Banking News Dated 13th September 2018

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Banking News: September 13, 2018


What’s at Risk for Insurers, Pension  Funds after IL&FS Downgrade to Junk
What’s at Risk for Insurers, Pension
Funds after IL&FS Downgrade to Junk

Sajeet Manghat
The Bloomberg News
Published on September 13, 2018

Investments by SBI Employee Pension Fund and SBI
Employees Provident Fund are over Rs 835.00 Crore

New Delhi, September 12 (Bloomberg): Infrastructure Leasing & Financial Services Ltd.’s downgrade to junk has put Rs 10,000 crore worth of investments by insurers and pension funds at risk.

Of the company’s standalone outstanding borrowing of more than Rs 16,500 crore as of May, about 60 percent is through non-convertible debentures, according to filings with the Registrar of Companies.

Nearly all these instruments, the documents show, are subscribed by insurance companies, and provident and pension funds, including Life Insurance Corporation of India, General Insurance Corporation Ltd. and the National Pension Scheme Trust.

Top IL&FS Debenture Holders

Investments in non-convertible debentures
as of May 30, 2018
 710 Crore
Postal Life Insurance Fund 
 687 Crore
NPS Trust
 665 Crore
 575 Crore
 540 Crore
SBI Employee Pension Fund
 425 Crore
SBI Employees Provident Fund 
 410 Crore
Rural Postal Life Insurance Fund
 318 Crore
India Long Term Debt Fund
 300 Crore
Source: Company filings

IL&FS’s non-convertible debentures and commercial paper were downgraded to junk after it missed repayment to Small Industries Development Bank of India Ltd., prompting a special audit by the central bank. Regulatory norms allow insurance and pension funds to only invest in the paper of companies operating in infrastructure and social sectors with a minimum rating of ‘AA’.

SC Khuntia, chairman of the Insurance Regulatory and Development Authority of India, suggested that insurers shouldn’t continue with investments in junk-rated paper. When there is such a downgrade, they should “withdraw that investment and put it somewhere else”, he said at an event. “They [investing companies] will have to find their own time to do that; and that’s what a prudent entity should do and is expected of them.”

For the Pension Fund Regulatory and Development Authority, it’s unprecedented. The regulator hasn’t faced such a situation of a “sudden downgrade to junk status”, Hemant Contractor, chairman at PFRDA, said, adding that he is not sure which funds “have investments in IL&FS”.

“But if we were to face a situation like this, what we will probably do is that because our combined investment is quite large, we will open a dialogue with the promoters and try to see how best they could redeem the bond or, at least, pay up whatever is due” said Hemant Contractor, Chairman, PFRDA.

Still, the companies may not be able to exit such investments immediately. Till then, a downgrade to non-investment grade requires insurers to first determine and then record the erosion in the value of the investment in the profit and loss account; or adjust the net asset value of the scheme in case of a unit-linked plan, an insurance consultant with one of the Big 4 accounting firms said requesting anonymity. Provident funds are also required to follow similar impairment guidelines, the person said.

LIC said it will strictly follow the IRDAI and the Reserve Bank of India rules to value IL&FS investments. Other insurers and pension funds were not immediately reachable. Emailed queries to IL&FS remained unanswered.

More Repayments Draw Near

IL&FS defaulted on payments on Rs 350 crore worth of inter-corporate deposits to SIDBI. IL&FS has another such payment worth Rs 150 crore due on Sept. 14, Bloomberg reported citing unnamed people. In all, the company’s filings show, about Rs 5,756 crore worth of debt is coming up for repayment in the next one year.

IL&FS is looking to mop up funds to repay its obligations. Its board is scheduled to meet on Sept. 15 to seek approval for raising a Rs 3,000-crore loan from two of its shareholders—Life Insurance Corporation of India and the State Bank of India Ltd.

According to Care Ratings, the company has plans to raise nearly Rs 8,000 crore—Rs 4,500 crore through a rights issue by September-end and Rs 3,500 crore in line of credit—from its promoter entities for meeting near-term liquidity needs.

L&FS Debt Burden

The company’s standalone debt of over Rs 16,506 crore implies a leverage of 3.04 times as of March this year compared with 2.23 times a year ago. Its consolidated leverage had risen to more than 8 times at the end of March last year—the number for 2017-18 is not available yet.

Breakup of Borrowings

IL&FS’ Standalone Outstanding Borrowings as On May 30, 2018

Debt  Amount
(Rs Crore)
Term Loans
Commercial Paper
Inter-Corporate Deposits
Covered Warrants
Loan repayable On Demand
Sub-Ordinated Debt

Rs 80,000-Crore Group Debt:

·       IL&FS is the holding company of the group with 24 direct subsidiaries and 135 Indirect subsidiaries.
·       On a consolidated basis, the company closed the financial year 2016-17 with a revenue of Rs 17,157 crore and a profit of Rs 142 crore.
·       The group’s consolidated debt stood at more than Rs 80,000 crore as of March 2017, according to its filings with the Registrar of Companies. Nearly, 80 percent or Rs 64,000 crore of it is contributed by its subsidiaries. The numbers for 2017-18 are not available yet.
·       The company provided just Rs 800 crore or 5 percent of loans and investments as general contingency as of March 2017, according to its filings.

Five subsidiaries account for nearly two-thirds of the group’s debt, according to the filings. These are:
·       IL&FS Energy Development Company Ltd.
·       IL&FS Transportation Networks Ltd.
·       IL&FS Engineering and Construction Company Ltd.
·       IL&FS Maritime Infrastructure Company Ltd.
·       IL&FS Financial Services Ltd.
·       Barring IL&FS Maritime, the other four were downgraded to non-investment grade.


‘Banks staring at haircuts of 60% on
stressed debt of Rs. 50,000 crore under ICE’

The Business Line
Published on September 13, 2018

Mumbai, September 12: With stressed debt of over Rs. 50,000 croreunder the independent credit evaluation (ICE) framework, banks have to take a haircut in the range of 40-60 per cent to achieve a rating of RP4 (moderate degree of safety regarding timely servicing of financial obligations; such debt facilities/instruments carry moderate credit risk), according to an industry study.

“The average sustainable debt for these assets is around 50 per cent,” said the study, Code of Hope, jointly conducted by the Associated Chambers of Commerce and Industry of India, and credit rating agency Crisil.

Resolution Plans

Under the Reserve Bank of India’s revised framework for resolution of stressed assets, Resolution Plans (RPs) involving restructuring/change in ownership in respect of large accounts (that is, accounts where the aggregate exposure of lenders is Rs. 100 crore and above) require independent credit evaluation (ICE) of the residual debt by credit rating agencies (CRAs) specifically authorised by the central bank for this purpose.

While accounts with an aggregate exposure of Rs. 500 crore and above require two such ICEs, others will require one ICE. Only such RPs which receive a credit opinion of RP4 or better for the residual debt from one or two CRAs, as the case may be, will be considered for implementation.

Terming the Insolvency and Bankruptcy Code 2016 (IBC) as a game-changing reform for India’s economy, the study noted that effective implementation of IBC will help in both, preserving the value of assets, and faster resolution, which also means that asset reconstruction companies (ARCs) would be able to churn capital faster and enhance returns.

The National Company Law Tribunal (NCLT) had approved resolution plans for 32 stressed assets under the Corporate Insolvency Resolution Process (CIRP) as on June 30, 2018, with resolution to the tune of Rs. 50,000 crore against total claims of Rs. 89,400 croreadmitted by financial and operational creditors.

Noting that the average resolution timeline for these 32 accounts were 260 days vis-à-vis the stipulated 270 days, the study said: “That’s a huge improvement on the recovery time of 3.5-4 years taken by asset reconstruction companies and 4.3 years as per the World Bank’s ‘Doing Business 2018’ report.”


Fuel hike continues! Petrol touches
all-time high of Rs 81 in Delhi today

The Financial Express
Published on September 13, 2018

The petrol prices touched an all-time high of Rs 81 in
Delhi on Thursday as the price was increased by 13 paise

New Delhi, September 13: The petrol prices touched an all-time high of Rs 81 in Delhi on Thursday as oil marketing companies (OMCs) increased fuel rates by 13 paise.

The rates of diesel were also increased by 11 paise reaching Rs 73.08 per litre in the national capital, according to IOCL app. While petrol was selling at Rs 80.87 per litre in Delhi yesterday, diesel was available at Rs 72.97 per litre.

In Mumbai, petrol is selling at Rs 88.39 per litre, and diesel is available at Rs 77.58 per litre today.

In Chennai, petrol is retailing at Rs 84.19 per litre and diesel at Rs 77.25 per litre today.

Petrol is available at Rs 82.87 per litre in Kolkata and diesel at Rs 74.93 per litre today.

Petrol prices were revised daily in India with effect from June 15, 2017. This was a marked departure from the earlier practice of revising petrol prices every fortnight.

Meanwhile, against the backdrop of rising fuel prices, Prime Minister Narendra Modi is likely to hold a review meeting on weekend to find out ways to stop the free fall of rupee against the US dollar and the ever-rising prices of petrol and diesel.

Meanwhile, Oil prices slipped on Thursday, although U.S. crude remained above $70 a barrel on the back of falling crude inventories and Brent was still close to $80 because of looming sanctions against Iran. U.S. West Texas Intermediate (WTI) crude futures were at $70.19 per barrel at 0024 GMT, down 18 cents from their last settlement. Brent crude futures dipped 11 cents to $79.63 a barrel.


Trump OKs sanctions on countries
that interfere in US elections

The Indo Asian News Service
Published on September 13, 2018

Washington, September 13 (IANS): US President Donald Trump on Wednesday signed a decree authorizing sanctions for countries that attempt to influence the November mid-term elections, while his administration denounced possible attempts to do so from Russia, China, Iran and North Korea.

The executive order instructs US intelligence agencies to determine if there are attempts afoot to influence the legislative elections, as occurred during the 2016 presidential vote, and establishes a mechanism for imposing sanctions if interference in any future US election is detected, EFE reported.

"There has been no evidence of a foreign power altering the outcome or vote tabulation in any US election," Trump said in a statement, nevertheless adding that "We're going to take strong action to secure our election systems and the process". The President has received harsh criticism from the Democratic opposition and from many Republicans for the scepticism with which he has treated the conclusions of the intelligence agencies that Russia attempted to influence the 2016 presidential vote with the aim of helping him win, and for his praise of his Russian counterpart, Vladimir Putin.

National Security Adviser John Bolton, meanwhile, denied on Wednesday that the criticism had influenced the president's decision to take measures to dissuade foreign powers from interfering in the races for both houses of Congress. "We felt it was important to demonstrate the President has taken command of this issue, that it's something he cares deeply about - that the integrity of our elections and our constitutional process are a high priority to him," Bolton told reporters on Wednesday. The intelligence agencies have already detected possible "attempts" to interfere with - or intervene in - the November elections by four specific countries.

"It's more than Russia here that we are looking at," National Intelligence Director Dan Coats told reporters on a conference call, specifying that US intelligence agencies are concerned about the ability of Iran, North Korea and China to interfere in the election, and threatening an "automatic response to that". Trump's executive order declares that a "national emergency" exists linked to possible foreign interference in the US elections, a declaration that creates a legal basis for the future imposition of sanctions linked to that issue. Within 45 days after any US election, the intelligence services will have to evaluate whether there were attempts by a foreign government or person acting as an agent of another government to interfere with the election, according to the decree.

The Departments of Justice and Homeland Security will then have another 45 days to decide whether or not to impose "automatic" sanctions and the heads of the State and Defence Departments will evaluate whether to levy even more severe punishments. Bolton said that the US considers interference to be not only attacks on election infrastructure but also the distribution of propaganda and disinformation. The sanctions would block US financial activities by those implicated in the election interference and those individuals would be prohibited from entering this country. A wide variety of additional sanctions could be imposed under certain conditions.


A decade after Lehman Brothers

Madan Sabnavis
The Financial Express
Published on September 13, 2018

The dominance of the Big 3 ratings agencies
and the Big 5 investment banks continues

A decade after the financial crisis permeated the veins of the financial structure of the world economy, some very interesting observations can be made. The financial crisis involved the adverse impact of financial engineering that typified the sophistication in the financial market where loans given for housing were repackaged and sold to investors (CDOs). More important, a consequence was that the originator and ultimate lender were different and not identifiable. A fall in the real estate market led to large-scale defaults where homes were confiscated, but had, by then, diminished in value. Markets collapsed as institutions went under.

Some were allowed to perish while others resuscitated. As banks stopped trusting each other and governments cut back on expenditure, central banks invoked ‘quantitative easing’ to revive their economies. This involved giving cash in lieu of securities that were not necessarily government bonds. BIS came in and introduced the Basel III norms that involved liquidity requirements. Regulation everywhere intensified and today the financial market seems more secure, or appears to be so.

But this entire process has been quite peculiar. First, the world economy is not quite back on its feet post-Lehman. While the US economy recovering has caused the Fed to increase interest rates, the picture across the major economic blocks is not clear. It is true, post-Lehman, the sovereign debt crisis emanated independently, changing the equations besides causing some disruptions in the form of Brexit and Donald Trump’s elevation as president of the US—where the approach to economic policy is now more aggressive and different from those pursued by his predecessors.

Second, while the financial crisis did lead to strong regulation across all countries, the domination of the super powers in credit rating and investment banking has not changed. While regulation spoke of having more competition in specific market segments, ironically, stronger regulation put up barriers to new players coming in as the regulatory cost became prohibitive. It was much simpler for the larger institutions to comply with the new regulatory structure as the cost could be absorbed by them. Therefore, the big three in the ratings business and the big five in investment banking continue to reign supreme.

Third, post-Lehman, the focus on inequality and governance caught public attention, with Thomas Piketty Capital in the 21st century setting the tone. The principal agent relationship that was first enunciated by Adam Smith stood even more clearly exposed as CEOs earned their income and bonuses through all the wrongdoings associated with the crisis, but didn’t have to pay for the same. Some continue to rule, rewarded with fat pays. The asymmetric reward pattern exists even today. Not surprisingly, there is a move for more government everywhere and this kind of social proclivity is something which Karl Marx would have been happy with.

Fourth, as a corollary, those responsible for the crisis went free while the policies pursued by governments aimed at cutting expenditure and better fiscal management, especially in the European countries, meant that the poorer sections suffered as allocations for social schemes came down (especially in the PIGS nations) as part of the packages recommended by IMF and European Commission. This is unlike in India where the NPA crisis has meant that several bank heads have been under investigation.

Fifth, for the first time, central banks gave liquidity to banks and financial institutions by exchanging corporate bonds like ABS and MBS for cash. OMOs normally involve government paper, but, in order to restore trust among players, it became necessary to provide liquidity against commercial instruments, which is probably the first of its kind. This happened across all developed countries to instil confidence in the players which held on to these instruments. Interestingly, at this time the LIBOR controversy also erupted where banks tended to understate their polled LIBOR rates to send incorrect signals to the market that all was well. The unmasking of this wrong-doing has helped to bring about a more regulated price discovery in the market.

Sixth, curiously the liquidity that was provided by the central banks did not go into lending internally for furthering investment. Growth remained depressed for the larger part of the decade. The money instead went to the EMEs that witnessed an upsurge in foreign inflows that in turn helped to boost their markets and currencies. A consequence was high level of monetisation in these countries and central banks had to sterilise these flows through absorption tools like the MSS bonds in India to keep the rupee (currency) steady.

Seventh, while QE was a bonanza for the recipients, it also meant that when these flows would stop, the reverse processes would be set in motion. Hence, the US decision to roll back QE and bond purchases (which the ECB is doing as well), caused EMEs to convulse at the prospect of FI flows slowing down. Subsequent increase in interest rates in the West has meant that the FI flows have started to move into the trickle mode, affecting all countries and currencies.

Eighth, countries have become inward-looking, starting with the US and the UK. When the global crisis threatened to degenerate into a 1930s-like Depression period, countries worked towards defending their economies by becoming less open in terms of trade. The WTO remains fairly irrelevant today and controls on imports have been the main policy thrust. The days of free markets and free trade are virtually done, and, while it is not as bad as the ‘beggar thy neighbour’ of the Depression era, it is ‘domestic economy first’ jingoism that is the order of the day.

Ninth, the smug explanation given in the past of the EMEs being decoupled from the world economy and establishing their power to drive forth the rest of the countries have been diluted. China has been at the forefront of being the target for all the inward-oriented policies of the West. With the focus now on teaching China a lesson through countervailing duties, the edifice of this story has been weakened considerably.

Tenth, post-Lehman and the euro crisis and an unrelated development of Brexit, the dollar has regained its hegemony and world still moves on this basis. The euro is struggling to stay relevant as there are pressures individual nations fare facing within their jurisdictions to move away. While the currency will hold, the final hurrah would be Trump’s as the dollar remains the anchor currency.

The Author is Chief economist, CARE Ratings


Public Sector Banks’ governance
poses Systemic Risk

Subir Roy
The Business Line
Published on September 13, 2018

If there is little change in the way the banks are run, a substantial pile of fresh bad debts will be generated again in a few years

Snowballing bad loans of public sector banks headed for the insolvency and bankruptcy process is widely known. But what is not so readily realised is the precise nature of the challenge that this poses for the country’s economic system. If these banks continue to be run essentially the same way they have been, then they may pose a systemic risk.

Public sector banks and their owner, the government, are ready for huge write-offs — in the vicinity of 60-70 per cent — where a resolution plan is approved by the creditors, and they may lose even more if firms go in for bankruptcy.

This will need huge recapitalisation of the banks, creating a substantial fiscal burden. The bill will eventually have to be paid to enable the banks meet their minimum capital adequacy requirements and remain in business. This is imperative as the pipeline for bank credit cannot be severely restricted. But that will not be the end of the story. After extensive write-offs and recapitalisation, if there is little change in the way the banks are run, then in a few years they will again have generated a substantial pile of fresh bad debts.

The banks have come to such a pass because of several reasons. One is the consequences of lending longer term to large infrastructure projects when their expertise lies in granting short term working capital loans. But the main culprit is the overarching control that senior government officials and their political masters have over banks. This has led to poor choice of the top management for the banks and inadequate governance standards.

Governance reforms

Fully aware of this reality, the current dispensation created the Banks Board Bureau, under the leadership of former CAG Vinod Rai, to bring about a fundamental change for the better in both selection of top management and governance standards. But that has been a futile endeavour.

As the quality of assets has deteriorated, the Reserve Bank of India has since 2014 issued increasingly rigorous directives to the banks to carry out asset quality reviews in order to end window-dressing and recognise non-performing assets (NPAs) for what they are.

Now things have come to a boil with the RBI issuing a directive in February that if creditors are unable to achieve a resolution for large NPAs of over Rs. 2,000 crore within 180 days, then they will have to be referred under the Insolvency and Bankruptcy Code (IBC).

With this deadline hanging over its head, the government came up with a new scheme in July, Project Sashakt. It outlined an elaborate process for large defaulters (above Rs. 500 crore), aimed at creating a vibrant market for online trading of stressed assets. Companies whose defaults cannot be resolved in this manner will, as a last resort, be brought under the IBC.

But under the new process, banks will first pass on their large sticky accounts to an asset reconstruction company (ARC) which will restructure the assets, define haircuts and transfer their ownership to one or more asset management companies (AMCs), which will be funded by sector-specific alternative investment funds (AIFs).

At the end of the process banks will get paid for the restructured assets (involving a haircut or discount), the ARC will be cash neutral and the ownership of the assets will pass on to the AMC-AIFs with a minimum 76 per cent of equity holding so that they can exercise ownership control. If this process is not completed in 180 days, a stressed company will go to the National Company Law Tribunal under the IBC process.

While the new process, Project Sashakt, has been welcomed by financial players it is widely agreed that success will depend on the stressed assets being realistically priced.

The inability of existing AMCs to make much progress in the resolution of stressed assets (estimated at Rs. 3-lakh crore for the above Rs. 500-crore category) is the reluctance of bank managements to agree to substantial haircuts (discounting of their dues).

Under these circumstances, what is the risk scenario facing the economy? The RBI says in its annual report for 2017-18 that over the medium term growth will depend on, among other things, “resolution of banking and corporate financial stress.” The latest financial stability report (June 2018) puts across the expert view that the risks of asset quality deterioration and additional capital requirement of banks will be “high”.

Future outlook

The report elaborates that around 60 per cent of experts feel that “continuous rise of NPAs and falling governance standards in banks continue to be a cause for concern.”

What the government has done through IBC and Sashakt is to take care of existing bad loans. This takes care of “continues rise in NPAs” mentioned above but not “governance standards”. Under this scenario, what happens beyond the medium term?

As things stand, with no change in governance standards (Vinod Rai exited BBB with little to show in terms of his recommendations being accepted), bad debts will reappear with the government being compelled to recapitalise the banks again. If this becomes a periodic feature, then we see a risk to the future of fiscal stability, maintenance of a pipeline for bank credit and growth. That would amount to a systemic risk.

The writer is a senior journalist.


Retail inflation cools to 3.69% in
August, IIP grows to 6.6% in July

The Business Line
Published on September 13, 2018

May spur RBI to hike rates in October, say economists

New Delhi, September 12: For many hapless consumers who are ravaged by the effects of the weak rupee and soaring domestic fuel prices, there was some solace on Wednesday in the form of good news on the retail inflation and industrial output front.

Retail inflation came in at a 10-month low of 3.69 per cent for August as compared to 4.17 per cent in the previous month. However, the latest Consumer Price Index (CPI)-based inflation print was higher than the 3.28 per cent level recorded in August last year.

Industrial output

Aided by some base effect and smart show by the manufacturing sector, factory output grew 6.6 per cent in July as compared to 1 per cent growth in July last year.

Last July and the subsequent months were characterised by the GST effects that depressed production processes especially in the SME segment.

For the April-July 2018 period, factory output grew 5.4 per cent higher than 1.7 per cent growth in same period last year, official data showed.

RBI policy rate hike

Many economists expect the Reserve Bank of India to go for a policy rate hike in its October policy review meeting.

Aditi Nayar, Principal Economist, ICRA, said the dip in the August CPI inflation below the Monetary Policy Committee’s medium termtarget of 4 per cent, juxtaposed by the looming inflation risks, the robust GDP growth print for Q1 FY19 and the continued weakening of the rupee, would complicate the next monetary policy decision.

On balance, the scales appear tipped towards a third consecutive rate hike in the October policy review, along with a change in stance to withdrawal of accommodation, unless crude oil prices and the rupee record an appreciable reversal in the intervening period, she said. Madan Sabnavis, Chief Economist, CARE Ratings, said: “Given the developments in the oil market and the currency we expect a rate hike of 25 bps in the October policy notwithstanding the sub-4 per cent inflation number”. CARE Ratings is looking at CPI inflation in 5-5.5 per cent range by end March.

Devendra Kumar Pant, Chief Economist, India Ratings, said a robust 1Q FY19 GDP growth, coupled with declining inflation trajectory and a relatively stable IIP growth, should make the RBI more optimistic about the economy and hold on policy rate in the forthcoming policy review in view of two back-to-back hikes.

However, the global developments manifesting in continued weakness of the rupee and elevated crude oil prices may prompt a rethink on the part of the RBI. Therefore, Ind-Ra, unlike its earlier stance, now believes that there may be a possibility of another rate hike this fiscal, Pant said.

However, some economists do feel that the cooling of inflation below the RBI’s comfort level raises the probability that the central bank may not go for another round of rate hike in October


A perilous edge

Prem Shankar Jha
The Indian Express
Published on September 13, 2018

Are all the owners and managers of these companies, and their bank managers corrupt, as the government would have us believe? The idea is absurd.

Indian industry is in meltdown. Seventy-eight of the largest companies in India are facing dissolution under the Indian Bankruptcy Code. Twenty have been declared insolvent and sent to the National Company Law Tribunal for dissolution.

Thirty more, all in the power sector, will also be sent to the guillotine because the Allahabad High court has denied them more time to sort out their woes.

Another 92 companies are on the chopping block because they are more than 180 days behind on their loan repayments. As if these woes are not enough, loan defaults by small companies have also doubled in the past year, signalling an imminent crisis in that sector as well.

Are all the owners and managers of these companies, and their bank managers corrupt, as the government would have us believe? The idea is absurd.

Most of the companies on the chopping block had dared to invest in infrastructure projects. And that the reason they did so was that the public sector was no longer doing it. This concentration of failure in the most capital-intensive projects, and the sheer pervasiveness of the collapse shows that the cause is not confined to individual delinquents, but systemic.

A systemic collapse can only result from a systemic failure.

In India, the RBI, has dealt it by imposing and then maintaining a regime of very high interest rates for industrial borrowers since 2010, regardless of the rate of inflation. It did this when inflation measured by the time-honoured wholesale price index was 8 per cent. It has persisted with this over the past four years when WPI inflation has been close to zero.

To justify this, three governors of the RBI in succession have argued that price stability will automatically lead to growth. They have buttressed this belief by citing a succession of IMF staff papers and other studies that have claimed to show that high rates of inflation do not raise the rate of economic growth, as was accepted for decades, but actually lower it. They did so despite the fact that not one of these studies has been able to define, let alone establish, the causal chain that leads from high inflation to low growth.

And they have done so despite the compelling theoretical and empirical evidence that some inflation has to accompany industrialisation because it requires the diversion of a part of the income of the economy from producing consumer goods to capital goods.

The economic miracle in south east Asia and China bears this out: South Korea had an average inflation rate of 21 per cent during the three decades in which it became an industrial powerhouse, and China has done so only with the help of stringent price controls on essentials.

Making price stability the first goal of policy, therefore, sacrifices growth at the altar of stability. That is what the RBI has been doing since January 2007.

What has made it impose this suicidal policy on the country, and why have two governments capitulated? The first reason is that our RBI governors have tried to outdo their industrialised country peers in orthodoxy by adopting inflation targeting without realising that the rich nations have entirely different goals.

But the second, more fundamental, reason is the imperative to keep the exchange rate stable. This has arisen because when the RBI raised the average domestic borrowing rate by 3 per cent in 2007-8, and did so a second time in 2010-11, it drove heavy industry and infrastructure companies to foreign capital markets, where unhedged loans were available for as little as 3 per cent.

Between 2008 and March 2015, around 300 of India’s largest companies borrowed Rs 4.5 lakh crore ($680 billion) abroad, mostly with maturity periods ranging from three to 20 years.

Between March 2014 and March 2015, after Narendra Modi’s victory became certain, borrowings increased by $181.9 billion. This raised India’s outstanding external debt by 38 per cent to $580 billion.

The euphoria was so intense that a large part of the new debt was not hedged against the risk of a fall in the value of the rupee. As a result, in 2015, 59 per cent of the $580 billion was vulnerable to devaluation.

For the borrowers, maintaining the exchange rate regardless of side effects has therefore become a matter of life and death. The goal of “inflation targeting” is not, therefore, price, but exchange rate stability. This quest has not only killed the real economy but created an imbalance between India’s foreign exchange debt and its reserves that has brought international hedge funds into the Indian money market, circling like wolves.

What India is experiencing is a mild version of Thailand’s economic collapse in 1997, which triggered the “Asian Financial flu”. The RBI has had the sense the rupee has depreciated by 10 percent in the last few months to 71.8 to the dollar, and is being hedged in forward markets at Rs 75.

The only way to stem the collapse is to lower the borrowing rate for loans with five or more years’ maturity to 4 per cent or less. This will allow embattled infrastructure and heavy industries to refinance their loans and revive the demand for consumer durables and office equipment.

The revival of these sectors and of housing, will greatly improve the viability the massive restructuring of debt by the public sector banks in the past three years. This has been a dismal failure so far because restructured companies faced the same market conditions as before.

Why 4 per cent? The short answer is that no country in the 19th century built the colossal infrastructure needed by industry with real interest rates of more than one or two per cent. In the 20th century, South Korea and China achieved their breakthroughs by raising capital at negative real rates of interest — hidden tax.

The risk that a reduction of interest rates could increase the outflow of foreign capital is real but likely to be short-lived.

First, industrialists burned by the plunging rupee will have no reason left to borrow abroad.

Second, the cheaper rupee will increase exports and reduce imports.

Third, lower returns on term deposits in banks will shift some of the money to the stock market causing them to rise.

When investment and consumer spending revive, these will gain value and pull foreign direct and portfolio investment back to the country and stabilise the exchange rate in a sustainable manner without killing investment.

But time is of the essence. Every day that the rupee depreciates, increases the repayment obligations of companies loaded with foreign debt and weakens their capacity to respond positively to measures designed to revive economic growth.

One more attempt to avoid domestic collapse by propping up interest rates will bring on the foreign exchange crisis that the government is mistakenly trying to avert through monetary policy alone.

Prem Shankar Jha is a senior journalist and author


Crisis of capitalism:
10 years after the Lehman collapse

Venky Vembu
The Business Line
Published on September 13, 2018

Has it been 10 years already?

Time flies, right? The collapse of the global financial services firm, on September 15, 2008, had a ripple effect — on economies and on livelihoods — around the world. Even India, which was relatively insulated, felt the impact as global trade ground down and credit lines dried up.

But is capitalism in crisis?

Right after the global financial crisis of 2008, the consensus opinion of economic historians was that capitalism was doomed. Eric Hobsbawm wrote that capitalism was “bankrupt” after the “greatest crisis of global capitalism since the 1930s”, when under the influence of the Great Depression in the US, the global economy shrank 15 per cent. In 2008-09, however, global GDP fell by only 1 per cent, but the contagion effect was widely felt.

Hasn’t the world come a long way since that time?

It’s easy to mistake the runaway financial markets around the world in recent months for proof that all is well. Remember, even before the 2008 crash, asset prices, including of housing and commodities, were booming, only to come crashing down when the party ended.

Aren’t booms and busts built into capitalism?

Of course, they are. As economists Raghuram Rajan and Luigi Zingales noted in their 2003 book Saving Capitalism from the Capitalists, efficient financial markets keep alive the process of “creative destruction” — whereby “old ideas and organisations are constantly challenged and replaced by new, better ones.” But what happened in 2008 was very different.

How so?

An asset bubble built on bankers’ avarice burst. The bankers got away with fat bonuses in good times; the banks had to be bailed out with taxpayers’ funds. It was a textbook case of “privatisation of profits” and “socialisation of losses”. Which is why there is now a clamour for an ‘overhaul’ of the capitalist economy to render it more equitable — and “accountable”. Some analysts see this as a revival of the politics of socialism.

Tell me more.

In the UK, the IPPR Commission on Economic Justice, put together by the Institute for Public Policy Research, has noted that in the decade since 2008, the UK has witnessed stagnant wages, and rising household debts. It wants an end to the “shareholder-driven model of capitalism” and an embrace of higher minimum wages and the inclusion of workers on company boards. There’s a similar trend under way in the US.

What’s happening yonder?

A recent round of primaries ahead of the November mid-term elections points to the fact that the politics of the Democratic party is lurching to the left. Senator Elizabeth Warner (a Democrat from Massachusetts), who is considered a likely candidate for the 2020 presidential election, recently introduced the Accountable Capitalism Act, under which companies would have to recognise that their duties go beyond maximising profits for shareholders, and protect the interests of other stakeholders: workers, customers, and the cities in which they operate.

What about India?

India is at the other end of the spectrum. Much of our polity is left-leaning; even the BJP, ostensibly a ‘right-wing’ party, is trapped in socialist policies. And for all of Narendra Modi’s proclamations that “government has no business to be in business”, his government has failed to deliver on the promise of “minimum government, maximum governance”. If anything, it’s the ‘crony capitalism’ model that has traditionally thrived in India. That too represents a failed capitalist model.

Source: Internet Newspapers and anupsen articles


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