The Duologue is a concerted effort by Vivek and Bheem to make sense with a unique lens. Now, on to the post!
Hello Everyone,
Note about Duologue
It's been a year since we started this Newsletter, majorly with an intention of consuming the news around more actively. To read between the lines, to ask deeper questions on the news presented to us, to search for facts and based on that form an informed opinion on things that matter to us. I chose to cover the Indian Economy out of my interest in the subject and majorly focused on macroeconomics and Indian Banking.
Vivek wrote on start-ups, technology and business strategy because of his interest and expertise in those areas.
We thought the insights and opinions we formed through our research should be put out in the open, to invite responses from our friends and the general public so that we could either help someone get a better understanding of a subject or we could be exposed to more facts/ insights from others so that we may update our understanding of an issue.
This post is an effort to further that cause. To look back upon a few of my pieces over the year, to see if my arguments and understandings hold the test of time and to see how I proceed further. With COVID having such a huge impact on both the economy and the start-up ecosystem and redefining all industries, I am hopeful that this next year we are able to provide you with some original analysis on the subjects.
Recap: Economy
So here is my take on the newsletters I have worked on over the year. Well, to be honest, I have not been active on the Newsletter in 2020 and duologue was more of a Monologue with Vivek alone navigating the ship. I apologise to you all and Vivek in particular and hope I present my views more often going forward.
COVID has had a profound impact on the Economy with British and the USA having registered a historic slowdown in their economies, India’s numbers for Q1-2021 are due in a few weeks but based on the RBI’s latest press conference, it is safe to assume that FY2021 would see a contraction of the Indian economy, for the first time since independence.
Export Surplus: In times of Deficit
This leads me to the 1st piece I wrote for Duologue, on the state of the Indian Economy, in anticipation of the Q1-2020 quarterly results. I had seen, how the consumption, investment, government spending and net exports had panned out in the quarter and hinted (correctly 🙂) that the GDP numbers were not expected to be good. I don’t think a major assessment is needed in the current scenario and that we are indeed headed for a recession.
However, I would like to touch upon the Net Exports as part of the GDP. India saw an exports surplus for the first time in over 20 years in June, 2020. However, it is not good news. It simply means that that the economic activity has been so muted and the global supply chains are so deeply impacted that we simply did not have as much imports as we normally do and hence India saw lower imports. Hence, a net export that was positive.
Monetary Policy: Liquidity & Postponing “BAD LOANS” recognition
The government's actions fall under what is referred to as the fiscal policy and RBI actions fall under the monetary policy.
We have seen the RBI coming out with numerous measures both at a microlevel and industry-specific over the year to tend to the economy, and more so during the pandemic. I had commented a couple of times on the RBI’s interventions.
One such occasion was when the RBI transferred a record Rs. 1.76 trillion to the government (to help manage its fiscal deficit) by using some accounting magic and by choosing a lower band set by the Bimal Jalan committee to transfer this record-breaking transfer. I had also argued that since a slowdown was impending, the RBI should be much more careful with managing its finances. The RBI, just today, announced it would transfer only Rs.56,000 Crores to the government as dividends to the government, while the government had had an expectation of over Rs. 60,000 crores. In times of crises, the RBI did not have a lot of money to transfer to the government!
Another time was on why repeated interest rate cuts would not have an impact on the actual lending rates of the Banks due to various factors but not limited to the poor asset quality of Public Sector Banks, higher interest rates offered by small savings schemes of government, crowding out of funds by the government thereby leaving little for the Banks to borrow from.
The broader theme though was that the RBI was becoming more pro-market and pro-government and was loosening the strings. Some would argue that these measures were necessary to help the growth of the economy.
We saw many such un-tightening measures through the year, the June 7, 2019 circular that gave Banks more flexibilities towards resolution of stressed assets, simultaneous purchase and sale of short term and long term bonds (Operation twist) in an effort to reduce the long term lending rates, extending the time period for the restructuring of MSME loans (Which the Govt them made it compulsory for the PSUs to follow to not declare any NPAs in this segment), extension for Date of Commencement of Commercial Operations for Projects, postponing of asset quality review of NBFCs, special long term repo contracts with Banks and many rounds of interest rate cuts, RBI intervening in the Franklin Templeton Mutual Fund issue.
Two important themes on RBI interventions emerge out of here, first to increase liquidity and the second the postponement of recognition of stressed assets. Now due to COVID, RBI has only doubled down on these measures. It has pumped in over 6 lakh crores into the market, has cut down interest rates multiple times(to the extent that FIIs flowing out of the country and further dilution of Indian Rupee is a real threat), it further relaxed the June 7 circular which had already diluted on the recognition of NPAs and extended moratorium to all loans for six months (Basically no income to Banks on loans under a moratorium for six months) and is soon to come up with one-time restructuring guidelines for all loans. Honestly, many of the measures are needed because COVID is a once in a generation shock to the economy and unprecedented measures need to be taken. But care has to be taken that these measures do not blow up into another NPA crisis like the one caused due to the measures taken during the 2008 recession period from which we are still emerging.
But one thing is certain, Banks are extra cautious in lending this time around. The Banks sat at an unprecedented excess capital 6 lakh crores in June 2020. The excess liquidity measures by the RBI and the repeated interest rate cuts could not nudge the Banks into lending due to the fear of how the COVID pandemic would pan out. Also, almost all major Private banks have raised capital during Q1-2021 in anticipation of a huge spike in NPA provisioning post the end of the moratorium and to start fresh lending when the scenario improves. It also helps them to have excess capital when they are expecting to not make a lot of money in the coming quarters.
BANKS: Merge and Sub-merge
Last year, Banking has seen a lot of action in the Indian financial world. I had covered the Merger of Public Sector Banks and how, though it is not a step that could solve any of the bad loan and capital adequacy problems of the Bank, it was an easy workable solution without many political consequences for a government to do by pushing merger of healthier and weaker banks and to infuse more capital into the Banks.
We had analysed using the Prompt Corrective Action framework of the RBI to see post-merger if these Banks would be “Globally Competitive Banks” as the government had packaged them, or would they become just weaker big banks, thus adding more stress into the already crippling Public Sector Banks. We saw that the latter was more probable (at least in a few mergers) unless there is more capital infused from the government. At the end of the day, there are many committees that have indicated at many reforms that have to be done to Public Sector Banks which the government did not do (End of dual control over PSBs by RBI & Govt, Govt to dilute stake to allow Market discipline to manage Banks, Professionally manage Banks, etc). Unless that is done PSBs can never truly recover and thrive.
Well, here is the story of the mergers from where we left it. The government did infuse over Rs. 70,000 crores into PSUs in FY2020 alone. Also, the RBI did its bit of tweaking to help the Banks. You see, the PCA framework has multiple parameters had has specific thresholds to control weak Banks. The RBI went ahead and diluted these parameters and thus aided weaker banks to function without them having to face adverse operational limits that the PCA framework imposes on the Banks. There were 11 Banks in the PCA framework in December 2018, by March 2019, it was down to 5. Well, to be fair, they exited the PCA framework even before the merger of Banks were announced, the PCA framework was not diluted after the announcement of the merger by the government. In his latest Book, ‘Overdraft’ the former RBI governor, Dr. Urjit Patel was wary of these dilutions to the framework and said it was unusual to remove banks from PCA framework before the annual audited results of the Banks were announced.
PCA is a type of market discipline and helps in the slow death of inefficient banks. Once there are operational restrictions that are placed on a bank, people tend to start pulling money out of these banks and put them in healthier Banks, thus leading to the slow death of inefficient banks. But by diluting the PCA framework guidelines themselves, there is a risk that a bank might not be healthy but might give an indication that it is until all hell breaks loose which could lead to a Bank run.
RBI, through its powers, placed Yes Bank under a moratorium in March 2020 after it saw that the health of the Bank had significantly deteriorated. To be fair on the RBI, the numbers of the Bank looked healthy enough for it to manage its business and were not too close to the PCA framework thresholds. Accounting errors, management tussle, underreporting of NPAs and low Provisioning of bad loans had masked the Bank’s true health. The Bank was eventually rescued by many Indian Banks, with SBI taking over 48% stake in the Bank. In hindsight, maybe RBI could have acted earlier, but one can never be sure.
Final Thread: Corporate Boost and Stagflation
I had written of the corporate tax cut-rate as well, arguing that it would not have any short term impact as India fundamentally had a demand problem and the tax rate could help in the medium to long run. Post-COVID, the government has come up with numerous schemes for the MSME sector and many welfare measures for the deprived but not much has been done for the corporates. I guess it was majorly because of this tax cut that was announced last year and so the government really does not have any legroom to further help them.
I wrote late last year of the dangers of stagflation but later said there was no real danger of a supply shock and that the inflation was caused due to high food inflation (onions). However, in the current scenario, stagflation is a real danger, given the global supply chains have been disrupted and the RBI has pumped in so much money and cut down interest rates to such an extent that it is causing inflation. Our growth rate is also expected to be in the negative region at least for the first 2 quarters. Given this, as in 2010, when India saw inflation of over 10%, a similar scenario is highly likely. Dr DV Subba Rao, the governor of the RBI from 2008-2013 had steeply cut down the interest rates in response to the 2008 recession but was slow in increasing the interest rates (earning him the nickname Baby Step Subbarao) and later admitted that maybe a faster increase in interest rates was in order. In its latest review of repo rates in August 2020, the RBI had held the interest rates steady cautioned by inflation that was over 6%.
Time will tell if we learn from the responses to past crisis which inadvertently created other problems (like high inflation, high fiscal deficit, ballooning of NPAs) and do not repeat them or if we let another crisis go to waste without any concrete reforms. As the year goes by and we see more data emerge and hear more announcements from the government & the RBI, I will keep you posted on how we are doing in this front.
Thanks for sticking around!
Regards,
Bheem
The Duologue is an effort by Vivek and Bheem to have a dialogue about varying topics.
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