Bailing in deposits - the only alternative is to nationalise banking

This article was published by DNA on its opinion page on 13th Dec 2017

There’s never a dull moment in banking these days. The Financial Resolution and Deposit Insurance (FRDI) Bill 2017, now sent to a Parliamentary Committee, has been the latest source of much-alarmed commentary recently. At the heart of the alarm is the concept of “bail in” introduced in the bill. Typically, when in stress, banks around the world have been bailed out, ie, external funds (mostly taxpayer) have been used to rescue depositors and bond-holders. A bail-in is just the opposite, where depositor/bond-holder funds could be used to rescue a distressed bank.

In simple terms, it would mean conversion of the bailed-in deposit into equity. In the case of FRDI, the relevant bail-in clause has a provision of “cancelling a liability owed by a specified service provider” and “modifying or changing the form of a liability owed by a specified service provider”. 

The principle of bail-in has been discussed in depth since the global financial crisis of 2008 when the US and Europe alone spent upwards of $1 trillion of taxpayer funds to bail-out stricken banks. The moral hazard question — using taxpayer money to bail-out private investors/depositors — is one that had to be answered. The Bank of International Settlements (BIS, the central bank of all central banks) and G20 formed the Financial Stability Board (FSB) in 2009 to draft rules to prevent an encore of such situations. Bail-in was part of the package of sweeping reforms suggested by BIS. Since then, a number of countries have implemented country-specific banking regulations around bail-ins. European Union’s Bank Recovery and Resolution Directive set out broad guidelines for rescuing distressed European banks. 

Since then, Europe has used bail-ins a number of times to rescue banks. Starting with a small Danish bank (Amagerbanken), which went bankrupt in 2011, prompting Denmark’s Finansiel Stabilitet to force bailing in of high-value deposits and bonds. This was small compared to Cypriot banks in 2013, which saw massive bail-ins of high value ( >Euro 100,000) deposits and bonds to rescue banks reeling from Greek sovereign defaults. Even more recently, in 2016, Banco Popular, Spain’s sixth-largest bank, had certain categories of bonds bailed in en masse, even though depositors were spared. 

In a nutshell, it is an idea whose time has not just come but has been tested live many times. What explains the “oh my God” reactions to FRDI then?

Prima facie, the rationale is deceptively intuitive — small depositors put their life’s savings into bank deposits. Corralling them as equity to rescue distressed banks is unfair and illogical. Politically, this has indeed been the case globally (and in India). Outside of cooperative banks, not a single depositor has lost any money in India, even when their banks went belly-up. In the recent past, instances of Global Trust Bank (GTB) and Bank of Rajasthan are illustrative — RBI organised bail-outs in each case to protect depositors. The issue is, all bailouts involve taxpayer funding, explicit or implicit. In the case of GTB, the same was implicit, via funding required in the Oriental Bank of Commerce that took GTB over. The recent Rs. 1.3 lakh crore recapitalisation programme of Public Sector Banks (PSB) is an instance of explicit taxpayer funding of bank bailouts. Back to moral hazards!

The bigger issue is simple — private sector banks, in good times, make profits for its shareholders. But in distress, they are expected to be bailed out by the state. 

A classic case of privatisation of profits and nationalisation of losses. It is an untenable equation, precisely why bail-ins become crucial. Banks are not ordinary enterprises. Sans a bailout or a bail-in, a bankrupt bank will have massive repercussions on not just the financial system but also the larger economy. Lehman Brothers is an illustrative case — a medium-sized investment bank, its bankruptcy nearly brought the financial system to a collapse.

Above all, while Lehman did not have depositors, its senior unsecured bondholders (same seniority in capital structure as depositors) received nothing more than 10-15 cents on every dollar they had invested. Turn back to the Cypriot example, where bailed-in depositors/bondholders have retained at least 40-50 cents to every dollar they had invested. No two cases are the same, but they do provide illustrative lessons.

In a nutshell, the choice between a taxpayer-funded bailout and a depositor-funded bail-in isn’t that much of Hobson’s territory. 

If bail-ins are considered sacrilege, the default option left is to nationalize banks altogether. That way, all profits would belong to taxpayers. And then, when there is a bank in distress, taxpayers pick up the rescue tab. The Indian banking system, with PSB having 70 per cent market share, have tackled the moral hazard quite elegantly. Unfortunately, some of those who cry loudest for privatisation of banks are also those that have expressed the greatest horror at the bail-in provisions of FRDI. Unfortunately, like in everything else in life, we cant have our cake and eat it too!

New Insolvency Law - the govt is right, market is wrong

This was published in the DNA Opinion page on 29th of Nov, 2017

The recent changes to the Insolvency and Bankruptcy Code (IBC) through an Ordinance has brought into stark relief an enduring cliché — “good politics is not good economics”. Or at least, that is the dominant narrative of the market and the financial nomenklatura (let’s call it the finklatura) that cheerleads the market. Prima facie, the rationale of the finklatura is unexceptionable. 

The amended IBC essentially bars controlling shareholders (or promoters) of companies from bidding for their bankrupt companies that are being auctioned off via the NCLT (National Company Law Tribunal)-overseen process. In its original avatar, only those promoters deemed as “willful defaulters” were proscribed from bidding. Before this amendment came through, bidders in many of these cases before the NCLT included promoters (eg, Ruias for Essar Steel).

The politics of this is ostensibly simple — harsh measures against big business make for good optics and good messaging.

Economically, the finklatura asserts, it’s the other way round. Currently, there are 12 identified bankrupt companies that are before the NCLT for auctions that try to minimise the haircuts creditors (primarily banks) will need to take on the loans outstanding. In the short run, with promoters out of the process, bids are likely to turn less aggressive. There are multiple reasons for that. Most of the 12 companies are in steel, power and infrastructure sectors. To start with, all of these are industries where an enormous amount of local operating domain knowledge is critical to successful operations. Second, all 12 are large, complex enterprises — typically insiders have a lot better handle on the complexities of effective management. Put both factors together, and it is clear why existing promoters would have greater confidence in running these companies, and therefore bid more aggressively, compared to any other third-party bidder. The cherry on the cake —– structurally, all three are what economists call oligopolistic markets, i.e, industries with few operating players. In other words, in the best of times, there are relatively few viable bidders, and removing the promoter from the fray takes away a large chunk of active interest in the auction. 

Less aggressive bids, naturally, would cause the banks to accept a price that demands a higher haircut on their loans (initial market estimates range from 10-20 per cent higher haircuts in bids). This, in turn, would mean banks requiring more capital to clean up their balance sheets. Given that the recently announced bank recapitalisation plan is fully taxpayer-funded, this would check all the wrong boxes — higher public debt, higher interest rates, potentially even an expansion of the recapitalisation required, and all their downstream adverse consequences. The economic impact, therefore, is clear, that we have (yet again) sacrificed economic gains at the altar of politics. Or is it?

Let us examine the economics of it. There has recently been a great deal of excitement around Richard Thaler’s Nudge Theory (primarily driven by, as is usual for arcane subjects, by the Economics Nobel Prize awarded to Professor Thaler). 

Simply put, a Nudge is an act (or influence) that alters behaviour, while not precluding any options for the user. Now, a law is somewhat more than simply a nudge, it is perhaps more akin to a shove. From a signalling standpoint though, this shove makes for interesting potential outcomes. Fundamentally, a strong, almost unforgiving insolvency law sends a strong message to promoters across the board. The message fundamentally seeks to alter promoter behaviour. It does not preclude the option of promoters taking loans in their enterprises but puts the fear of God on ensuring prudence, analytical rigour and above all, integrity, in the utilization of loans. 

India’s promoters don’t fall sick, only their companies do — has been an oft-quoted, and sadly, accurate description of Indian capitalism. The spectre of promoters of distressed companies remaining in a saddle, infusing no additional equity, even as banks take large haircuts on loans — militate against a very fundamental definitional tenet of the market economy. Under that tenet, creditors are senior to equity shareholders over assets of a company.

In other words, creditors need to be repaid in full before equity-holders can own any assets of a company that has defaulted on servicing its loans. Seldom has this been honoured in its letter and spirit in India. The new law and the ongoing resolution process should, hopefully, establish the seniority of the creditor in the capital structure, for perhaps the first time in India.

All policymaking is political. In this case, the good politics of the law makes for good economic principles too. Ben Graham, the legendary investor, described markets as being a voting machine in the short term (tallying up stocks that are popular and unpopular) and weighing machine in the long term (assessing the substance). In the case of the new Insolvency law, the nomenklatura representing the markets is seemingly in its voting phase. Ironically, the vote-driven government seems to have “weighed” it in a lot better!     

Interest Rates: Stars Are Aligning, Not In The Direction Markets Hope!

This article was published by the Business World Magazine on the 26th of Nov, 2017

Interest rates are always in the news, but decibel levels on India's rates have gone up manifold since the last quarterly GDP growth print (of 5.7%) came out. The general refrain has been that India's rates, especially real interest rates (ie, net of inflation) are too high, and are adversely affecting growth and other macro outcomes like jobs. At the receiving end of most criticism has been the Reserve Bank of India (RBI), for not cutting policy rates aggressively. 

Unfortunately, like it is most of the times, the noise is likely to remain just that. Macro variables have not only vindicated RBI's stance on keeping rates steady, but also point towards marginal hardening of market yields.

To start with, the global monetary cycle, after years of easy money, is turning. Of the three major Central Banks (in US, Europe, Japan), two have embarked on a major unwinding of the Quantitative Easing (QE) that started after the global financial crisis in 2008, and injected trillions of dollars of liquidity in the global markets. At the same time, the global economy has started showing a coordinated upturn - IMF has recently upgraded its global growth forecasts to their best levels in five years. Global growth is expected to be 3.6% in 2017 (compared to 3.2% in 2016), driven by both developed markets (22% in 2017, compared to 1.7% in 2016) and developing markets (4.6% versus 4.3%). For well over a year, we have seen the goldilocks period in global growth since 2008 - with jobs, industrial production and global trade all moving up in tandem in a secular trend across the world. Both these factors, ie, unwinding of QE and strong global growth, together have meant that global interest rates are on their way up, limiting the headroom for Indian interest rates to decline from current levels.

India's macro variables on the other hand have started worsening at the margin. The key ballast for the economy in the last couple of years has been stable twin balance sheets (fiscal and trade) and low inflation, even as the economy settled to a low(er) growth equilibrium. The twin deficits have worsened. One, trade deficit is trending higher (averaging $12.6 billion in FY2018 compared to USD8 billion in the previous year). Two, fiscal situation of both state and central government have worsened, with farm loan waivers, state pay commission payouts, and now, the big bank recapitalisaiton plan (more of that later). To make things a little more interesting, inflation too seemed to have bottomed out, with more upside risks as global oil prices approach the USD60 level. In a nutshell, there is more at risk today for RBI to cut interest rates than many would have us believe.

The last piece in the interest rate jigsaw is the mega bank recapitalisation plan, funded substantially via a 1.3 lac crore Recap bond issuance. Ostensibly, this shouldn't expand the fiscal deficit - as many in the government, led by the Chief Economic Advisor have been at pains to explain. While "below the line" is the fashionable imprimatur of the Recap bonds, the impact of such definitions are optical rather than real. Effectively, the government (or some government institution) will issue bonds. While there might be adequate liquidity in the system to subscribe to these bonds, it expands the supply of bonds in the economy. In other words, it takes up the debt-GDP ratio, and skews the demand/supply dynamics for the bond market, adversely at the margin. At the end of the day, all bond (and equity) supply has to be financed by the same pool of financial (largely household) savings in the economy. Ergo, a large addition to the existing stock of bonds makes additional demands on the same pool, irrespective of the accounting treatment.

At the end, the real question is, does it matter? Will a reduction in interest rates by (say) 100 basis points kickstart the private investment cycle? When capacity utilisation in industry is running at mid-70% levels, the answer is almost obvious. In the last three year, the Indian economy has been marked by remarkable macro-stability in an increasingly uncertain world. By lowering rates today, is the marginal gain, in terms of higher potential growth, worth the risks of deteriorating macro? Historically, there has been very little correlation between interest rates and growth in India. Our growth challenges are elsewhere, in inadequate demand. Lower interest rates don't make for a good enough solution in the toolkit - the rates doves are barking up the wrong tree!

Moody's upgrade is a milestone in India's development journey

This was published in the Economic Times dated 20th Nov, 2017

In India’s argumentative ideas space, no news is good news. Therefore, the kerfuffle over the upgrade of India’s sovereign ratings by Moody’s (to Baa2, from Baa3) is entirely expected. For the partisan, it is a definitive validation of the government’s economic management. To naysayers, it is at best empty optics at a time when the economy is slowing down, at worst highly suspect on timing and credibility. Curiously, both miss essential woods for trivial plants.

First, the basic point – credit ratings, like most ratings, are predominantly an evaluation of the past, even though the objective is to provide guidance for the future. An upgrade is typically rare, especially so after the global financial crisis in 2008. It takes years of evaluation of policies (primarily related to macro-stability – debt-levels, sustainability of public finances, stability etc) before rating upgrades are done. In this case, the upgrade is especially creditable as it comes barely four years since India was classified as one of the “fragile five” economies, struggling with high twin deficits in fiscal and current accounts. To that extent, the current government deserves a lot of credit – it has privileged macro-stability over growth from its first day. It started with its first Budget, when the Finance Minister stuck with the deficit target set by his predecessor, a number that was received with much scepticism when it was presented by P Chidambaram. Since then, government has been a dogged “fiscal fundamentalist”, refusing any slippages even as growth plunged in the recent quarters. On the external account, a combination of luck (declining oil prices) and pluck (RBI ignoring shrill calls for massive reduction in interest rates), has kept the situation on an even keel.

Second, in many ways, this upgrade is merely a partial correction of a historical anomaly. Baa3, the toe-end of investment grade, clubs India with a bunch of countries with far worse macro-indicators. It’s a point that has been made repeatedly by Indian policymakers, most notably by Chief Economic Advisor Arvind Subramaniam in a section in the last Economic Survey. India’s structural strengths, eg, public debt entirely funded via rupee loans, all but a small part via local savings – were seemingly ignored while benchmarking on headline numbers.

Third, and most important point, is one of future signaling. What does it mean for India’s economic prospects going forward?

To start with, the sovereign rating is an estimation of the sovereign’s ability to repay its loans. An upgrade, technically, lowers the cost of borrowing for the sovereign. This is of limited practical utility to India, as the Indian government does not fund its deficits via offshore commercial bond markets. The entire public debt of India is funded via the domestic Rupee (INR) bond market, and foreign investor participation there is very small, and tightly regulated through quotas.   

Sovereign rating also serves as a benchmark for corporate entities domiciled in that country, as corporate ratings are (barring very exceptional cases) capped at the sovereign rating of the home-country of the corporate. Soon after the sovereign upgrade, Moody’s upgraded a bunch of Indian corporate entities (largely public sector companies). Over time, this has an impact on corporate ratings down the chain as well. While not automatic with a sovereign upgrade, a higher sovereign rating opens up fresh space for corporate upgrades too. This would result in reduction in cost of borrowing for Indian companies looking to raise financing from offshore bond markets.

Most important though is the optical macroeconomic signal. A ratings upgrade gives out a positive narrative on policy and builds incremental confidence in foreign investors. There are material benefits of the same, eg, in terms of incremental foreign investment pools from global Pension and Life Insurance firms that have minimum ratings criteria for investing. Typically, such incremental flows would tend to bid up Indian bond prices (both onshore and offshore) – we have already seen the first signs of the same in the form of dropping yields on government bonds. Higher bond prices, or lower yields, would tend to lower cost of funds – marginal for the government, but significant for corporate sector. Incrementally higher foreign flows tend to bid up INR too, making investments in a host of other Indian financial assets – equities, Real Estate – incrementally more attractive to foreign investors. It is especially propitious time for Public Sector Banks (PSB), that would find it easier to raise capital as part of the recapitalization plan announced earlier this month (PSB are expected to tap public markets to raise nearly 60,000 crores as a part of this plan). Lastly, as a net importer, a higher INR flows through as lower inflation into the economy, as imported goods become cheaper.

This isn’t an unmixed blessing. High levels of foreign flows resulting in rapid currency appreciation can result in loss of export competitiveness, with adverse consequences. South Korea’s meltdown in 1997-98 was at least partially due to a similar situation, barely a couple of years after it received a sovereign ratings upgrade.

In a nutshell, a ratings upgrade isn’t a major climax, nor is it much ado about nothing. It is a positive milestone, and quibbling about the size of the same is essentially narcissism of minor differences. But it is merely one milestone in India’s development journey, where there are miles to go before we can even think of dozing off!

Bank Reforms - preparing for the next crisis?

This was published in the DNA newspaper dated 1st Nov 2017

The Public Sector Bank (PSB) recapitalisation plan announced by the government has sparked off renewed debates on the shape and future of Indian banking. The big policy and philosophical question is — what should the Indian banking system look like in the future? Unfortunately, we are saddled with seriously flawed assumptions on what constitutes “reform” in India — some of them borrowed wisdom from the West, yet some more are ideological postures. Let us look at some of the key postulates.

One, the idea of having fewer, (much) larger banks. It’s an old idea, but embedded firmly across the political divide, and was first mooted by P Chidambaram as Finance Minister. Chief Economic Advisor (CEA) Arvind Subramanian reiterated its salience a few days ago. Ironically enough, this is one idea where India is bucking the global trend. Since the global financial crisis in 2008, regulators globally have become extremely wary of banks that are too large. The reason for that is intuitive.

First, larger the bank, larger is its footprint, and hence greater the damage to the wider economy should it fail. Second, Risk Management 101 dictates diversification is a key mitigant of risk, while concentration is a contributor to it. Ergo, smaller, more numerous banks are preferred to larger, fewer ones, from a systemic risk management perspective. Globally Systematically Important Banks, or GSIB — a list of essentially Too-Big-To-Fail (TBTF) institutions — have been identified, and they are required to have more stringent control around capital and risk. In this context, the idea of having larger Indian banks is bizarre, because its stated aim would be to merge small banks into fewer TBTF ones, thereby increasing risks to the system!

Two, assumption of public ownership of PSB to taxpayer-funded “bailout” through recapitalisation. It has been established many times over the years — banking obligations, when banks are under stress, automatically devolve to the taxpayer, irrespective of ownership. Whether Korean banks post the 1997-98 Asian Crisis, US/European banks post the 2008 global financial crisis, or Indian banks many times over (remember Global Trust Bank, Bank of Rajasthan?) — in a crisis, banks need to be bailed out by the government, irrespective of whether they are owned privately or publicly. Banks aren’t ordinary corporate enterprises — failure of a bank has large social impact. Further, increasing complexity of the financial system means there are snowballing effects of a bank failure that are difficult to assess. Therefore, the taxpayer liability isn’t an issue of ownership, but the quality of regulation to ensure risks are appropriately managed.

Three, privatisation as a panacea for all ills. This is an ideological position — based primarily on faith rather than reason. The assumption is the issues afflicting PSB are on account of its state-ownership, which somehow make them structurally vulnerable to taking poor-quality decisions, sometimes compromised with integrity issues. From Leendert Neufville in Holland in the 18th century to a range of Asian banks in the 20th century to American and European banks in 2008 — history is replete with privately-owned banks collapsing on the weight of poor decision-making. Regulatory investigations in the last few years in private sector banks have shown up numerous cases of moral turpitude too. Even in India, large private-sector banks have been found out making poor-quality decisions on transparency, risk-management and governance. In other words, there is too much data disproving the hypothesis of superior governance of a privately-owned banking system.

The question then is, what should policy-makers focus on? The focus should be at the core of the issue, i.e., risk. Banks are fundamentally risky enterprises, allowed a level of leverage in their capital structures and a level of interconnectedness with large parts of the economy that no other commercial enterprise (barring perhaps insurance) is allowed. The example of Lehman Brothers is illustrative. It was a mid-sized bank with no retail deposits — and its collapse engendered a crisis to the global financial architecture. No wonder, banks have a social compact of “backstop” from the taxpayer.

That is where the real issue lies — not in ownership, not in size. Regulators should be concentrating on mitigating that risk on society. Fundamentally, it means converting banks into utilities — essential institutions, but ones that don’t take risks that can put society at risk (similar to, though not the same as, a telephone company). Solutions lie in the domain of smaller (not larger) banks, higher capital requirements, lesser risk-taking, greater state oversight (and not lesser via privatisation) and higher governance. In other words, make banks (and banking) a boring affair. Unfortunately, most of the oft-discussed, clichéd solutions today are taking the other direction — taken to their conclusions, they will increase the risks to the system, and make it even more vulnerable to future taxpayer bailouts.

Through history and literature, bankers have rarely been boring. From the usurious Shylock in Merchant of Venice to the murderous Patrick Bateman in American Psycho to the philandering Humphry Wellwood in The Children’s Book — bankers are usually flamboyant, somewhat unscrupulous characters. The real objective for regulators would be around converting bankers (and banks) into Mr Banks, the benign, boring Bank of England official in the Mary Poppins books. That, and not ideological positions around size and ownership, is what will shape for a safer, better banking architecture for India in the future.

Credit Growth - the real issue is demand, not supply

This was published in the Op-Ed pages of Mint newspaper on 19th Oct, 2017

A constant lament around the state of the economy today is on “low credit growth”. Generally, the twin balance sheet issues are the identified villains. As fresh data on non-performing assets (NPA) keep coming in with numbers worse off at the margin, the noise levels keep getting institutionalized.

The narrative is simple enough—banks are not lending because they don’t have balance sheet capacity to lend (most banks, especially public sector ones, do not have enough capital to write off NPAs and write fresh loans). As a result, credit supply to the larger economy is being crimped, thereby constraining growth. Anaemic growth in non-food bank credit growth (9% in financial year 2016-17, or FY17, in negative territory this fiscal year) is held up as empirical basis of the hypothesis. Weaker-than-expected quarterly gross domestic product (GDP) growth (at 5.7%) provides the ostensibly clinching evidence that weak credit growth is pushing down growth.

Like many popular hypotheses though, this too has a case of missing some really large woods for the trees. First, the popular narrative conflates one source of supply of credit (bank loans) with the overall demand for credit. However, one of the remarkable changes in the Indian financial sector over the last three-four years has been the steady erosion in the importance of banks as financial intermediaries. A host of other credit suppliers—mutual funds, insurance companies, non-banking financial companies (NBFCs)—have taken market share away from traditional banks. These new suppliers of credit are also experimenting heavily with alternative credit instruments (away from loans), like corporate bonds and structured financing instruments. These are often more flexible and cheaper than vanilla bank loans.

Consolidated credit growth (bank loans, corporate bonds, NBFC loans) has been 13% in FY17, while bank loans alone grew only by 9%. The former represents a more representative estimate of real credit growth in the economy, than bank loans alone. The popular press (and even some of the more informed commentary) tends to focus only on bank credit, missing the real big story on disintermediation of credit. The real growth in credit demand is quite in line with nominal GDP growth and the 70% capacity utilization levels in Indian industry.

Second, the base effect of the Ujwal Discom Assurance Yojana (Uday) bonds. Since March 2016, the adoption of the Uday programme by state governments has transferred a large chunk of bank credit from state electricity distribution companies (discoms) to state government-issued Uday bonds. As the latter don’t get counted as “non-food credit”, growth numbers are automatically depressed going forward. Adjusted for Uday bonds issuance of Rs1.7 trillion in FY17, total credit growth in the year would have been about 11.4%, higher than the headline number of 9% and partially higher than the FY16 number of 11%.

Third, even for bank loans, the issue doesn’t seem to be so much about supply (or the willingness of banks to lend) as it is about finding bankable borrowers to lend to. In the recently released Reserve Bank of India (RBI) data on sectoral deployment of bank credit, banks have registered healthy growth in loans to the personal segment, trade, NBFCs. On the other hand, large swathes of manufacturing industries show barely any growth in bank credit.

There are multiple factors at play here. Highly rated (AAA) borrowers are increasingly finding the corporate bond market a cheaper source for fund-raising, compared to traditional banking channels. On the other side of the spectrum, in the riskier (and stressed) segments of borrowers, bank funding has shrunk—partly on regulatory diktat, and partly on account of the diminishing risk appetite of banks. These borrowers have tapped alternative sources of funding—via structured finance instruments—from NBFCs, private equity and alternative investment funds (AIFs).

Fourth, and somewhat non-linearly related, is the dramatic increase in equity raising by Indian industry over the past two years. Total equity raised via public (and rights) issues has risen by 200% over the last three years. At least part of the fresh equity raised has gone towards replacing debt in the capital structure.

We have a fundamental demand issue today in the economy. Total credit flows into the economy mirror the aggregate demand, and as we have seen above, are not a constraint. We looked at commitments raised by AIFs, a key emerging source of “risk-funding” today. As of FY17, only around 40% of the total funds raised by AIFs (in excess of Rs80,000 crore) have been deployed—thereby illustrating a paucity of deployment opportunities even for risk capital.

Unfortunately, most policy actions are concentrating on supply-side fixes (bank consolidation, NPA resolution, etc.). While these are important and necessary, they won’t help kick-start growth. As seen above, there is enough capital available to fund any amount of bankable projects coming on stream. The real issue is elsewhere—it is around lack of demand (both domestic and exports) for Indian industry. This is resulting in capacity utilization picking up painfully slowly, and constraining fresh investments by industry. Paraphrasing Cassius in Julius Caesar, the fault lies within (the industry), not in our stars (of the banking system).

A blueprint for job growth - Urban Employment Guarantee, an idea whose time has come

This article appeared in the DNA opinion page on 29th of September, 2017

The decibel levels have suddenly shot up. The lament of jobless growth is a long-debated one. The last quarterly GDP growth print (at 5.7 per cent) has now seemingly thrown up risks of significant economic slowdown too. To be sure, quarterly GDP numbers are estimates that are prone to massive revisions in the best of times, and we have a still-stabilising method of national income accounting. The issue is even starker for jobs, where almost no standardised, empirically robust data is available on a high frequency basis to make sure determinations.

However, policymaking cannot wait for perfect data. What is certainly verifiable are some indicators that point towards enduring weakness the economy. Capacity utilisation of Indian industry has hovered around the early 70 per cent range for many quarters now (RBI Capacity Utilisation Survey shows a slight decline in Mar 2017 from Mar 2016, at 74.1 per cent). Aggregate credit growth, while much higher than the oft-quoted bank credit growth, is in high single digit levels, and at the margin lower than previous year. Topline sales (and profit) growth numbers of listed firms display the same trend — and are generally undershooting beginning-of-the-year forecasts. On jobs, with the general collapse of private investment (especially Real Estate, the biggest jobs-creating sector), and struggles in the big employment-intensive services (IT and Financial Services) — it is safe to assume that we have a problem.

What should the policymaking response be? While there is never a dearth of ideas in India, is there something that can boost growth and generate additional employment at the same time, and quickly? Often, lessons are closer home than we realise. The National Rural Employment Guarantee Programme (NREGA) provides an interesting template. NREGA by design is an employment generating programme, and by many accounts was a big factor in India quickly bouncing back from the effects of the Global Financial Crisis in 2008.

There is, therefore, merit in considering a National Urban Employment Programme (NUEP) on similar lines. A well-funded NUEP will provide a soak for the urban and semi-urban unemployed, and provide an immediate Keynesian consumption boost to the economy. In principle, the consumption boost should enhance capacity utilisation levels, and hasten a revival of private investment, which is really the big driver of growth and employment. There are three big questions to be addressed though.

First, why a cash transfer programme (which is what employment programmes are), and not enhanced infrastructure expenditure? A couple of reasons. First, NUEP-type programmes are quicker on execution than large infrastructure projects, and hence would tend to have more immediate macro impact. And second, this provides for an immediate employment safety net to the most vulnerable, again something that would come only with a time lag in an infrastructure investment programme. Above all, some of the traditional assumptions around employment-intensity of infrastructure spending have been revisited in the last few years — it takes far fewer people to build a 100 km of highways than used to be the case a decade back.

Second, what would be the sort of jobs created under this programme? NREGA is designed around basic earthworks projects in rural areas, targeting employment for primarily untrained, barely literate farm labour. The workforce available in urban areas is likely to be better educated, and equipped to be trained for more.

They can, therefore, be deployed in auxiliary units for a range of urban services — municipals, schools, traffic control, even elements of basic policing – with a certain amount of training. India suffers from very large capacity gaps in all these areas.

For example, there is one police officer for every 720 Indians. The UN-prescribed standard is one for every 454. While a semi-permanent workforce with rudimentary training cannot be used for cutting-edge frontline policing duties, they could certainly be used for basic administrative and support services to enhance capacity.

Third, and perhaps most important, what should be the size of this programme? Targeting to create how many jobs? As a benchmark, the allocation to NREGA in the current year is Rs 48,000 crore. Let us assume that NUEP has a similar outlay. At an average wage of Rs 1.2 lakh/job (the approximate level at which a single wage-earner can ensure a family of 4 is above the urban poverty level), and assuming a 20 per cent support cost (ie, part of the outlay not accruing to wages, NREGA average is 30-35 per cent), this would create around 32 lakh jobs. India has around 1 crore new entrants into the jobs market every year. 32 lakh vacancies-on-demand will create a material tightness in the labour market to make a dent in wages and opportunities.

The last point would be, is it affordable? The amount in question would represent around 0.3-0.4 per cent of GDP. In a scenario where the banking system is flush with post-Demonetisation liquidity, that amount of excess government borrowing can be easily funded. It will have an electrifying message politically, while giving an instant consumption boost to the economy, with all-round multiplier effects. It is an idea whose time has come!

Managing Wealth in times of Constant change

This was published in the DNA newspaper, dated 15th of Sep, 2017

“This time it’s different”, is an oft-ridiculed cliché used in the financial markets, mostly to debunk the idea that a particular phase of the market (usually bullish) has stronger legs than similar phases in the past. Markets are never one sided though, and excesses always tend to be shed through corrections later. This has been the case for centuries of trading history.

What has been truly “different” in the last few years though, especially in the new millennium, is the pace of structural changes presenting themselves to investors. Some are planned (like GST), some related to Moore’s Law effects (like technology), and some are simply Black Swans (like the global financial crisis). Consequently, money management has become tougher. Managing wealth, with its separate, often counter-intuitive and variable sets of objectives, has become tougher still. A few closely-held beliefs need to be junked / modified in order for investors to ensure their money keeps working hard (to use yet another old cliché!).

One, asset allocation is important, but “buy, hold, forget and see it five years later” is an incredibly stupid strategy. Traditional measures of risk, eg volatility, are not by themselves able to capture the impact of severe draw-downs on portfolios due to sudden market or regulatory events. When asset allocations start getting skewed due to sharp upward movements in a particular asset class (say equities), the vulnerability of the portfolio to Black Swan shocks go up exponentially. Investors and their advisors need to be a lot more on top of their portfolios, constantly optimising the same in line with their objectives and risk tolerances.

Two, liquidity management is as important an activity as identifying the next best investment opportunity is. This is especially true of Indian investors, given their heavy exposure to real estate, an asset class most prone to liquidity issues. As it is, even ostensibly liquid instruments have been affected by liquidity issues in the recent past (the JP Morgan Liquid Fund a couple of years back). On top of that, liquidity is often completely ignored in a chase for yields and/or the next exciting investment idea. There is a time and space for illiquid investments, but it is important to define sharply both the time and the space before making such investments.

Three, indexation is a two-way street. Investors judging their portfolios against index performance when broader markets are doing well should do the same when they are doing badly. This is a key difference between managing wealth (for individuals) and managing money (for institutions). At the heart of the difference is the fact that institutions are perpetual going concern entities, while individuals have finite lifespan with (often) non-discretionary objectives. Ergo, relative performance vis-à-vis an index for an individual is an academic, rather than practical construct. In other words, managing personal wealth, more often than not, is an absolute return approach by default. By definition, absolute return approaches do not sit well with benchmarks.

Four, volatility is not an enemy of investors, it can be a very useful friend, if used wisely. The conventional wisdom is for investors to avoid volatile markets, but it is often volatile markets that present the best opportunities. Looking back, in the current millennium, some of the best entry-point opportunities in equity markets presented themselves when markets were at their most volatile – think 2004, or 2008, or even 2013! Rule of thumb is to remain calm and behave with as much dispassionate emotion as possible when volatilities spike up.

Five, and perhaps most importantly, when an individual is looking to “manage wealth”, it is important to concentrate heavily on that, and not on fund managers managing various products in the underlying portfolio. Wealth management is a far more complex, multi-faceted and involved process than only managing a pool of money (which is what fund managers do). It involves elements of tax, estate, succession and other objectives that are non-linear in nature. They require far more attention and diligence than obsessing over an incremental 1% in portfolio returns. Ignoring the former could result in much larger impact. Unfortunately, too many individuals (and their advisors) spend almost their entire attention and time-spans on evaluating product performance, and too little time on what is really critical to successfully managing wealth.

As the Chinese say, the best benediction is “to live in interesting times”. We are fortunate to live in very interesting times. It also means we need to have newer, and sometimes less “interesting” approaches to managing wealth optimally.

Crackdown on Corruption - a Crackdown on Economic Growth?

Corruption is an emotive issue, and anti-corruption is a potent political platform, like it has been for the Modi government. A slew of policy interventions – Demonetisation, RERA, GST – have been predicated on eliminating corruption. An interesting question to consider, morally abhorrent as it is, if corruption’s actually a facilitator of economic growth?

Usually, corruption is assumed to hinder growth through increase in transaction costs, inefficiency and arbitrary decision-making.

Consider a though experiment, around the Real Estate Regulation and Development Act (RERA). The new law aims at curbing unethical practices, reduces discretionary decision-making, and generally aims to clean-up the Real Estate sector. At the same time, implementation of this law has seen a massive decline in the rate of new launches by developers, softening of property sales and fear of a general slowdown in the sector. Given that Real Estate is highly employment-intensive, this portends bad news for growth and jobs. While its early days yet (for the new law), could we surmise that a certain amount of corruption greased the sector, and has caused a slowdown now that the grease has been taken out?

Corruption as a grease (or sand) to wheels of development has long been studied by academics. And the counter-intuitive narrative, ie, corruption could have positive effects on growth, has long (and erudite) legs.

Samuel Huntington famously wrote in 1968,“only thing worse than a society with a rigid, over-centralised, dishonest bureaucracy is one with a rigid, over-centralised, honest bureaucracy”. The hypothesis sits well with day-to-day experience (especially) of the poorer sections, with local municipal authorities. A broken water tap is often repaired quicker with a bribe than via strict adherence to laid down processes.

Is it a poor country phenomenon? Or, as some people have suggested, there is an Asian Paradox (it happens in Asia)? Let us look at some headline numbers. The table below posits a sample of countries at various levels of incorruptibility (as measured by Transparency International rankings) against their economic performance.

Source: IMF, Transparency InternationalCPI: Corruption Perceptions Index, Transparency International

As we can see, while richer countries tend to have high CPI scores, there are notable exceptions like Italy, Saudi Arabia and South Korea (per-capita incomes above USD 10,000 – “rich country” benchmark) with comparatively low CPI. At the same time, while a lot of Asian countries tend to rank lower, Singapore and Japan buck the trend. It is also remarkable that India and China, both with fairly low CPI scores (and ranks), have been the fastest growing major economies in the world for over 2 decades. So, is “good corruption” a reality?

There was further empirical boost to the hypothesis of “good corruption” in a more recent (2008) cross-country study by Professors Jac Heckelman and Benjamin Powell, titled Corruption and Institutional Environment for Growth. They found that definition of corruption as “good” or “bad” for growth depended heavily on the institutional environment. In countries with low economic freedom, high levels of regulation and inefficient bureaucracy, corruption has a positive effect on growth. Lower corruption aids growth when institutions are strong. Sounds intuitively familiar? The water tap is repaired faster with bribes if the municipality is an inefficient entity?

Research on Asian (especially East Asian) countries, with generally imperfect institutions, tends to have some vindication of the hypothesis. Prof CJ Huang of Feng Chia University, Taiwan, in perhaps the most comprehensive quantitative study on the topic (his coverage was on 10 East Asian countries, including China), found an overwhelming positive impact of corruption on economic growth.

In the Indian context, Prof Aseema Sinha of the Woodrow Wilson Center found widespread evidence of bribes facilitating investment and growth, in her book, Regional Roots of Developmental Politics in India (2005). She quotes a manager of a large company in West Bengal, “I wish there was more corruption in West Bengal. Then things might move and I would know that I could do something to speed things up. Currently, nothing moves; government officers are usually honest and morally superior, but they refuse to help you.” In contrast, the same study also found that bureaucrats in Gujarat worked very hard to facilitate new investments, but demanded 5-8% as bribes. Essentially, this is the concept of speed money that hastens economic processes.

In a nutshell therefore, can growth slowdown be blamed (partly) on anti-corruption policies? Like with everything else in policy-making, a black-and-white answer is impossible. It is widely recognized that corruption eats away at the vitals of a society, reduces efficiency, and thus is structurally sub-optimal in the long term. Politicians have to balance short term exigencies with a long term vision, and make appropriate choices.

What is clear though, is that the narrative of corruption as an unambiguous negative isn’t quite correct always. There is an alternative narrative to consider.

Defence expenditure: Fantasy replaces deft planning

This article was published in the DNA, dated 27th of Jul, 2017

In the recent Unified Commanders’ Conference, the Indian military has reportedly asked for an allocation of Rs 26.84 lakh crore for the next 5 years. To put the figure in context, this represents a number that is almost triple of the previous five years’ allocation. The annual simple average of the demand made this time (Rs 26.84 lakh crore over 5 years) would be double the defence budget allocated for the current fiscal (Rs 2.74 lakh crore). The numbers, analysed whichever way, are staggering.

Let us look at the headline numbers. At current levels, defence expenditure constitutes 2.1 per cent of the GDP. Assuming a 10 per cent nominal growth in GDP (6-7 per cent real GDP growth plus 3-4 per cent deflator, or inflation), the demand for 26.84 lakh crore represents 3.3 per cent of total GDP generated over the next five years. Realistically though, expenditure cannot go up overnight from 2.1 per cent of the GDP this year to 3.3 per cent next year. They will go up gradually, with a “hockey stick” (exponential) increase towards the latter half. However, that also means, given the same numbers (expenditure demand and GDP, over five years), the ratio will likely touch 5-6 per cent in 2022. Very few countries that could manage to sustain such levels of 3 per cent of GDP over 4-5 years in the late 80s ended up with a bankrupt treasury in the 90s.

Next, how do these numbers stack up on a global comparative basis? It’s an old chestnut in military policymaking, ie, India doesn’t spend enough on defence. Is that correct? There are two benchmarks typically used.

First, defence expenditure as a percentage of GDP, popularly used, but largely limited in its real policymaking import, as it is not truly reflective of fiscal affordability. As per the World Bank, the numbers stack up as follows: China (1.94 per cent), East Asia-Pacific (1.73 per cent), European Union (1.48 per cent), Republic of Korea (2.64 per cent), Pakistan (3.55 per cent), Russia (4.86 per cent), Turkey (2.13 per cent), Israel (2.38 per cent) and US (3.30 per cent)

India’s very much in the global ballpark. We are higher than China (and Asia-Pacific average), lower than Pakistan, and in the same range as Turkey and South Korea (both having complex military challenges). Major countries that spend significantly more — US, Russia, Israel — are characterised by very large domestic Military Industrial Complexes (MIC). Military expenditure accounts for large investments and employment in these economies. The situation is quite the opposite in India.

Second, share of defence expenditure in total government expenditure — less popular, but a lot more insightful for policymaking, as it reflects fiscal constraints.

It is here that the real constraints become starkly visible. India already spends a very high proportion of government revenues on defence. In fact, defence is the single biggest item in the Union Budget, outside of debt servicing.

The only major country higher is Pakistan. In a country with significant deficits in social and economic capital, the fiscal space for a bigger share of the pie for defence simply does not exist.

Lastly, India’s high import-intensity of defence expenditure makes it an inefficient medium to channelise Keynesian boosts to the economy. With 70 per cent of all defence capital expenditure spent on imports (India’s been the top weapons importer in the world now), and low multiplier on military imports, the ability of policymakers to allocate part of government “pump priming” expenditure to defence is absent.

In a nutshell, plans with numbers like Rs 26.84 lakh crore are pipe dreams rather than effective plans. On top of that, we have a severe issue in terms of quality of military spends.

In the last 5-6 years, 45-50 per cent of the defence budget has been spent on personnel costs (salaries and pensions). This component is expected to grow exponentially, thanks to more “boots on ground” — Indian Army has expanded by 25 per cent in the last 15 years. And, now the new big daddy of Budget Expenditure is OROP. Increase in personnel costs in the years to come would far outstrip nominal GDP growth.

This is not new, or even surprising. A generalist MoD bureaucracy and a (largely) hands-off political class have let the military get away with fantastic wish lists in the name of planning. Unless structural changes are brought about in organisation and management, we will continue to have hopes as plans in India’s military.

 

Obsession with Fiscal Deficit is Hurting Growth, and hurting democracy too

This was published in the DNA Op-Ed page on the 5th of July

Farm loan waivers have reignited concerns of fiscal deficit (FD), which is essentially the difference between the government’s revenues and its expenditure. While the focus on FD reaches its zenith just before the Union Budget, it is a core element of our economic narrative. Is 3.5 per cent too high, or 3.2 per cent? From rating agencies to economists to pundits, FD has assumed divine dimensions, with a 0.2-per cent slippage deemed blasphemous.

The question is, how important is FD to growth and welfare? Textbooks are divided. Neoclassical theories frown upon FD like plague, Keynesian theories privilege FD as a preferred policy tool, and Ricardian theories preach complete indifference to the concept itself!

The neoclassical view, the source of most punditry on the subject, base FD’s divinity on four basic canons.

One, debt (incurred to fund FD) growing faster than income (GDP) is unsustainable. Two, excessive debt leaves us vulnerable to foreign investors pulling out, triggering an economic crisis. Three, high FD causes an increase in interest rates, increasing the cost of capital for the private sector. And four, the moral argument of burdening our children to finance our consumption today.

Not trusting “irresponsible politicians” to protect the holy covenants, a Fiscal Responsibility and Budget Management (FRBM) law was enacted in 2003 to enforce discipline through prescribed targets. Unfortunately, this has meant elected representatives are constrained on a key policy tool to react to economic distress — because of technocratic limits.

Beyond the point of (democratic) principles, obsession with FD is untenable on multiple grounds. To start with, the divinity canons are tenuous in the Indian context. The Government of India (GoI) doesn’t borrow overseas (from foreign investors) to fund FD. It is funded entirely out of domestic savings. With capital account controls, GoI bonds represent the highest-quality investment for the domestic investor. Ergo, GoI can run high levels of FD without triggering a currency crisis. This is the exact opposite of oft-quoted examples — Russia, Argentina, Greece — where high FD triggered economic crises. In all these cases, governments depended heavily on foreign investors to fund FD.

When the basic issue is a lack of demand, the antidote has to stimulate demand. Private sector investment decisions are not predicated on a 1-per cent higher (or lower) interest rate, but capacity utilisation and expected future demand. Obsession with an incremental 0.5-per cent FD jeopardises growth and ability to service debt in the long term.

A hard FD target acts as what Harvard professor Lawrence Summers calls a harmful ‘repression of budget deficit’. To meet the target, the government imposes arbitrary spending cuts on maintenance and critical investments in social and physical infrastructure. The result is a lowering of national productivity, leading to lower long-term growth. We have seen this with distressing regularity in India, where FMs have cut investments to meet FD targets.

Currently, the biggest challenge confronting the economy today concerns jobs. Boosting job creation by 3-4 per cent (and nominal GDP by a bit more) will do a lot more to balance the FD in the future (after all, FD’s real relevance is as a percentage of GDP) than targeting a sacrosanct number today.

Above all, causality between low FD and growth is extremely tenuous in terms of data in India. High growth has typically been a result of higher demand creation. Without supporting data, to base policy on ideology is simply bad policy-making.

The bigger philosophical question though is the usurping of sovereign democratic powers by an unelected technocratic elite. The FRBM Act was a primer. Recently, the NK Singh Committee appointed to recommend improvements to FRBM has suggested setting up of an autonomous Fiscal Council (staffed by technocrats) to administer and monitor FD targets set out in the law. This would represent a further erosion of political authority to tackle a political economy question.

Forex Reserves to the rescue

This was published in the DNA Opinion Page on 19th of June

The Public Sector Bank (PSB) recapitalisation debate continues unabated. Clearly, “simple” options — amalgamation, Bad Bank, Indradhanush — are “dead on arrival”. It is also quite clear that the government has limited appetite to infuse fresh capital, given fiscal constraints. Depressed valuations make raising capital from public markets a challenge, especially for weaker PSBs. So, is there a game left in town?

There could be, via direct Central Bank (CB) intervention. In recent times, both in the US and in Europe, CBs have bailed out banks, primarily through purchases of stressed assets (mortgage-backed securities in US, Greek bonds in Europe). The modus operandi is simple. Say, a bank needs to write off $100 of stressed assets, and it does not have the capital to do so. The CB prints $100 of fresh money uses it to buy out the stressed assets, enabling the bank to remain solvent. This, of course, means an increase in CB balance sheet and consequently money supply in the economy, which could fuel inflation. But in the low inflation scenarios in US/Europe for many years, it has been a politically acceptable risk to take.

Can RBI do this in India? Technically yes, practically difficult. India, unlike US/Europe, typically suffers from high inflation. While inflation has been tapering off recently, it is often vulnerable to systemic shocks like oil prices and bad monsoons. As recently as the last monetary policy, RBI flagged off upside risks on inflation. Ergo, RBI printing more money to buy back NPAs (non-performing assets) from banks has significant inflation risks, making it politically untenable (as well as running counter to RBI’s Inflation Targeting mandate).

There could, however, be another way, and that is to use RBI’s foreign exchange reserves to directly recapitalise banks. How does this work? Today, RBI holds $380 billion of Fx reserves as assets in its balance sheet. These are typically deployed in a variety of financial market instruments — predominantly hi-grade Treasuries (like US), Bonds and Gold. RBI could use a part of these reserves to buy capital instruments issued by PSBs. This would achieve a couple of objectives:

• It doesn’t expand RBI’s balance sheet/money supply — it simply swaps one type of securities (say, US Treasuries) for another (Indian Bank Capital, or IBC). There is no increase in money supply and downstream pressure on inflation.
• It keeps the funding off the government’s budget. Consequently, it does not deteriorate fiscal ratios. Let’s look at the broad math:

Total Banking NPA — estimated at $180 billion

Haircut required to make the loans viable (say) — 50 per cent

Capital required for write-offs — $90 billion

Now, RBI uses (say) $45 billion of its reserves to buy IBC, providing 50 per cent of the required capital. Such a large capital injection will lift underlying sentiments and stock prices, enabling PSBs to tap the capital markets for the balance $45 billion. Coupled with other reforms (Bankruptcy Code, RBI cover for bankers to settle NPAs etc), PSBs could start on a cleaner slate. In a few years, stock prices could rise sufficiently for RBI to sell off the IBC at a profit, similar to what happened with the TARP programme (to bail out banks in 2008) in the US.

There is no free lunch, and this approach isn’t without risks. The biggest is the fact that Fx reserves are not sovereign wealth. RBI has liabilities (primarily remittance claims from foreign investors/importers) against these reserves. These reserves are usually deployed in liquid, high-quality securities to enable RBI to have liquidity in times of stress. As IBCs would be illiquid, Private Equity-type investments, it would mean RBI has proportionately fewer reserves to call upon in an emergency.

That being said, $45 billion constitutes a fairly small part (12 per cent) of India’s reserves, and can be relatively quickly replenished given the strong capital flows that we are seeing today. A repaired banking system will add to the “India story” and further enhance those flows.

This isn’t an idea that’s new, but one whose time certainly has come (to at least being evaluated). India’s PSBs need capital, and to use a Sherlockian adage, once all wickers have been burnt, the one left standing is the most plausible one. Using Fx reserves is a plausible wicker left to recapitalise India’s PSBs.

Can central bank stem NPA rot?

This was published in the DNA on the 29th of May 2017

Indian banking is often in the news — sometimes as entertainment (around high-profile failed airline promoters), but mostly serious. The government’s recent NPA Resolution Amendment to the Banking Regulation Act is a serious development, which comes not a day too soon. NPAs now, at nearly Rs 9.6 lakh crore, account for 15 per cent of all bank loans and constitute a serious bottleneck to growth. However, is it kosher for RBI, as does the Central Bank (CB), to get operationally involved in the resolution of NPAs? And, is it enough?

The short answer to the first question is, absolutely. The puritan argument is that it represents a conflict of interest for the CB. A regulator cannot be seen to be resolving what is essentially a commercial decision of a regulated entity. However, taken to its natural conclusion, this approach will result in the banking industry proving the old chestnut “operation successful, patient died”. Ergo, CBs often get involved. The Bank of Japan (BoJ) recapitaliSing Japanese banks in the late 1990’s, US Fed acting as a lead arranger of rescue finance for LTCM in 1998 and the US Fed (2008) buyback of $1.5 trillion of distressed mortgage securities — these are but a few recent instances of active CB involvement in bank bailouts. In short, this is par for the course.

Now, for the second (and real) question — is it enough? A basic background first.

What are the basic steps involved in resolving a bad loan (NPA) issue? It normally consists of three basic rules:

Firstly, recognising the bad loan. Secondly, estimating and affecting a haircut on the loan, either to make the underlying business viable or to sell off the loan, and thirdly, generating capital to absorb the haircut.

Over the last few years, RBI has done stellar work in recognising NPAs. However, it is in the resolution of these loans where the ball got stuck.

First, thanks to the scourge of the 3 Cs (CBI, CAG, CVC), PSB bankers have been loathe to structuring haircuts for any loan gone bad. Arrests of senior bankers (including an ex-chairman of IDBI Bank) have further queered the pitch. Second, a limited tenure of most PSB bankers have meant that they have found it easier to simply evergreen the loans. In simple parlance, leave the problem for their successors. As a result, a stressed loan of (say) 100, after unpaid interest, interest on interest, fines on delays, balloons up to 200 or more by the time someone starts taking action.

This is where the new Ordinance helps. With this, bankers have received RBI cover to take decisions. RBI has a high (and deserved) reputation of integrity and professionalism. Haircuts agreed to by bankers under the direction, supervision and operational monitoring of RBI are unlikely to invite allegations of personal corruption that they could otherwise. While the process is still complex, with relatively few cases accounting for the bulk of bad loans (the top 20 cases account for over half of stressed loans by value), decisions should now be happening at a faster clip.

This brings us to the last, and by no means the least, of the issues — capital. Once the bank has identified the bad loan and determined a fair haircut value for the asset — it needs capital to recognise the haircut on its balance sheet.

Unfortunately, bank recapitalisation has progressed inadequately. The total outlay in the Union Budget for bank recapitalisation is Rs 10,000 crore — perhaps 20 per cent of what the banks really need. Cute acronyms (like Indradhanush) and toothless governance structures (like Bank Boards Bureau) have been tried. If that seems Tughlakian, policymakers are talking about a bigger one — consolidation. The merger of associate banks with SBI is being touted as a precursor. Easy in theory, but has a rather simple tautological fallacy — the banking system simply does not have surplus capital to absorb the aggregate PSB capital gap. It’s a classic case of adding 2 and 2, repeatedly, hoping each time that the answer somehow will be 10! SBI quarterly results showed it up starkly — nearly Rs 3000 crore of standalone profits, but Rs 3000 crore of loss on a consolidated (with the subsidiaries) basis. In short, even a small amalgamation pulled the giant down. Clearly, consolidation is not a likely solution.

Unfortunately, the new ordinance does nothing on capital. The solution has to be about someone writing out a big cheque, which only the government can plausibly do so.

The new Ordinance covers two of the three steps required for a resolution. It’s a big, necessary step forward. But it is not sufficient to resolve the issue — till the government recapitalises PSBs.

Human Shield - yet another necessary evil in India's fight against terrorism

It doesnt take much to generate outrage these days, thanks to both mainstream and social media. However, the kerfuffle over the "human shield" incident has been a topic worthy of debate. Using a civilian as a shield to facilitate tricky counter insurgency operations is neither new nor unusual - either in India or outside - but the images of a civilian tied to the bonnet of the jeep driving through villages is undeniably evokes strong reactions.

Besides the usual battle lines between "liberals" and "right wing", an interesting divergence has been in the military circles, with several ex-servicemen coming out against the modus operandi adopted by Maj Gogoi in this case. They have quoted Geneva Convention, Indian Army ethos, counter insurgency doctrines and more. As Lt Gen H S Panag, ex-Army Commander, summarised,  

"The image of an alleged ‘stone pelter’ tied in front of a vehicle as a ‘human shield’, will forever haunt the Indian Army and the nation"

Another ex-serviceman, Retd Col Alok Asthana, surmised that the action went against the ethos of the Army and undermined its honour.

Honour is essential to a professional army. But the top brass in Indian defence, at both the military and the ministry level, seem to have forgotten that.

But is it really so? Is the human shield the first time a somewhat distasteful tactic has been used in countering insurgency? Or is it but another in a series of such innovations that the Indian security establishment has had to adopt to counter the threat of insurgencies and terror? Lets look at a few examples.

Mizoram

The Mizo insurgency was one of the first such challenges faced by independent India. On Mar 2, 1966, the Mizo National Army (MNA), the primary Mizo insurgency group, overran large parts of Aizawl, the capital of Mizoram, as well as a few smaller towns around it. It included the Treasury, Armoury as well as the Assam Rifles headquarters. After the initial attempts by the Indian Army to relieve the city was beaten back, the Prime Minister Indira Gandhi ordered the Indian Air Force (IAF) to conduct operations. In the first (and till now, only) case, IAF fighters strafed Aizawl with guns and bombs, destroyed large parts of the city, and killed several civilians. But the operation succeeded, MNA melted away into the jungles, and the might of the Indian state was re-established in Aizawl.

In 1967, the Eastern Command of the Army, led by Gen Maneckshaw, launched a programme called "regrouping of villages". It basically meant driving out villagers from villages and grouping them in fewer hamlets (called Progressive and Protected Villages, or PPV). The idea was it would be easier to monitor fewer number of villages and therefore cut off the support to MNA from the populace living in the rural hinterland. some 500 villages were regrouped into 100 odd PPVs - it accounted for 95% of Aizawl's rural population. Did it work? Open question, but the last PPV was dismantled only in 1980, 6 years before the Mizo Accord that ended the insurgency. It was one of a large bouquet of measures required to tackle a well armed insurgent group.

Punjab

One of the deadliest challenges faced by the Indian state. KPS Gill is widely credited for ending the insurgency, using unconventional means that would not pass muster in "normal" situations. One of them was the "hostage" strategy. A tactic that was a straight lift from the terrorist playbook, it involved picking up (either physically by the police, or through more discrete means) members of the families of known terrorists. Keeping such hostages achieved two purposes. One, it meant that terrorists left the families of policemen (most of whom came from rural Punjab) alone. Two, it worked as a lever for select influential leaders of Khalistan groups to come forward and assist the police in exchange for the security of their families. This was carried out widely in rural Punjab, which is where bulk of the Khalistan leadership emanated from.
The result was a resounding success. This, along with many other measures, helped end the militancy by 1995, barely 11 years after Op Bluestar. In 1985, it was the greatest national security threat faced by India, and no one could imagine that it would be defeated by 1995.


Naxalite movement in West Bengal

There was a time in the late '60/early '70s when the city of Calcutta was literally hostage to the depradations of Naxalites. Policemen were killed in broad daylight, businessmen killed and driven off and the slogan of "China's Chairman is our Chairman" adorned most walls of the city. Biggest issue was the urban middle class sympathy for the movement - some of the brightest young boys from middle/upper middle class families provided leadership to the Naxals. Under an unconventional police chief, Ranjit Gupta, the state (and central) govt turned the tide using what can be mildly termed strong arm tactics. To start with, the police started randomly picking up students from hostels known for their Left wing activism. Many of them were sent to jail and kept without trial for years. Several were simply shot in cold blood. Many families were given a stark choice - to send their boy out of Bengal (preferably out of India), or see him incarcerated or killed soon. Most families exercised the former option. It was a campaign that sent shivers down the cities of Bengal, but it slowly but surely cut the oxygen of fresh recruits to the Naxal movement. By the mid/late '70s, Naxalism had ceased to be a threat to the state.

These are but a few instances. Counter Insurgency (CI) is a complex, dirty business. Hearts and minds is identified as key to CI, but any such campaign can only succeed once the majesty of the state has been established. A neutral populace will tend to side with the group wielding the most coercive power.

Ergo, its perhaps unfair to judge the officer who took the Human Shield call. The Indian Army (and state) have adopted far more distasteful tactics in defence of the state in the past, and succeeded. They were necessary to defend the freedoms and ideas of India for the vast majority of India's citizens.