An institution learns humility

Whoever chose this header for the story – whether the journalist herself or her Editor – he or she deserves praise for doing so. The header of the article is “RBI’s 12 February circular makes a comeback with a dash of humility”. Nice.

All institutions need to go through the cycle of competence – confidence – overconfidence-overreach-setback-humility. Probably, RBI had to have its moment. Its circular of 18th February 2018 was an over-reach. I went through the circular (‘Prudential framework for resolution of stressed assets’, June 7, 2019) It does not relax the credit discipline and yet it provides time for resolution before the non-performing debt goes before the bankruptcy court.

Monetary policy transmission in India

In its monetary policy meeting last week, the Reserve Bank of India’s Monetary Policy Committee cut the policy rate – the repo rate – by 25 basis points. This is its third rate cut since December 2018 and it was unanimous. The Committee also unanimously decided to move to an ‘accommodative’ stance indicating further easing down the road. So far, so good.

Transmission from RBI policy rate to the lending rates fo banks remains the big challenge in India. See this article in ‘Business Line’, for example. Some banks have even increased their lending rate since the last RBI policy rate cut!

Everyone – including my friend Gulzar Natarajan – points out that Indian banks have a much higher share of their liabilities in bank deposits. These deposits are fixed in nature. Therefore, interest rates on them are payable at a fixed rate regardless of the movements in the policy rate. Since they cannot come down with cuts in the policy rate, the lending rates too cannot be lowered. Ergo, there is no transmission.

Gulzar even shared a chart with me that showed that Indian banks’ deposits as a % of overall liabilities is higher compared to other developing nations.

But, the truth is that Current and Savings Accounts (CASA) are more than 40% of overall deposits. 41.3% to be precise. The last data point available – in a easy to retrieve manner, that is – is from February 2019. See here.

Current accounts pay no interest and the interest payable on savings accounts is 4% – at the lowest balance between the 11th and the end of the month. That is as low as one can get, in terms of savings account balances. In the first ten days, the balance could be higher due to salary deposits. That is why they are excluded!

Therefore, the argument is somewhat unconvincing. Not untrue but not the total explanation.

The explanation lies in lack of competition with the central bank prescribing a floor for lending rates via its formulaic Marginal Cost of Deposits based Lending Rate (MCLR). I wrote about it in my MINT column last Tuesday.

If one went through the RBI Internal Working Group Report on the MCLR and the previous base rate, published in October 2017, one would realise that these are not MCLR (i.e., not marginal) but that they are also binding floors for lending rates.

Note a key sentence in the report:

One bank included a negative spread under business strategy due to market competition, which was in contravention to regulatory guidelines. (PAGE 47)

Indeed, that should be the case. Banks should have the freedom to take the basic of decisions for a commercial entity – the pricing decision. But, they do not.

India needs genuine competition in lending rates between banks. Neither the owner nor the regulator must intervene. It will also enable the owners to figure out which of them are worthy of further capital infusion, growth and which of them deserve to be merged, consolidated or weeded out.

Of course, the second thing is the Small Savings Interest Rate. Check out the table in page 26 of the said report (Table II.8).

Interest rates offered on bank deposits are lower than that of the interest rates on small savings and these interest incomes are tax-free too. The Government-announced interest rates on these Small Savings Schemes are higher than that of the rates that would be offered if the government sticks to the formula that it promised – linking the interest rate to the 10-year Government bond yield. It has not. On top of it, there are tax benefits.

That is the second (or, even the first) biggest hindrance to transmission. That is why I felt that the usually meticulous Indira Rajaraman quite did not get it right in her column on the topic of transmission. She is right with her conclusion, of course. The multiple strands that link the funding of government budgets (of the States and the Union) to the National Small Savings Fund (NSSF) need to be broken. She is right on that one.

But, more than that, the idea of offering a higher interest rate on a product that is even safer than a bank deposit and with tax benefits is a sure-fire killer of the banking system profitability and of transmission of monetary policy.

Some politically unpopular decisions need to be taken. They will be unpopular in the short-term. But, a government with its back to the wall on the banking system and with such low actual economic growth (more on that in a separate blog post) has to take some decisions and face up to the tradeoffs. There are no costless choices here.

Surjit Bhalla had got this one right. One of the most important decisions ever taken by a FM was taken by Yashwant Sinha when he lowered the interest rate on Small Savings Deposits. That did play a big role – among many other things – in India’s post-2002 economic boom.

Surjit Bhalla had got this one right. One of the most important decisions ever taken by a FM was taken by Yashwant Sinha when he lowered the interest rate on Small Savings Deposits. That did play a big role – among many other things – in India’s post-2002 economic boom.

Cash, community and branches

This long article in Quartz on the closure of branches in rural Scotland by the Royal Bank of Scotland is well worth a read. It is an interesting case study on many things related to business, economics and society.

One of the important take-aways in this is credibiity, trust and integrity. RBS promised that it would not close a branch if theirs was the last branch left standing in a community and proceeded to do exactly the opposite.

This is not how one wins back trust for capitalism.

Incidentally, the article has many useful links.

STCMA – 06 May 2019

(1) An empirical essay on the non-causal (or, non-correlation) link between money supply measures and consumer price inflation. Some of the comments below the essay are unfair. The paper reinforces the argument that the evidence of consequences of loose monetary policy are to be found elsewhere and that inflation dynamics remains the least understood phenomenon by economists, among others. By sheer elimination, the only thing that seems to be explaining inflatin dynamics is the wage dynamics. As long as workers’ anxieties are high and wage growth low, we should expect conventionally measured consumer price inflation to remain low in the developed world.

(2) Following deregulation, bank credit flows more to non-productive investments, says this brief based on an empirical work published in November 2018. At the same, credit guidance, with political economy, leads to inefficient credit allocation. That is the evidence from developing economies. Where is the golden mean and how to find it?

(3) Four decades after Washington and Beijing re-established diplomatic ties, the doors on scientific and technological engagement appear to be closing fast. A wary US has accused its biggest trading partner of getting ahead by unfair means, from forced technology transfers to intellectual property theft and industrial espionage. …. Since last summer, Chinese students involved in robotics, aviation, engineering and hi-tech manufacturing – priority areas in Beijing’s “Made in China 2025” industrial policy – faced tighter visa controls. [Link]

(4) China is encouraging consumer credit loans now. Doesn’t sound like the right thing to do and sounds more like desperation, especially if you read this news in conjunction with this story too, on tighter foreign exchange approvals for Chinese residents, taking money out. Does not sound like a healthy economy.

(5) This BBC story presents a more balanced picture, than stories that appeared elsewhere, of the election results in Spain. Socialists did surprisingly well but so did the so-called ‘Far Right’ Vox party.

(6) Hong Kong’s extradition laws – deporting people to the mainland to face trial – are drawing protests. I guess, one would say, that is unsurprising. The laws supposedly contain safeguards against people charged with political and commercial crimes from being sent to the mainland. But, not many are convinced that they would be honoured.

(7) One more example of technology running amok – cashless and till-free shopping at a Sainsbury pilot in the UK. Just as backlash over social media platforms are rising, this too would face a backlash:

Last year’s Access to Cash study, commissioned by Link, found 8m people would struggle to exist in a cashless society, noting that those with a heavy reliance on cash tend to be older and poorer. Most basic bank accounts, designed for those with a poor credit history, do not come with contactless cards. [Link]

(8) Jamil Anderlini’s short piece in FT on the Islamic world’s mostly silent indifference (read, ‘acquiescence’ in reality) to China’s treatment of Uighur Muslims is a good read. Two important quotes:

In the aftermath of the horrific mosque shootings in Christchurch in March, Jacinda Ardern, New Zealand’s prime minister, earned great praise throughout the Islamic world for her sensitive and empathetic response to the tragedy. But on a trip to Beijing barely two weeks later, Ms Ardern refused to mention the situation in Xinjiang, despite public calls from Muslim and human rights groups to do so. [Link]

The New Zealand Prime Minister’s non-reaction is rather typical of the so-called Liberals. Their selective outrage is what has lost them trust, goodwill and credibility among voters and alienated most of them towards other relatively more outspoken outfits in their own countries. They continue to refuse to heed the lessons. That is irrational. Does that go together with the tag of ‘liberal’?

AND

Put it this way: mocking Donald Trump and his administration or criticising American policy will not trigger US sanctions. Countries, companies or, indeed, newspapers that attempt the same with Xi Jinping and China do so at their peril. [Link]

(9) As a former Australian Prime Minister, would Kevin Rudd not be embarrassed by what Paul Keating has to say on China? [Link]

NPA recovery in India

On December 28, 2018, RBI released the ‘Statistical Tables Relating to Banks in Inda, 2017-18′. I just quickly browsed the table-headers online and looked at NPA recoveries in India :’ NPAs of Scheduled Commercial Banks Recovered through Various Channels’. The trend has not been good. In that sense, the implementation of the Insolvency and Bankruptcy Code (IBC) has been very timely. It may have initial troubles, changes and resistance, etc.

Which momentous change would go unchallenged or has gone unchallenged by entrenched interests? The table below shows the percentage recovery (col. (2)); percentage recovered through SARFAESI Act (Col. (3)) and the fourth column is the amount referred to the various sources for recovery – Debt Recovery Tribunals, Lok Adalats and SARFAESI Act. The recovery % are proportions of these amounts (Col. (4)).

Source: RBI

Let us see how these numbers evolve in 2017-18 and later, after IBC becomes accepted and established. Clearly, the table shows that IBC had not come a day too soon!

Finance and Federal Reserve

In my first column for MINT for 2019, I dealt with the issue of the Federal Reserve backtracking on its rate hike trajectory. Methinks it is sustained pressures from ‘financial market types’ that led the Fed chairman to cave in. I don’t buy the argument that he is tightening on two fronts: federal funds rate and quantitative tightening. So what? One acts through the banking channel (from the overnight lending rate to bank loan rates) and one acts through the capital markets channel – through the yield curve. All the rates, across the yield cuve, were depressed extraordinarily – in magnitude and for an inordinately long time. So what if all points in the yield cuve were rising? Financial conditions still remained accommodative.

This was the burden of my column. I was not impressed with the arguments of Stanley Druckenmiller and Kevin Warsh nor was I impressed with the arguments of John Mauldin. My friend Gulzar Natarajan had urged me to read his ‘Thoughts from the Frontline’. I read the last four of them last evening. You can read two of them – pertaining to the discussion of Fed monetary policy – here and here.

Nor did Gavyn Davies impress me with his arguments. So what if the Federal Reserve were triggering an economic recession? Recessions must be welcomed after excesses have built up in so many areas – from corporate debt to leveraged loans to market concentration in tech firms

‘Wrath of the financial markets’ that Viral Acharya (RBI Deputy Governor) invoked in a speech in October is felt more by central bankers than governments and that too not in public interest but in self-interest of the financial community.

Dean Baker has a list of ‘facts’ or resolutions to improve debates on economic policy in 2019. Item no. 6 is about finance. His list is about the ‘facts’ that are often obscured in economic policy debates:

6) A large financial sector is a drain on the economy
The financial sector plays an important role in a modern economy. It allocates capital from savers to those who wish to borrow. A poorly functioning financial sector is a drag on growth. The same is true of a bloated financial sector.

The financial industry is an intermediate sector, like trucking. This means that it does not directly provide benefits to households, like a housing, health care, or education. For this reason, we should want a financial sector that is as small as possible for carrying through its function, just as we would want the trucking sector to be as small as possible to deliver the goods in a timely manner.

Over the last four decades the narrow financial sector (securities and commodity trading and investment banking) has more than quadrupled as a share of the economy. It would be difficult to argue that capital is being better allocated or that savings are more secure today than 40 years ago.

This means we have little to show for this enormous expansion of the financial sector. It would be comparable to seeing the size of the trucking sector quadruple with nothing to show in the form of faster deliveries or reduced wastage. Finance is of course also the source of many of the highest incomes in the economy.

These facts make for a strong case for measures that reduce the size of the sector, like financial transactions taxes, reduced opportunities for tax gaming, and increased openness in pension fund and endowment contracts. In any case, it is important to recognize that a big financial sector (as in Wall Street) is bad for the economy, not the sort of thing that we should be proud of.

Reducing the size of the financial sector will also mean that its influence on monetary policy will come down. About time.

Are India’s ‘shadow banks’ a bigger risk than China’s?

Well, that is what Andy Mukherjee thinks or his editorial team thinks, if one went by the header of the article that he has written.

Now that New Delhi has replaced an independent-minded technocrat at the Reserve Bank of India with a former finance-ministry bureaucrat, it’s reasonable to expect that shadow banks will be encouraged to expand again.

That is quite a loaded sentence. Airbrushes or ignores a lot of other issues with Mr. Patel.

T.T. Ram Mohan offers an alternate perspective that is well worth a read. This paragraph is worth noting:

Thirdly, the particular suggestions from the government that have led to tensions with the RBI cannot be construed as attempts to infringe the autonomy of the central bank. Take, for instance, the issue of the appropriate level of reserves for the RBI. This is a technical matter on which reasonable people can legitimately differ. It is entirely appropriate to refer the matter to an independent committee. This would not have happened had the government not pressed its point vigorously.

He ends on this note:

Will New Delhi be prepared to pull the rug from under the non-bank lenders if they push things too far? On that count, hold no hope. China’s shadow banking may be a lot bigger than India’s, but India’s is already too big to fail.

May be, he is right. But, I think he is far too dramatic here. Banks are being recapitalised and lending has picked up. So, I am not sure if India’s NBFCs are ‘too big to fail’.