Preliminary thoughts on the evolving situation surrounding YES Bank

This was inevitable. Andy Mukherjee of Bloomberg had suggested on 13th January that the Government of India (GoI) and the Reserve Bank of India (RBI) must bite the bullet but budget time-table came in the way, I guess. Even then another month had elapsed.

Hence, some are concerned that there could still be a big contagion like it happened in the case of the collapse of IL&FS in October 2018. Possible. One can never say never to things in fluid and rapidly evolving local and global situations.

However, there is an important difference between October 2018 and now. Then, RBI leadership took a rigid, uncompromising and doctrinaire approach to both liquidity provision and inflation targeting. Monetary policy was restrictive and liquidity provision was inadequate. Indeed, RBI had an important role to play in precipitating India’s economic slowdown in 2018.

The current RBI leadership is more pragmatic and less academic. Hence, the hope is that the repeat of the ripple effects of the collapse of IL&FS would be avoided now.

What follows are my (current) take-aways and the situation could evolve differently. I am aware.

(1) Since the financial system was already largely impaired and credit to non-financial industry was growing at below 5%, there cannot be a big incremental damage.

(2) Lenders to YES Bank and investors in YES Bank would take a hit. Mutual funds list is there. But, most of them have already marked down their exposure to zero value (see https://www.bloombergquint.com/business/heres-how-much-mutual-funds-are-exposed-to-yes-bank-debt)

(3) State Bank of India (SBI) has assets ten time (10.3x) the size of YES Bank (Ref: https://www.bloombergquint.com/global-economics/india-must-end-yes-bank-s-theater-of-the-absurd). Together, the Life Insurance Corporation of India (LIC) and SBI can absorb this. 

Pl. read the excellent article by Aarati Krishnan of ‘BusinessLine’ on the portfolio of LIC and how secure it is.

(4) Some market commentators point to potential contagion effects. At this stage, the analysis is largely speculative. Withdrawal limit of Rupees 50,000.00 is reasonable for retail depositors and, in any case, and curbs on depositors’ withdrawals will likely go well before April 3.

As for loans to small and medium enterprises, as noted earlier, loans have already dried up and, hence, the incremental impact will be negligible, if at all.

Settlement of derivatives positions has to be clarified. I have no doubt that, before too long, RBI will issue necessary clarifications.

As for the impact on stock markets, they were unsettled even before this development, by global developments. One should not be worried by potential action in stock markets and further declines. Stock prices will become cheaper for long-term investors.

The real issue is how the clients of YES Bank would fund themselves going forward. While most of them would have made or attempted to make alternative arrangements in the last few months, this space has to be watched. Incremental credit crunch needs to be avoided.

(5) There is also a view circulating that meaningful reforms would happen in India only with personnel and leadership change in the Ministry of Finance. That is mischievous.

There have been corporate and personal income tax cuts; consolidation of public sector banks; government’s intent to get out of IDBI has been announced; the Finance Minister has followed through on de-criminalising many of the violations of the provisions of the Companies Act; the budget has improved transparency of the fiscal arithmetic, etc.

India’s economic growth slowdown is due to the financial sector crisis and history has it that all economies experience a deep and prolonged slowdown when the slowdown is set off by banking and financial sector crises. India is not experiencing uniquely severe slowdown. 

Yes, this is an opportunity for meaningful reforms. Yes, it is an opportunity to redefine the balance between government-owned and privately owned commercial banks. But, the solution to all problems is not privatisation and privately-owned banks in advanced economies nearly collapsed the world economy in 2008 and might do so again. Indeed, the collapse of the YES Bank is a cautionary tale of the so-called superiority of the model of private ownership in financial institutions.

That said, the opportunity to improve the resilience of India’s financial system as much as possible remains to be grasped.

Availability of liquidity for Small and Medium Enterprises (SME) is largely a working capital issue and that is as much a failure of banks to make risk-based lending as it is that of large buyers of MSME supplies not paying on time – both government and non-government buyers. That is a systemic change and change in MoF leadership will not solve the issue.

(6) Covid-19, as of now, has had limited impact on India’s health system and the number of infections is exceedingly low, for a large country. India escaped SARS because, by February, India turns warm. It is no exception this time. I expect India to be less affected than most countries.

Covid-19 might also end up contributing to an improvement in India’s bilateral trade deficit with China. See the positive Cummins India story, for example. It could be repeated in other cases.

Overall balance of payments would be less affected as reduced investment flows would be offset by improved trade balance and I don’t see the current account deficit worsening, because of still-weak economic growth impulses and further likely delays in the recovery of investment demand. Further, crude oil prices will remain depressed for the year, helping keep India’s import bill under check. Recent rupee weakness is not a cause for worry and perhaps is, on balance, a good thing.

There will be supply chain disruptions to some industries. Some analysts wonder whether the impact of Covid-19 would be inflationary or deflationary in India. I think it would be mostly deflationary rather than inflationary and hence, allowing RBI room to continue to ease policy conventionally and unconventionally.

India’s economic growth rate for 2020-21 could be 5.5% (my personal central case) with downside risk all the way to 5%. That is the current estimated growth rate for 2019-20.

By the time the dust settles on Covid-19, it might turn out to have done a good deed for India for some of the migration of global supply chain out of China would not be easily reversed. For example, see this riveting story on how the incidence of swine flu conitnues to be suppressed in China. By now, it is common knowledge that the outbreak of Covid 19 had happened a month before the world came to know of it.

It is significant that a cross-party group of twenty senators has urged the UK government to reconsider granting Huawei a role in the country’s 5G telephone network.

(7) Finally, visible leadership from the very top and communication are essential. Such communication too should be non-defensive and non-reactive. They should merely aim to reassure and soothe rather than refute genuine or exaggerated criticisms. 

Being a commentator in these times is far easier than to be a decision-maker. Arm-chair wisdom is relatively intellectually undemanding and most of it is with the benefit of hindsight too. In the rush to get their story out, commentators make big errors. Imagine how difficult it must be to make decisions in real-time under uncertainty often with imperfect and inadequate information?!

Decision-makers should ignore commentators and simply focus on communicating and taking decisions with only one consideration:

Help, if and only if possible, in the short-term, without sacrificing the medium to long-term growth prospects.

Overall, it is possible for India to end the year with a stronger and better base for faster growth with some reasonable steps combined with a calming and reassuring communication. Noise can and should be ignored.

Matter of detail

Recently, I read reports of how the Insolvency and Bankrupty Resolution Process had helped better recovery from bank assets declared bad, compared to other resolution regimes. All the reports referred to a table from the RBI report. But, none of them referred to the report. It took a bit of digging out to find out which report of RBI, released in December, that the newspapers were referring to. It wa the report titled, ‘Trend and Progress of Banking in India’ released on 24th December 2019. The table that they had reprinted was Table IV.10. Forget about mentioning the Table number. They had not even mentioned the name of the report.

You can check out the three news-stories here, here and here.

In contrast, ‘The Economist’ had carried a story on the productivity slowdown in emerging economies. They cited a World Bank report but in the chart that they had reproduced, they had mentioned the name of the World Bank report, ‘Global Economic Prospects’ published in January 2020. You can access the story in ‘The Economist’ here.

Night lights and India and China growth estimates

Ran into this well-written, sober and reasonable note by Robert Barbera and Yingyao Hu at Johns Hopkins University on the luminosity based growth data and official GDP growth data estimates for China. The note is from December 2018. The good thing about the paper is that they don’t badmouth official GDP growth estimate for the sake of it. They explain how and why the discrepancy between the two estimates arises.

The original paper by Yao and Hu is here. Check out tables 11 and 12. The date of this paper is August 2019. India’s official GDP growth estimates too are overstated but not to the extent that China’s is. Also, the volatility of China’s official growth estimate is too low. We all know that it is ‘too smooth’.

RBI Occasional Paper (July 2019) offers a more granular look at GDP growth and other real-economy measures and how they stack up with luminosity data. It is a good paper too.

India did grow quite strongly between 2003 and 2012 punctuated in the middle briefly by the 2008 crisis but the sustainability of that growth model (or the lack thereof) is illustrated by the subsequent slowdown that is still ongoing. Luminosity data captures that well.

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:

2016-1839.127
2014-1631.759
2012-1432.736
2010-1227.683
2008-1018.850

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]