Stress in the Banking Sector

Recent Developments

Reserve Bank of India’s biannual Financial Stability Report has once again flagged the fact that risks to the banking sector remain worryingly “high”.

In the central bank’s assessment, risks have stayed elevated due to:

* Continuous deterioration in asset quality

* Low profitability

* Liquidity issues

Important Role of Commercial Lenders:

Given the central role commercial lenders have in the financial system — serving to harness public savings and direct the flow of crucial credit to the most productive industrial and infrastructure sectors — any systemic risk to the banking industry has the potential to ripple across the entire economy.

Risks faced by Lending Sector:

A systemic risk survey completed in October was itself rather downbeat. Out of 34 categories of risk, the survey rated only 11to be very low or low, leaving 23 to be rated as medium to high risk.

Cyber security, credit growth, asset quality, capital adequacy, infrastructure creation and corporate profitability were already considered high risk then. Demonetisation has only increased the risk.

Given the above scenario, we revisit the recommendations made by Standing Committee on Finance (Chair: Dr. M Veerappa Moily)

Standing Committee Report Summary: Non-Performing Assets of Financial Institutions

The Standing Committee on Finance (Chair: Dr. M Veerappa Moily) submitted its report on Non Performing Assets of Financial Institutions on February 24, 2016. The report makes recommendations to improve the management, and facilitate recovery of Non-Performing Assets.

* Non-Performing Assets: A non-performing asset (NPA) is a loan given by a financial institution, which ceases to generate income. NPAs include loans where payment has been overdue for more than 90 days. The Committee observed that despite the government and the Reserve Bank of India (RBI) taking several steps, NPAs continue to increase.

* Empowered Committees: It observed that banks do not have adequate capability to undertake credit appraisal. Credit appraisal involves evaluating capacity of the borrower, to ensure he is capable of repaying the loan. In this context, it recommended that specially empowered committees should be set up at three levels, namely (i) RBI, (ii) banks, and (iii) borrower, to continuously monitor large loan portfolios. Further, these committees may be mandated to submit periodical reports on their findings, to the central government and Parliament.

* Restructuring of loans: The Committee observed that currently banks restructure loans on the basis of classification of their assets, and other benefits related to provisioning. It suggested that banks should carry out such restructuring by taking into account the temporary inability of the borrower to repay the loan and to preserve the economic value of the assets. It further suggested that indicators should be developed for projects when a loan is sanctioned. The indicators would facilitate monitoring of loans, and pre-empt the possibility of an NPA.

* Wilful defaulters: Wilful default refers to a situation where a borrower defaults in making repayments, despite having sufficient resources. The Committee observed that wilful defaulters constituted 21% of the total NPAs of banks. In this context, it suggested that banks should make names of the top 30 wilful defaulters public. Such a step would act as a deterrent for others to default willingly on loan repayment. It suggested that necessary amendments should be made to the RBI Act, 1934, and any law or guideline in force, to allow for such public disclosure. Further, the Committee recommended that names of companies that have undergone restructuring of their loans, should also be made public.

* Timeline for Corporate Debt Restructuring: Corporate Debt Restructuring (CDR) is a voluntary mechanism, which involves restructuring of debt of entities which are facing problems in repaying loans. The Committee observed that currently deliberations among stakeholders to settle CDR cases continue for years. It recommended that a timeline of six months should be introduced to settle such cases.

* Strategic Debt Restructuring: Strategic Debt Restructuring (SDR) empowers banks to take control over the management of the defaulting company, by converting the loan into equity. The Committee recommended that a change in management of the company should be made mandatory, in cases involving wilful default, or where funds have been diverted and no recovery is possible.

* Absorbing written off NPAs: The Committee suggested that the RBI should consider allowing banks to absorb their written-off assets gradually, in a staggered manner. This would help the banks in restoring their balance sheets to normal health.

Revisit Pathankot, Uri, Nagrota

Fatalities Due to Negligence?

Behind the grim toll 2016 has inflicted on Indian soldiers and police personnel in Kashmir lies one, little-noticed fact: Almost half of the 87 fatalities, the worst since 2009, can be attributed to events like the Uri and Nagrota attacks, which involved flaws in basic training or poor perimeter security at bases.

Lax Perimeter Security – Both Pathankot and Nagrota

Indian Express has revealed that the terrorists who attacked the XVI Corps headquarters at Nagrota scaled its wall simply by climbing a tree growing alongside the officer’s mess.

The technique was almost identical to that used by terrorists in Pathankot, where they took advantage of Eucalyptus trees next to the boundary wall.

No Lessons Learnt from Pathankot

Even though J&K Governor N.N. Vohra had ordered a security review of all bases after the Pathankot attack, the military experts who audited the Nagrota base were either careless or remiss.

No Action taken on Recommendations Post Pathankot Incident

In the wake of the Pathankot attack, the ministry of defence had tasked former army Vice-Chief Lieutenant-General Philip Campose with studying the problem. General Campose’s report recommended:

* Rectification of the training of base security teams

* Acquisition of technologies like night-vision devices and movement sensors.

These technologies were not purchased when the Uri attack took place; they were not available at Nagrota either.

Accountability?

In any other country, these failures would have sparked a national scandal. In India, the deaths of soldiers barely provoke concern — a silence passed off as patriotism.

The country has not been told why there was no perimeter wall at Uri, though funds had been found to build a golf course there.

In the absence of accountability, it ought to surprise no-one that neither the ministry of defence nor the army leadership feel any sense of urgency to rectify the situation. Thus, a toxic culture of mediocrity runs through the executive leadership of institutions that are India’s ultimate guardians.

That terrorists wish to kill Indian soldiers does not surprise; the failure to address glaring problems, though, is shocking.

Lapses like these could be condoned if they did not involve the lives of women and men who serve the country — and if the means to protect them were not so easily available and affordable.

Defence Minister Manohar Parrikar needs to let sunlight into the stables, and then set to work in earnest with shovel and broom.

Note: INS Betwa tipped over recently while undocking at Naval Dockyard, Mumbai. There too we had discussed the importance of fixing accountability. Here is the link to that discussion:

http://sheriasacademy.blogspot.in/2016/12/editorial-round-up-071216.html

Bihar brings Reservations to Judiciary

Recent Developments:

Bihar government has decided to introduce a 50% job quota for scheduled castes (SC), scheduled tribes (STs) and backward classes in the superior as well as subordinate judiciary.

Earlier, there was no provision for reservation in the appointment of judges to the superior judicial service. But, the subordinate judicial service, under which munsif magistrates are recruited, had 27% seats reserved for the SCs, STs and most backward classes (MBC).

As per the new rules:

* 21% seats will be reserved for extremely backward castes (EBCs)

* 12% for backward castes (BCs)

* 16% for SCs

* 1% for ST candidates

The state government has also made provisions for vertical reservation for women (35%) and physically challenged persons (1%).

Critical Analysis of the above move:

Appointments to the judiciary should be made only on merit as the consequences of taking in unsuitable candidates to fill reservation quotas can be detrimental and will dilute standards in an institution which requires rigour and excellence. The judiciary in India is still an institution which commands respect across the board.

A report by the National Commission for Schedule Castes, on reservation in the judiciary, argued for it saying reservation in premier institutes like the National Law Schools can create a talented pool of legal professionals from socially and economically disadvantaged communities. It is oblivious to the fact that such a pool of talented professionals will not need reservations in the first place. And if students getting into colleges under reservation do need further quotas for jobs, then reservation as a policy clearly isn’t working.

In the specific context of reservation in judiciary, the Punjab and Haryana High Court, hearing a plea for lowering qualification marks for scheduled caste and tribal candidates, had observed “in the matter of appointment to Judicial Services, efficiency and quality are non-negotiable”, and had quashed the plea. The political class needs to pay greater heed to the HC’s words.

Way Ahead:

There is enough data to substantiate the point that facilitating quality education will reap richer rewards for the disadvantaged classes than reservation.

PRICE’s all-India survey for 2013-14 shows upper caste households headed by an illiterate person earned Rs 87,862 per year versus Rs 138,037 for tribal (reserved category) households headed by people who had studied till primary or middle school.

The goal therefore has to be creating an environment for scheduled castes and other disadvantaged groups to avail of high-quality education and attain at least university-level competence, not reserving jobs.

Other Blogs on Reservation:

Karnataka’s Employment Reservation Policy

http://sheriasacademy.blogspot.in/2016/12/editorial-round-up-261216-karnatakas.html

Rajasthan high court order on Gujjar Quota

http://sheriasacademy.blogspot.in/2016/12/editorial-round-up-121216.html

Towards Integrated Inland Water Transport

Rise and Fall of India’s Water Transport System:

India is a land of rivers. So it is but natural that all those who ruled this country have used the waterways for trade. During the Mughal rule, inland trade flourished, which in turn gave rise to many economic hotspots. But over the centuries inland water trade collapsed as rail and road trade improved.

Though India has a 7,500 km long coastline with approximately 14,500 km of navigable waterways, it has not been able to harness the potential to the fullest. A minuscule 3.5 % of trade is done through waterways in India as against 47% in China, 40% in Europe and 35% in neighbouring Bangladesh.

But history always comes to a full circle and now that the road and rail lines are congested, there is an express demand to reopen the waterways. Reopening waterways has another major advantage: Transport by shipping is far more cost-efficient than that by road or railways.

Recent Developments:

In March, Parliament passed the National Waterways Act, 2016, paving the way for the Union government to turn over 100 across India into national waterways.

Taking that decision forward, the Centre has signed a deal with the Massachusetts Institute of Technology for developing ferry services at 18 locations in Allahabad, Varanasi, Patna Munghyr, Kolkata and Haldia.

Challenges in Development of National Waterways

Engineering Challenge:

* The decision to develop waterways is not without controversies because to make a river navigable requires constant and steady water flow at a set minimal limit depending on the tonnage of weight to be shipped. This has to be managed artificially. The river has to operate like a canal.

* Nachiket Kelkar, an expert in river and water ecologies, in an article for environment advocacy group South Asia Network on Dams, Rivers and People, puts it this way: “This will involve the construction of locking barrages to hold water for vessel movement, concretisation and building of embankments to create port terminals, and regular (high-intensity) capital dredging of river sediment deposition along channel bottoms and margins.”

* Also, the riverbed must be dredged to maintain minimum depth, and it must have state-of-the-art inland ports, a modern river information system and Digital Global Positioning System for night navigation.

Political Challenge

* The project can also potentially create interstate rancour say campaigners. River linkages and water sharing arrangements will have to be worked out between states.

(There will surely be ecological and financial challenges too.)

Last Word: As the National Waterways Bill notifying the new waterways was passed in Parliament, minister of road transport and highways Nitin Gadkari had said, “Inland Waterways is a much cheaper and environment-friendly mode of transportation”. While this is correct, the ambitious plans to develop 101 rivers into an integrated Inland Water Transport (IWT) system also has the potential to run into trouble at a future date.

India's CPEC Dilemma

The $46 billion CPEC is the flagship project within the even more ambitious Belt-Road programme of Chinese leader Xi Jinping, a transcontinental infrastructure project that would effectively convert the Middle Kingdom into the logistics hub of Eurasia and, potentially, the centre of the global economy.

Recent Development:

* A part of CPEC has been operationalized in November, 2016.

* Days after a senior Pakistani General suggested that India should shun its “enmity” with Pakistan and join the $46 billion China-Pakistan Economic Corridor project, the Chinese foreign ministry has called the offer a “goodwill gesture”, exhorting India to take it up.

India’s Reaction to CPEC thus far:

India has opposed the project, bilaterally with China “at the highest level” as well as at the UN. Relations with China have deteriorated considerably since President Xi Jinping’s visit to Pakistan to announce the project in April 2015. Initially, New Delhi sought to play down its significance, as it was made just weeks before Prime Minister Narendra Modi travelled to China, and the government would have hoped to dissuade Beijing from pushing the more objectionable projects that run through disputed territory.

Contextualizing the ‘offer’ to India to join CPEC:

The offer to India was made along with offers to other “neighbouring countries”.

Iran: Chabahar port in Iran, which was initially seen as a competitor of the China-developed Gwadar port in Pakistan, is now being featured as the latter's "sister port".

Central Asia: Central Asian republics are pinning their hopes on talks with the Taliban - and, thereby, on Pakistan's role in the process - for the settlement of the Afghanistan problem and the economic and trade boom that is expected to follow.

Afghanistan: Further north, despite its problems on terror from Pakistan, Afghanistan is becoming a nodal point for China’s connectivity projects to Iran.

Russia: After having maintained a studied distance from the CPEC, Russia has suddenly decided to link it with its own Eurasian Economic Union project. Read together with Russia's recent dalliances with Pakistan, including its latest tripartite meeting with China and Iran, whereby it has virtually ceded to Pakistan crucial control over peace-making in Afghanistan by agreeing to facilitate the slackening of international censure of the Taliban, it looks like the party in India's neighbourhood is truly hotting up.

Way Ahead:

The Hindu: While India has done well to shore up relations with others in the region, it cannot afford to be blindsided by their involvement with the OBOR project and Chinese plans. CPEC is no longer a project in Pakistan, but one that runs through it, a project that will link 64 countries.

The Telegraph: Isolation, or isolationism for that matter, one must remember, has never been in India's scheme of things. Fostering of economic ties and soft borders were the cornerstone of its plan to settle the Kashmir problem with Pakistan. However, isolation of India happens to be the centrepiece of Pakistan's strategy - economic or otherwise. China, as well the other nations betting on the CPEC, appear to have momentarily forgotten Pakistan's problematic regional perspective. It is all very well to link up China to West Asia through one belt, one road. But no economic ecology in the subcontinent can thrive if it fails to link up with India's vast market. India ought not to terribly worry about missing a party.

Note: What does CPEC indicate about China’s rise in Asia and the world order?

China’s very own Marshall Fund? Symbolically it would be potent evidence of what economic benefits a country that allies with Beijing can expect. Chinese officials themselves speak of how the CPEC will not be just about trade and transit, it will be about bringing stability to Pakistan. Taming, as it were, a rogue state with poured concrete. And, if successful, Beijing would be able to argue it succeeded where Washington had failed.

CPEC - a sign of the ability of the Chinese government to act strategically on a grand scale: This is not something that comes naturally to Beijing. Even the all-powerful Communist Party is known to be nervous about domestic reaction to its foreign ventures. One reason China’s foreign aid has been grants rather than loans has been the negative social media reaction it gets at home to the gifting of money to foreigners. The Belt-Road has also received criticism. Completing the CPEC would be evidence its public will support an expensive project of questionable economic benefits but great strategic consequence.

CPEC - A test of China’s ability to work holistically in a foreign land: The China and Pakistan relationship has so far been military-to-military. Building CPEC will mean working with almost every stakeholder in Pakistani society, not traditionally a strong point of Chinese foreign policy.

In the coming years the corridor will be a test not of Chinese engineering, but of that country’s ability to use its influence on a whole host of fronts – and how ready it is to be rules-making superpower.

Agni V Success

Objective Information on Agni V:

1) The Agni V is an intercontinental ballistic missile with a range of 5,500 to 5,800 km.

2) Agni V is nuclear capable, with a payload capacity of 1,500 kg of high-explosive warhead.

3) It has been developed by the Defence Research and Development Organisation (DRDO) under the Integrated Guided Missile Development Program (IGMDP).

4) It is the fifth variant in the series of medium to long range Agni missiles. Agni I, II, III have already been inducted for military use.

5) The successful induction of Agni V will give India long-range strike capability.

6) The missile has previously been tested in 2012, 2013 and 2015.

7) Once the Agni-V is inducted, India will join the superexclusive club of countries with ICBMs (missiles with a range of over 5,000-5,500km) alongside the US, Russia, China, France, UK.

8) Agni-V is capable of striking even the northernmost parts of China

Significance of Agni V Success:

Boost to India’s Arsenal: With this test, Agni-V is now ready for induction into the Strategic Forces Command, which already operates other Agni missiles with a target range from 700 km to 4,000 km, besides Prithvi-II.

Credible Nuclear Deterrence: Successful test-firing of the long-range ballistic missile Agni-V for the fourth time is a significant step towards building a credible nuclear deterrence. With this test and the recent commissioning of the indigenously built nuclear submarine INS Arihant, India is inching towards creating a robust and world-class second-strike capability. For a nation sworn to no-first-use of nuclear weapons, a reliable second-strike capability is an absolute necessity.

Apart from whole of Pakistan, China too in range: India already has nuclear-capable missiles that can reach all of Pakistan and Agni V is clearly intended to provide a similar deterrent capability with respect to China.

Big Boost to India’s Defence Development Structure: Agni V has lived up to the hopes of its creators at the Defence Research & Development Organisation. Agni V missile is “a game-changer” that can perform different roles, from carrying multiple warheads to providing anti-satellite capability and even launching tiny satellites into orbit. Like its progenitor, Agni III, this missile has a two-metre diameter (as compared to the one-metre diameter of Agni I and II). Agni III and V are therefore the first Indian missiles that can potentially be equipped with several warheads each (known as Multiple Independently Targeted Re-entry Vehicles or MIRV). MIRVs, however, pose their own technological challenges, especially the need to considerably shrink the size and weight of nuclear warheads. Despite China's earlier start, its ballistic missiles are still thought to be equipped with single warheads, not MIRVs.

Way Ahead:

Neighbours must start talking with each other on Nuclear Matters: Responsible possession of nuclear-armed missiles for the purposes of deterrence also requires working assiduously to remove sources of friction that can erupt into open conflict. It is also important that India, Pakistan and China start talking to each other on nuclear matters.

* From bases in Qinghai and Yunnan provinces, Chinese missiles too can reach all of India.

* An assessment carried out by an Indian strategic studies group found that Pakistan had a “credible deterrent structure” organised around the solid-propellant Shaheen-1 and -2 missiles.

Nuclear Triad not yet complete or competent: Just a few days ago, the Nirbhay land attack cruise missile meant to carry nuclear warheads failed for the fourth time during a test. There are several such gaps to be filled to ensure a foolproof nuclear triad.

A credible second-strike capability should also be complemented by a modern, powerful military:  The Indian military is in crying need of modernisation across its three arms.

* The Air Force has a huge shortage of fighters;

* The Navy’s submarine arm is far from meeting multiple challenges;

* The Army needs an array of new platforms.

Note: Definition of Nuclear Triad: A nuclear triad refers to the nuclear weapons delivery of a strategic nuclear arsenal which consists of three basic components: land-based intercontinental ballistic missiles (ICBMs), strategic bombers, and submarine-launched ballistic missiles (SLBMs).

Editorial Round-Up (26.12.16): Karnataka’s Employment Reservation Policy

Karnataka’s Dangerous New Reservation Policy

Issue:

* Karnataka government has released draft amendments to the Karnataka Industrial Employment (Standing Orders) Rules of 1961 that would implement 100% reservation for Kannadigas for blue-collar jobs in the private sector.

* This would extend to all companies receiving government concessions, except those in the infotech and biotech sectors. Those that don’t comply will be penalized by being denied the concessions.

Employment Scenario in Karnataka:

The Economic Survey Of Karnataka 2015-16, released earlier this year by the state government paints a healthy picture of Karnataka’s labour situation. By every major metric, the state is performing considerably better than the Indian average.

* Karnataka’s labour force participation rate is 57.8% compared to a national average of 55.6%.

* The unemployment rate combined across urban and rural populations is 1.7%, exactly half the national rate of 3.4%.

* A more granular look shows that among the various socioeconomic groups, some of the highest rates are found among the least educated at the bottom of the ladder—precisely the workers the policy is purporting to protect.

Potential Impact of the above Policy (If implemented)

* The unemployment that does exist will not be solved by the policy. Indeed, the reverse is more probable.

* The move would be a blow to industry confidence. This manner of ham-handed meddling, imposing unreasonable restrictions, makes operating in the state economically unviable.

* It also raises the question of similarly unreasonable constraints—whether related to labour or in another area entirely—the state government may choose to impose in future.

* Karnataka’s economy has grown on the back of tech-enabled industries that must compete globally; this uncertainty will not leave them feeling sanguine about future prospects. The exemption for the infotech and biotech sectors is a mere sop. It is slated to last for only five years, with no certainty of what the scenario could be beyond that. And there are plenty of other related tech industries that would be affected—e-tailers hoping to set up logistics hubs in the state, for instance, or manufacturers like Foxconn that are considering setting up plants to manufacture electronic items in Karnataka, among other states.

* The end result of industry loss of confidence and business moving elsewhere would, of course, be a decline in the economic well-being of the Kannadiga blue-collar workers the policy is supposed to protect.

* Economic Benefits of Labour Mobility will be lost: A large number of studies have provided empirical evidence of the economic benefits of labour mobility, both to the workers’ regions of origin and the region where they find employment—from keeping the labour market competitive and thus improving production efficiency, to higher education levels for the next generation via remittances, enabling them to move up the employment value chain.

Will the above policy stand legal scrutiny?

The Supreme Court has capped employment reservation at 50%—and only in the public sector at that. As the Uttar Pradesh government found out to its detriment when the Allahabad high court ruled its 2007 reservation initiative unconstitutional in 2011—a judgement upheld by the Supreme Court.

Way Ahead:

* The Karnataka government is repeating the mistake governments in other countries have made—and in previous years, nativist politicians in states like Maharashtra. Blocking migrant labour will broaden access to employment only in the short term.

* The sustainable method of doing so, conversely, is by enabling the native population on multiple fronts—education, health, social safety net. Karnataka has done better on this front than most other states. It is a pity it is attempting to change course now.

Editorial Round-Up (25.12.16): Anti-Globalization Trend

Walls are Back

Issue: The global order - one that upheld open borders and open societies - is being challenged by forces of reaction.

Statement made by Prince Charles:

Prince Charles has warned about “the rise of many populist groups across the world that are increasingly aggressive to those who adhere to a minority faith”.

“All of this”, the Prince of Wales continued “has deeply disturbing echoes of the dark days of the 1930s”, when Fascist parties began their triumphant rise across Europe.

Symptoms of the above phenomenon:

* Brexit

* Election of Donald Trump

* Rants of hatred against religious and ethnic minority groups in Western Countries

* In France, Marine Le Pen's National Front has gained ground; in Germany, it is the uber-right-wing party, Alternative for Germany

Why are the above changes occurring?

* The right is not rising in a vacuum, like some kind of pathological bloom. Technological change, and the dismantlement of the welfare state, today threaten the immiseration of great swathes of the Western middle and working classes.

* Entire sectors of employment will have given way to automation inside a generation.

* Left-liberal parties have, for the most part, failed to engage with the growing desperation of this mass of people, leaving the field open for demagogues and ethnic-religious nationalists.

* Divisive tendencies fuelled by the experiment of a forced economic union in Europe, as a result of which wealthier nations were occasionally perceived to be shouldering the burden of those that performed badly.

* Rattled by an influx of refugees from a conflict-ridden Middle East and engulfed by the fear of terrorism, voters across Europe have been turning to conservative parties for succour.

* The recession of 2008 demolished beliefs in stability. It left the working masses even more impoverished and vulnerable to conservative propaganda.

* While policies favouring corporate organizations did nothing to assuage their fears, their faith in the political elite also evaporated. In times of crisis, people cling to what reassures them most: fear of minorities and 'outsiders', and a myopic view of nationhood.

Analysis and Way Ahead:

* Fascism, it is true, shares many features with the new right-wing populism, but it is important to note the historical  context is vastly different. In the 1930s, Fascism broke from the moribund traditional right to defeat communism.

* Today’s European populists differ only in aesthetics, not ideological substance, from Margaret Thatcher or Ronald Reagan. They are saviours of the traditional right, not a breakaway.

* For ethnic-religious bigotry to be defeated, long-forgotten progressive ideas of community and welfare must be given centre-stage again, but grounded in the realities of our changed industrial-technological landscape.

* Imagining such an alternative is harder than calling Trump a fascist — but spitting abuse at the right, it has long been clear, is doing nothing to stop its rise.