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.


Thursday, April 14, 2016

Water crisis and the IPL

Read an excellent interview with Yogendra Yadav on the furore over the water crisis in Maharashtra and elsewhere and the question of moving IPL out of the state (since ordered by the High Court).

It's not that IPL is going to impact the water situation. It's just it seems rather extravagant in the face of a crisis:
I am in favour of shifting the matches. Not because I feel there is any relation to the IPL matches and the drought, not because the IPL is aggravating the drought, nor do I believe that shifting IPL matches from these grounds will alleviate the drought.
There is no direct relation, but there's a symbolic relation. The IPL is not a sport, but an extravaganza. It is a festival.
It is a tamasha and there is something obscene and vulgar about holding this kind of festivity in the middle of a drought.
And how would not holding the IPL matches help? It would help not in terms of litres of water and so on; all these arguments are silly. This entire controversy, this judgment and the petition has served one cause -- it has reminded this country that there is a severe drought.
Over 50 crore (500 million) Indians are currently suffering from a livelihood crisis, something to which the whole country had shut its eyes for the past six months.
The drought began in October 2015. We conducted our first Samvedna Yatra on October 2 and the whole country was ignoring the situation. If this IPL controversy wakes the country up to this reality, I cannot complain.
Yadav says the solutions to the water problem are all there in government documents:
Some of the most effective and routine things they should have done, about which everyone knows, is to repair canals, hand pumps and water supply channels and identify affected areas. These are routine matters about which every bureaucrat knows.
All this has been written in a Government of India document, Manual for Drought Management. It spells out the steps that need to be taken to avoid this (water crisis).
But, politically, a more difficult thing which they needed to do was to disallow growing sugarcane in drought-stricken areas. Sugarcane is one of the most water-guzzling crops. We gave this suggestion also.
Second, opening of new sugarcane and liquor factories could have been postponed by six months. Our third suggestion was to regulate water bottling plants, which take away some of the best potable water.
Moreover, diverting water for industrial purposes can't be a priority at a time when you have such a serious water crisis. We had suggested regulating this.

Global growth: medium-term prospects are tepid

The world is not about to return to rapid growth in the medium-term. Recovery will be slow in both advanced and emerging economies. Because people don't see a rapid recovery in the future, demand will be depressed today. Those are the bleak messages from Olivier Blanchard, IMF's former Chief Economist.

Blanchard notes that estimates of long-term potential growth have come down by 0.5 to 1 per cent since 2007. The reasons? Ageing and low productivity growth. Blanchard writes:
Productivity growth has been much lower since 2007, more so in Europe where the rate has declined by over 1 per cent in major countries, than in the US, where it has only declined by 0.5 per cent. This decline reflects in part cyclical factors and the effect of lower capital accumulation. But there is more to it: for the US at least, the evidence points to a slowdown in underlying productivity, starting before the crisis and reflecting the end of a period of successful implementations of IT innovations. The safe assumption is that the high pre-crisis productivity growth rate was unusual, and we should expect lower underlying productivity growth in future.
Expectations of the future feed into the present. When people believe that things aren't going to be a lot brighter in future, they will cut back on spending, whether investment or consumption. That will affect the ongoing recovery in the advanced world. Lower growth in the advanced world will impact emerging markets through lower demand for exports and a drop in commodity prices. Add to this the slowdown in China because of problems internal to that country and the picture is complete.

Blanchard believes there's little that policy can do to change the picture- neither negative interest rates nor helicopter money can change the long-term reality.

If this is correct, we in India should be bidding goodbye to growth of over 8 per cent in the medium-term. For 2016-17, the upper end of the range forecast by the finance ministry, 7-7.75 per cent, should be a challenge.

Wednesday, April 13, 2016

Central banks' push into negative territory is not working

Central banks have tried one thing after another since the 2007 financial crisis: lower interest rates, quantitative easing and, most recently, negative interest rates. They aren't getting the results they want: the IMF has recently again downgraded its growth forecast for the world. So, what next?

Well, one thing to understand, as Martin Wolf points out, is that negative interest rates are not entirely the work of the monetary authorities. Central banks are merely responding to supply-demand conditions. Where investment demand is way below savings, rates are bound to fall- and they could go into negative territory as well. Wolf writes:

Some will object that the decline in real interest rates is solely the result of monetary policy, not real forces. This is wrong. Monetary policy does indeed determine short-term nominal rates and influences longer-term ones. But the objective of price stability means that policy is aimed at balancing aggregate demand with potential supply. The central banks have merely discovered that ultra-low rates are needed to achieve this objective.

Wolf is right. He is also right in pointing out the big danger that goes with negative rates. Banks are passing on negative rates to borrowers but not depositors for fear that the latter will not park funds with them. This is bound to impact banks' bottom lines and threaten financial stability. The other concern with negative rates is that they low rates are getting consumers to save more, spend less- a point made by Larry Fink of Black Rock.

So, what do we do? The Economist has urged more unconventional measures: monetisation of the government's deficit (or helicopter money) and pushing up wages through tax incentives. Both will cause an increase in inflation and hence in aggregate nominal demand.

The Economist correctly points out that there is a more conventional tool that governments can employ: fiscal policy. It is worth pushing up public debt when the cost of it is as low as it is today. The time is ripe for a massive push to infrastructure in the advanced economies (exactly what we are attempting here in India today under different conditions).

Finally, the advanced economies of Europe need to get their banks' balance sheets into shape (again, echoing conditions in India). This means writing down bad debts and raising capital from the markets. The problem for European banks is that markets may not be in a mood to advance them funds. We are better placed here given that 70 per cent of banking assets are with public sector banks and the government can infuse funds into them instead of having them raising money from the market.

Lower interest rates, fiscal expansion and bank balance sheet repair- the ingredients of a recovery are much the same in the advanced economies as in India although the relative weights for each may vary.

Monday, April 11, 2016

How do you attract and keep millenials?

That's the biggest challenge that firms face today: how do you attract bright, young people and how do you keep them?

Lucy Kellaway has a scathing piece in FT on what you should NOT do and what you might do.

The standard answer, which she got from a Columbia university prof, was: motivate through learning, market your benefit, invest in HR.When she put this to her kids, all beginning to work, it was met with derision.

What puts off new recruits to a firms and makes them want to leave sooner rather than later? One reason certainly is that they don't get the necessary respect or attention:
One graduate told me she had just spent four months working on a deck of 250 PowerPoint slides no one would ever read. Another said juniors at her law firm were expected to nip out to buy sandwiches for seniors, as if they were their fags at Eton. A graduate with a first in English from Oxford university said her boss insisted on checking every email she wrote before it was sent, making her doubt her own ability to write a sentence. Almost everyone complained of the sheer stupidity of the tasks they were given to do. 
Another is the gap between expectations and the reality. Employers promise youngsters the most exciting jobs in the world and then go on to under-deliver by a wide margin. Then, there is the gap between what companies profess and what they practise:
More dangerous still is the gap between the corporate bullshit and the business itself.  A young graduate at a management consultancy tells me that every day it is drummed into him by superiors that the firm always acts in the best interests of the client. But every week he watches the same people trying to flog further costly services that the client doesn’t need. 

Kellaway has a simple answer to the problem of retaining millennials: stop promising big things and just try to make the job a little interesting.

I can assure you that this is not a British thing. A few months ago, a student of mine here at IIMA told me that he was in touch with dozens of his seniors. Not one of them was enjoying his or her job. They were sticking to their jobs because it meant a certain status and money and because there weren't too many meaningful alternatives (unless you wanted to go into academics).

Maybe my sample is biased but, amongst middle and senior executives I have come across in the public sector, I see less complaint, a greater sense of fulfillment. In many cases (such as the Railways), a very deep sense of loyalty. Clearly, all the money the private sector is throwing at people doesn't seem to be creating loyalty or satisfaction.

Thursday, April 07, 2016

Fending off a boss who wants you to flout rules

The Economist cites a recent survey that showed that 9% of employees faced pressure from their bosses to compromise on their ethical beliefs; 21% of employees who reported misconduct at work said they faced retaliation from their firms.

How to fend off a boss who wants you to do the crooked thing? One study shows that if you sport a religious symbol at work, bosses are less likely to ask you to do something is illegal or immoral. Maybe there's merit, then, in sporting a cross or having an image of a god at work or even wearing a tilak.

I nearly fell for this. Until I came to the end of the article. There's another study shows that those who make a show of righteousness are not likely to act more righteously:
In a further experiment, Ms Desai gave her participants the opportunity to behave ethically or unethically. Then, in what they believed was an unrelated study, they were given the option of appending a moral quotation to an e-mail to others in their group and/or to one sent just to themselves. Those who chose to signal their righteousness only to the outside world were more likely to have misbehaved in the first part of the experiment. 
There's the risk, therefore, that if you wear your religiosity on your sleeve, the boss will think there's a better chance of getting you to bend rules.

Moral of the story: do not expect academic studies to enlighten you in such matters. Trust your own instincts.

Wednesday, April 06, 2016

Constraints on the US Fed

There has been talk of the spillover effects of the actions of advanced country central banks, notably the US Fed, on other economies. This limits the freedom of action of those economies, especially emerging markets.

It is equally true, however, that conditions in the emerging markets impose constraints on the actions of advanced economies' central banks, as an article in the Economist points out:
IN THE weeks after December 17th, when the Federal Reserve raised its benchmark interest rate for the first time in nearly ten years, confident Fed officials told markets to expect four additional rate hikes in 2016. It has been obvious for a while that this guidance was wildly optimistic. Economists have been downgrading growth forecasts and markets have been retreating. At its meeting earlier this month the Fed acknowledged reality: it not only left rates unchanged, but also signalled in its projections that it expects to raise them by just two notches this year. This climbdown was not a surprise, but it does conceal a surprising admission: that American monetary policy is constrained, in part, by conditions in global financial markets.
The main reason is that in integrated financial markets, no economy can afford to be out of step with policies in the rest of the world nor can policy makers ignore conditions elsewhere. Policies cannot be framed only with respect to conditions in the domestic economy. Last December, it seemed natural for the Fed to hike the policy rate given that unemployment rate was down to 5% and inflation was edging up to the 2% mark. However, the Fed hike had immediate repercussions:
In late 2015 the expectation of a rate rise in America sent capital gushing into the country, pushing up the value of the dollar and tightening credit conditions elsewhere in the world. An expensive dollar makes American exports less competitive and places a drag on growth and inflation in the American economy. The effect on investors’ appetite for risk is more immediate.

Between the Fed’s December meeting and early February, American stocks dropped by 10%; share prices in Europe and Asia fell by more. The spread between corporate-bond yields and those on safe government debt rose sharply (see chart). Not until mid-February, as policymakers around the world sought to soothe markets with promises to support growth, did the panic dissipate. Since then, share prices have recovered and the dollar has fallen in value; with its decision on March 16th, the Fed confirmed investors’ suspicion that it would not continue on its planned tightening path.
It is interesting that in these conditions, the very definition of an inflation target is changing. When the US Fed talks of a 2% inflation rate as its target, it does not mean the inflation rate at a given point in time. It means the average inflation rate over a given period. So, if inflation was below 2% in recent years, it can afford to be above 2% in the coming years. This is what one calls ex-post justification- after the event, you find an argument to justify your position.

Friday, April 01, 2016

Why we need the public sector in banking

Most people make the case for public sector banks (PSBs) on grounds of meeting large social need- inclusion, priority sector, regional development, etc.

There is, however, a more solid case to be made for PSBs. This is that PSBs are a force for stability. Private banking systems are inherently unstable, as a recent book, which I have reviewed in EPW, makes clear. The author, Adair Turner, former head of UK's FSA, argues that private banks have every incentive to expand credit as much as possible. An excess of credit leads on to boom and the inevitable bust. Given the low levels of capital required by banks, an economic bust means a banking crisis.

There's really no way to avoid a banking crisis in today's private banking systems without restricting their ability to create credit. The extreme solution was proposed years back by the Chicago School which argued for 100% reserves in banking- all bank deposits should be invested only in safe securities and banks should exist primarily for the purpose of making payments. In other words, a zero credit banking system is the only safe system. Turner thinks this is too extreme a solution and instead proposes limits on banks' ability to create credit.

I would argue that an alternative is to have a public sector-dominated banking system. PSBs do not have the same incentives to create credit recklessly. That is because executive  pay is not linked to credit creation and the profit it generates. Secondly, unanticipated risks and losses and arise don't translate into bank failure and a banking crisis. Although depositors in India are insured only upto Rs 1 lakh of the deposits they hold, the public believes that the government stands behind their deposits in full. In other words, the sort of unlimited guarantee on bank deposits that came into vogue in Europe after the financial crisis of 2007 is something that is implicit in a PSB-dominated system.

This explains why we have not any failures in banking or a crisis despite the huge increase in NPAs in recent months. Even in the weaker PSBs, depositors are not queuing up to ask for their money. Contrast this with the situation in a large private sector bank in 2009 when the mere whiff of trouble almost caused a run on the bank.

Banks in India will have to fund projects whose risks are not always clear- as we have seen in infrastructure in recent years. Banks can't steer clear of these risks because there's nobody else to fund them- we don't have long-term financial institutions and bond markets to do the job. However, when these risks materialise, that should not translate into a banking crisis. These conditions can be met only with  a PSB-dominated banking system.

Free tuitions at top US universities?

America's top universities, such as Harvard, are under pressure from activists to make tuition free to their students, the Economist reports. The argument is a straightforward one: their endowments are so large that they don't to charge their students any fee- Harvard sits on an endowment of $36 bn.

American universities are not willing to offer free tuition or even reduce their fee, which has soared by 220% since 1980.  Why would they raise the fee when they can afford not to charge students? Simple. Higher fees mean greater power to spend- on new buildings, research, higher salaries for faculty. And if students can raise loans to pay the fee, why not? "We can rip off students, so we will"- seems to be the motto. Many will see shades of this in the IIMs' own propensity to raise fee in recent years.

American colleges argue that they try to care of needy students by providing financial aid- at Harvard, 70% of students are covered by aid of some sort. However, students still have to raise large loans to fund their education. The evidence is that this does come in the way of inclusiveness- those outside a small elite are intimidated by the thought of taking large loans to fund their education.

Again, one sees echoes of all this in the IIM system. The argument is made that most students can afford to take loans given that placement salaries are high. There are two flaws in this argument. One is that several students will still be discouraged from coming to IIMs  given the uncertainty about paying off large loans. The second is that high fees in the IIM system cause other B-schools to raise their fees even though their placement salaries are not high enough to justify the fee. So great is the demand for igher education that students will take the risk of going to lower B-schools even though they are not sure the salaries they will get will make the fee worthwhile.