IBA’s helping hand
EDITORIAL IN BUSINESS LINE
As an apex body the IBA is in a position to mediate to the mutual benefit of hard-pressed borrowers and banks now flush with funds.
Slowly, the shell-shocked economy is being treated to a stream of positive signals from Mint Street and New Delhi. While the Reserve Bank of India launched a softer monetary policy with a bouquet of liquidity-boosting measures last Saturday, North Block and the Prime Minster, Dr Manmohan Singh, have in the last few days met with bank chiefs and industry captains to assure them of support in this critical period. Bank chiefs are talking of softer interest rates. And the In dian Banks’ Association, in a novel move, intends to facilitate flow of bank credit to beleaguered mutual funds.
The IBA’s role in easing liquidity problems for mutual funds facing redemption pressures opens up tremendous possibilities for other borrowers who need funds to ride the humps created by a series of factors beyond their control. In this case, the association will act as a facilitation centre, enabling mutual funds to link up with banks that have the ‘headroom’ to lend; it would do this by collecting daily data on their members’ funds position to lend under the RBI scheme for credit to mutual funds. By serving as a sort of clearing house, the IBA brings together mutual funds — the borrowers — and banks — the lenders — in the same way that Internet websites help consumers match their needs to the best deals available for various services, as for instance, travel. As the apex body of the domestic banking industry, the IBA is in a position to mediate more actively to the mutual benefit of hard-pressed borrowers and banks now flush with funds. The RBI’s Saturday measures alone will inject Rs 1,40,000 crore; banks today have credit proposals worth some Rs 50,000 crore to consider but an aversion to risk is staying their hand. Not just small and medium enterprises but large corporations are finding credit difficult or just too expensive. Private airlines, for instance, were turned away by the large public sector banks that prefer the national carrier and its implicit sovereign guarantee. The IBA must expand its facilitation services to affected industries and bridge the gap between fund-flush but wary banks and credit-starved but blue-chip companies caught in the downward spiral.
With the RBI’s fund-injection measures, policymakers seem to have eased one problem; the possibility of interest rates falling will further brighten the prospects for the borrower. Now the issue is actual lending to grease industry’s wheels once again. Who better than the IBA to lend a helping hand?
Drowning in liquidity
S. S. TARAPORE IN BUSINESS LINE 7 11 08
Injecting large doses of liquidity would only result in hair-curling inflation in 12-15 months. The central issue that needs to be addressed is whether the Indian monetary policy response to the global meltdown was appropriate, says S. S. TARAPORE.
The global financial meltdown is unprecedented and the contagion has spread like wild fire. The central issue we need to address is whether the Indian monetary policy response was appropriate. The major industrial countries have worked in concert and pumped in large liquidity into the system and we, in India, have done likewise. What was ostensibly a liquidity problem is turning into a solvency problem.
We need to look at the path-breaking work, in 1926, by a Russian economist, Nickolai Kondratieff entitled Long Waves in Economic Life. The major premise was that capitalist economies experience long wave cycles of boom and bust and that each cycle lasts 50-60 years.
This work was unfortunately considered as a veiled attack on Stalin’s total collectivisation of agriculture and, in 1938, he was given the death penalty. Today’s economists and policymakers would do well to carefully imbibe Kondratieff’s fundamental work.
According to Kondratieff, there are four phases of the long wave cycle: Inflationary growth, stagflation/recession, deflationary growth or a plateau and, finally, depression. Furthermore, Kondratieff held the view that in each phase of the cycle, policy reactions are tempered by knowledge and experience and the endeavour is to attain a higher peak.
No room for complacency
Policymakers and opinion makers, the world over, would make us believe that all this is history and that we now have sound systems in place to ward off a long depression. The problems which have become visible may be only the tip of the iceberg and the world economy could well be headed to a depression.
In India, we are being assured that as we do not have the complex financial products, which have been the bane of industrial countries, we are protected from the international turmoil. Our systems could be as strong as or as fragile as global systems and, hence, there is no room for complacency. Furthermore, we could be at a different inflexion point of the cycle that could be deceptive. Still, the Indian situation is of relatively high growth of around 7.5 per cent in 2008-09 and 6-6.5 per cent in 2009-10. What is worrisome is that while, in recent weeks, inflation has somewhat abated, it is intolerable as it is still in double-digits. In such a situation, a large and sudden injection of liquidity is a cause of anxiety.
Monetary management
To be effective, monetary policy has to recognise the inevitability of real sector cycles. During the boom, there is a general euphoria and the central bank is egged on to lower interest rates and to flood the system with created money. As the party gets uncontrollably merry, the central bank has to take away the punch bowl but, by then, the downturn of the cycle would have started. The art of good monetary management is to undertake monetary tightening during the upturn of the cycle, well before the upper turning point is reached.
This is precisely what the former RBI Governor, Dr Y. V. Reddy, tried to do all along since 2004. Admittedly, monetary policy cannot be formulated in a vacuum but has to be consistent with the overall direction of economic policy. Dr Reddy’s parting remarks were telling when he said that had he had his way he would have tightened further. Dr Reddy was pilloried and burnt at the stakes but the merits of his monetary policy are slowly being recognised. His “Beatification” and subsequent “Canonisation” would take place only after the definitive history of the recent period is written.
In the major industrial countries and in a number of emerging market economies, large liquidity has been pumped in. Likewise, in India, the Reserve Bank of India (RBI) has recently pumped in at least Rs 300,000 crore, approximately equivalent to 7.5 per cent of banks’ deposit liabilities.
The repo rate has been reduced from 9 per cent to 7.5 per cent. The old central banking dictum on interest rates was “up by ones” and “down by halves” but the recent Indian experience appears to be “up by quarters” and “down by ones”.
Credit extension
Apart from a liquidity shortage, resulting in a cessation of credit, the situation in India has been one of over-extension of credit relative to the resources of the banking system. The year-on-year incremental credit-deposit ratio is a staggering 96 per cent. No wonder the banks have no resources to lend. After three years of unbridled 30 per cent per annum credit expansion, there is bound to be a slowdown.
The problem in India regarding credit expansion is structural and not shortage of liquidity. The former RBI Governor, late Dr I. G. Patel, would often tell the banks “do not lend the money you do not have.”
Rather than suddenly pumping in over Rs 300,000 crore of liquidity into the system within a few weeks, it would have been preferable to calibrate the release. Furthermore, the sharp reduction in the repo rate has made it even more out of kilter with other rates in the system. To be effective, the RBI’s policy signalling rate should be a penal rate and not a subvention.
The history of foreign institutional investments the world over is that large inflows are followed by outflows and, as such, the fall in the forex reserves was predictable. Admittedly, when forex reserves fall precipitously, the RBI should step in and prevent a total dislocation in the credit system by releasing some domestic liquidity.
Illustratively, if Rs 100 is withdrawn as a result of a forex reserve loss, the RBI should restore, say, only Rs 75. Excessive replacement of the reduction in liquidity will only reinforce the subsequent forex reserve loss.
Over time, the RBI’s exchange rate management has been par excellence. One should not look at nominal exchange rates in relation to the US dollar but monitor the Real Effective Exchange Rate (REER). In the recent period, the RBI has allowed only a gentle depreciation of the REER, which is only appropriate. Rather than opening up external commercial borrowings, the authorities should have considered:
Increasing the ceiling on FII investment in the government securities market; and
Non-Resident External Rupee Accounts (NRERA) should have been made free from reserve requirements and deposit rate control on such deposits should also have been lifted.
This relaxation should not apply to Foreign Currency Non-Resident (Banks) Deposits; in fact, this scheme, which was a creature of the 1990-91 crisis, should be abolished.
The world over, there has been too much merry-making. May be the time has come to face up to a long, dark winter of depression.
In India, measures to alleviate the pain will only result in greater pain. Injecting large doses of liquidity would only result in a hair-curling inflation in 12-15 months. We should not look for magical solutions. The role of the fisc and external sector management deserve separate examination.
(The author is an economist.
Banking on agriculture
The present slowdown, more than ever before, highlights the need for investments in farm-related industries.
If numbers alone could tell stories, then the Government could claim to have scripted a very happy narrative for agriculture. Both in his Budget speech this February and subsequently, the Finance Minister, Mr P. Chidambaram, stressed the increase in Gross Capital Formation from 10.2 per cent in 2003-04 to 12 per cent three years later. He also cited the jump in agricultural credit as evidence of the “turnaround” in the sector. So confident was he of the stream of bank funds to the rural sector that he hiked the current year’s target to Rs. 2,80,000 crore. If the dip in disbursals over the first half of the current fiscal is indicative of the prevalent mood among bankers, then the year may end far short of that figure. Ministry officials are sanguine the rest of the fiscal will more than make up for the first half’s deficit; but what difference would it make to the sector?
Not much. Almost all through the years when credit was rising, policymakers had begun narrating quite another story. In 2005, the Finance Minister, and in the following year, the RBI, introduced “financial inclusion” as a policy initiative to combat the startling truth of more than half the farmers having no access to any form of credit—formal or otherwise. Fifty per cent of the rural population was virtually outside the exchange economy. Nothing could have been a more eloquent proof of the failure of policy thus far — the Lead Bank Scheme of 1969 and the subsequent priority sector lending mark-ups — than the fact that just 22 per cent had access to formal bank credit, and 27 per cent benefited from moneylender while 51 per cent could do neither. For three years, new initiatives such as the use of self-help groups, banking correspondents and micro-finance institutions have become part of the inclusion drive. But how should the government judge their success in extending credit? Will the banking sector that views even private airlines as risky ventures today rush into a sector that has stayed sluggish over the years? And in any case, what would bank finance or a savings account do for those hapless farmers than help them meet present consumption needs?
The present slowdown, more than ever before, highlights the need for investments in farm-related industries and equally, an open and transparent process of land transfers that can allow the least productive farmers and labourers to find alternate employment. Only then will those rural credit numbers tell the story they were meant to.
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
WELCOME TO
26TH NATIONAL CONFERENCE
AT NEW DELHI
15TH TO 18TH NOVEMEBR, 2008
EDITORIAL IN BUSINESS LINE
As an apex body the IBA is in a position to mediate to the mutual benefit of hard-pressed borrowers and banks now flush with funds.
Slowly, the shell-shocked economy is being treated to a stream of positive signals from Mint Street and New Delhi. While the Reserve Bank of India launched a softer monetary policy with a bouquet of liquidity-boosting measures last Saturday, North Block and the Prime Minster, Dr Manmohan Singh, have in the last few days met with bank chiefs and industry captains to assure them of support in this critical period. Bank chiefs are talking of softer interest rates. And the In dian Banks’ Association, in a novel move, intends to facilitate flow of bank credit to beleaguered mutual funds.
The IBA’s role in easing liquidity problems for mutual funds facing redemption pressures opens up tremendous possibilities for other borrowers who need funds to ride the humps created by a series of factors beyond their control. In this case, the association will act as a facilitation centre, enabling mutual funds to link up with banks that have the ‘headroom’ to lend; it would do this by collecting daily data on their members’ funds position to lend under the RBI scheme for credit to mutual funds. By serving as a sort of clearing house, the IBA brings together mutual funds — the borrowers — and banks — the lenders — in the same way that Internet websites help consumers match their needs to the best deals available for various services, as for instance, travel. As the apex body of the domestic banking industry, the IBA is in a position to mediate more actively to the mutual benefit of hard-pressed borrowers and banks now flush with funds. The RBI’s Saturday measures alone will inject Rs 1,40,000 crore; banks today have credit proposals worth some Rs 50,000 crore to consider but an aversion to risk is staying their hand. Not just small and medium enterprises but large corporations are finding credit difficult or just too expensive. Private airlines, for instance, were turned away by the large public sector banks that prefer the national carrier and its implicit sovereign guarantee. The IBA must expand its facilitation services to affected industries and bridge the gap between fund-flush but wary banks and credit-starved but blue-chip companies caught in the downward spiral.
With the RBI’s fund-injection measures, policymakers seem to have eased one problem; the possibility of interest rates falling will further brighten the prospects for the borrower. Now the issue is actual lending to grease industry’s wheels once again. Who better than the IBA to lend a helping hand?
Drowning in liquidity
S. S. TARAPORE IN BUSINESS LINE 7 11 08
Injecting large doses of liquidity would only result in hair-curling inflation in 12-15 months. The central issue that needs to be addressed is whether the Indian monetary policy response to the global meltdown was appropriate, says S. S. TARAPORE.
The global financial meltdown is unprecedented and the contagion has spread like wild fire. The central issue we need to address is whether the Indian monetary policy response was appropriate. The major industrial countries have worked in concert and pumped in large liquidity into the system and we, in India, have done likewise. What was ostensibly a liquidity problem is turning into a solvency problem.
We need to look at the path-breaking work, in 1926, by a Russian economist, Nickolai Kondratieff entitled Long Waves in Economic Life. The major premise was that capitalist economies experience long wave cycles of boom and bust and that each cycle lasts 50-60 years.
This work was unfortunately considered as a veiled attack on Stalin’s total collectivisation of agriculture and, in 1938, he was given the death penalty. Today’s economists and policymakers would do well to carefully imbibe Kondratieff’s fundamental work.
According to Kondratieff, there are four phases of the long wave cycle: Inflationary growth, stagflation/recession, deflationary growth or a plateau and, finally, depression. Furthermore, Kondratieff held the view that in each phase of the cycle, policy reactions are tempered by knowledge and experience and the endeavour is to attain a higher peak.
No room for complacency
Policymakers and opinion makers, the world over, would make us believe that all this is history and that we now have sound systems in place to ward off a long depression. The problems which have become visible may be only the tip of the iceberg and the world economy could well be headed to a depression.
In India, we are being assured that as we do not have the complex financial products, which have been the bane of industrial countries, we are protected from the international turmoil. Our systems could be as strong as or as fragile as global systems and, hence, there is no room for complacency. Furthermore, we could be at a different inflexion point of the cycle that could be deceptive. Still, the Indian situation is of relatively high growth of around 7.5 per cent in 2008-09 and 6-6.5 per cent in 2009-10. What is worrisome is that while, in recent weeks, inflation has somewhat abated, it is intolerable as it is still in double-digits. In such a situation, a large and sudden injection of liquidity is a cause of anxiety.
Monetary management
To be effective, monetary policy has to recognise the inevitability of real sector cycles. During the boom, there is a general euphoria and the central bank is egged on to lower interest rates and to flood the system with created money. As the party gets uncontrollably merry, the central bank has to take away the punch bowl but, by then, the downturn of the cycle would have started. The art of good monetary management is to undertake monetary tightening during the upturn of the cycle, well before the upper turning point is reached.
This is precisely what the former RBI Governor, Dr Y. V. Reddy, tried to do all along since 2004. Admittedly, monetary policy cannot be formulated in a vacuum but has to be consistent with the overall direction of economic policy. Dr Reddy’s parting remarks were telling when he said that had he had his way he would have tightened further. Dr Reddy was pilloried and burnt at the stakes but the merits of his monetary policy are slowly being recognised. His “Beatification” and subsequent “Canonisation” would take place only after the definitive history of the recent period is written.
In the major industrial countries and in a number of emerging market economies, large liquidity has been pumped in. Likewise, in India, the Reserve Bank of India (RBI) has recently pumped in at least Rs 300,000 crore, approximately equivalent to 7.5 per cent of banks’ deposit liabilities.
The repo rate has been reduced from 9 per cent to 7.5 per cent. The old central banking dictum on interest rates was “up by ones” and “down by halves” but the recent Indian experience appears to be “up by quarters” and “down by ones”.
Credit extension
Apart from a liquidity shortage, resulting in a cessation of credit, the situation in India has been one of over-extension of credit relative to the resources of the banking system. The year-on-year incremental credit-deposit ratio is a staggering 96 per cent. No wonder the banks have no resources to lend. After three years of unbridled 30 per cent per annum credit expansion, there is bound to be a slowdown.
The problem in India regarding credit expansion is structural and not shortage of liquidity. The former RBI Governor, late Dr I. G. Patel, would often tell the banks “do not lend the money you do not have.”
Rather than suddenly pumping in over Rs 300,000 crore of liquidity into the system within a few weeks, it would have been preferable to calibrate the release. Furthermore, the sharp reduction in the repo rate has made it even more out of kilter with other rates in the system. To be effective, the RBI’s policy signalling rate should be a penal rate and not a subvention.
The history of foreign institutional investments the world over is that large inflows are followed by outflows and, as such, the fall in the forex reserves was predictable. Admittedly, when forex reserves fall precipitously, the RBI should step in and prevent a total dislocation in the credit system by releasing some domestic liquidity.
Illustratively, if Rs 100 is withdrawn as a result of a forex reserve loss, the RBI should restore, say, only Rs 75. Excessive replacement of the reduction in liquidity will only reinforce the subsequent forex reserve loss.
Over time, the RBI’s exchange rate management has been par excellence. One should not look at nominal exchange rates in relation to the US dollar but monitor the Real Effective Exchange Rate (REER). In the recent period, the RBI has allowed only a gentle depreciation of the REER, which is only appropriate. Rather than opening up external commercial borrowings, the authorities should have considered:
Increasing the ceiling on FII investment in the government securities market; and
Non-Resident External Rupee Accounts (NRERA) should have been made free from reserve requirements and deposit rate control on such deposits should also have been lifted.
This relaxation should not apply to Foreign Currency Non-Resident (Banks) Deposits; in fact, this scheme, which was a creature of the 1990-91 crisis, should be abolished.
The world over, there has been too much merry-making. May be the time has come to face up to a long, dark winter of depression.
In India, measures to alleviate the pain will only result in greater pain. Injecting large doses of liquidity would only result in a hair-curling inflation in 12-15 months. We should not look for magical solutions. The role of the fisc and external sector management deserve separate examination.
(The author is an economist.
Banking on agriculture
The present slowdown, more than ever before, highlights the need for investments in farm-related industries.
If numbers alone could tell stories, then the Government could claim to have scripted a very happy narrative for agriculture. Both in his Budget speech this February and subsequently, the Finance Minister, Mr P. Chidambaram, stressed the increase in Gross Capital Formation from 10.2 per cent in 2003-04 to 12 per cent three years later. He also cited the jump in agricultural credit as evidence of the “turnaround” in the sector. So confident was he of the stream of bank funds to the rural sector that he hiked the current year’s target to Rs. 2,80,000 crore. If the dip in disbursals over the first half of the current fiscal is indicative of the prevalent mood among bankers, then the year may end far short of that figure. Ministry officials are sanguine the rest of the fiscal will more than make up for the first half’s deficit; but what difference would it make to the sector?
Not much. Almost all through the years when credit was rising, policymakers had begun narrating quite another story. In 2005, the Finance Minister, and in the following year, the RBI, introduced “financial inclusion” as a policy initiative to combat the startling truth of more than half the farmers having no access to any form of credit—formal or otherwise. Fifty per cent of the rural population was virtually outside the exchange economy. Nothing could have been a more eloquent proof of the failure of policy thus far — the Lead Bank Scheme of 1969 and the subsequent priority sector lending mark-ups — than the fact that just 22 per cent had access to formal bank credit, and 27 per cent benefited from moneylender while 51 per cent could do neither. For three years, new initiatives such as the use of self-help groups, banking correspondents and micro-finance institutions have become part of the inclusion drive. But how should the government judge their success in extending credit? Will the banking sector that views even private airlines as risky ventures today rush into a sector that has stayed sluggish over the years? And in any case, what would bank finance or a savings account do for those hapless farmers than help them meet present consumption needs?
The present slowdown, more than ever before, highlights the need for investments in farm-related industries and equally, an open and transparent process of land transfers that can allow the least productive farmers and labourers to find alternate employment. Only then will those rural credit numbers tell the story they were meant to.
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
WELCOME TO
26TH NATIONAL CONFERENCE
AT NEW DELHI
15TH TO 18TH NOVEMEBR, 2008
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