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.”

Tuesday, April 19, 2016

World economy: welcome to the 'new mediocre'

World economic growth in 2016 will be poorer than thought earlier. Ditto in 2017- so says the IMF.

In terms of market values, world output will grow at 2.4 % in 2016-  growth of around 3% is considered modest. Is this a short-term thing or does it presage a long-term trend?

Many economists think it's the latter. The world is entering a period of low growth- what IMF Managing Director Christian Lagarde calls the 'new mediocre. Why is the world sliding into a low growth era. There are several competing hyptheses:

i Secular stagnation: This is a term coined by Alvin Hansen, an economist, in the 1930s. It has been resurrected of late by Larry Summers. The basic idea is that demand for goods is declining for a number of reasons. One is low population growth in the developed world.Another is that modern industry is less capital intensive and hence demand for investment goods is lower per unit of output than before- consider that   Facebook is worth billions in market cap while employing a fraction of what GM or GE employ. Thirdly, inequality is rising. This means the rich appropriate more and more of incremental income. They can consume only so much, so spending is impacted and so is investment. We have high savings and low investment, which is what explains why real interest rates are so low today.

ii. Liquidity trap: This is Krugman's view and it's a variant on the above. Monetary policy is ineffective at the low interest rates we have today and hence can't do much to stimulate output

iii. Falling productivity: Richard Gordon argues that economic growth is simply population growth multiplied by productivity growth. Both are falling. So, we have to accept that growth will be low in the years to come.

iv. Debt overhang: This is the view propounded by economists Rogoff and Reinhart. There's excess debt in the world economy following the financial crisis. Coming out of the debt overhang typically takes very long.

Now, if you accept any of the above, it means that it's futile for policies to push growth (although Summers think that public spending on infrastructure in the developed world can still make a difference).

The IMF in, its latest World Economic Outlook, seems to think that current growth rates represent policy failures- too much reliance on monetary policy and too little on fiscal policy and structural reforms. A combination of these along with moves to put life into banking systems in the Eurozone and elsewhere could make a difference.

I doubt that the political will exists for the purpose. I also believe that geo-political risks are pretty high, given the return of the  Cold War. So, we're going to be stuck with the 'new mediocre' for a while. That's bad news for those hoping for a return to 8 per cent plus growth rates in India.

More in my article in the Hindu, How to better the 'new mediocre'.

I have to say the title is rather deceptive- I argue there's little you can do to better the 'new mediocre'.

Sunday, April 17, 2016

Indian banking prospects

I have a detailed paper in EPW on The changing face of Indian banking

My conclusions:

India’s banking sector is going through a period of stress. It is as if the global financial crisis is impacting the Indian economy and Indian banking with a lag. It would be unwise to draw conclusions or prescriptions about Indian banking by looking at performance indicators over the past three years of stress. One has to consider the post-reform period as a whole and, in particular, the decade of 2003-12. Over a long period, there has been a secular improvement in efficiency and stability. It is important to understand that public ownership has been an important factor underlying this trend.
While competition is set to increase in the coming years, it is unlikely to impact full-scope commercial banks in a significant way, except for PSBs that have lagged behind badly in technology and performance. There is scope for improvement in the performance of PSBs within the framework of public ownership. We need to strengthen management and governance at PSBs while recognising the uniqueness of the PSB model. The answer does not lie in getting PSBs to conform to practices of private banks.
It is important to find ways to deal with stressed assets in the system. This entails creation of an independent authority to vet restructuring agreements between PSBs management and promoters, infusion of greater capital into PSBs than is currently envisaged and resolution of various issues in the economy at large.