Thursday, June 09, 2016

8 per cent growth in 2016-17 ? Unlikely

The growth rate of 8 per cent in the last quarter has revived talk of a return to 8 per cent growth rate in the near future. Sorry to be a bit of a spoilsport but I'm afraid this is highly unlikely.

In 2015-16 the Indian economy grew at 7.6 per cent compared to 7.2 per cent in 2014-15. This was mainly on account of the steep fall in oil prices which translated into a surge in private consumption and also into higher government capital expenditure through higher taxes on oil products.

The hope was that this bonanza would continue in 2016-17 although in a muted form, with oil prices falling further to $30. This hope is being dashed by the rebound in oil prices to $50, which was the average for 2015-16. This takes away the whole of the contribution of 1-1.5 percentage points to growth that arose from the sharp fall in oil prices in 2015-16.

Some analysts think this will be compensated by greater rural consumption following better monsoons and better urban consumption because of the Pay Commission hike. I estimate the benefits on account of this two factors at 0. 3 per cent and 0.6 per cent of GDP respectively. As you can see, this doesn't compensate for the impact of oil prices.

Another blow is that the world economy is not only not reviving but is likely to slow down. The Economic Survey (2015-16) expected exports to contribute a solid 1.3 percentage points to growth. This looks likely to get washed out. In fact, export growth could slow down even further, dragging down economic growth.

Lastly, analysts have been making a hoopla over increased public capital expenditure. They overlook the fact that this is being offset by compression of government expenditure on other counts and also higher taxes. The fiscal deficit is going to shrink by 0.4 percentage points. That, basic economics should tell us, means a shrinkage in demand from the government. Using a multiplier of 1, this means minus 0.4 percentage points of growth.

I add up the numbers and find that the Indian economy is likely to grow at 7 per cent rather than 8 per cent in 2016-17- unless oil prices fall back to well below $50.

That's the short-run view. The medium-term outlook is just as sombre. Whoever is forecasting a return to 8 per cent growth has some explaining to do.

More in my article in the Hindu today, Tempering economic ebullience.

Monday, May 30, 2016

Committee to review FRBM targets

I was on ET Now along with Prof M Govinda Rao to discuss this topic.

My view is that there is  a strong case for revisiting the targets. I give many reasons. Here I will mention two. One, our deviating from the FRBM target for nearly a decade past the deadline has not led to an unsustainable debt  situation. On the contrary, India is among the few economies whose debt to gdp ratio has declined over the past decade- at 67% of GDP today, it looks quite okay.

Two, we worry about the fiscal deficit because it can impact on interest rates. The impact on long-term rates of fiscal deficits is negligible, as empirical work has shown. However, the deficit can impact on short-term rates. On this count, concerns must be subdued at the moment given relatively low oil prices.

More fundamentally, I would question the idea that the way to reduce the fiscal deficit to GDP ratio is to attach the numerator, that is, reduce expenditure and, if possible, raise tax rates or increase the tax base. The point is that that is not how our ratio came down significantly in the first decade of the 2000s when we were almost close to attaining the 3% FRBM target at one point.

Rather, the numerator, the GDP, shot up due to exogenous factors, such as the global boom, and also due to the increase in the savings and investment rate over time. This also caused the numerator to decline because tax revenues rise with rising GDP.

The bottomline: the presumption that reducing the fiscal deficit is the key to better or stable growth must be questioned. It's very often the other way round. You do various things to boost growth - and the the fiscal deficit to gdp ratio takes care of itself. 

Thursday, May 19, 2016

Rajan controversy generates more heat than light

A fair bit of dust has been kicked up by Subramaniam Swamy's letter to the PM asking that RBI Governor Raghuram Rajan not being given another term in office. However, it's disappointing that much of the analysis focuses on personalities and does not attempt an objective analysis of Rajan's performance. There are three areas in which Rajan needs to be judged: monetary policy, bank regulation and foreign exchange management.

Most of the controversy is over Rajan's handling of monetary policy. The charge against him is that he reduced interest rates too late and too little. But the reluctance to cut interest rates arises from the more fundamental policy of inflation targeting and the particular band - 4 to 6 per cent- to which the RBI has committed itself. This leaves little room for flexibility on interest rates and its inevitably corollary is a certain loss of output in the short-run. Since the finance ministry agreed to this policy, it would not be correct to fault Rajan alone for this policy. I believe there is room to revisit this policy.

On bank regulation, Rajan has moved to open up space for niche players such as payment banks and small banks while also promising on-tap licenses. Foreign banks have been noticeably reluctant to come in through the subsidiary route given the requirement of capital. The cumulative impact of these policies on the competitive situation  will not be significant in the medium term.

In respect of public sector banks, it is the finance ministry that has called the shots even on matters of governance. The overhauling of bank boards and the appointment of new CEOs for banks is yet to happen- and it will happen under the auspices of the Bank Board Bureau on which the RBI will be represented through a Deputy Governor. My own view is that having the RBI Governor head the appointments process would have been a better bet for now if only because the Governor (and I don't mean this particular governor) is more capable of exercising the necessary independence in this matter. Rajan must given due credit for not having bought the line on bank privatisation- I am surprised that his remarks on the need to improve governance in the private sector first have not got the attention these deserved. Rajan has also been circumspect on PSB consolidation- he has indicated that it may not be appropriate to burden PSBs with mergers at a time when they face several other challenges.

Finally, forex management. There is a school that believes that the RBI has helped shore up the rupee unduly and that this has hurt exports. This could be true but there are serious risks to rupee depreciation at a time when emerging markets have faced large outflows of capital. On balance, it appears that erring on a slight over-valuation was worthwhile.

We must also give Rajan due credit for upholding the stature and independence of RBI and for his efforts at communicating with audiences in India and abroad. For Rajan, it must be some consolation that he's not the only central banker under fire at the moment. In the UK, politicians have asked for Bank of England governor ( a Canadian by the way) to be sacked for saying that Brexit could have serious short-term implications for the British economy. ECB chief Mario Draghi has been bashed by the German finance minister for his unconventional monetary policies. And Janet Yellen, the Fed chief, would not have been pleased to hear that Donald Trump would replace her if re-elected.

Tuesday, May 10, 2016

Fresh storm over executive pay

Executive pay has been  a subject of controversy for several years but nothing has come out of it all- CEOs are still laughing they way to the bank.

Small wonder that a fresh storm has erupted over some of the most recent news on executive pay. British Petroleum boss was given a 20% rise in a loss making year for the company. Although this was rejected by shareholders, the vote was non-binding. And VW's recently departed CEO got 6 million pounds as performance-related award despite the scandal that has sent the company's stock plummeting.

In the UK, hedge fund TCI  has taken a stake in VW in order to shake up its governance, FT reports. 
The reason put forward by its head is an interesting one. It's not the cost of CEO pay itself; it is that aggressive incentives lead to bad behaviour that impose costs on shareholders. Think of what happened at the leading banks in the world in the financial crisis of 2007.

Norway's oil fund, the world's biggest sovereign fund, has decided to take a position on executive pay. By this it means, the level of pay, not just the structure of the pay package.

The moves by the two funds are a good start. CEOs can get away with outrageous pay packages thanks to boards packed with yes-men. Also because institutional investors are not willing to invest the time and effort required for reform of pay. One reason is that those at the head of institutional investors themselves command huge packages, so it's a case of  birds-of-a-feather. Who wants to invite attention to their own obscene packages?

A third reason for soaring CEO packages is that investors don't really mind as long as the going is good- they are certainly not concerned about things like equity that angers social activists.

The best argument to make is not a moral one. It is that outsized pack packages are not in shareholders' own interests. They will lead, one way or another, to under-performance in the long run  because performance is the result of collective effort, it's not magic wrought by one person. If you focus too much of the reward one person, the collective effort is undermined.

Monday, May 09, 2016

Don't expect bankruptcy code to change things overnight

The Bankruptcy Code, passed by the Lok Sabha and pending in the Rajya Sabha, is a considerable improvement on existing bankruptcy procedures:
  • It brings disparate insolvency procedures under a uniform institutional structure 
  • It sets a 180 day time limit for resolution
  • It keeps insolvency matters out of the purview of civil courts
  • It has provisions for Insolvency Professionals who will be part of the insolvency resolution and will be incentivised through fees linked to recovery
 There are three issues that the Code cannot and does not address:
  • Legacy NPAs at banks- so it's not going to help address our immediate problems
  • Bankers being unwilling to take a loss in restructuring cases, given the fear psychosis in banking. Given this, it's not clear how they can stick to the 180-day deadline
  • Clogging up of matters in the adjudicating authorities and appellate tribunals to be created- the necessary infrastructure will take long to create and will not be equal to the sheer volume of cases, given our past record. Governance of regulatory and appellate authorities badly needs improvement- and not just in respect of bankruptcy.

Saturday, April 30, 2016

Default drama in banking

I was on Bloomberg TV yesterday to discuss issue related to loan defaults and how to address this issue.

Friday, April 29, 2016

Vijay Mallya's offer

Excuse me if I sound naive or I am missing important details but it seems to me that, on the face of it, businessman Vijay Mallya's offer to banks is a pretty decent one and banks should get into serious talks with him. They can hope to write back losses and boost profits in the quarter ahead if they do so.

FT reports today that Mr Mallya is willing to repay 440 million pounds out of a principal amount of 512 million pounds. The Indian papers had reported an offer of close to Rs 7000 crore. The banks need to clearly indicate what figure is acceptable to them and what terms they would like. Simply rejecting an offer does not take us anywhere.

Bankers know very well that going down the legal route- getting Mr Mallya extradited and, perhaps, arrested on return- will not take them very far. Indeed, the danger is that a legal battle will stretch out for years and the banks get back very little. The government needs to make up its mind: does it want to get Mr Mallya or does it want the banks' money back?

I had a chance to talk to some bankers. They all agreed that they go for Mr Mallya's offer. However, they told me they would not lift their little finger until the government told them in writing that that they could go ahead. As one of them put it," Who wants the CBI after him five years from now?".

It's a pretty sad state of affairs. We are faced with banking paralysis today, a variant of the policy paralysis that undermined the UPA government. Stalled projects can't go through to completion because banks are unwilling to take a hair-cut and plough in fresh funds. They can't effect recoveries again because they can't take the necessary hair-cuts. Because they can't effect recoveries, their capital position is worsening and they are unable to make new loans. Fear psychosis has gripped bankers in the public sector- so much so that bankers are now focused on retail lending and would like to stay out of corporate loans and especially project finance.

Banking paralysis is, perhaps, the biggest factor impending our economy recovery along with falling exports. The government needs to get its act together. The steps required are: an independent Settlement Advisory Board to vet loan settlements; recovery followed by fresh lending; and infusion of greater capital into banks. Without this combination of measures, prospects of accelerating growth are pretty dim.

Here is a quote from Mr Mallya's interview with FT:
Chain-smoking cigarillos and sipping English tea, the pony-tailed multimillionaire confirms he has offered, in a submission to India’s Supreme Court, to repay £440m on outstanding principal of £512m borrowed from state banks. 

But the banks declined because — in his words — they are fearful of taking any haircut on their loans in the face of the public frenzy whipped up against him in India.
“It is important to understand the environment in India today. The electronic media is playing a huge role not just in moulding public opinion but in inflaming the government to a very large extent.”

.....Mr Mallya blames the political climate for the failure to reach a deal with the banks, a climate that saw him described this week as a “fugitive from justice” by the country’s attorney-general.
“As professional bankers, they would like to settle and move on but, because of my image as portrayed, they are reluctant to be seen as giving me any discount,” he says. “It will attract huge media criticism and inquiries by vigilance agencies in India.”