Be sure of what you want. You may get it.

Based on the current repo rate of 5.4 per cent, the impact on SBI’s profitability is compressed to 10 basis points (bps). Home loans offered by the bank now start at 8.1 per cent. However, we are in a declining repo trajectory.

Therefore, if the central bank announces another rate cut anywhere between 25 and 40 bps — in October or later — profitability or net interest margin (NIM) may take a huge knock. At 3 per cent in the June quarter, numbers have just about started firming up and looking better.”

Source: “Linking loans to external benchmark may delay SBI’s profit revival – Profitability may take further hit on policy rate cut of 25-40 bps [Link]

The Chinese proverb I have used in the header is a very profound one.

The shrill case for rate cuts with a tasteless header

My young friend Karan Bhasin urged me to wait until I read his full piece in Swarajya when I told him that I was disappointed with the header of his article. He said that the header was not his choice. Fair enough. Then, I have to protest to the editors of the magazine strongly at that tasteless pitch for RBI rate cuts.

In a balance-sheet constrained economy, rate cuts seldom have positive effects and may have effects in areas where we don’t want. Now that the government had cut the corporate taxes aggressively, companies might be willing to borrow and invest for the tax cut might have shifted the sentiment in the commercial sector more decisively.

That, in fact, proves the point that rate cut works only when certain pre-conditions are present. It is a limited tool. Its omnipotence is overstated in the West and now, it seems, in India too.

With the benefit of hindsight, RBI was too reluctant to cut rates in 2017. It should have dropped them more as liquidity tightened. It dropped the repo rate only by 25 basis points throughout 2017. It began the year at 6.25% and dropped it to 6.0% in August. 2017. It raised rates twice in 2018 because, by then, the Federal Reserve was raising rates and the rupee was weakening.

Official statistics for real GDP growth in 2016-17 and in 2017-18 is 8.0%. So, may be, was RBI that wrong in maintaining a real repo rate of around 2.0% then?

Karan writes:

This suggests that the RBI believes that the economy overheated in 2017 and 2018 while the exact opposite happened thanks to their policy choices.

8% growth rate (official print) was an overheating economy. One cannot have an official growth print of 8% and then call for aggressive rate cuts. More useful to tell the government to come clean on the actual growth rate.

Growth began to slow in the second half of 2018-19. RBI could have cut rates aggressively then. But, with foreign currency loans repayments (check out the net international investment position data every quarter on dollar amounts falling due for repayment) and an aggressive Federal Reserve (that did a about-face only in December 2018), a central bank has to have its eye on the currency too, even if it is not a policy objective.

Interest rate cuts may help but to suggest that it is guaranteed to work or that it is the only game in town is to let the government off the hook for its acts of omission and commission that contributed to the economic growth slowdown. [To be sure, the Supreme Court and the private sector had big roles too in the slowdown].

Also, it follows the fashion of placing monetary policy at the heart of economic cycles. It is far less potent that it is made out to be and it works only under rather specific conditions. Else, it gives rise to excessive risky lending, asset bubbles and deprives savers of their income.

In India, with banks reluctant to lend and companies still saddled with debt in their balance sheets (check out the interest coverage ratio of Indian non-financial corporations), low rates flow to consumers.

In the last eight years, household debt growth has far outpaced nominal GDP growth:


The table above depicts percentage growth rates (not annualised) over two-year windows in India’s household debt (nominal and in rupees), based on BIS Quarterly data on non-financial credit.

Further, the compounded annual growth rate of credit card outstanding (one of the categories of personal loans) over the last four and quarter years has been 29.6%. This is available from Table 171 of RBI Handbook of Statistics on the Indian Economy. Data available up to July 2019 at the time of writing this and goes back to April 2007.

This is what happens when the commercial sector is constrained by its own balance sheet from borrowing further. Money flows to the easy but not necessarily the most ideal borrowing segment of the economy. Bankers’ risk aversion to lend to even eligible borrowers must be fixed. That requires not just recapitalising banks but an enabling environment that does not punish them for commercial decisions going wrong. These are in the realm of the government.

The government had been slow to recognise the problem of bad debts and even slower to find answers. This dates back to 2015. To blame the RBI alone for the economic slowdown is way off the mark.

The way the Goods and Services Tax had been implemented (may be, that is what was feasible in a federal and large polity like India) could not have but induced uncertainty among businesses. Insolvency and Bankruptcy code is a good and essential game-changer but it has had short-run consequences for economic growth.

The obsession over tax revenue growth was another major growth dampener. Relative to RBI, the government has been, by far, the biggest contributor to the economic growth slowdown.

Without accounting for these and fixing some that need to be fixed- which are in the realm of government, an uni-dimensional call for RBI to cut rates is not only wrong but also dangerous.

As I had mentioned in my column in Mint today (not my original idea – I am citing someone else), with RBI and the Government asking banks to link their lending rates to external benchmarks while rates on liabilities (deposits) are fixed, banks’ net interest margins will be substantially affected. If aggressive rate cuts are made, this problem will get far worse, making banks chase aggressive and riskier loans (they will carry a higher lending rate) and paving the way for a future cycle of non-performing assets.

Finally, to keep up the shrill attack on the central bank week after week, ignoring its record open market operations (pumping money into the economy) in the last one year which then enabled a record dividend payout from RBI to the government, with strong language (bordering on abuse) is an exercise in losing friends and turning people away.

The magazine too deserves to be reprimanded for its rather tasteless and wrong header.

Baretalk policy prescriptions for the Indian economy

In today’s column in Mint, I had argued that the government had to step in and stem the creation of bad debts by its own policies (mostly State governments) on power and coal pricing, coal linkages, etc. [Parenthetically, in this regard, Harish Salve’s comments on Supreme Court’s role in the economic slowdown is an important and pertinent one.] It is not enough for the government to provide just bank capital. It has to figure out the root cause of reluctance to lend.

My friend in Singapore who read this piece shared an anecdote with me on a retired public sector bank executive just to make the point that honest lending would not just be possible under such circumstances. Depressing.

In the previous four weeks, I had commented on different measures and approaches that the government and the Reserve Bank of India to encourage better flow of credit. By no means, the ideas are original. I am only channelling and contemporising the wisdom of my elders and the knowledgeable.

Last week (September 10), I wrote on why the government should level the regulatory playing field between public sector banks and private sector banks. I was channelling Dr. Y.V. Reddy’s wisdom there.

The week before that (September 3), I had defended the transfer of RBI excess capital to the Government and the payment of an outsized dividend, under the circumstances. In that note, I had left a wisdom in the end:

One of the important lessons of the current slowdown for the government is that it is always easier for a government to hurt and even halt economic activity than to revive it.

On August 19th, I offered a few more ideas on combating the structural-cyclical slowdown in India such as calling all BJP Chief Ministers for a conclave to agree on a minimum programme and to lease government land for long-term (99 years), etc.

On August 12th, I wrote about macroprudential measures, again taking the ideas that Dr. Y.V. Reddy had proposed in his comment on a paper by Alan Taylor at a conference in Switzerland in 2010. In that column, I made the following point which, I think, is important:

it is important to bear in mind that the Union government is the dominant owner of the banking system. Government policies (input prices, raw material linkages and power tariffs, for example) cripple the financial viability of bank borrowers. When the government breaches its contractual obligations, the money it saves is eventually not saved as it goes towards recapitalizing banks to close the capital shortage created by bad debts. Thus, the burden that had to be borne by certain specific consumers becomes the general burden of taxpayers. This is both inequitable and inefficient. [Link]

On August 5th, I had written about the applicability of Basel capital adequacy norms only for internationally active banks. The two concluding paragraphs are important:

The problem is that the discourse has become so puritanical that such a move would be seen as a dilution of prudence and credit discipline and interpreted as another sign of the central bank caving into pressure from North Block or South Block or both. Therefore, the government and the central bank must approach this in a calibrated manner and communicate clearly so that it is not painted as another attack on institutions by the government.

To begin the process, the government and the central bank could consider appointing a committee to re-examine the relevance of capital adequacy norms prescribed for internationally active banks in the Indian context. The terms of reference for such a committee should be formulated in a manner that strikes a balance between India’s economic growth and employment imperatives and maintaining a sound banking system. India should not prioritize one at the cost of the other. [Link]

On July 29th, I concluded that small minds cannot create a large economy. I had written that Indians were not that easily capable of seeing the big picture and sweat the small stuff too much. In other words, we can be easily persuaded to stay petty and put petty considerations ahead of big and more important things.

Investment slowdown and demonetisation

The analysis in this piece and the attribution, in particular, are deeply problematic. This attributes the abrupt slowdown in India’s private corporate sector investments in 2016-17 to demonetisation that happened on 8th November 2016.

There was demonetisation and it would have had an impact on the informal sector and it is supposed to have diverted transactions to the formal sector. There was ‘Asset Quality Review’ of banks’ assets going on. Demonetisation was announced without any fore-warning on Nov. 8. So, it was not as though firms were downsizing investments due to the anticipated demonetisation. Firms were doing it anyway – because of excess leverage and, may be, even tax uncertainties. Investment decisions are taken and implemented over a few years. It will be felt over time and not instantaneously.

Second, one did not have to be too conspiratorial about it. RBI Monthly Bulletin (March 2019) has enough reliable information on the ‘on-the-ground’ investment slowdown. Usually, this comes out in the September monthly bulletin. This time, it too took time and RBI brought it out in March 2019.

There has been a steady decline in the capital expenditure commitments of the corporate sector since 2011. Expenditure incurred in 2016-17 would have been committed much earlier. There was a ‘cliff-dive’ in 2017-18, as per RBI numbers. But, these are subject to revision.

There was an ongoing investment slowdown and demonetisation may or may not have compounded it. We will not know sure for a long time, if at all. But, to leap to conclusions – without taking into account normal economic relationships and lead-lag patterns – is to stake one’s own intellectual credibility to puncture the government’s credibility. Not necessary.

India’s banking trilemma

Notwithstanding the controversies that dogged his tenure at the Reserve Bank of India as its Governor, Urjit Patel has made an important and interesting presentation at the Stanford-India conference in June on India’s banking sector problems. As Urjit Patel frames it, the ‘Impossible Trinity’ of Indian banking is this: Dominance of government-owned banks in the banking sector, independent regulation and adherence to public debt-GDP targets. India can have only two of the three.

But, in fact, political economy considerations dictate that India follows only the first of the three. In the presence of the first, the other two are impossible, except in terms of appearances.

India’s banking crisis is a huge opportunity missed.

His presentation is worth going through and storing for reference. Lots of good tables and charts.

Ninan’s missed opportunity

Last weekend (June 29, 2019), T.N. Ninan wrote an article on the departure of Viral Acharya from RBI. He is the Deputy Governor. His first term ends in January. He is leaving six months ahead in July.

Viral Acharya has been personally courteous to me. In fact, when I pointed out that RBI surveys (quarterly surveys) should be captured in Excel for download and analysis, he quickly set the ball in motion and it became a reality. Now, we can download the survey results and do analytical stuff with it.

That is not the point. His departure is neither the end-of-the-road for RBI independence nor is it an embarrassment for the Indian government.

Ninan writes:

Similarly, those within the Indian government system do not speak out publicly against the government they serve. When you are the governor or deputy governor, you do not have the freedom of speech that an ordinary citizen enjoys. Differences are aired only internally. On the occasions when someone feels the need to start a public debate, it is not done in apocalyptic terms. Naturally, when Dr Rajan and Dr Acharya spoke out bluntly (in the case of the former, on issues with which he was not officially concerned), it did not go down well.

No employer will allow their employees to speak out against them publicly when you are still working for them. No private sector enterprise would allow that. Nor, for that matter, do foreign governments – even those in developed countries – allow that.

Independence of the central bank does not mean that they cannot be questioned. It does not mean that they are not accountable to anyone. If they are forced to overturn a decision taken in public interest by the sheer weight and force of authority without logic, that is an assault on institutional independence.

Indeed, those who brandish independence as the first line of defence against and all criticisms are the ones who are shutting out debate.

I was happy to see the header in a MINT report on RBI’s revised circular on the recognition of non-performing assets after the Supreme Court struck it down. The report said that the new circular was an exercise in humility. Well said. I found the new circular pragmatic and it did not sacrifice credit discipline.

Mr. Ninan concludes his article thus:

Today, with growth having slowed and macroeconomic challenges in every direction, would the government have benefited from the advice of “Harvard” economists? Perhaps, but judging by past record it probably would not have paid much heed.

Is that so? But, Andres Velasco provides a counter perspective. India, probably, does not miss much or would not miss much.

Mr. Ninan has missed an opportunity to write a more useful piece. That is a pity because he is one of the more perceptive, experienced and balanced commentators in the country.

Monsoon forecasts

The June 2019 Monthly Bulletin of RBI has an article on the accuracy of monsoon forecasts by India’s Meterological Department and Skymet, a private forecaster. The conclusion of the paper is sobering:

There is no significant correlation between the projected rainfall (IMD and Skymet) and actual rainfall in India. While none of the forecasts are close to the actual, the performance of the IMD’s SSLRF is better than FSLRF and Skymet. Both IMD and Skymet have failed to predict drought and excess rainfall in most of the cases. Nevertheless, the SSLRF nailed down the 2015 drought and its probability of predicting near-normal monsoon has been reasonable and higher than FSLRF and Skymet. In contrast, the predictive power of the international agencies, viz., BOM and NOAA in forecasting extreme rainfall (which generally coincides with the El Nino and La Nina conditions) is much better than that of the IMD. The comparative assessment of all forecasts suggests that for generating macroeconomic forecasts, the use of IMD’s SSLRF and the predictions of international agencies like NOAA and BOM in conjunction may be appropriate as the preliminary forecasts of IMD (FSLRF) and Skymet released in April appear to be noisy. [Link]