Tag: RBI | Page 4 | Vivek Kaul

6 September, 2020

GDP contraction: No easy solutions but a chance for deep economic reforms

Summary: It is worth saying that if all problems had solutions, they wouldn’t be called problems in the first place.

If you follow the news media closely or even if you don’t, you would know by now that the Indian gross domestic product (GDP) for the period April to June 2020 contracted nearly by a fourth or 23.9% to be very specific. GDP is the measure of the economic size of any country during a certain period.

But what does this really mean? GDP growth is ultimately a reflection of whether economic transactions are growing or not. Or to put it simply whether people are buying and selling more things than they did in the past. And when this does not happen, the GDP contracts or to put it simply, the economy contracts.

Let’s try and understand this through an example. Let’s say it’s the first weekend of the month and your salary has just hit the bank account. With money in your pocket you feel like going to the multiplex at the local mall to watch the latest blockbuster.

Once you are there, you buy the ticket. You also buy a soft-drink and a huge tub of popcorn as well. How can any movie watching experience be complete without eating popcorn? Having seen the hero dhishumed the bad guys and won over the damsel in distress for nearly 150 minutes, you are now hungry.

You now go to the Food Court in the mall and have a sumptuous and late weekend lunch. Done with the lunch you are passing an apparel retailer. You go in and buy that pair of jeans you have been wanting to buy for a while. It’s still not too late and then you go and do a round or two of bowling. After all this, still feeling rich you hail an app cab home even though prices are surging.

Now what is happening here? Every time you are buying something you spend money. This money is going into the accounts of businessmen who are selling you stuff. This money is then used to pay the employees of these businesses. It is also used to pay the suppliers. It is used to pay for the shop rental and so on. Everyone who gets paid like this including the employees can then go out and spend money in a similar way like you did.

This is called the multiplier effect of spending. With the covid pandemic, people have stayed at home and this multiplier effect has broken down to a large extent. With the breakdown many businesses haven’t earned money or not as much as they need to, in order to stay viable.

This has led to employees being fired. In some other cases salaries have been cut and jobs offers have been rescinded. This has had a further negative impact on the multiplier effect and more jobs have been lost in the process. Not surprisingly, private consumption during April to June contracted 26.7%.

Through much of April, people were at homes under a lockdown. After April, the economy has started to open up but that still hasn’t led to people feeling confident enough to go out and spend money. This anomaly will take time to correct.

Also, with covid now spreading at the rate of more than 85,000 cases per day, it is no longer just an urban India phenomenon. As it spreads to semi-urban and rural India, it will impact consumption, though not in the same negative way as it did between April and June. The impact will be lower.

With a physical lockdown in place and migrant labour moving away from the economically well-off parts of the country to their homes, construction and infrastructure building took a backseat between April and June. In fact, construction contracted by a little more than 50% during the period. This played its part in the economy contracting.

Also, in an environment where consumer spending took a beating investment in the economy contracted by 47.1%. Companies ultimately make things for people to buy. And if that space is contracting, there is no point for companies to keep investing in the economy. In the months to come, the private consumption will improve and so will investment as a result. But it will take a while for both consumption and investment to reach pre-covid levels.

So, what’s the way out of this? Banks have cut interest rates in the hope of people and businesses borrowing and spending more. But that isn’t happened. People and businesses borrow and spend more when they are confident about their economic future. Right now, the confidence is missing.

In this environment, companies and brands need to offer discounts and offers to get people to consume again. In fact, a bit of that is already on and as the festival season comes in, more offers and discounts will hit the market.

One thing that the government can clearly do to get consumption going again is to reduce the GST on two-wheelers from 28% to 18%. What it loses out in taxes per unit of sales, it will make up for in volume. Also, if more two-wheelers sell, everyone from tyre manufacturers to steel companies, will benefit.

The government needs to step in and spend more, in the process create some economic activity. The government expenditure between April and June went up by 16.4%. The government put in money into female Jan Dhan accounts. Now is the time to put money in male Jan Dhan accounts as well.

The government also increased the allocation and spending to the Mahatma Gandhi National Rural Employment Guarantee Scheme. It is important to keep offering work under the scheme through the year.

But given the gravity of the collapse this has clearly not been enough. Hence, everyone expects the government to do more. Now doing more needs more money. The trouble is that the government tax collections have collapsed by close to 30% between April and July this year.

The government can borrow more. The Reserve Bank of India can also print money and fund government expenditure. In fact, it is already doing that to some extent. But all these moves come with their own set of negative repercussions. Printing money can lead to higher inflation as a higher amount of money chases the same amount of goods and services. It can also lead to the rupee depreciating against the dollar quickly and the foreign investors in turn wanting to leave India. This is something that can disturb the general macroeconomic stability of the country.

And that explains the reluctance of the government on this front.

While, the government is clearly tied on the spending more front, it can possibly push in more economic reforms at this point of time. One area that clearly needs reform is the Goods and Services Tax system, which instead of freeing up the Indian economy has acted in a negative way. Another area that clearly needs reform is India’s public health infrastructure.

The big philosophical question that the government needs to try and find an answer for, if it is really interested in development, is, whether it should spread itself as thin as it currently does, or should it concentrate on a few main areas like defence, physical infrastructure, education, agriculture, external affairs, etc. This lack of concentration has harmed India quite a lot over the years and any sort of focus will help.

While these reforms may not lead to immediate benefits they will work well for the economy in the longer-term, something which we shouldn’t miss out on with the current focus on covid.

Beyond that there isn’t much that the government can do. Also, it is worth remembering here that the Indian economy was already in trouble before covid pandemic struck.

To conclude, it is worth saying that if all problems had solutions, they wouldn’t be called problems in the first place.

A slightly shorter version of the article originally appeared in the Deccan Herald, on September 6, 2020.

8 November, 2017

Demonetisation–The Unanswered Question

Time flies.

It has been one year since that fateful day last year, when prime minister Narendra Modi, suddenly announced that Rs 500 and Rs 1,000 notes, would be useless, in a matter of few hours.

Modi was lauded for this “brave” decision. In a country, where politicians do not like to take decisions, here was one politician who had decided to make one.

The trouble is that nobody told us on what basis had the decision been taken. Every decision, has consequences, especially a decision as disruptive as demonetisation turned out to be. And given this, there has to be some logic behind why the decision was made in the first place.

It doesn’t take rocket science to understand that if 86.4 per cent of the currency in circulation is made useless overnight, in a country where 80-98 per cent of the transactions happen in cash (depending on which estimate you would like to believe), the buying and selling of things is bound to crash. When economic transactions crash, it leads to a slowdown of the overall economy, which is precisely what happened in India.

As Jean Drèze writes in Sense and Solidarity—Jholawala Economics for Everyone: “For instance, a study by Nidhi Aggarwal and Sudha Narayanan… shows that mandi arrivals of non-perishable agricultural commodities crashed across the board within a week of demonetisation. The declines range from 23 per cent for cotton to 87 per cent for soybean.”

This happened because agricultural markets in India operated in cash and with no cash around, the farmers were in no position to sell what they had produced. The onion market in Lasalgaon (near Nashik, and India’s largest onion market) continues to face this problem, a year later.

Many informal markets crashed in the aftermath of demonetisation and haven’t been able to revive again. The growth of the non-government part of the economy, which forms close to 90 per cent of the economy, for the period April to June 2017, fell to a little over 4 per cent, in the aftermath of demonetisation.

On top of that the total amount of deposits with banks increased dramatically and because of that the interest rates crashed. This hurt many people (especially senior citizens) who depend on interest from deposits for their survival. It also hurt those who use fixed deposits to save for the long-term. At the same time, the fall in interest rates did not lead to an increase in bank lending. In fact, bank lending in the aftermath of demonetisation has crashed.

The question that remains is on what basis was the decision to demonetise taken? Was there any logic to it or was it just taken on a whim? The closest answer to this has come from Arjun Meghwal, a junior minister in the Modi government. He told the Lok Sabha in February 2017: “RBI held a meeting of its Central Board on November 8, 2016. The agenda of the meeting, inter-alia, included the item: “Memorandum on existing banknotes in the denomination of Rs500 and Rs1000 -Legal Tender Status.””

Meghwal passed the buck on to the Reserve Bank of India (RBI). A Right to Information query was filed with the RBI by a correspondent of the Press Trust of India (PTI). In the query, the central bank was asked to provide the minutes of the meeting in which the decision to demonetise Rs500 and Rs1,000 notes was taken. Over and above this, it was also asked to share its correspondence with the Prime Minister’s Office (PMO) and the Finance Ministry, on the issue of demonetisation.

The RBI replied: “The information sought in the query carries sensitive background information including opinions, data, studies/ surveys etc. made prior to the completion of the process of withdrawal of legal tender character of Rs500 and Rs1,000 notes… Disclosure of such information would detriment economic interest of the country from the viewpoint of the objectives sought to be achieved by such decision.”

Basically, the RBI refused to answer the RTI query. And a year later, we still don’t know on what basis was demonetisation carried out.

The column originally appeared in the Bangalore Mirror on November 8, 2017.

26 July, 2017

What a Slowdown in Retail Loans Tell Us About a Slowing Economy

In the recent past a lot has been written about the overall slowdown in bank lending. Take a look at Figure 1. It essentially tells us about the loans given out by banks during the period between May 2016 and May 2017, and May 2015 and May 2016, before that.

Let’s start with non-food credit. These are the loans given out by banks after we have adjusted for food credit or loans given to the Food Corporation of India and other state procurement agencies, for buying rice and wheat directly from farmers at the minimum support price (MSP) for the public distribution system.

Figure 1:

Type of Loan	Total Loans Given Between May 2016 and May 2017 (in Rs Crore)	Total Loans Given Between May 2015 and May 2016 (in Rs Crore)
Non-Food Credit	4,22,001	6,25,975
Loans to industry	-56,455	24,383
Retail Loans	1,94,553	2,27,863

Source: Reserve Bank of India

The total amount of non-food credit given out between May 2016 and May 2017 is down by 33 per cent to Rs 4,22,001 crore, in comparison to the period between May 2015 and May 2016. Hence, there has been a huge overall slowdown in the total amount of loans given out by banks over the last one year, in comparison to the year before that.

Why has that been the case? The major reason for the same are loans to industry. Banks are in no mood to give out loans to industry. During the period May 2016 and May 2017, the total loans to industry actually shrunk by Rs 56,455 crore. This basically means that on the whole the banks did not give a single rupee of a new loan to the industry. During the period May 2015 and May 2016, banks had given fresh loans worth Rs 24,383 crore to industry, overall.

This is happening primarily because banks have run a huge amount of bad loans on loans they had given to industry in the past. As on March 31, 2017, the bad loans ratio of public sector banks when it came to lending to industry, stood at 22.3 per cent. Hence, for every Rs 100 of loan made to industry by public sector banks, Rs 22.3 had turned into a bad loan i.e. the repayment from a borrower has been due for 90 days or more.

Not surprisingly, these banks are not interested in lending to industry anymore. This has been a major reason behind the overall slowdown in lending carried out by banks, as we have seen earlier.

But one part of lending that no one seems to be talking about is retail lending carried out by banks. This primarily consists of housing loans, vehicle loans, consumer durables loans, credit card outstanding, loans against fixed deposits, etc. The assumption is that all is well on the retail loan front.

As far as bad loans are concerned, things are going well on the retail loans front. But what about the total amount of retail loans given by banks? Between May 2016 and May 2017, the total amount of retail loans given by banks stood at Rs 1,94,533 crore. This was down by around 15 per cent to the amount of retail loans given by banks between May 2015 and May 2016. This, despite the fact that interest rates on retail loans have come down dramatically in the post demonetisation era. You can get a home loan now at an interest of as low as 8.35 per cent per year.

A major reason for this slowdown in retail loans are housing loans, which form the most significant part of retail loans. Between May 2016 and May 2017, the total amount of housing loans given by banks stood at Rs 92,469 crore down by 22 per cent in comparison to the housing loans given out by banks between May 2015 and May 2016.

Lower interest rates on home loans haven’t helped much. The only explanation of this lies in the fact that high real estate prices continue to be the order of the day across the country. How do things look with vehicle loans which form a significant part of the retail loans? Between May 2016 and May 2017, banks gave out vehicle loans worth Rs 18,447 crore, 26 per cent lower than the vehicle loans given out by banks between May 2015 and May 2016.

What does this tell us? It tells us very clearly that things have deteriorated even on the retail loans front. People take on retail loans only when they are sure that they will be able to continue repaying the EMIs in the years to come (unlike corporates). The fall in the total amount of retail loans lent by banks over the last one year clearly tells us that the confidence to repay EMIs, is not very strong right now.

This is another good indicator of the overall slowdown in the Indian economy, which has happened in the post demonetisation era.

The column originally appeared in Equitymaster on July 24, 2017.

23 June, 2017

The Bank Ponzi Scheme

RBI-Logo_8

Every six months the Reserve Bank of India (RBI) publishes a document titled the Financial Stability Report . In the December 2011 report, it pointed out that at 55 per cent, loans to the power sector constituted a major part of the lending to the infrastructure sector. It further said that restructured loans in the power sector were on their way up.

Restructured loans are essentially loans where the borrower has been given a moratorium during which he does not have to repay the principal amount. In some cases, even the interest need not be paid. In some other cases, the tenure of the loan has been increased.

This was nearly five and a half years back, and the first time the RBI admitted that there was a problem in the bank lending to the power sector. In the December 2012 report, the RBI said: “There are also early signs of corporate leverage rising among the several industrial groups with large exposure to infrastructure sectors like power.”

When translated into simple English this basically means that many big industrial groups which had taken on loans to finance power projects had borrowed more money than they would be in a position to repay.

In the years to come by, other sectors along with the power sector also became a part of the RBI commentary on loans which were likely not to be repaid in the future. In the June 2013 report, the central bank said: “Within the industrial sector, a few sub-sectors, namely; Iron & Steel, Textile, Infrastructure, Power generation and Telecommunications; have become a cause of concern.”

In the December 2013 report, the RBI said: “There are five sectors, namely, Infrastructure [of which power is a part], Iron & Steel, Textiles, Aviation and Mining which have high level of stressed advances. At system level, these five sectors together contribute around 24 percent of total advances of scheduled commercial banks, and account for around 51 per cent of their total stressed advances.”

Dear Reader, the point I am trying to make here is that the RBI knew about a crisis brewing in the industrial sector as a whole, and power and steel sector in particular, for a while. In fact, in the June 2015 report, the RBI pointed out: “the debt servicing ability of power generation companies [which are a part of the infrastructure sector] in the near term may continue to remain weak given the high leverage and weak cash flows.”

The funny thing is that while the RBI was putting out these warnings, the banks were simply ignoring them and lending more to these sectors. Between July 2014 and July 2015, banks gave out Rs 86,500 crore, or 71.5 per cent, of the Rs. 1,20,900 crore that they had lent to industry to the two most troubled sectors, namely, power and iron and steel.

What was happening here? The banks were giving new loans to the troubled companies who were not in a position to repay their debt. These new loans were being used by companies to pay off their old loans. A perfect Ponzi scheme if ever there was one. If the banks hadn’t given fresh loans, many of the companies in the power and the iron and steel sectors would have defaulted on their loans.

Hence, the banks gave these companies fresh loans in order to ensure that their loans didn’t turn into bad loans, and so, in the process, they managed to kick the can down the road. In the process, the loans outstanding to these companies grew and if they were not in a position to repay their loans 2-3 years back, there is no way they would be in a position to repay their loan now.

Many of these projects, as Raghuram Rajan put it in a November 2014 speech, “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.”

The corporates brought in too little of their own money into the project, and banks ended up over lending. Over lending also happened because many promoters in these sectors were basically crony capitalists close to politicians to whom banks couldn’t say no to.

Over and above this, the steel producers had to face falling steel prices as China dumped steel internationally. In case of power producers, plant load factors (actual electricity being produced as a proportion of total capacity) fell. Along with this, the spot prices of electricity also fell. This did not allow these companies to set high tariffs for power, required for them to generate enough money to repay loans.

All these reasons basically led to the Indian banks ending up in a mess, on the loans it gave to power and iron and steel prices.

The RBI has now put 12 stressed loan cases under the Insolvency Bankruptcy Code, in the hope of recovering bad loans from these companies. Not surprisingly, steel companies dominate the list.

The column originally appeared in the Daily News and Analysis on June 23, 2017.

22 May, 2017

The Banking Ordinance is no magic pill for ailing banks

RBI-Logo_8

Recently, the government promulgated the Banking Regulation(Amendment) Ordinance, 2017, to tackle the huge amount of bad loans that have accumulated in the Indian banking system in general and the government owned public sector banks in particular. Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more.

This Ordinance is now being looked at the magic pill which will cure the problems of Indian banks. Will it?

The Ordinance essentially gives power to the Reserve Bank of India(RBI) to give directions to banks for the resolutions of bad loans from time to time. It also allows the Indian central bank to appoint committees or authorities to advise banks on resolution of stressed assets.

The basic assumption that the Ordinance seems to make is that the RBI knows more about banking than the banks themselves. This doesn’t make much sense for the simple reason that if the RBI was better at banking than the banks themselves, it would have been able to identify the start of the bad loans problem as far back as 2011, which it didn’t.

Over and above this, this is not the first time that Indian banks have landed in trouble because of bad loans. They had landed up in a similar situation in the early 1980s and the early 2000s as well, and the RBI hadn’t been able to do much about it.

In fact, at the level of banks, many banks have been more interested in postponing the recognition of the problem of bad loans. This basically means they haven’t been recognising bad loans as bad loans. One way of doing this is by restructuring the loan and allowing the borrower a moratorium during which he does not have to repay the principal amount of the loan. In some cases, even the interest need not be paid. In some other cases, the tenure of the loan has been increased. In many cases this simply means just pushing the can down the road by not recognising a bad loan as a bad loan.

Why have banks been doing this? The Economic Survey gives us multiple reasons for the same. Large debtors have borrowed from many banks and these banks need to coordinate among themselves, and that hasn’t happened. At public sector banks recognising a bad loan as a bad loan and writing it off, can attract the attention of the investigative agencies.

Also, no public sector banker in his right mind would want to negotiate a settlement with the borrower who may not be able to repay the entire loan, but he may be in a position to repay a part of the loan. As the Economic Survey points out: “If PSU banks grant large debt reductions, this could attract the attention of the investigative agencies”. What makes this even more difficult is the fact that some of defaulters have been regular defaulters over the decades, and who are close to politicians across parties.

Hence, bankers have just been happy restructuring a loan and pushing the can down the road.

Over and above this, writing off bad loans once they haven’t been repaid for a while, leads to the banks needing more capital to continue to be in business. In case of public sector banks this means the government having to allocate more money towards recapitalisation of banks. There is a limit to that as well.

Also, a bigger problem which the Economic Survey does not talk about is the fact that the rate of recovery of bad loans has gone down dramatically over the years. In 2013-2014, the rate of recovery was at 18.8 per cent. By 2015-2016, this had fallen to 10.3 per cent. Hence, banks were only recovering around Rs 10 out of the every Rs 100 of bad loans defaulted on by borrowers. This is clear reflection of the weak institutional mechanisms in India, which cannot change overnight.

Also, many of the companies that have taken on large loans are no longer in a position to repay. As the Economic Survey points out: “Cash flows in the large stressed companies have been deteriorating over the past few years, to the point where debt reductions of more than 50 percent will often be needed to restore viability. The only alternative would be to convert debt to equity, take over the companies, and then sell them at a loss.”

The first problem here will be that many businessmen are very close to politicians.
Hence taking over companies won’t be easy. Over and above this, it will require the government and the public sector banks, working with the mindset of a profit motive, like a private equity or a venture capital fund. And that is easier said than done.

The column originally appeared in the Daily News and Analysis on May 22, 2017.