Desirable deleveraging and inevitable growth slowdown

Late last night, a good friend sent me a link to a news-story. The Vice-Chairman of NITI Aayog has blamed Raghuram Rajan, former Governor of RBI, for India’s economic growth challenges, notwithstanding the fact that India recorded a 8+% real GDP growth (y/y) in 2018Q2 or 2018-19Q1. I do not believe in the latest CSO numbers post 2011-12 base year change and other revisions to the methodology made. The new GDP numbers are as problematic as the old one is, except in different ways.

In theory, deleveraging can reduce economic growth and it does. As a factual statement, it is correct. As a ‘pass the buck’ statement, it is problematic. But, if one listened to the actual clip (barely 85 seconds), he does not blame. He states the deleveraging matter-of-factly.

However, Andy Mukherjee sent me the link to his interview to ‘’ wherein he blames the former RBI Governor more directly:

“When you give crocin to an ill person every two hours instead of the prescribed eight, then the person will become comatose,” said Kumar. [Link]

The clip that is available on the site does not feature this comment, however. Perhaps, there is a fuller clip elsewhere which has this comment. But, he is right that the economy was slowing down already before demonetisation happened.

Below are the growth rates from the quarter ending March 2016 to September 2017. He is right about the slowdown having set in before demonetisation. But, will it have continued to drop further but for demonetisation? Hard to prove one way or the other.

9.3 8.1 7.6 6.8 6.1 5.6 6.3

I would like to draw the attention of the readers of this blog to my column published in August 2017 on Mr. Rajiv Kumar’s views on foreign and local talents for policymaking posts.

Before I could write a blog post, Andy Mukherjee had deconstructed the imputed statement of the Vice-Chairperson of NITI Aayog.  Andy Mukherjee makes the point that commercial credit was growing at 10.8% (y/y) when Raghuram Rajan demitted office in September 2016. But, Rajiv Kumar, in the ANI clip, mentioned industrial credit growth and he had got his facts right.

Industrial (overall) credit growth in Sept. 2016 was 0.9% (y/y). Growth in credit to micro&small, medium and large industries were -1.2%, -2.6% and 1.4% respectively, in September 2016.

Perusing BIS statistics on Credit-to-GDP gap (actual-trend), one notes the following, for India:

2012 2013 2014 2015 2016 Q4 16 Q1 17 Q2 17 Q3 17 Q4 17
1.6 -0.1 -3.2 -3.8 -8.1 -8.1 -6.3 -9.0 -8.0 -8.7

India’s credit-GDP gap (actual-trend) had turned negative in 2014 and it remains negative up to 2017Q4 (latest data available in BIS). Therefore, the credit growth had slowed well before Dr. Rajan ordered AQR and directed banks to come clean. Banks had turned cautious because they knew that they were sitting on a problem and the borrowers too had severe credit indigestion. It was a demand as well as a supply issue.

So, the real problems were not the essential deleveraging nor the directive to clean up the balance sheet. Both were needed. Rajiv Kumar was not portraying the former Governor in a bad light. In fact, he does say to Jyoti Malhotra at ‘’, that it was a ‘heroic attempt’ by Dr. Rajan to clean up the banks.

Indeed, the real reason for the credit growth slowdown (desirable) and economic growth slowdown (inevitable) was the unsustainable credit and economic growth up to 2011. The Prime Minister was right to draw attention to the ‘phone-a-loan’ scam under the previous government.

So, in that spirit, if I were the Government, I would have put out the following press release after the RBI Annual Report came out, showing the return of the majority of demonetised currency notes to RBI:

“We undertook the demonetisation exercise to either smoke out black money and to gather precious information. The fact that 99.3% of the currency notes came back is not a source of disappointment to us but a source of information. Together with technology and returns being filed under GST, we are on the path to ensuring that more citizens pay their legitimate tax dues to the government, without harassing them, such that development priorities get the funding they need.

We sanctioned and fully stood behind RBI to facilitate Asset Quality Reviews at Banks and we backed the attempts to get to the bottom of the problem of Non-Performing Assets. Those efforts are paying off now. We implemented the Insolvency and Bankruptcy code to allow ease of exit of businesses and creditors as much as the Government was focused on Ease of Entering and Doing Business and we introduced the Goods and Service Tax to make India an efficient and an integrated market, scaleable for businesses and employment generation.

All of these would entail short-term sacrifices. But, we have put India on a higher growth path. Recent IMF review of the Indian economy has put India’s economic growth potential at 7.25%, capable of rising to 7.75%.

In 2012, India’s growth potential had dropped to 6.6% We have, with all these structural measures, raised it back above 7%. With our steadfast attempts at cleansing our banks, to be followed by a better framework for their future management, with our focus on creating hard infrastructure and with the financial inclusion measures we have undertaken, we are confident that India’s potential growth will rise to 8% and beyond that.

All important victories are hard-earned. Nothing worth cherishing comes easy or handed to us on a platter. We were handed a poisoned chalice in 2014. We have worked hard to make it a nectar. That involves short-term growth and even political sacrifices. We are happy and proud we did not flinch from taking the necessary and short-term unpopular decisions. Our efforts are paying off. The economy is on a solid growth path. We have achieved over 8% growth in the first quarter of the current financial year. Better times lie ahead.

We have had a good monsoon. We are now focusing on redressing the enduring concerns of our farmers and the fundamental priorities of the farm sector, in general. We are empowering farmers. That is our priority. At the same time, we are not losing sight of medium-term economic stability as we approach the elections next year. Thank you.”

When I shared the above draft government ‘press release’ with a friend, he told me the following:

Governments prefer to be hated for the wrong reasons than speak the wholesome truth, which admits errors of judgement in good faith. And they will never understand that people value honesty so much that they forgive honest mistakes!

Brilliant! Could not have put it any better.

Pro-cyclical finance

Eric Cinnamond, a blogger, I discovered recently wrote:

As the current expansion marches on, I’ve been thinking more and more about business cycles and how I incorporate cyclicality into my valuation process. [Link]

He cautioned against extrapolation of current record earnings and the need to normalise earnings for cycles.

But, a recent Wall Street Journal article on how financial institutions are ramping up personal loans now is an eye-opener for those who are not convinced of the cyclicality of finance:

American Express Co. , Goldman Sachs Group Inc., LendingClub Corp. and Social Finance Inc. are among those behind an onslaught of unsolicited mailings offering unsecured loans, known as personal loans, as large as $100,000. In the first half of this year, lenders mailed a record 1.26 billion solicitations for these loans, according to market-research firm Competiscan. The second quarter marked the first period that lenders mailed out more offers for personal loans than credit cards, a much bigger market, according to research firm Mintel Comperemedia. [Link]

The increase in personal loans as the economic cycle has matured is amazing. Once again, lenders are taking on more risk at the peak of the cycle and are also persuading borrowers to take on more risk at this late stage in the economic cycle. The chart embedded in the article offers telling evidence of that.

personal loans

This should not be surprising at all:

Now, as the market gains momentum, borrowers who took out personal loans more recently are falling behind on payments at a faster rate, according to TransUnion, and several lenders are reporting higher losses.

This should be very worrying, of course:

Last year, more than 1.5 million personal loans were given to people with credit scores below 601, on a scale that tops out at 850, according to TransUnion. That is the highest number in more than a decade. Currently, borrowers with credit scores considered prime or better account for just over half of personal-loan balances, according to TransUnion.

But, newspapers that were responsible once upon a time are focusing on the wrong finance problem: campaign finance of the President of the United States of America!

A tragedy and a travesty if…

In today’s MINT, Ajit Ranade argues clearly and convincingly against the Government or the Parliament diluting RBI’ norms issued in February for recognition of non-performing debt. He is right and I agree with him. I had written on this right after RBI came out with its NPA recognition norms in February 2018.

This story in MINT on how the ICICI Bank had made an accounting rule change that enabled it to keep its non-performing loan ratio low and that too without disclosing the rule change to shareholders only strengthens the RBI directive issued in February.

It is all about a culture of accountability that is sorely lacking in India. It is missing almost everywhere, especially in public space.

It will be a travesty and a tragedy to dilute RBI norms issued in February.

Dodd-Frank and Matt Taibbi

Matt Taibbi will, forever, be remembered for the label, ‘Vampire Squid’ that he came up with, for Goldman Sachs. No matter what else he writes.  In passing, I should mention that Pratap Bhanu Mehta will be remembered for writing, ‘While we were silent’ in 2013 no matter how many times we disagree with what he writes.

Matt Taibbi’s take on the two major political parties in the United States features flawed logic. In fact, it contradicts his earlier piece on how Democrats helped pass the Bill that diluted the Dodd-Frank Act. More on that later.

The reality is that one can smell Republicans (the political party in the USA)/Conservatives from a distance: they want status quo to continue. No disturbances or perturbations (a jargon that economists love to use) to the staus quo. ‘Do not interfere’ is their message to the government – on social and on economic affairs.

Democrats, on the other hand, were supposed to be the party of the underdogs. Instead, they favoured Wall Street interests. They repealed Glass-Steagall and they helped pass Commodities Futures Modernisation Act that kept many financial products out of regulatory purview. They became a party of elites, by stealth. That is fradulent. In fact, he should go back and re-read his own piece, titled, ‘Obama’s Big sellout’ written in December 2009 or early 2010. It is no longer available in the ‘Rolling Stone’ site. But, I found an extract here.

Hence, calling Republicans a party of ‘open con’ does not cut it. It was and is open, all right. It is no con game. We know their agenda.

He then wrote a piece about “The Economic Growth, Regulatory Relief and Consumer Protection Act (Pub.L. 115–174, S. 2155), signed into United States federal law by President Donald Trump on May 24, 2018.”. It amended the Dodd-Frank Act or the Financial Stability Act, 2010.

He was right on some of the factual details. The word, ‘may’ has been changed to ‘shall’ in one place. True. Some limits have been increased from 50bn. to 100 bn. to 250 bn. US dollars, etc. But, he did omit some key aspects that lead us to a different interpretation.

The amendments do include the following:

(b) Rule Of Construction.—Nothing in subsection (a) shall be construed to limit—

(1) the authority of the Board of Governors of the Federal Reserve System, in prescribing prudential standards under section 165 of the Financial Stability Act of 2010 (12 U.S.C. 5365) or any other law, to tailor or differentiate among companies on an individual basis or by category, taking into consideration their capital structure, riskiness, complexity, financial activities (including financial activities of their subsidiaries), size, and any other risk-related factors that the Board of Governors deems appropriate; or

(2) the supervisory, regulatory, or enforcement authority of an appropriate Federal banking agency to further the safe and sound operation of an institution under the supervision of the appropriate Federal banking agency. [Link]

There is also a provision for ‘globally systemically important bank holding companies’:

(f) Global Systemically Important Bank Holding Companies.—Any bank holding company, regardless of asset size, that has been identified as a global systemically important BHC under section 217.402 of title 12, Code of Federal Regulations, shall be considered a bank holding company with total consolidated assets equal to or greater than $250,000,000,000 with respect to the application of standards or requirements under. [Link]

In plain English, S.2155 does not prevent the Federal Reserve from exercising its authority with respect to Bank Holding Companies where it deems necessary. The real issue is whether the Federal Reserve is keen. See here and here.

Amendments to the Dodd-Frank Act will not cause the next crash. That train has already left the station. If at all they do cause banks to take on more risks, it will be because theri capital requirements have not been raised enough and because the Federal Reserve has allowed monetary policy to remain too loose and interest rates to remain too low for too long.

Ultimately, it is all about appropriate pricing of capital and pricing it too cheaply and way below fair, risk-adjusted level is the biggest gift that the Federal Reserve continues to shower on the financial industry.

In another article, Taibbi makes the case for a Financial Transactions Tax in the United States. I endorse that, wholheartedly. He is right. But, he is pushing the envelope on facts when he writes that the European Union has already ’embraced’ it. That simply is not true. I wish it were true. It isn’t.

Read what he writes here and decide for yourself:

A financial transactions tax might help incentivize Wall Street to once again emphasize true long-term investment, as opposed to spending all day moving piles of money around. As with Medicare-for-all, it might take a while for Americans to accept an idea already embraced in Europe. [Link]

It is still in the works. Lo and behold, Brexit is supposed to have gummed it up, because it will be difficult to enforce in the UK that won’t be part of the European Union and hence financial transctions would migrate there. That is the logic for the dealy. So, FTT in Europe is still coming.

The lesson is that it has become impossible to read anyone and take what they write at face value, without doing some fact-checking oneself. Well, if you are reading this, remember that it applies to this blogger too!

So, caveat emptor!

The twin hats of Andrew Haldane

My good friend Amol Agrawal (what an amazing and inveterate blogger, he is!) had a blog post on a recent speech by Andrew Haldane of the Bank of England (BoE) on the low  or non-existent productivity growth in the United Kingdom. I left the following comment on his blog post. It is slightly updated here.

I can understand you being excited about a speech by Andrew Haldane. He still does not fail to impress and provoke thinking. But, look carefully. What is institutional infrastructure for diffusion? What is the agency or agencies to be created? In the private or in the public sector? Who would fnance it? How would it be assessed? What would it take to judge that it has done a good job (or not) of diffusing innovation? I guess that the speech is silent on these. Otherwise, you might have blogged on it. I confess that I am yet to go through the speech.

But, there is another more important point to make with respect to Mr. Haldane. He failed to connect the dots of his own speeches, research and what went on before 2008. He produced such insightful research on banks and finance before 2012 that it is a great pity that he did not carry those insights wit him on to his new job. He behaved rather differently and disappointingly after he became the Chief Economist of BoE from being the Director in charge of Financial Stability.

He continued to insist on interest rates being kept too low for too long. To what effect? To what consequences? In fact, the lack fo productivity diffusion is an indictment of the low interest rate policy. Where is the incentive to do the hard work on productivity improvements and undertake investments that enhance them when easy money can be made speculating on high-end properties in London suburbs which is what low interest rates facilitate?

He knows of the BoE research that showed very clearly that banks create money. [Prof. Richard Werner at the University of Southampton has done further excellent empirical work on it. He calls the last century of economics teaching and learning wasted effort! Check out his papers.]

He knows again from BoE Research that most middle-class and lower middle-class Englanders have only interest-bearing deposit accounts as their financial assets. Low interest rates hurt them. Low interest rates help those who buy financial assets and real estate assets with debt. They borrow cheaply and big and the discounted value of future cash flows on equities is inflated by the low funding cost. Of course, it is not just the short end of the interest rate curve that remained low for long but even the entire yield curve with BoE Asset purchases.

To what end? How much his research helped him or influenced him to make public policy decisions and choices that enhanced public welfare?

In short, much as I admired and still admire his reserach, his hard work, his evidence based conclusions, etc., he scores rather poorly as a public policy exponent and technocrat.

Please do read Paul Tucker’s ‘Unelected power’. It is dense. I have only done four chapters. Not easy. But, worth it.

Out of logic; out of control

Let us see:

E-Commerce Marketing companies’ marketing expenditure and discounts should be capitalised and not deducted from business income. Mercifully, rejected by the Appellate Tribunal. [Link]

But, the Revenue department was willing to treat loan waivers as business income and tax them. Supreme Court has ruled against it. [Link]

The Income Tax Department asks banks to pay service tax (now GST) on free services, retrospectively since 2012. Some bankers have called it ‘frivolous’ demand. Quite. But, a lot worse than that. This boggles the mind for several reasons. This reveals a perverse and cynical logic, at one level. At another level, it is complete lack of coordination and harmony between different departments of the same Ministry. Very worrying in more ways than one. [Link]

No wonder, India’s Business Optimism Index is at its lowest since 2014 and that India’s ranking has slipped to the sixth place. How will there be a capex cycle? [Link]


Interest rates and growth

This article by Rohan Chinchwadkar of IIM Tiruchi made me happy for more than one reason:

  • It is from a faculty member from one of the newer IIMs
  • It is well and simply written. It does not try to overdo its point
  • It sources a recent piece of international research
  • It shows a faculty member who is in touch with contemporary reserach. Good for students
  • It was well timed – on the eve of the RBI Monetary policy meeting
  • It presented a paper that had turned conventional wisdom on its head

Not much can be asked of an op.-ed.

Kudos to MINT for publishing it.