
As Baig and Das point out: “We expect the government to rely on disinvestments as a key source of revenue to reduce the fiscal deficit, but as seen from this year’s experience, there is no guarantee that such a strategy would work. Further, trade union activism could come in the way of the government pursuing an aggressive disinvestments/privatization agenda, which then will likely put pressure back on expenditure compression (particularly capital expenditure) to achieve the headline fiscal deficit target.”
Also, what does nothelp is the fact that growth in tax collections is nowhere near what had been assumed initially. The direct taxes (corporation and income tax primarily) were assumed to grow at 15.7%, in comparison to the last financial year. They have grown at only 5.5% between April and October 2014.
The indirect taxes (customs duty, excise duty and service tax) were supposed to grow at 20.3%. They have grown by only 5.9%
The situation clearly does not look good. And given that finance ministers do not like to miss targets they set, it is more than likely that Jaitley will now do a Chidambaram and slash asset creating plan expenditure majorly in the months to come. In fact, the plan expenditure for the first seven months of the financial year fell by 0.4% to Rs 2,66,991 crore.
As the old French saying goes: “plus ça change, plus c’est la même chose”. The more things change, the more they remain the same.

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 12, 2014

11 December, 2014

Despite low oil prices, India may not gain much. Here’s why

Vivek Kaul

Oil prices have been falling for a while now. The price of the Indian basket of crude oil as on December 10, 2014, stood at $63.16 per barrel. At the beginning of this financial year, as on April 1, 2014, the price had stood at $104.56 per barrel. Hence, prices have fallen by close to 40% since then.
Analysts expect that oil prices will continue to remain low in 2015. In a report titled 2015: It Likely Gets Worse Before It Gets Better analysts at Morgan Stanley give three possible scenarios for the price of oil. In the worst possible scenario they expect the price of oil to touch $43 per barrel in the second quarter of 2015 (i.e. the period between April and June 2015).
As the Morgan Stanley analysts write: “ With OPEC on the sidelines, oil prices face their greatest threat since 2009…Without intervention, physical markets and prices will face serious pressure, with 2Q15[April to June 2015] likely marking the peak period of dislocation.”
As I have explained on previous occasions the Saudi Arabia led Organization of the Petroleum Exporting Countries(OPEC) is interested in driving down the price of oil to ensure that shale oil firms operating in the United States and Canada become unviable. This is why OPEC hasn’t cut oil production majorly in recent months, even though oil prices have fallen dramatically.
The conventional thinking is that a fall in oil prices will benefit India tremendously. A major reason for the same is that India imports nearly four fifths of the oil that it consumes. Hence, a fall in oil prices will mean that there will be lower oil imports and this will mean a lower trade deficit (i.e. the difference between imports and exports).
Further, lower oil prices will also mean lower inflation and a lower fiscal deficit for the government. Fiscal deficit is the difference between what a government earns and what it spends. In the years gone by, the government did not allow the oil marketing companies to sell diesel, cooking gas and kerosene oil, at a price that was viable for them. The government compensated these companies for a part of the under-recoveries.
This led to the government expenditure shooting up which pushed up the fiscal deficit. While this sounds good in theory, things are not as straightforward as they are made out to be. Neelkanth Mishra and Ravi Shankar of Credit Suisse discredit this argument in their recent research report titled 2015 Outlook: Growth at any price?
Let’s look at these points one by one. The government had budged Rs 63,426.95 crore as oil subsidy for this financial year. This as always has been the case in the past was a very optimistic assumption, given that a significant part of the oil subsidies for the last financial year were unpaid. The oil subsidies that had not been paid for during the course of the last financial year amounted to Rs 35,000 crore. This has been paid from this year’s budget. Given this, despite a dramatic fall in oil prices there isn’t going to be a huge impact on the fiscal deficit. If oil prices continue to remain low during the course of the next financial year (April 2015 to March 2016) it will benefit the government on the fiscal deficit front, feel the Credit Suisse analysts.
What about inflation? Petrol and diesel together make up for around 2% of the consumer price index. Over and above this, the government has raised the excise duty on petrol and diesel twice in the recent past. This has reduced the “passthrough to consumer prices”. Hence, consumers haven’t benefited as much as they should have.
Further, “LPG[domestic cooking gas] and kerosene, which have higher weights[in the consumer price index],are still subsidised, so the fall in crude will not directly impact retail prices,” write Mishra and Shankar.
Now let’s look at the trade deficit or the difference between imports and exports. Oil imports in the month of October 2014 fell by 19% to $15.2 billion in comparison to the same period last year. Despite this, the overall trade deficit for the month rose to $13.3 billion from $10.6 billion a year ago.
Why is that the case? With global growth slowing down, exports slowed down by 5% to $26 billion. Further, India seems to have rediscovered its appetite for gold with gold imports rising by 280% to $4.17 billion from $1.09 billion in October 2013.
So, despite falling oil prices India may not gain much immediately. Also, falling oil prices mean lower incomes for oil exporting countries and this will slow down their consumer demand, which will have an impact on Indian exports.
Professor Eswar Prasad of Cornell University explained this in an interview to CNBC. As he said: “Right now if oil goes to USD 65 or even slightly lower it is not a big negative but it does imply that there is going to be a lot of weakness in external demand and countries in Latin America like Venezuela which already have a very difficult situation, emerging markets like Russia and of course the Middle Eastern countries plus some of the European economies like the UK and Norway that rely on oil exports to a significant extent are going to be facing fairly difficult situations. This will affect their budgets and their current account balances which in turn will affect their consumption demand. So, softness in consumption demand is ultimately not good for anybody in the world including India.”
Neelkanth Mishra of Credit Suisse also made a similar point in an interview to The Economic Times. Mishra’s argument was that if oil exporting countries earn lower, their sovereign wealth funds will invest a lower amount of money in other countries, including India.
As he said: “Further, capital flows get impacted, too — if you look at the sources of funds that invest in India, it’s primarily the sovereign wealth funds (SWFs), the pension funds and the insurance funds. If Norway, Saudi Arabia, Abu Dhabi, Qatar, or Kuwait are not going to see the kind of surpluses that they used to then they will have less capital to send out, which will mean that capital flows into India will not be as strong as they were.”
Norway, Abu Dhabi and Saudi Arabia run the three biggest sovereign wealth funds in the world.
To conclude, what these points clearly tell us is that a fall in oil prices will not benefit India as much as it is being made out to be.

The article originally appeared on www.FirstBiz.com on Dec 11, 2014

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

11 December, 2014

As tax collections slow down, govt fiscal deficit shoots to its highest level in 16 years

Vivek Kaul

The Controller General of Accounts declares the fiscal deficit number at the end of every month. The cycle works with a delay of month. So, at the end of November 2014, the fiscal deficit for the first seven months of the financial year (April to October 2014) was declared.
The fiscal deficit for this period stood at a rather worrying 89.6% of the annual target of Rs 5,31,177 crore. Fiscal deficit is the difference between what a government earns and what it spends.
One reason the fiscal deficit is number is so high is because the government’s expenditure is spread all through the year, whereas it earns a substantial part of its income only towards the end of the year. But even keeping that point in mind, the fiscal deficit for the first seven months of this financial year is substantially high than it usually has been in the years gone by.
For the period April to October 2013, the fiscal deficit had stood at 84.4% of the annual target for that year. In fact, the accompanying table shows us that the fiscal deficit for the first seven months of this financial year has been the highest over the last sixteen years.

Period	Fiscal deficit as a proportion of the annual target
April to Oct 2014	89.60%
April to Oct 2013	84.40%
April to Oct 2012	71.60%
April to Oct 2011	74.40%
April to Oct 2010	42.60%
April to Oct 2009	61.10%
April to Oct 2008	87.80%
April to Oct 2007	54.50%
April to Oct 2006	58.60%
April to Oct 2005	60.90%
April to Oct 2004	45.20%
April to Oct 2003	56.00%
April to Oct 2002	51.50%
April to Oct 2001	54.50%
April to Oct 2000	45.70%
April to Oct 1999	72.20%
April to Oct 1998	67.00%

Source: www.cga.nic.in

Also, I couldn’t look for data beyond 1998, given that it wasn’t available online. The table makes for a very interesting reading. The fiscal deficit level up to October 2007 was under control. It took off once the government decided to crank up expenditure to meet its social obligations.
Further, the average fiscal deficit for the first seven months of the year between 1998 and 2013 stood at 61.75% of the annual target. Hence, the number for this year at 89.6% of the annual target, is very high indeed.
Why has this happened? The income of the government during the period has gone up by only 5.3%. The budget presented in July earlier this year assumed that the income would grow by 15.6% in comparison to the last financial year.
The collection of direct as well as indirect taxes has been significantly slower than what was assumed. The direct taxes (corporation and income tax primarily) were assumed to grow at 15.7% in comparison to the last financial year. They have grown at only 5.5%.
The indirect taxes (customs duty, excise duty and service tax) were supposed to grow at 20.3%. They have grown by only 5.9%. In fact, within indirect taxes, the collection of customs duty has fallen by 1.7%.
What this clearly tells us is that the finance minister Arun Jaitley made very aggressive assumptions when it came to growth in tax collection and will now have a tough time meeting the numbers.
What makes the situation worse is the fact that Jaitley’s predecessor, P Chidambaram, had made the same mistake. In fact, in 2013-2014, Chidambaram had projected a total gross tax collection of Rs 12,35,870 crore. The final collection stood around 6.2% lower at Rs 11,58,906 crore. Given this, Jaitley could have avoided falling into the same trap and worked with a more realistic set of numbers. But then those projections wouldn’t have projected “acche din”, the plank on which the Bhartiya Janata Party had fought the Lok Sabha elections.
Even with such a huge fall in tax collections, Chidambaram managed to beat the fiscal deficit target that he had set by essentially pushing expenditure of more than Rs 1,00,000 crore into the next financial year (i.e. the current financial year 2014-2015).
Chidambaram essentially ended up passing on what was his problem to Jaitley. Jaitley cannot do that because he will continue to be the finance minister (or someone else from the BJP government will).
So what can Jaitley do if he needs to meet the fiscal deficit target of Rs 5,31,177 crore or 4.1% of GDP that he has set? The first thing that will happen and is already happening is that the plan expenditure will be slashed. The plan expenditure for the first seven months of the year fell by 0.4% to Rs 2,66,991 crore.
This was the strategy followed by Chidambaram as well in 2013-2014. The plan expenditure target at the time of the presentation of the budget was at Rs 5,55,322 crore. The actual number came in 14.4% lower at Rs 4,75,532 crore. This is how a major part of government expenditure was controlled.
The government expenditure is categorised into two kinds—planned and non planned. Planned expenditure is essentially money that goes towards creation of productive assets through schemes and programmes sponsored by the central government.
Non-plan expenditure is an outcome of planned expenditure. For example, the government constructs a highway using money categorised as a planned expenditure. But the money that goes towards the maintenance of that highway is non-planned expenditure. Interest payments on debt, pensions, salaries, subsidies and maintenance expenditure are all non-plan expenditure.
As is obvious a lot of non-plan expenditure is largely regular expenditure that cannot be done away with. The government needs to keep paying salaries, pensions and interest on debt, on time. These expenses cannot be postponed. Hence, the asset creating plan expenditure gets slashed.
The second thing that the government is doing is not passing on the benefit of falling oil prices to the consumers. It has increased the excise duty on petrol and diesel twice, since deregulating diesel prices in October.
The third thing the government will have to do is to get aggressive on the disinvestment front in the period up to March 2015. The disinvestment target for the year is Rs 58,425 crore. But until now the government has gone slow on selling shares that it owns both in government and non-government companies because of reasons only it can best explain.
The recent sale of shares in the Steel Authority of India Ltd(SAIL) was pushed through with more than a little help from the Life Insurance Corporation of India and other government owned financial firms. This is nothing but moving money from one arm of the government to another arm. It cannot be categorised as genuine disinvestment.
This is something that Chidambaram and the UPA government regularly did in order to meet the disinvestment target. Despite this they couldn’t meet the disinvestment target in 2013-2014. The government had hoped to earn Rs 54,000 crore but earned only Rs 19,027 crore.
Also, selling assets to fund regular yearly expenditure is not a healthy practice. If at all the government wants to sell its stake in companies, it should be directing that money towards a special fund which could be used to improve the poor physical infrastructure throughout the country. Right now, the money collected through this route goes into the Consolidated Funds of India.
In the months to come we could also see the government forcing cash rich companies like Coal India (which has more than Rs 50,000 crore of cash on its books) to pay a special interim dividend to the government, as was the case last year.
This is the way I see things panning out over the next few months. Nevertheless, the proper thing to do would be to put out the right fiscal deficit number, instead of trying to use accounting and other tricks to hide it.
The first step towards solving a problem is to acknowledge that it exists.

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 11, 2014

3 December, 2014

Rajan and RBI have done their bit, now the ball is in government’s court

One of the laws of forecasting is to publicize the forecasts that you get right. On November 17, 2014, I wrote a piece titled Raghuram Rajan won’t cut interest rates even in Hindi.
In the Fifth Bi-Monthly Monetary Policy Statement released yesterday (December 2, 2014), Raghuram Rajan, the governor of the Reserve Bank of India (RBI), kept the repo rate unchanged. Repo rate is the rate at which the RBI lends to banks.
This was along expected lines. Rajan unlike many other central banks believes in clear communication. As Alan Greenspan, the Chairman of the Federal Reserve of the United States, the American central bank, from 1988 to 2006, once said “I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I’ve said.” Rajan does not believe in this school of thought and what he writes and says is normally very clear.
And that’s true about the latest monetary policy statement as well. He lays out very clearly what the Indian central bank is thinking at this point of time.
Let’s look at a few statements that Rajan made in the monetary policy statement. These statements are italicized and what follows is my interpretation of the statements.
“Further softening of international crude prices in October eased price pressures in transport and communication. However, upside pressures persist in respect of prices of clothing and bedding, housing and other miscellaneous services, resulting in non-food non-fuel inflation for October remaining flat at its level in the previous month, and above headline inflation.”
What Rajan means here is that overall inflation(i.e. rate of price rise) has been falling. But the prices of a part of the consumer price index which consists of non food and non fuel items haven’t been falling as fast as the overall inflation has been. Given this, its not yet time for the RBI to cut the repo rate or the rate at which it lends to banks.
“Survey-based inflationary expectations have been coming down with the fall in prices of commonly-bought items such as vegetables, but are still in the low double digits. Administered price corrections, as and when they are effected, weaker-than-anticipated agricultural production…could alter the currently benign inflation outlook significantly.”
Inflationary expectations (or the expectations that people have of what future inflation is likely to be) have been coming down. This means that people expect the rate of price rise to come down in the days to come. Nevertheless, the inflationary expectations are still on the high side, given that they remain in the low double digits.
Further, agricultural production is likely to fall as well. “It is reasonable to expect some firming up of these prices in view of the monsoon’s performance so far and the shortfall estimated for kharif production,” the statement read. This could push up inflation in the days to come. The RBI needs to wait and see how these factors pan out, before deciding to cut the repo rate.
“Inflation has been receding steadily and current readings are below the January 2015 target of 8 per cent as well as the January 2016 target of 6 per cent. The inflation reading for November – which will become available by mid-December – is expected to show a further softening. Thereafter, however, the favourable base effect that is driving down headline inflation will likely dissipate and inflation for December (data release in mid January) may well rise above current levels.”
A large part of the above statement is self explanatory. The Rajan led RBI expects the rate of inflation to have fallen further for November 2014. Nevertheless, a large part of this fall in inflation is because of the favourable base effect feels the RBI. What this means is that inflation in November 2013 was at a high level. This high inflation in November 2013 will make the inflation in November 2014 look small. (For a detailed explanation of the base effect click here). The RBI expects this base effect to go away after November and inflation to rise. Hence, it wants to wait and watch and see how the situation turns out by early next year.
This statement is also important from the point of view of inflationary expectations. They start to come down only once the people see low inflation being maintained for a while. And if inflation actually has to be controlled, the inflationary expectations need to be controlled first.
“ Risks from imported inflation appear to be retreating, given the softening of international commodity prices, especially crude, and reasonable stability in the foreign exchange market. Accordingly, the central forecast for CPI inflation is revised down to 6 per cent for March 2015.”
In this statement the Rajan led RBI acknowledges that one of the reasons for the falling inflation is a fall in oil prices. The RBI also says that it largely expects the inflation not to spike from here but is not totally sure about it. And given that they have revised the inflation number for March 2015 to 6%. Earlier it was at 8%. This statement reaffirms the fact that the RBI wants to wait and watch and be sure that the low inflation environment is here to stay. In short, it doesn’t want to jump the gun.
“With deposit mobilisation outpacing credit growth and currency demand remaining subdued in relation to past trends, banks are flush with funds, leading a number of banks to reduce deposit rates.”
“Some easing of monetary conditions has already taken place. The weighted average call rates as well as long term yields for government and high-quality corporate issuances have moderated substantially since end-August. However, these interest rate impulses have yet to be transmitted by banks into lower lending rates.”
In these statements Rajan points out that interest rates on deposits have fallen despite the RBI not reducing the repo rate. He also acknowledges that RBI plays a limited role in influencing interest rates. Further, the overall rate of loan growth for banks has been falling. Given this, the government and big corporates have been able to raise money at lower interest rates since the end of August 2014.
This quip is aimed at the businessmen who have been asking Rajan to cut interest rates. Further, this slowdown in the loan growth for banks has not transmitted into lower interest rates for everybody as yet. The government and the big corporates are the only ones who have benefited from it.
“The Reserve Bank has repeatedly indicated that once the monetary policy stance shifts, subsequent policy actions will be consistent with the changed stance. There is still some uncertainty about the evolution of base effects in inflation, the strength of the on-going disinflationary impulses, the pace of change of the public’s inflationary expectations, as well as the success of the government’s efforts to hit deficit targets. A change in the monetary policy stance at the current juncture is premature. However, if the current inflation momentum and changes in inflationary expectations continue, and fiscal developments are encouraging, a change in the monetary policy stance is likely early next year, including outside the policy review cycle.”
This is the crux of the monetary policy statement. What Rajan is saying here is that the RBI is still not totally convinced about cutting the repo rate. It doesn’t feel comfortable in declaring that the battle against inflation has been won.
It feels that if the rate of inflation continues to remain low, the inflationary expectations continue to fall and the government is able to meet its fiscal deficit targets, only then would have the RBI achieved what it set out to, after Rajan took over as the governor in September 2013.
Fiscal deficit is the difference between what a government earns and what it spends. The difference is made up through borrowing. If the government borrows more, it pushes up interest rates because it leaves a lower amount for others to borrow.
Once the RBI sees these three factors under control it will start cutting the repo rate and it will do that at a rapid rate. This, the central bank feels is likely to happen early next year. It has also made it clear that once it is convinced about the need to cut the repo rate it will do that without waiting for the days on which monetary policy is scheduled.
The phrase to mark here is “early next year,” which is open ended. Since Rajan has talked about waiting to see if the government is able to maintain its fiscal deficit target, the repo rate cut is likely to happen after the budget is presented in late February.
There are a couple of other points that I would like to make:

a) It was nice to see Rajan stick to his guns and not fall for the pressure to cut interest rates. This, despite the fact that Arun Jaitley went on an overdrive demanding that the RBI cut interest rates. He even met Rajan on December 1.

b) Further, Rajan has always maintained that if inflation is controlled economic growth will follow. As he wrote in the 2008 Report of the Committee on Financial Sector Reforms: “The RBI can best serve the cause of growth by focusing on controlling inflation.”

He repeated the same statement while talking to reporters yesterday. As he said “There is a major misconception in the industry that the RBI is not concerned about growth. The central bank is concerned about growth and the way to sustainable growth is to have a moderate inflation…RBI wants the strongest growth for India that is possible. We’re talking of years of sustainable growth for which you need to fight inflation.”
This statement should go a long way in countering those who had been trying to portray RBI’s efforts at countering inflation in a negative way and trying to hold it wrong for the low growth environment that prevails in the country these days.
In the end, like good central bank governors often do, Rajan acknowledged that there is only so much that the RBI can do. If economic growth has to be revived the government needs to get its act together. As he said towards the end of the monetary policy statement “A durable revival of investment demand continues to be held back by infrastructural constraints and lack of assured supply of key inputs, in particular coal, power, land and minerals. The success of ongoing government actions in these areas will be key to reviving growth.”
The RBI due to its own efforts and with some luck(like oil prices crashing) has brought inflation under some control. Now it’s over to the government.

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 3, 2014

26 November, 2014

What Arun Jaitley can learn from Rajan’s IRMA speech

Vivek Kaul

A few days back I wrote a piece questioning the logic of the State Bank of India entering into a memorandum of understanding with Adani Enterprises to consider giving it a loan of up to $1 billion. My logic was fairly straightforward—Adani Enterprises already has a lot of debt (around Rs 72,632.37 crore as on September 30, 2014) and is just about earning enough to service that debt.
Several readers wrote in on the social media saying what was the problem if Adani was offering an adequate security against the loan? Raghuram Rajan, the governor of the Reserve Bank of India, answered this question in a speech yesterday. Rajan was speaking at the third Dr. Verghese Kurien Memorial Lecture at IRMA, Anand.
As Rajan said “The amount recovered from cases decided in 2013-14 under DRTs (debt recovery tribunals) was Rs. 30,590 crore while the outstanding value of debt sought to be recovered was a huge Rs. 2,36,600 crore. Thus recovery was only 13% of the amount at stake. Worse, even though the law indicates that cases before the DRT should be disposed off in 6 months, only about a fourth of the cases pending at the beginning of the year are disposed off during the year – suggesting a four year wait even if the tribunals focus only on old cases.”
So, just because a bank has a collateral does not mean it will be in a position to en-cash it, as soon as the borrower defaults on the loan. As big borrowers (read companies and industrialists) have defaulted on loans over the last few years, the non performing assets of banks, particularly public sector banks have gone up.
As on March 31, 2013, the gross non performing assets (NPAs) or simply put the bad loans, of public sector banks, had stood at 3.63% of the total advances. Latest data from the finance ministry show that the bad loans of public sector banks as on September 30, 2014, stood at 5.32% of the total advances. The absolute number was at Rs 2,43,043 crore. During the same period the bad loans of private sector banks was more or less constant at 1.8% of total advances. Interestingly, public sector banks accounted for over 90% of bad loans in 2013-2014 (i.e. between April 1, 2013 and March 31, 2014).
All these points have several repercussions. The first is that banks need to charge a higher rate of interest in order to compensate for the higher credit risk (or simply put the risk of the borrower defaulting on the loan) they are taking on. As Rajan said in the speech “The promoter who misuses the system ensures that banks then charge a premium for business loans. The average interest rate on loans to the power sector today is 13.7% even while the policy rate is 8%. The difference, also known as the credit risk premium, of 5.7% is largely compensation banks demand for the risk of default and non-payment.”
Simply put, those who default in effect ensure that those who repay have to pay a higher rate of interest. The irony is that banks give out home loans to individuals at 10-11%. This shows that lending to individuals is a better credit risk for them than lending to infrastructure companies.
As Rajan put it “Even comparing the rate on the power sector loan with the average rate available on the home loan of 10.7%, it is obvious that even good power sector firms are paying much more than the average household because of bank worries about whether they will recover loans.”
Also, a report in the Business Standard today suggests that the RBI is “mulling action in terms of limiting loan-sanctioning powers of banks with stressed asset ratios.”
The stressed asset ratio is the sum of gross non performing assets plus restructured loans divided by the total assets held by the Indian banking system. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank) by increasing the tenure of the loan or lowering the interest rate.
The Business Standard report carries a list of 14 public sector banks that have a stressed asset ratio of 12% or more. Central Bank of India has the highest stressed asset ratio of 20.49%, followed by the United Bank of India at 19.7%.
If the RBI decides to limit the loan-sanctioning power of these banks, it will do so in the backdrop of the finance minister Arun Jaitley asking banks to lend more. A few days back Jaitley said “We have asked banks to go out there and lend without any fear. They should do proper appraisals of projects and provide loans to infrastructure projects.” Like in almost everything else, he was following the tradition set by his predecessor P Chidambaram.
The stressed assets of many public sector banks did not cross 12% because they did not carry out proper project appraisals. It crossed such high levels because the banks were forced to lend to crony capitalists close to the political dispensation of the day i.e. leaders of the previous United Progressive Alliance (UPA).
Take the case of GMR Infra. For the period of three months ending September 30, 2014, the company paid a total interest of Rs 845.04 crore on its debt. Its operating profit was Rs 101.14 crore. The company had a total debt of Rs 39,187.45 crore as on March 31, 2014. What this clearly tells us is that the company is not earning enough to pay the interest that it has to, on the total debt that it has managed to accumulate.
This is true about many other companies as well particularly in the infrastructure sector, which is dominated from crony capitalists. These companies borrowed much more than they should have been allowed to in the first place. Also, many promoters got away without putting much of their own money in the business.
As Rajan said “The reason so many projects are in trouble today is because they were structured up front with too little equity, sometimes borrowed by the promoter from elsewhere. And some promoters find ways to take out the equity as soon as the project gets going, so there really is no cushion when bad times hit.” This could not have happened without the tacit support of the political dispensation of the day.
And this perhaps led Rajan to quip that India is “a country where we have many sick companies but no “sick” promoters.” “In India, too many large borrowers insist on their divine right to stay in control despite their unwillingness to put in new money. The firm and its many workers, as well as past bank loans, are the hostages in this game of chicken — the promoter threatens to run the enterprise into the ground unless the government, banks, and regulators make the concessions that are necessary to keep it alive. And if the enterprise regains health, the promoter retains all the upside, forgetting the help he got from the government or the banks – after all, banks should be happy they got some of their money back!” Rajan added.
Another implication of the massive increase in bad loans for public sector banks has been that the law has become “more draconian in an attempt to force payment.” As Rajan put it “The SARFAESI (Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests) Act of 2002 is, by the standards of most countries, very pro-creditor as it is written. This was probably an attempt by legislators to reduce the burden on DRTs and force promoters to pay. But its full force 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.” This leads to a situation where upcoming entrepreneurs do not want to take the risk of growing bigger by taking on more loans and may choose to continue to remain small.
To conclude, Rajan’s speech at IRMA was an excellent summary of all that is wrong with the Indian banking sector. He also made suggestions on how to set it right. The promoters should not try and finance mega projects with tiny slivers of equity, he suggested. Banks needed to react quickly to borrower distress. And the government needed to set up more debt review tribunals. These are simple solutions that need political will in order to be implemented.
Arun Jaitley has been asking the RBI to cut interest rates for a while now. He has also asked banks to lend more. Nevertheless, it’s not as simple as Jaitley thinks it is. First and foremost the government needs to ensure that big borrowers cannot just get away with defaulting on loans. This in itself will have a huge impact on interest rates.
As Rajan put it “It is obvious that even good power sector firms are paying much more than the average household because of bank worries about whether they will recover loans. Reforms that lower this 300 basis point risk premium of power sector loans vis-a-vis home loans would have large beneficial effects on the cost of finance, perhaps as much or more than any monetary policy accommodation.”
This is something that Jaitley should be thinking about seriously in the days to come, if he wants banks to genuinely bring down lending rates.

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