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.

Bhushan, Sinha and Shourie on Rafale

Late on Wednesday evening in Singapore, a good friend forwarded me this link and asked me to go through it fully. It is a press statement or article written by M/s Yashwant Sinha, Arun Shourie and Prashant Bhushan.

At the outset, we have to note that the first two were Ministers in NDA 1 government of Vajpayee. PM Modi has sidelined them. They are bitter and angry. Mr. Bhushan was part of AAP and has pitted himself against the NDA 2 government in many instances.

Their press statement was released in which is also not so favourably disposed towards the NDA 2 government, to put it mildly.

Most SELL-SIDE research (research by stockbrokers and investment banks is called SELL SIDE research) in Financial Sector falls under this category. When they issue a BUY call on a stock, one does not know if they truly believe in the stock or if their investment banking interests dictate that they issue a BUY recommendation. There is a natural conflict of interest. So, it will be of interest and worthy of attention only when SELL SIDE issues a SELL recommendation.

So, like the SELL SIDE above, these three gentlemen have a natural conflict of interest. They have an axe to grind. When someone is bitter and has a personal animus, there will be a tendency to overstate the case, exaggerate a bit here and there and hide some inconvenient details, etc. One cannot lightly dismiss these possibilities.

Therefore, they have to make a rather rigorous case to convince the listener/reader that they have risen above their personal considerations. In this particular instance, when they have taken up something as important and critical as national security, the onus on them to be thorough with their homework is several notches higher.

My current reading of their press statement does not convince me that they have passed the above test. May be, I am wrong. One can never be certain, if one were honest.

To summarise their statement, they think that Government of India is vastly overpaying for the Rafale jet fighter, implying kickback, etc. It is not sharing the details of the contract. It has awarded the ‘Manufacturing under license’ to a favoured Indian private sector entity. These are serious allegations. Very serious. So, how seriously should we take them?

1) what is HAL’s record in defence production? How long did it take to produce the Light Combat Aircraft (single-jet, single-seat) and how comfortable are the Indian Navy and Air Force about the LCA? See here for details. It is a bit strange that Dr. Shourie, the man who privatised public sector enterprises is now batting for HAL with its track record of delivery.

(2) The questions raised by the three gentlemen sound so obvious. So, why were they not raised before and by others?

(3) How many defence manufacturing firms were there in India in the pvt. sector before? I presume the answer is zero. So, naturally, no firm will have a record. You have to begin somewhere.

(4) Understand the hsistorical context: When Korea wanted to become a steel power, they had no resource advantage or knowhow. They told Japan to pay war reparations in steel drawings and plans and depute people. The rest is history. Moral of the story: one has to start somewhere.

(5) Didn’t the French Government endorse the GoI answer on certain confidentiality provisions, after the ‘No confidence’ motion debate? See here:

Hours after Congress president Rahul Gandhi questioned the Rafale Deal, France responded saying a security agreement it concluded with India in 2008 legally binds the two countries to protect the classified information relating to operational capabilities of defence equipment.

That seems to make sense. Few countries would want details of the exact weaponisation and the customisation of a fighter plane to be made public. In fact, there is a healthy precedent with the UPA government Defence Ministers on this. See here.

(6) According to a Government of India press release, the process of acquiring a fighter jet was initiated in 2002 when NDA 1 was in office. UPA 1 and UPA 2 were in office for ten years from 2004 to 2014. They had not finalised and procured the fighter jets in these ten years.

The contract was signed late in 2016 finally, I think. By, August 2016, it was not signed yet. See here.

(7) The three gentlemen follow the ‘post hoc ergo propter hoc’ logic with many of their assertions. In other words, they are innuendoes, as of now.

(8) The clincher: the price of Rafale aircraft:

The most serious allegation that the three gentlemen have brought up is that the Government of India has increased the price from 670 crores per plane conveyed to the Indian Parliament in Nov. 2016 to 1660 crores per plane now!

In Feb. 2015, the French government agreed to sell 24 Rafale Jets to Egypt at EUR5.2 billion. Taking the average exchange rate of EURUSD and USDINR in Feb. 2015 (Source:, the price per aircraft works out to Rupees 1525.2 crores. That was in Feb. 2015. The Indian Rupee is now 10% weaker (USDINR = 68.60) than it was in Feb. 2015 (62.03735 USDINR then) and there are India-specific customisation which could be different from Egypt’s.

So, the current price of Rupees 1660 crore per aircraft for India does not seem odd or does not stink. Perhaps, there is nothing to see here.

It is quite possible the Minister who gave the price of 670 crores per plane in November 2016 was misquoting or did not take into account the correct exchange rate.

Many seem to forget that the Indian rupee depreciated 50% against the US dollar in 2011-13 period, thanks to double-digit inflation, high current account deficit and high budget deficit under UPA 2 government.

Yes, Indian sloppiness can be and is a security risk. Worse, India’s economic performance then was bigger security risk and some are working overtime to bring the risk back.

(9) Now, what about the bad debt problem in the Indian banking system? I think it is a very big economic and a security risk.

Let us crunch some back-of-the-envelope numbers:

India’s nominal GDP as of March 2018: 168,000,000,000,000.0

Stressed loans at 8% of GDP:                     13,440,000,000,000.0

Assume 60% goes bad                                   8,064,000,000,000.0

Assume 50% recovery rate; rest bad:        4,032,000,000,000.0

That can buy                                                   242 Rafale jets at the price of 1660 crores per                                                                                 plane.

Did the three gentlemen issue a press statement and urge the Opposition political parties to get to the route of the bad debt problem in Indian banks, to find out when these loans were made (under UPA 1, UPA 2 or NDA 2?), to whom, recommended by whom (UPA or BJP politicians?), sanctioned by whom and approved by whom and under what authority, etc.?

Tail-piece: In India, nothing except obituaries seems to be above politics. See here. Not even national security.

Final word:

Notwithstanding the above, given the nature of the allegations and given the previous Cabinet status of the two gentlemen making the allegations, it is incumbent upon the Government to share as much details as possible with the public to assure them that the transaction has been undertaken solely with natinal interest in mind and that it is above board.

Demonetisation update 11 – some good reads

I have come across some good reads. I must confess that I have been reading mostly (or, only) MINT columns. Hence, the list is going to be high on pieces that appeared in MINT.

(1) Vijay Kelkar and Ajay Shah have written about six battlefronts in the war on corruption. I have my quibbles on full capital account convertibility. Policymakers must have the choice of imposing capital controls. CAC is only tangentially related to domestic corruption in India. CAC does not have much of a basis in economic theory. The rest is fine by me, more or less.

(2) Niranjan’s piece is a good one for two reasons. One, he is right that India’s policy experiment is a huge treasure for academics. Academics from different disciplines will be salivating at the prospect of writing so many papers on this. I had written in a blog post that many case studies could and would be made out of this exercise. Second, he is right that its deeper effects will take time to be understood.

Niranjan asks the question:

Is it created by the central bank through the expansion of its balance sheet? Or is it created through the expansion of bank credit that the central bank then accommodates?

Bank of England has answered it, unambiguously. It is the latter.

(3) This piece, written by two academics associated with the Indian School of Business, takes a narrow look at whether the poor are suffering by standing in the lines. They show that they may not be the ones who are standing in the line. That part of it is addressed well. But, my friend Rajan Govil points out that the broader point must be whether employment in the informal sector will be affected. The impact on the poor from that is far more crucial than that, says he. Point taken. However, the narrow point is well argued by the two academics.

(4) This piece, forwarded by a friend and published in Economic Times is excessively panglossian on the impact of demonetisation. Ignores behavioural impacts and is vague about the short and the long run. My point is that it is too soon to argue for or against the move from the economic impact angle.

(5) Surprisingly poorly argued piece by Ruchir Sharma. He highlights the Indonesian amnesty which pardoned wealth stashed abroad by taxing it at 4% if brought back.But, doesn’t it have moral hazard written all over it? Is there any guarantee that it would not lead to further hoarding of wealth abroad with periodical amnesty at such low rates of taxation? Second, nations have to get richer, no doubt. But, that does not mean that they cannot pursue corruption. Even rich nations are being advised to ban high denomination notes as part of the fight against corruption.

(6) Monika Halan takes on some of the critics of the demonetisation in this piece. But, the point I liked the most is this:

But for a country waiting for big bang reforms, the way we are reacting to what is a big bang reform tells us that we like reform as long as it does not touch our lives.

In one of my blog posts, I had written that India has not had structural reforms at all. That is why no one has felt any pain. No real reform is painless. I had also added that none of these people would make good leaders if they do not have the courage to inflict pain, when needed and for a larger purpose. Moral clarity and courage are needed to do so.

The rest of her responses to critics’ points are well made. I have made them too and more in my forthcoming comprehensive piece for ‘Swarajya’ print magazine.

(7) Bloomberg has many interesting charts here but the slant is very negative. The slant was very negative in their BloombergView piece too. The header, ‘India’s misguided war on cash’ says it all. I wonder why.

(8) Another friend forwarded a comment by Mr. Yashwant Sinha, former Finance Minister, published in NDTV. He had written that the Indian economy faced three disruptions – Trump and the Fed tightening, GST and now demonetisation. He was commenting on the tepid job creation in the Indian economy, if it may be called that. I was actually going to do a blog post separately on that, after I had noticed that the Labour Bureau of the Government of India had some new updates on the employment and unemployment situation in the country. Mr. Sinha is right about the absolute criticality of jobs and he is also right that, in the short-run, this demonetisation drive may actually be anti-employment. It need not necessarily be but it might well be.

(9) I had listened to Dr. Arun Shourie’s interview to NDTV on this matter. I have no comments on the contents of the interview. He might have reached an inflection point from where his comments hurt his credibility more than they hurt the government. That would be sad. He deserves better and he should realise that.

(10) Tamil writer Jayamohan has a longish blog post in Tamil on the war on black money. He is supportive and calls out the Leftists for their hypocrisy. But, there is also the obligatory attacks on the Prime Minister. Wonder why.

(11) MINT has curated some of the columns that had appeared in their pages on this topic and published a TO READ list. Pleased to find our (Gulzar and mine) piece in it. This is our second joint piece for MINT, based on our ‘Can India grow?’ report for Carnegie India. The first one appeared on Nov. 15.

Splendid isolation

One of the most important/best articles I have read this year: “Complete confusion between principal and principle”. Well said. Check out the comments. It is worth the effort.

Former Indian Finance Minister (and BJP leader) Yashwant Sinha’s piece on the media faithfuls of the government feigning short-term and long-term memory loss. Article is from August 29th but well worth a read.

For once, I agree with this edit in THE HINDU on the Indian government’s so-called economic reform measures announced over Thursday and Friday.

FT Beyondbrics blog post on the mysteriously large net FII inflows into India. It makes sense to me.

Financial Express interviews Professor Arvind Panagariya on the release of the second edition of his book – edited by him and Prof. Bhagwati. He does not buy the argument that coalition politics explains economic paralysis (or, if I may add, with wrong economic decisions) in India. I agree.

Sad news for microfinance

John Elliott (ht: Narayan Ramachandran) has a good piece on Dr. Manmohan Singh’s (non) role in India’s economic reforms. On this aspect, Surjit Bhalla got it right. Once he correctly lauded Mr. Yashwant Singh, finance minister in the NDA government, as a more genuine reformer. To an extent, Mr. Chidambaram could also be considered a reformer. He tried a bold budget in 1997.

Sajjid Chinoy tries to shed some optimism on India’s reform prospects. One hopes that he is right.

This is very sad news indeed.  Bharatiya Samruddhi Finance Limited – India’s oldest Microfinance Institution – is on the verge of closure, according to this MINT story. I know Mr. Vijay Mahajan well. I have tremendous respect and admiration for the work he has done at the policy level and at the grassroots level.  I sincerely hope that closure is not eventually required. The Andhra Pradesh Government has burnt down the house to kill a few bedbugs and, in the process, has dealt a heavy blow to financial inclusion.

The sector needed a crisis, alright, to mend its ways but it did not deserve a death blow. Further, the Andhra Pradesh Government has plans to set up its own Non-Banking Finance Corporation. Is that 21st century governance? Should governments be running NBFCs?

As Vijay correctly points out in this news-article, 92 lakh borrowers are now unlikely to get credit from any bank, let alone future MFI. Is that financial inclusion?

I hope this serves as a wake-up call for the AP Government rather than the beginning of the end of the private sector MFI

And, finally, Yeddyurappa resigns.