UPSC GK: What does depreciating Rupee mean for Indian Economy? (ECONOMICS)

The rupee has fallen 5.2% in the current financial year, from close to 65 on March 28 to an 18-month low of 68.42 against the dollar on Wednesday. As worries for importers, travellers and even students rise steadily, analysts are watching the currency’s steady march towards the 70-mark as international crude oil prices continue to rally and foreign funds flow out.

Why has the rupee been falling?

There are three major reasons. The rise in crude prices, portfolio outflows from India due to the selling of stocks, especially by foreign portfolio investors (FPIs), and a growing anticipation of interest rates rising in the US.

Brent crude prices have increased from $70.30 to over $80 per barrel since the beginning of the new financial year in April. This is mainly due to concerns over supply disruptions after the rise in US tensions with Iran, which contributes 11-12% of OPEC production. As oil prices rise, India’s trade deficit — excess of imports over exports — will worsen, which can in turn impact the current account deficit.

Expecting US interest rates to go up, FPIs have taken out Rs 27,000 crore from India in April and May so far, which is over $4 billion in less than two months. As the US Federal Reserve raises rates further — which is bound to happen — FPIs will prefer to invest in their home country as the arbitrage gain while investing in India and emerging markets will decline. A weakening rupee will also lower returns, which will in turn impact future inflows.

What does this mean for imports?

Importers will be hit as the cost of getting goods or equipment into India will increase. When the rupee weakens, importers, especially oil companies and other import-intensive companies, have to shell out more rupees to buy an equivalent amount of dollars. In this sense, a weak rupee can act as a kind of import tax. For the oil sector, it is a double whammy, as the rise in crude prices and the decline in rupee value add to retail fuel prices. Margins of oil companies will come under pressure.

And what about exports, then?

Exporters, especially software exporters, stand to benefit, as they get more rupees while converting dollar export earnings into Indian currency. This is expected to boost exports, which have been showing single-digit growth. In FY18, exports grew 9.78%, and given exports in April 2018 showed only 5.17% growth, it appears that the issues with GST implementation are yet to be overcome. The twin impact of FII outflows and worsening trade balance can hit the rupee further; to keep external metrics stable, therefore, exports of both services and merchandise need a further push.

So how is this situation affecting the overall economy?

The fiscal and current account deficits are interlinked. When fiscal deficit is high, government borrowing rises, leading to higher interest rates. However, when foreign funds start flowing in, the rupee strengthens and exports become more expensive. Crude prices are expected to rise further this year, and imports are expected to grow by at least 14%, says a note from SBI Research. This is bound to enlarge the import bill and push up the trade deficit, which will in turn add to the CAD and push the FY19 figure to 2.5% of GDP. A widening CAD has macroeconomic implications. The best way to bridge the gap is by boosting inflows, but Indian markets have been witnessing FPI outflows, instead. Also, the rise in import costs as a result of a weak rupee can boost inflationary pressures.

Is the middle class affected as well?

A weak rupee is making overseas travel costlier this holiday season — a traveller will have to shell out more rupees to buy dollars. Students studying abroad too will see their costs rise. In 2017-18, Indian travellers spent $4 billion abroad; students spent $2 billion.

But these are good times for those who receive remittances from abroad. According to the World Bank, the Indian diaspora remitted about $69 billion in 2017, the most in the world. The value of these remittances in bank accounts in India rises as the rupee depreciates against the dollar. If non-resident Indians or their families were to receive an amount similar to 2017 this year, and if the rupee were to continue to trade at the current exchange rate, it would translate into an extra $3.5 billion.

How desirable is it then, to have the rupee “as strong as the dollar”?

On August 20, 2013, when the rupee fell by 98 paise to 64.11 in a day, Narendra Modi, who was then the Chief Minister of Gujarat, said, “If the rupee keeps falling like this, other countries will start taking advantage of India.” Politicians have on several occasions spoken of the need for a stronger rupee. The currency’s fall and rise can be both negative and positive, depending on the macroeconomic situation, inflows, crude prices, strength against other currencies, real effective exchange value, etc. A strong rupee can hurt exports, but a weak rupee can push up the import bill.

So, what is the ideal value of the rupee against the dollar?

It’s difficult to say. The RBI, which manages the rupee’s movement, says that it never fixes a value; rather, it facilitates the orderly movement of the currency. The RBI buys dollars from the market when the rupee strengthens, and sells the US currency when the rupee weakens. It tries to maintain a balance by taking into account all external and internal factors. India’s foreign currency assets fell by around $6 billion to around $394 billion recently as the RBI apparently sold dollars from its foreign exchange kitty to stabilise the currency. With the markets witnessing foreign outflows in April and May, the RBI recently took several measures to attract more capital flows. It enhanced investment limits, relaxed rules for foreign investors, and revised the minimum residual maturity requirement and cap on aggregate FPI investments in central government securities.

Credit: Indian Express Explained (http://indianexpress.com/article/explained/rupee-decline-indian-economy-stock-market-international-crude-oil-prices-5188797/)  

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UPSC GK: How has the new Insolvency & Bankruptcy law performed? (ECONOMICS)

The first major resolution under India’s new Insolvency and Bankruptcy law went through last week, with Tata Steel announcing its takeover of Bhushan Steel, a development that Piyush Goyal, standing in as Finance Minister for Arun Jaitley, described as a “historic breakthrough” in resolving the legacy issues of banks. Several others from among the 12 major defaulters whose cases RBI had referred to the National Company Law Tribunal (NCLT) for resolution, too, are expected to report progress over the next few months as bidders pitch for their assets.

The new law passed in May 2016 provides for either resolution or winding up of a distressed firm, which is referred to the NCLT under a legal framework. Since the law was notified in November 2016, over 800 cases have been admitted, and about four times that number of applications have been rejected. Orders for resolution or liquidation have been passed in 200 cases, mostly for winding up. Along the way, as promoters attempted to game the system, the government has worked to keep out willful defaulters, and those whose accounts were classified as bad loans, from bidding again unless they repaid their loans. The government concedes it is in uncharted territory here, and Jaitley told Parliament this January that implementing the law was a “learning experience”, and that the government would continue to make changes to it.

The economic impact

There are clear signs of behavioural change among promoters and company managements after the law kicked in. With the tightening of rules by the regulator, and with banks having to set aside more funds to cover losses, corporates and promoters are scrambling to ensure payments. In the past, lenders were comfortable with the backing of collateral — assets such as land, shares, etc. — while approving loans. Now, the cash flows of companies are increasingly the key determinant, and promoters are being forced to bring in more of their capital to ensure what is known as “more skin in the game”, that is, a stronger demonstration of their commitment.

Capacity constraints

The 180-day window for completion of the resolution process is ambitious — it is 12 months in the UK, for example. The law has been criticised, and questions have been raised on the calibre of the new breed of insolvency professionals mandated to manage the affairs of troubled companies in the interim. It is to be kept in mind, however, that judicial delays in the past too, have contributed to the swelling of bad loans, and that many of those on the NCLT benches are going through their own learning processes. Many of the glitches, indeed, are not because of the law, but because of the capacity constraints in developing quality resolution professionals, adding more benches, and in driving institutional change and the behaviour of lenders. Recent experience shows that bankers who agree to forego a part of their dues — or settle for a “haircut” — continue to have reason to fear action by investigating agencies, the presence of an oversight committee notwithstanding.

The challenges

Over the next year or two, this law will be seen as one of the legacies of this government. But in the medium term, this could well test banks and the government with new challenges. The balance has tilted towards the lenders for now, but promoters are increasingly working to lower their debt to banks, raising money from the corporate bond market or through overseas borrowings, instead. Over the last few years, India’s corporate bond market has seen much higher volumes, with more companies tapping it for funds. But as policymakers welcome this shift away from banks, they will have to reckon with the challenge of good borrowers migrating to that market or to other forms of borrowing. The vacuum created by public banks that now control 70% of assets in India, will be reflected in the expansion of Non Banking Finance Companies and their lending portfolios.

For the government, the challenge is to revive investment — a formidable task in this environment, with banks weighed down by debt, a tax regime that many businessmen view as being unfriendly and unstable, and an atmosphere of perceived promoter bashing. The worry also is that banks and industry are weighed down at a time of strong global growth; the contrast is with 2004-08, when India was able to capitalise on such growth. Few will disagree with what the new law seeks to achieve — creative destruction — but the pain could last longer than expected.

Credit: Indian Express Explained (http://indianexpress.com/article/explained/how-the-first-fruit-of-insolvency-law-also-spotlights-its-wider-challenges-tata-steel-bhushan-steel-5184691/)

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UPSC GK: Regulating Crypto-currencies (ECONOMICS)

What is the RBI’s stance?

In the most direct action taken so far by regulatory authorities on the issue of cryptocurrencies, the Reserve Bank of India (RBI), during its monetary policy announcement on April 6, directed all regulated agencies, including banks, to stop doing any business with “any person or entity dealing with or settling virtual currencies (VC)”.

What does this mean?

The circular says that banks have to stop all services to those dealing in VCs, including maintaining accounts, registering, trading, settling, clearing, giving loans against virtual tokens, accepting them as collateral, opening accounts of exchanges dealing with them and transfer/receipt of money in accounts relating to the purchase or sale of VCs. In addition, the RBI gave its regulated entities three months from the date of the circular to exit any such relationship they might already be in.

Why did this happen?

This decision did not come out of the blue. The RBI and the government have repeatedly issued warnings to people dealing in cryptocurrencies, with the Finance Ministry even referring to them as “Ponzi schemes” in which investors stand to lose all their money. The fear among regulators and policymakers is that cryptocurrencies, being an alternative source of value to fiat currency, could be misused to launder black money or finance terrorist activities. It has also been reported that the RBI has constituted a committee to look into the merits and demerits of issuing a central bank digital currency, which will have the status of a fiat currency. So, ring-fencing non-state cryptocurrencies could be the first step towards the issuing of a single, fiat virtual currency by the RBI.

What has been the effect so far?

Several cryptocurrency exchanges have said that though harsh, the RBI’s stance does not explicitly say that it is illegal to buy and sell cryptocurrencies, or that running a cryptocurrency exchange in India is illegal. Instead, this move only segregates cryptocurrencies from fiat currency. Most exchanges are going ahead with their cryptocurrency to cryptocurrency transactions. Some have filed writ petitions challenging the RBI’s order on the grounds that it violates their rights under Article 19(1)(g) of the Constitution.

Credit: THE HINDU EXPLAINS (http://www.thehindu.com/opinion/op-ed/the-low-down-on-the-rbis-order-on-regulating-cryptocurrencies/article23750972.ece)

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UPSC GK: India now on US Currency Monitoring List (ECONOMICS)

On April 13, the US Treasury Department delivered to Congress the semi-annual Report on Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States Treasury, which found that six major trading partners warrant placement on the ‘Monitoring List’ for their currency practices. Five of these countries — China, Germany, Japan, Korea and Switzerland — were already on the list, India has been added this year. The US move and the higher rise in March trade deficit created nervousness in the foreign exchange market on Monday, with the rupee falling 29 paise against the US dollar to close at 65.49, a more than six-month low.

What does the report say?

Frequent intervention by the central bank in the foreign exchange market means that India has increased its purchases of foreign exchange over the first three quarters of 2017. Despite a sharp drop-off in purchases in the fourth quarter, net annual purchases of foreign exchange reached $56 billion in 2017, equivalent to 2.2% of the GDP. The pick-up in purchases came amidst relatively strong foreign inflows, both of FDI and portfolio investment. Notwithstanding the increase in intervention, the rupee appreciated by over 6% against the dollar and by more than 3% on a real effective basis in 2017. India had a significant bilateral goods trade surplus with the US, totalling $23 billion in 2017, but the current account is in deficit at 1.5% of the GDP and the exchange rate is not deemed to be undervalued by the IMF.

So India met two of the three criteria for the first time in this report — having a significant bilateral surplus with the US and having engaged in persistent, one-sided intervention in foreign exchange markets. US Treasury Secretary Steven T Mnuchin says in the report, “We will continue to monitor and combat unfair currency practices, while encouraging policies and reforms to address large trade imbalances.”

How do central banks intervene and why?

Central banks intervene in the foreign exchange market to reduce volatility in the exchange rate and often to build foreign exchange reserves or to manage these reserves. They intervene to ensure that their currencies are neither overvalued or undervalued. If the currency is overvalued, it can hurt a country’s competitiveness in exports while an undervalued currency will have an impact on inflation. For instance, when the currency is appreciating, a central bank intervenes in the market by buying foreign exchange — say, the USD or Euro or any other currency — which leads to an increase in the supply of the local currency and in turn lowers its value. To combat depreciation of the currency, the central bank sells foreign exchange. It is also done to manage expectations in the forex market. India’s central bank — the RBI has intervened in the market to build the country’s reserves especially after 2013 when the rupee came under attack. Since then reserves have risen.

Why has the RBI been buying dollars?

The US report says India has generally been a net purchaser of foreign exchange since late 2013, when the RBI sought to build a stronger external buffer in the wake of large emerging market outflows globally. Prior to 2013, intervention for several years had generally been less frequent, and when it had occurred, it had been broadly symmetric, as for example during 2007 and 2008, when the RBI engaged in both purchases and sales of foreign exchange at various points in the midst of volatile global financial markets. The RBI has noted that the value of the rupee is broadly market-determined, with intervention used only during “episodes of undue volatility”. Foreign exchange intervention picked up in the first three quarters of 2017, in the context of strong capital inflows, with FDI of $34 billion and foreign portfolio flows of $26 billion over the first three quarters of the year.

On what basis is a country named a ‘currency manipulator’?

The three pre-conditions for being named currency manipulator are: a trade surplus of over $20 billion with the US, a current account deficit surplus of 3% of the GDP, and persistent foreign exchange purchases of 2% plus of the GDP over 12 months. All three apply to India. “While there has not been a dramatic increase in trade surplus with the US, the RBI accumulated reserves by absorbing the inflows into domestic capital markets. This caution seems unwarranted considering that India runs a trade deficit overall, based on 36 currency REER (real effective exchange rate), the rupee is still overvalued,” said Abhishek Goenka, CEO, IFA Global.

What about the rupee? Will this report of the US Treasury impact the currency?

The rupee fell 29 paise against the US dollar to close at 65.49 on Monday. However, forex dealers don’t expect a sharp fall as the RBI then props up the rupee by selling dollars. Notwithstanding the pick-up in intervention, the rupee appreciated 6.4% against the dollar over 2017, while the real effective exchange rate also continued its general uptrend from the last few years, appreciating by 3.1%. In its most recent analysis, the IMF maintained its assessment that the rupee is moderately overvalued. The RBI’s most recent annual report assessed the rupee to be “closely aligned to its fair value over the long term”.

How have India’s foreign exchange reserves moved?

According to latest RBI data, released last Friday, India’s forex reserves rose by $503.6 million to touch a record high of $424.86 billion in the week ended April 6, 2018. Of this, foreign currency reserves were $399.776 billion. Direct intervention has supported a steady increase in foreign exchange reserve levels. At the end of 2013, foreign currency reserves were $268 billion, or 2.3 times short-term external debt, 6 months of import cover, and 14% of the GDP.

How are analysts viewing this Monitoring List of the US Treasury?

Indranil Sen Gupta of Bank of America Merrill Lynch Global Research says, “We continue to expect the RBI to recoup foreign exchange reserves if it can, despite being put on the US Treasury Report’s currency manipulator watch list. It should continue to pursue an asymmetrical policy of buying forex when the dollar weakens and allowing Rs 65-66 per dollar when it strengthens.” The RBI’s forex reserves are inadequate: import cover, at 11 months, is running well below the pre-global financial crisis level of 14 months, share of portfolio investments has jumped to 120% of forex reserves from pre-crisis level of 70%. “Second, we see RBI forex intervention at $15bn/ 0.6% of the GDP in FY19 — which is well below 2% of the GDP required to be named currency manipulator — with the current account deficit set to rise to 1.9% of the GDP when portfolio inflows are slowing,” Merrill Lynch says.

Credit: Indian Express Explained (http://indianexpress.com/article/explained/simply-put-why-india-is-on-us-currency-monitoring-list-5140032/)

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PSU Bank Recapitalisation - The Hindu (25.02.18)

(Latest Op-Ed First; Verbatim Compilation of The Hindu Op-Ed; Best to read in the order of oldest to latest article to get a comprehensive understanding; Consider repetition to be revision)

Compiler’s Note: This issue becomes all the more relevant given the scams that have emerged in recent times. While the government pumps in more capital into banks, it must also ensure that leakages from the system are reduced to bare minimum. #UPSC #Economics

Banking on good faith: on efforts to recapitalise PSBs (29.01.18)

About ₹1 lakh crore is expected to be pumped into India’s 21 public sector banks by March, which the Centre hopes will enable them to extend fresh credit lines worth over ₹5 lakh crore to spur economic activity. Of the capital injection — the first half of an ambitious ₹2.11-lakh crore recapitalisation programme for ailing public sector banks announced last October — about ₹8,100 crore is from the government’s budgetary resources. Banks are expected to tap the markets for ₹10,300 crore, while recapitalisation bonds worth ₹80,000 crore are to be issued to finance the rest. Leaving aside the market-raising efforts by banks, over half the fresh capital of over ₹52,000 crore is being directed to the 11 public sector banks that the Reserve Bank of India has placed under the prompt corrective action, or PCA, framework. The RBI deploys the PCA to monitor the operation of weaker banks more closely to encourage them to conserve capital and avoid risks. For these entities, this capital offers a fresh lease of life as it will help meet regulatory requirements under the Basel-III regime as well as cushion them to an extent from possible haircuts on stressed loans that are going through the insolvency resolution process. State Bank of India, the country’s largest, and the nine others that are out of the RBI’s PCA net will receive nearly ₹36,000 crore in order to strengthen their lending capacity.

While announcing this package, the government has described each of the banks as “an article of faith”. Its assertion that no public sector bank will fail and that depositors’ money will remain safe should allay customers’ worry about the safety of their savings under the proposed Financial Resolution and Deposit Insurance legislation. Rating agencies have given the move the thumbs up, but remain unimpressed about governance reforms packaged with it. These include tweaks to existing systems for closer monitoring of big-ticket loans, identifying niche areas where a bank has strengths, restricting corporate exposure to 25%, and a new performance management system. Actual capital inflows will depend on their performance on these fronts and their ability to meet the government’s service priorities, including smoother credit flows to small businesses. More structural reforms may well be on the anvil in the second half of this recap plan, which RBI Governor Urjit Patel had described as providing a real chance to meet the banking sector’s challenges for the first time in a decade. Yet, the absence of any reference to consolidation through mergers is glaring. Moreover, while the government has repeatedly ruled out privatisation of these banks, the only one where it intended to offload its majority stake, IDBI Bank, has got the largest allocation of ₹10,610 crore. At best, this sends out mixed signals.

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Will bank recapitalisation fix NPAs? YES | ASHVIN PAREKH

This will give the banking system time to enhance its credit portfolio

The move on the part of the government to inject capital of ₹2.11 lakh crore into public sector banks (PSBs) is commendable and a decisive step.

In making this move, there was an implied acceptance that the recovery process set up through the Insolvency and Bankruptcy Code (IBC) reform had not been working at the desired pace. When the Reserve Bank of India asked PSBs to work on the recovery process for 12 large exposures which account for 50% of the total non-performing assets (NPAs) worth ₹8 lakh crore in the banking system, it was expected that by December 2017, the banks would recover about ₹ 2 lakh crore. But it’s already November and we know that recovery is eluding us and the process may take longer. Till then the banking system will starve for capital.

Capital needs

In addition, the first few resolutions that have taken place so far have suggested that the size of the haircuts the banking system is expected to take will perhaps be much more than the original estimate of about 50% of the exposure amount. This means that there will be additional loss of capital. We are at a stage where the recovery will become more expensive in terms of capital in the banking system. If you take a haircut of 90% then you have to write off additional 40% of the exposure amount, and that would hurt your capital requirement. Therefore, there must have been a view that till the recovery process gathers momentum, more capital would be required. There is also a time dimension associated with this equation.

The economic value, and therefore the value recovered from borrowers, may perhaps grow after 8-10 quarters. At present, the value at which the resolution happens is sub-optimal. The government’s decision to put more capital into the banking system could pay off if the banking system were to hold these assets for this period.

Focus on clean-up

It is significant that capital is being infused into banks. This could give the banking system a good breathing time to enhance its credit portfolio and restore value out of the NPA accounts. We may have to watch the situation unfolding over the next three years. During this time, the regulator, banks and the government will have to focus on the quality of public sector banking assets, the NPAs and the recovery. There has been a broad-brush approach to the quality assessment. The system will have to conduct more analysis, more evaluation sector-wise in terms of its potential for value restoration and enhancement. They will have to understand which sector is in a position to restore more economic value in six to eight quarters. Some sectors may perhaps take longer.

The last thing the economy and the banking system can afford is a further drop in economic value. What may be perceived as a ₹8 lakh crore problem today might grow into a much larger amount. The quality of governance will play a significant role in this regard. There has not been any worth-while effort on this unfortunately. There will have to be more reforms to put a higher order of governance in the banking sector. Ensuring performing boards at public-sector banks do become more critical.

The last point which is equally important is that as long as the government wants to hold on to 51% equity in PSBs we cannot have periodic injection by way of recap bonds.

To fund the economy, the government will have to make a yearly budgetary allocation of the amount of capital required by PSBs. Programmes such as Indradhanush and small budgetary allocations will not work. The PSBs need budgetary allocation of at least ₹75,000-80,000 crore each year.

Ashvin Parekh is Managing Partner of Ashvin Parekh Advisory Services LLP

Will bank recapitalisation fix NPAs? NO | C.H. VENKATACHALAM

When the government provides capital, it is out of savings that people have kept in banks

The announcement of a stimulus into PSBs has been apparently understood as a bounty for the banks. A euphoria is being projected that the government has been too generous to the banks and is serious about helping them to resolve the bad loans crisis. The quantum of capitalisation announced leads one to believe so. In reality, this will not enable banks to recover the alarmingly huge bad loans which is the main issue confronting them.

Stressed assets

The total stressed assets, bad loans, and restructured loans in banks are in the region of ₹15 lakh crore. From AIBEA, we have been demanding the publication of names of defaulters and to declare wilful default as a criminal offence. Successive finance ministers have avoided both these demands.

Instead of taking tough action on defaulters, the NDA government came out with a “novel scheme” to foist insolvency and bankruptcy proceedings on defaulters. This measure is not going to result in the recovery of bad loans. That is why the RBI has asked PSBs to be prepared for a deep haircut, up to 50% of the dues. Recently, on one account, a bank managed to recover just 6% of the total loan amount of ₹950 crore. On 12 accounts, the dues are ₹2.5 lakh crore. One can only imagine the additional provisions banks will have to make this year. There are more skeletons in the cupboard.

Rewarding the defaulter

But why this sudden rush to ‘punish’ corporate culprits? The fact is that this is not a punishment, rather it is a reward. The defaulter promoter can himself bid before the IBC proceedings. Obviously, he is likely to be the highest bidder. So, he will retain his company but will have to shell out less than what he borrowed. This is legal innovation to pay less. But in the bargain, banks will lose huge amounts. One can safely predict that all banks will be running into losses by the end of the current financial year. Last year, while the gross operating profits were ₹1,58,982 crore, after provisions for bad loans (₹1,70,370 crore), the net loss was ₹11,388 crore. This year, it is bound to be worse. The IBC is only a ploy to extend favours to big corporates to escape from their liability at the cost of the public exchequer.Now let us see whether the recap announced by the Finance Minister will help PSBs, labelled as inefficient and incompetent. If banks would have recovered these loans, their interest revenue would have been more, income levels higher, profits high and they would have generated capital internally out of the profit. That door is closed because banks cannot recover loans through the IBC route. Thus, the banks’ capital gets eroded and the capital adequacy ratio (CAR) becomes adverse.

Lending requirements

If banks do not have adequate capital, they cannot lend. This would dampen the economy, which is already in the doldrums. If there is an economic crisis, the next elections will be a question mark for the NDA. Hence to bolster the economy, banks have to be advised to give more loans. To give more loans, more capital is essential. That is why the announcement on recapitalisation.

In the last three years, banks have written off ₹1,88,287 crore. We have to bear in mind that when banks lose money or when the government recapitalise PSBs, it is all people’s money and out of public savings kept in trust in the banks. People’s money should be for people’s welfare and not to fund corporate default or to recapitalise the banks to adjust these bad loans.

C.H. Venkatachalam is general secretary of the All India Bank Employees’ Association (AIBEA)

Will bank recapitalisation fix NPAs? IT'S COMPLICATED | D.K. MITTAL

A welcome step, but it is a very temporary solution and only treats symptoms

The decision by the government to further capitalise public sector banks is a welcome move. But does it really solve the problem of the lack of capital adequacy of public sector banks? Let us examine.

Too many infusions

It is the fourth time since the mid-eighties that PSBs are being infused with substantial capital due to high NPAs (15-20 %). The Net Present Value (NPV) of capital infused by the government in PSBs would be well over ₹10 lakh crore. If capital infusion was the solution, why is it happening again and again? As it turns out, it is a very temporary solution and only treats symptoms and not what causes these symptoms.

The recurrence is because of two sets of issues: governance and regulatory framework. For improving governance of PSBs, questions like the tenure of senior management have to be addressed. This was the recommendation of the Narasimhan Committee of 1991 and 1998. Public Sector Bank chiefs and their managing/executive directors must have a fixed tenure of at least five years. The second issue is the salary structure of senior management. The amount of remuneration they get and the kind of political and economic influence their decisions have are nowhere comparable to what happens elsewhere. To offer incentives by way of very good annual bonus based on performance should enable them to take the right decisions.

Adopt best practices

The third issue would be of professionalisation through lateral entry at the level of general managers and not at the ED/MD level. Fourth, the banking boards need to be manned by professional directors rather than political nominees. Last, accountability needs to be fixed by removing senior management for non-performance.

There are a few gaps in the regulatory framework as well. One of them is joint lending. Borrowers borrow from one bank and go to another and borrow money. Banks do not talk to each other. Also, there are issues in getting loans approved for large projects. Borrowers have to run to 20 banks to get a sanction, which is uneconomical, costly and leads to corrupt practices as bank officials seek favours to agree to a proposal. We need to adopt some best practices by creating a framework for funding of projects (over a size) to be undertaken by one bank which downsells it within a period of, say, 90 days, but could breach exposure limits in that period.

Another issue is the appointment of statutory auditors. In the best private sector companies, the auditors are shortlisted by promoters and then assessed by the Audit Committee and Board. Also, in case of wrong reporting, these have to be punished by at least prohibiting them to audit any financial entity regulated by the RBI, the Securities and Exchange Board of India, the Insurance Regulatory and Development Authority and the Pension Fund Regulatory and Development Authority.

And last, action must be taken against promoters who have siphoned off funds and transferred them to their personal assets. These assets must be forfeited and the RBI needs to move ahead on that.

Quick action plan

To fix NPAs, we need, in addition, resolution of the above issues, a quick action plan. First, NPA cases caused by the cyclical nature of the sector need to be supported if there are no issues with fund utilisation.

For other cases, the right approach would be to do what we did for UTI 64 in 2000-01. Also, we need to deal with NPAs sector by sector like power, roads, steel and so forth. We need to pick NPAs from PSBs of each sector, park them in one place by creating an entity like a SUUTI (specified undertaking of the Unit Trust of India), fund the banks and invite international and national investors to dispose of the assets.

In sum, this infusion is a welcome step but there are issues that should have been dealt with first. The good part is that after putting this capital, the government’s equity would be close to 70-80% in each PSB. The government could make a huge profit by selling this equity after improving the management of PSBs.

D.K. Mittal is a former secretary in the Department of Financial Services

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The stimulus and after (02.09.17)

The Financial Times of London described the recent recapitalisation of public sector banks in India as collecting used tiffin boxes. It said banks are like intermediaries, not unlike the dabbawalas of Mumbai who deliver home cooked meals to offices, and return used tiffin boxes back in the evening. Banks collects savings from depositors and give it to borrowers. The intermediaries have not been collecting their deliveries back (that is, the bad loans), and the clean-up is as messy as uncollected used tiffin boxes!

Low credit offtake

The metaphor is a bit mixed up but catches the imagination. A better metaphor would be “cleaning the carburettor” of the credit pipeline. Bad loans have clogged the pipes, and new credit has stopped flowing.

One of the most reliable leading indicators of economic growth is the growth of non-food credit. High growth in credit foretells healthy growth of GDP, since credit goes mostly into investment and building of new capacity. India is predominantly a bank finance-led economy, so when bank lending slows down, it surely impacts future growth. Bank credit growth has been at nearly a 60-year low. Even the growth of money supply is at a 55-year low. This stark metric tells us about the growth slowdown. Of course, there are many proximate causes as well, such as demonetisation and the roll-out of the goods and services tax (GST).

Credit offtake slowed down because of both demand and supply side factors. On the demand side is the fact that industry has low capacity utilisation rates (factories lie idle); domestic industry is losing market share to low cost imports, made worse by GST, which has tilted the field in favour of imports, and also by the strong currency. The corporate sector is also deleveraging and paying off its past high debts. All this means demand from the private sector for large-scale new credit is muted.

Burden of bad loans

On the supply side, the big constraint on fresh lending is the burden of non-performing assets (NPAs). The NPA ratio has been deteriorating for more than six years, and worse is yet to come. The diagnosis of worsening NPAs reveals five different causes, not all caused by the bankers themselves. The first is the disproportionate share of loans that went to infrastructure. These projects are of long gestation and long payback period, so unsuitable for bank lending. That creates an asset liability mismatch for banks, since the liability side is of a short-term nature. During the UPA regime, public-sector banks were under pressure to fund the ambitious $1 trillion infrastructure vision. Normally such projects ought to be funded by long-term bonds or developmental organisations like the World Bank or the Asian Development Bank, or the IDBI in its original avatar. But in the absence of those options of development finance, it fell to public sector banks to provide infrastructure finance. This led to over-exposure.

The second reason for deterioration of loans could be the impact of key judicial decisions like abrupt cancellations of coal mines and spectrum allocation. When the same were re-allocated through expensive auctions, it proved to be a fatal burden on respective business models of power, steel and telecom. The third reason for worsening NPA ratios could be the delays caused by land acquisition and environmental clearances. This reason for NPAs was adequately documented in the Economic Survey. The fourth reason is the Asset Quality Review mandated by the Reserve Bank of India (RBI) in 2015. This was much needed, since it put a stop to the “extend and pretend” culture around worsening credit.

To be fair, the RBI showed great regulatory forbearance in allowing lenders to work out remedies for genuine cases which faced a business cycle downturn. Various options were made available, including extending duration of loans, debt restructuring, swapping equity for debt and so on. But it does not seem to have made any significant difference. The NPA recovery process has since got a boost due to the new insolvency and bankruptcy law. The government too announced the Indradhanush scheme focused on banking reforms and recapitalisation of NPA-burdened banks. Two instalments of infusion in the past two years proved woefully inadequate as the NPA ratio continued to mount.

The fifth reason for worsening NPA is an omnibus called “malfeasance”. This includes cosy relationships between banker and borrower, crony capitalism, political interference in lending decisions (a legacy of the past), a less than vigorous attempt to recover past dues, careless due diligence, etc.

There may be other reasons as well. The fact is that 10% of all loans have gone bad. No wonder that after provisioning, for many public-sector banks their net worth would be completely eroded. Hence the days of piecemeal and feeble remedies are gone.

More reforms needed

In the light of this background, the decision to inject ₹2.11 lakh crore of capital into public sector banks is a welcome boost. This was also evident from the reaction of the stock market as some bank stocks soared by as much as 35%. It is somewhat a moot point that this injection could have been done at least one year ago.

The injection is clever because it has been done without busting the promised fiscal deficit target. It has been financed by the sale of recapitalisation bonds. Banks are currently flush with cash which was deposited after demonetisation. Much of that same cash will be used to buy those bonds. The proceeds of the sale of these bonds will be put back into the bank as fresh equity by the government. It’s a neat roundtrip of depositors’ cash coming back as capital. To that extent it is taxpayers who are funding this equity injection. More details are awaited. For instance, since banks are listed entities, should not other shareholders apart from the government also be asked to make a matching equity infusion? What about the windfall gains that arose as a result of this equity infusion? How will the bonds be repaid by the government? What will be their duration? Will they be traded? Would they instead be converted into perpetual bonds, never to be repaid, as was done to the 1992-93 bonds?

Suffice to say that this capital infusion provides banks with the much-needed room to make fresh loans. In the coming days of Basel-3 where much capital is needed for risk provisioning, the NPAs are a millstone which prevent fresh lending.

With this big bang recap effort, we can expect the growth pipes to be unclogged. Of course, the recapitalisation effort is useless without accompanying reforms which can prevent a recurrence. Those reforms are mostly about governance, meaning granting genuine autonomy to banks in their functioning, including all aspects such as lending, recovery, and recruitment decisions. Banks have to be accountable to shareholders, including the government, through their respective boards. That’s the fourth crucial “R” that was part of this recap package – recognition, recapitalisation, resolution and reform. Without reform of credit functioning, culture, treatment of delinquencies and even ownership structure in banking, this recap effort will only be stopgap. Assuming reform is coming (witness the huge increase in India’s global rank in ease of doing business), let’s raise a toast to the bank recap.

Ajit Ranade is an economist

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A bold step in bank reform (27.10.17)

With India’s economic growth faltering in the last couple of years, the government has been casting about for ways to galvanise the economy. Last November, it tried demonetisation. It was a bold move but its economic benefits will be long in coming while the short-term disruption has been very real and demoralising. This year, it pushed through the goods and services tax (GST). Again, this is hugely positive over the medium term, but is painful in the short run.

Cheering the markets

The government seems to have realised that a simpler, more effective remedy is at hand: recapitalising public sector banks (PSBs) and enhancing the flow of credit. The proposal to recapitalise PSBs to the extent of ₹2.11 trillion (₹2.11 lakh crore) is a winner by any reckoning. It is, perhaps, the most effective way to provide a much-needed fiscal stimulus to the economy and revive growth. Small wonder that the markets have given the move a rapturous welcome.

To understand the significance of bank recapitalisation, we need a little primer on bank capital. Regulation requires that banks hold assets only in proportion to the capital they have. ‘Capital’ is a combination of equity, equity-like instruments and bonds. For a given balance sheet, there is a certain minimum of capital that banks must hold. This is called ‘capital adequacy’. The higher the capital is above the regulatory minimum, the greater the freedom banks have to make loans. The closer bank capital is to the minimum, the less inclined banks are to lend. If capital falls below the regulatory minimum, banks cannot lend or face restrictions on lending.

When loans go bad and turn into non-performing assets (NPAs), banks have to make provisions for potential losses. This tends to erode bank capital and put the brakes on loan growth. That is precisely the situation PSBs have been facing since 2012-13.

‘Stressed advances’ (which represent non-performing loans as well as restructured loans) have risen from a little over 10% in 2012-13 to 15% in 2016-17. This has caused capital adequacy at PSBs to fall. Average capital at PSBs has fallen from over 13% in 2011-12 to 12.2% in 2016-17. The minimum capital required is 10.5%. An estimated 10 out of 20 PSBs have capital of just one percentage point above the minimum or less. Inadequate capital at PSBs has taken its toll on the flow of credit. Growth in credit has fallen below double digits over the last three years. Between 2009-10 and 2014-15, annual credit growth was in the range of 15-20%. In the ‘India Shining’ period of 2004-09, credit growth had been over 20%.

Some observers ascribe the deceleration in credit growth to poor demand. They say that corporates have excessive debt and are in no position to finance any investment. This may be true of large corporates. However, it is not true of enterprises in general. One study, which covered over 4,000 companies, showed that the debt to equity ratio fell below 0.8 (which is a low level of debt) in 2008-09 and remained low until 2012-13. (J. Dennis Rajakumar, ‘Are corporates overleveraged?’, Economic and Political Weekly, October 31, 2015).

Moreover, demand for investment finance may have decelerated but demand for working capital remains strong. If anything, the introduction of GST has increased small business demand for working capital. Low growth in credit is confined to PSBs. Private banks have seen loan growth of 15% this year.

Evident since 2014

The government has realised that there is a problem with the supply of credit. It has to do with PSBs’ inability to lend for want of adequate capital. The National Democratic Alliance (NDA) government should have recognised the problem when it assumed office in May 2014. At the time, stressed advances were already 10% of the total. The NDA government should have moved swiftly to recapitalise PSBs.

Instead, it chose to sweep the problem under the carpet. Market estimates had placed the requirement of government capital at a minimum of ₹2 lakh crore over a four-year period. In 2015, under the Indradhanush Plan, the government chose to commit a mere ₹70,000 crore over the period.

The dominant view in government at the time seemed to be that PSBs had messed up in a big way, so putting more capital into them was simply ‘money down the drain’. Their role needed to be shrunk through consolidation or by selling strategic stakes to private investors.

This is a mistaken view. The bad loan problem at PSBs is not entirely the result of mismanagement. There have certainly been cases of malfeasance and poor appraisal of credit. However, as the Economic Survey of 2016-17 made clear, these are not responsible for the bulk of the NPA problem. The problem is overwhelmingly the result of factors extraneous to management.

PSBs, unlike their private sector counterparts, had lent heavily to infrastructure and other related sectors of the economy. Following the global financial crisis of 2007, sectors to which PSBs were exposed came to be impacted in ways that could not have been entirely foreseen. Blaming PSBs for the outcomes and starving them of capital was not the answer.

The failure to quickly recapitalise PSBs has adversely impacted the economy in many ways. First, it has come in the way of adequate supply of credit. Second, it has hindered the effective resolution of the NPA problem and kept major projects from going through to completion. Resolution requires banks to write-off a portion of their loans in order to render projects viable. They cannot do so if they see that write-offs will cause their capital to fall below the regulatory minimum. Third, corporates are stuck with high levels of debt and are unable to make fresh investments.

The government’s move to recapitalise banks changes the picture. Of the ₹2.11 trillion package, ₹1.35 trillion will be towards issue of recapitalisation bonds. PSBs will subscribe to these bonds. The government will plough back the funds into banks as equity. Another ₹180 billion will be provided as budgetary support. The remaining ₹580 billion will be raised from the market. Analysts believe the package should enable banks to provide adequately for NPAs and support modest loan growth. Once PSBs have enough capital and are in a mood to lend, they can liquidate excess holding of government securities and use the cash to make more loans.

Analysts worry about the fiscal impact of the recapitalisation package. International norms allow borrowings for bank recapitalisation not to be counted towards the fiscal deficit. In the past, India has used this accounting fudge. The proposed recapitalisation bonds are likely to add to the fiscal deficit unless the government resorts to other fudges such as getting the Life Insurance Corporation of India or a separate holding company to issue the bonds. The government should not worry unduly about missing the fiscal deficit target of 3.2% of GDP. The markets will understand that the fiscal stimulus is well spent.

Getting the record straight

Analysts also fret over repeated bailouts of PSBs and the costs to the exchequer. They seem to think that bank bailouts have to do with government ownership and inefficiency and the answer is to privatise some of our PSBs. They couldn’t be more wrong.

The overwhelming majority of bank systems worldwide are privately owned. And yet these systems are prone to periodic bouts of bank failures. The International Monetary Fund has documented 140 episodes of banking crises in 115 economies in the world in the period 1970-2011. The median cost of bank recapitalisation in these crises was 6.8% of GDP. India’s cost of recapitalisation over a 20-year period is less than 1% of the average GDP during this period.

The Modi government has shown courage in opting for substantial recapitalisation of banks. This is not something that fits into the ‘reform’ mantra whereby private is good and public is bad. Reserve Bank of India Governor Urjit Patel has welcomed the move in effusive terms: “The Government of India’s decisive package to restore the health of the Indian banking system is in the view of the [RBI] a monumental step forward in safeguarding the country’s economic future.” Indeed. The government’s recapitalisation move promises to do more to quickly usher in ‘acche din’ than any other single measure it has initiated during its tenure.

T.T. Ram Mohan is a professor at IIM Ahmedabad. E-mail: ttr@iima.ac.in

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Pursuit of growth: PSB recapitalization (26.10.17)

The Centre’s decision to infuse ₹2.11 lakh crore of fresh capital into public sector banks over the next two years, through a blend of financial mechanisms, should help revive the growth momentum. Saddled with bad loans as well as stressed assets of close to ₹10 lakh crore, India’s banking sector has been naturally wary in recent quarters of extending fresh loans, as reflected in bank credit growth slipping to a 60-year low of just 5% this April. Since its first year in office, the government has been seized of what Chief Economic Adviser Arvind Subramanian calls the twin balance-sheet problem. If over-leveraged companies are unable to invest or borrow afresh, and banks are unwilling or/and unable to finance fresh investments, a private investment-led recovery is unlikely. However, it was only late last year that a new bankruptcy law was introduced, and over the course of this year the Reserve Bank of India has asked banks to invoke insolvency proceedings in the case of 50-odd accounts if settlements remain elusive. Banks, under pressure from the RBI to acknowledge the stress on their books, face the prospect of taking heavy haircuts to write off some of these loans at whatever residual value remains in the businesses. When combined with their need to scale up their capital base to comply with Basel III norms, public sector banks have naturally been in damage control mode rather than chasing growth like their private sector peers.

The three-part package for lenders includes ₹18,000 crore from the Budget, ₹58,000 crore that banks can raise from the market (possibly by tapping the significant room available to dilute the government’s equity that remains well over 51%) and the issue of recapitalisation bonds worth ₹1.35 lakh crore. Though there are still many unknowns about the nature of these bond issues (whether they will affect fiscal deficit calculations or be off-balance-sheet sovereign liabilities, for instance), the overall plan gives banks a better sense about their immediate future. The bonds will front-load capital infusion while staggering the fiscal impact, which Mr. Subramanian expects to be limited to the annual interest costs on these bonds of about ₹9,000 crore. The Centre is betting this will strengthen the banks’ ability to extend credit at a faster clip. RBI Governor Urjit Patel has said this is the first time in a decade that there is a real chance of meeting the banking sector’s challenges. But it is still a long haul. While more details on this package are awaited, including how banks will be picked for funding and the possible interplay with proposed mergers of banks, equally critical will be the reforms that Finance Minister Arun Jaitley has promised as a necessary adjunct. Banks are where they are, not just because of capital constraints but also because of their inefficiencies and past lending overdrives.

(All of the above articles have been taken straight from The Hindu. We owe it all to them. This is just an effort to consolidate opinions expressed in The Hindu in a subject-wise manner.)

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.