It’s time big business stops blaming Rajan and RBI for everything

ARTS RAJAN

Vivek Kaul

When small children don’t get enough attention from their parents, they cry. And until they get attention, they keep crying.
Big business in India is a tad like that. For the last one year it has been crying itself hoarse in trying to tell the Reserve Bank of India(RBI) to cut interest rates. But the RBI led by Raghuram Rajan hasn’t obliged.
In the monetary policy statement released yesterday, the RBI decided to maintain the status quo and not cut the repo rate, as big business has been demanding for a while now. Repo rate is the interest rate at which RBI lends to banks.
The lobbies which represent the big businesses in India reacted in a now familiar way after the monetary policy.
The Confederation of Indian Industries said that the economic recovery was still fragile and a decision to cut interest rates would have helped the small and medium enterprises (SME) sector, which is credit starved currently. The lobby further added that if interest rates would have been cut businesses would have borrowed more.
On the face of it this sounds like a very genuine concern.
But Raghuram Rajan explained the real issue with SMEs not getting enough loans in a recent speech. The bad loans of Indian banks, in particular public sector banks, have gone up dramatically in the recent past.
As on March 31, 2013, the gross non performing assets (NPAs) or simply put the bad loans, of public sector banks, had stood at 3.63% of the total advances. 
Latest data from the finance ministry show that the bad loans of public sector banks as on September 30, 2014, stood at 5.32% of the total advance.
Why have bad loans gone up by such a huge amount? “The most obvious reason,” as Rajan put it was “that the system protects the large borrower and his divine right to stay in control.” Who is the large borrower? Big business.
As Rajan explained: “The firm and its many workers, as well as past bank loans, are the hostages in this game of chicken — the promoter threatens to run the enterprise into the ground unless the government, banks, and regulators make the concessions that are necessary to keep it alive. And if the enterprise regains health, the promoter retains all the upside, forgetting the help he got from the government or the banks – after all, banks should be happy they got some of their money back.”
Banks have tried to repossess assets offered as collateral against these loans in order to recover their loans, but haven’t been very successful at it. As Rajan put it in his speech: “The amount recovered from cases decided in 2013-14 under debt recovery tribunals was Rs. 30,590 crore while the outstanding value of debt sought to be recovered was a huge Rs. 2,36,600 crore. Thus recovery was only 13% of the amount at stake.”
Big businesses have been able to hire expensive lawyers and managed to stop banks from repossessing their assets. The small and medium enterprises haven’t been able to do that. Rajan said just that in his speech:“The SARFAESI [ Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest] Act of 2002 is, by the standards of most countries, very pro-creditor as it is written. This was probably an attempt by legislators to reduce the burden on debt recovery tribunals and force promoters to pay. But its full force is felt by the small entrepreneur who does not have the wherewithal to hire expensive lawyers or move the courts, even while the influential promoter once again escapes its rigour. The small entrepreneur’s assets are repossessed quickly and sold, extinguishing many a promising business that could do with a little support from bankers.”
Hence, small and medium enterprises have had to face problems because big businesses have decided to borrow and not to repay.
The CII further suggested that if RBI had cut interest rates businesses would have borrowed more. It needs to be clarified here that interest rates are not simply high because the repo rate is high at 8%. There are other reasons for it as well.
Big businesses have defaulted on such a huge quantum of loans that banks have had to charge the borrowers who are repaying a higher rate of interest. As Rajan put it in his speech “The promoter who misuses the system ensures that banks then charge a premium for business loans. The average interest rate on loans to the power sector today is 13.7% even while the policy rate is 8%. The difference, also known as the credit risk premium, of 5.7% is largely compensation banks demand for the risk of default and non-payment.”
This when the average home loan in the country is being given at 10.7%. Hence, a home loan to an individual is being given at a lower rate of interest than loans to power companies. And only big businesses defaulting on their loans are to be blamed for it.
Rana Kapoor who is the President of a business lobby called Associated Chambers of Commerce and Industry of India said: “RBI has obviously overlooked strong demand from the industry for a cut in the interest rates. The industry’s demand for lower interest rates was fully justified.”
Kapoor is the founder managing director and CEO of Yes Bank. It needs to be pointed out here that the bad loans of Yes Bank for the period of three months ending September 30, 2014, went up by 178.3% to Rs 54 crore in comparison to the same period last year.
What is surprising here is that a banker whose bad loan book has exploded is demanding a rate cut. I am sure Mr Kapoor understands how credit risk operates.
Also, business lobbies and businesses tend to totally ignore the fact that the RBI cannot do much about creating economic growth beyond a point.
As economist Tim Dudley puts it: “As long as people have babies, capital depreciates, technology evolves, and tastes and preferences change, there is a powerful underlying (and under-appreciated) impetus for growth that is almost certain to reveal itself in any reasonably well-managed economy.”
The phrase to mark here is “well-managed economy” and that is largely the government’s prerogative. Rajan acknowledged this
in the latest monetary policy statement. As he said towards the end of the monetary policy statement “A durable revival of investment demand continues to be held back by infrastructural constraints and lack of assured supply of key inputs, in particular coal, power, land and minerals. The success of ongoing government actions in these areas will be key to reviving growth.”
Criticising or trying to tell RBI what it should be doing, is not going to help big business much. If they have to criticise, it is the government they should be criticising. But that as we all know is not going to happen any time soon. Meanwhile, the RBI will continue to be the favourite whipping boy of big business.

The article originally appeared on www.FirstBiz.com on Dec 4, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

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RBI and Rajan are on the right track: the inflation monster needs to be killed first

ARTS RAJANVivek Kaul 

There is almost a formula to it.
A few days before the Reserve Bank of India(RBI) is supposed to meet to review the monetary policy, business lobbies and industrialists start coming out with statements demanding that the RBI cut the repo rate. Repo rate is the interest rate at which RBI lends to banks and sets the benchmark for the interest rates at which banks in turn lend to businesses and consumers.
This time was no different. “We hope for a 50 basis points cut in the repo rate as retail inflation has started receding,”
Confederation of Indian Industries (CII) Director General Chandrajit Banerjee had said on March 30, 2014.
Rana Kapoor, president, Associated Chambers of Commerce and Industry of India (Assocham), echoed the same sentiment when he said that the RBI should cut the repo rate by 50 basis points. One basis point is one hundredth of a percentage.
But the RBI did not oblige the lobbies this time as well. In it’s first First Bi-monthly Monetary Policy Statement, 2014-15, the central bank decided to keep the repo rate at 8%. This, despite the fact that inflation as measured by the consumer price index(CPI) has been on its way down.
In February 2014, CPI inflation was at 8.1%. This after it had touched 11.24% in November 2013. A major reason for the fall has been a fall in food prices.
As RBI governor Raghuram Rajan had said in speech on February 26, 204 “inflation measured by the new CPI has remained in double digits during April 2012 to January 2014, averaging 10 per cent over this period. Food inflation, which has a weight of 47.6 per cent in the index, has contributed the largest share of headline inflation. Food inflation itself has stayed in double digits throughout this period, edging down to 9.9 per cent only in January 2014.” In February 2014, food prices rose by 8.57% in comparison to last year.
Has the risk of food prices rising at a much faster rate gone away? Not really. Unseasonal rains and hailstorms in parts of the country have damaged crops, and this is likely to push up prices again. The RBI also thinks that the fall in food prices may be temporary. “Retail inflation measured by the consumer price index (CPI) moderated for the third month in succession in February 2014, driven lower by the sharp disinflation in food prices, although prices of fruits, milk and products have started to firm up,”
the RBI statement said.
It also feels that vegetable prices may not fall any further. “Since December 2013, the sharper than expected disinflation in vegetable prices has enabled a sizable fall in headline inflation. Looking ahead, vegetable prices have entered their seasonal trough and further softening is unlikely,” the RBI statement said.
The central bank also feels that there are “risks…stemming from a less-than-normal monsoon due to possible el nino effects.” Even this could drive up food prices.
Having said that, what is the link between interest rates and food prices? Prima facie there does not seem to be any link. But Rajan explained a link in his February speech. As he said “There has been an increase in liquidity flowing to the agricultural sector, both from land sales, as well as from a rise in agricultural credit. More loans to agriculture have fostered substantial private investment in agriculture, but may also have pushed up rural wages.” This in turn has played a part in pushing up food prices in particular and overall prices in general. And hence it is important to maintain high interest rates.
Rajan had also said that “monetary policy is an appropriate tool with which to limit the rise in wages, especially urban ones. The slowdown in rural wage growth may be partly the consequence of tighter policy limiting wage rise elsewhere.”
Also, non fuel- non food inflation, which constitutes around 40% of the consumer price index continues to remain high. “Excluding food and fuel, however, retail inflation remained sticky at around 8 per cent. This suggests that some demand pressures are still at play,” the RBI statement said. This number has barely budged for a while now. Non fuel-non food inflation takes into account housing, medical care, education, transportation, recreation etc. And this is a major reason why the RBI does not seem to be in any mood to cut the interest rate.
Business lobbies need to understand a basic point here. India’s retail inflation continues to remain high despite a collapse in investment. As Chetan Ahya and Upasna Chachra or Morgan Stanley write in a recent research report titled
Five Key Reforms to Fix India’s Growth Problem and dated March 24, 2014, “Public and private investment fell from the peak of 26.2% of GDP in F2008 to 17.3% in F2013. Indeed, private investment CAGR[compounded annual growth rate] was just 1.4% between F2008 to F2013 vs. 43% in the preceding five years.”
Now imagine what would happen if investments were to pick up a little? Inflation instead of coming down would have gone up for sure, creating further economic problems.
As economist Rajiv Malik of CLSA writes in a column in the Business Standard today “In fact, it is more than likely that if the investment had not weakened as much as it needed to – or if it had recovered sooner or more strongly than has been the case – India’s macroeconomic imbalances, including elevated inflation, would have been much worse.”
If India’s economic growth has to come back on track, the inflation monster needs to be killed first. And given that RBI and Rajan are on the right track.

The article appeared on www.FirstBiz.com on April 1, 2014

(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Japan to India: Busting the biggest myth of investing in real estate

India-Real-Estate-MarketVivek Kaul 

Japan saw the mother of all real estate bubbles in the 1980s. Banks were falling over one another to give out loans and home and land prices reached astonishingly high levels. As Paul Krugman points out in The Return of Depression Economics “Land, never cheap in crowded Japan, had become incredibly expensive: according to a widely cited factoid, the land underneath the square mile of Tokyo’s Imperial Palace was worth more than the entire state of California.”
As prices kept going up, the Japanese started to believe that the real estate boom will carry on endlessly. In fact such was the confidence in the boom that Japanese banks and financial institutions started to offer 100 year home loans and people lapped it up.
As Stephen D. King, the chief economist at HSBC, writes in his new book 
When the Money Runs Out “ By the end of the 1980s, it was not unusual to find Japanese home buyers taking out 100 year mortgages (or home loans), happy, it seems, to pass the burden on to their children and even their grand children. Creditors, meanwhile, naturally assumed the next generation would repay even if, in some cases, the offspring were no more a twinkle in their parents’ eyes. Why worry? After all, land prices, it seemed, only went up.”
Things started to change in late 1989, once the Bank of Japan, the Japanese central bank, started to raise interest rates to deflate the bubble. Land prices started to come down and there has been very little recovery till date, more than two decades later. “Since the 1989 peak…land prices have fallen by 60 per cent,” writes King.
E
very bull market has a theory behind it. Real estate bull markets whenever and wherever they happen, are typically built around one theory or myth. Economist Robert Shiller explains this myth in The Subprime Solution – How Today’s Financial Crisis Happened and What to Do about It. Huge increases in real estate prices are built around “the myth that, because of population growth and economic growth, and with limited land resources available, the price of real estate must inevitably trend strongly upward through time,” writes Shiller
And the belief in this myth gives people the confidence that real estate prices will continue to go up forever. In Japan this led to people taking on 100 year home loans, confident that there children and grandchildren will continue to repay the EMI because they would benefit in the form of significantly higher home prices.
A similar sort of confidence was seen during the American real estate bubble of the 2000s.
 In a survey of home buyers carried out in Los Angeles in 2005, the prevailing belief was that prices will keep growing at the rate of 22% every year over the next 10 years. This meant that a house which cost a million dollars in 2005 would cost around $7.3million by 2015. Such was the belief in the bubble.
India is no different on this count. A recent survey carried out by industry lobby Assocham found that “over 85 per cent of urban working class prefer to invest in real estate saying it is likely to fetch them guaranteed and higher returns.” 

This is clearly an impact of real estate prices having gone up over the last decade at a very fast rate. The confidence that real estate will continue to give high guaranteed returns comes with the belief in the myth that because population is going up, and there is only so much of land going around, real estate prices will continue to go up.
But this logic doesn’t really hold. When it comes to density of population, India is ranked 33
rd among all the countries in the world with an average of 382 people per square kilometre. Japan is ranked 38th with 337 people living per square kilometre. So as far as scarcity of land is concerned, India and Japan are more or less similarly placed. And if real estate prices could fall in Japan, even with the so called scarcity of land, they can in India as well.
Economist Ajay Shah in a recent piece in The Economic Times did some good number crunching to bust what he called the large population-shortage of land argument. As he wrote “A little arithmetic shows this is not the case. If you place 1.2 billion people in four-person homes of 1000 square feet each, and two workers of the family into office/factory space of 400 square feet, this requires roughly 1% of India’s land area assuming an FSI(floor space index) of 1. There is absolutely no shortage of land to house the great Indian population.”
The interesting thing is that large population-shortage of land is a story that real estate investors need to tell themselves. Even
 speculators need a story to justify why they are buying what they are buying.
Real estate prices have now reached astonishingly high levels. As a recent report brought out real estate consultancy firm Knight Frank points out, 29% of the homes under construction in Mumbai are priced over Rs 1 crore. In Delhi the number is at 11%. Such higher prices has led to a drop in home purchases and increasing inventory. “The inventory level has almost doubled in the last three years. In the National Capital Region, the inventory level reached 31 months at the end of March 2013 against 15 months at the end of March 2010, while in the Mumbai Metropolitan Region the inventory level has jumped from 17 months to 40 months. In Hyderabad, it reached 49 months in March 2013 as compared to 23 months in March 2010, according to data by real estate research firm Liases Foras. Inventory denotes the number of months required to clear the stock at the existing absorption rate. An efficient market maintains an inventory of eight to ten months,” a news report in the Business Standard points out.
The point is all bubble market stories work till a certain point of time. But when prices get too high common sense starts to gradually come back. In a stock market bubble when the common sense comes back the correction is instant and fast, because the market is very liquid. The same is not true about real estate, because one cannot sell a home as fast as one can sell stocks.
Real estate companies in India haven’t started cutting prices in a direct manner as yet. But there are loads of schemes and discounts on offer for anyone who is still willing to buy. As the Business Standard news report quoted earlier points out “As many as 500 projects across India are offering some scheme or the other, in a bid to push sales in an otherwise slow market. According to 
Magicbricks.com, an online property portal, Mumbai has the maximum number of projects with schemes/discounts at around 88, followed by Delhi with 56 and Chennai and Pune with 33 each. Kolkata has 30 such offers, while Hyderabad has 18 and Bangalore has 16. On a pan India level, Magicbricks has about 274 projects with discounts offer.”
Of course the big question is when will the real price cuts start? They will have to happen, sooner rather than later.

The article originally appeared on www.firstpost.com on July 2, 2013

(Vivek Kaul is a writer. He tweets @kaul_vivek)