The Reserve Bank of India Is Changing Again

While RBI’s central board has certain powers, these have been rarely used to oppose finance ministry action

Time was when the Reserve Bank of India (RBI) resembled more a Soviet rationing officer than a conventional central bank. Mercifully, 1991 and economic reforms ended all that; the RBI got down to conventional central banking, which included moving the economy slowly out of administered interest rates, ending automatic monetization of government debt and shrinking its autarchic footprint. After a 26-year hiatus, there are misgivings that RBI could be lapsing into some of its old habits.

In the now defunct central banking format practised by RBI, all credit over Rs1 crore was rationed. Under a scheme called Credit Authorization Scheme, the RBI vetted all large loan proposals. Even though the floor was raised gradually over time, RBI continued to have a say in how much banks could lend to whom, and at what rate. The RBI was also the implementer (and custodian) of the government’s illiberal measures: banks had to compulsorily invest 40% of deposits in low-priced government securities and keep 20% with RBI as a cash reserve. Of the balance 40% left for lending, 40% had to be mandatorily lent at concessional rates, leaving “commercial” banks with only 24% of deposits to play around with. No wonder average lending rates ranged between 16-18% and non-performing assets were rarely recognized, leave alone provisioned.

These are now part of the nation’s sepia-tinted economic history. The RBI has been easing controls for the past 26 years, even though it has retained numerous other controls as part of its mandate to ensure monetary and financial stability. The overall process has not always been smooth or linear. Economic disruptions, both exogenous and endogenous, have occasionally forced the RBI to slow down or undertake course correction.

In recent months, there are suspicions that RBI’s reform mandate may have changed. The central bank’s role in the demonetization exercise sowed the first seeds of doubt. While the RBI’s central board has certain powers, these have been rarely used to oppose government action. Then, as well as now, the RBI would have gone along with the decision. But, here’s the crucial difference: governor and deputy governors could have used different platforms to speak their mind about the extreme decision. They would have made attempts to explain the economic shock to citizens. Instead, RBI’s March report on the macro-economic impact of demonetisation is an exercise in politesse.

Perhaps RBI doesn’t want to speak out because collateral damage from demonetisation has kept it incredibly busy.

Demonetization led to a liquidity surge, forcing the RBI to step in. Banks had no alternative route to deploy this liquidity, given the uncertainty created by demonetisation and industry’s non performing assets (NPA) induced aversion to bank credit. The RBI implemented a four-stage liquidity management programme, using different instruments at different times. Surplus liquidity also depressed debt yields. Around the same time, on 14 December, the US central bank Federal Reserve raised interest rates leading to outflow of foreign portfolio investment (FPI) from Indian debt markets—Rs46,087 crore went out during the last three months of 2016. This continued in January too. Consequently, the rupee-dollar exchange rate also mirrored these trends, depreciating initially and then staying range-bound for a month.

Then, suddenly around end-January, yields on the 10-year government bond started perking up. Foreign portfolio investment inflows also rushed in—Rs51,679 crore during February-April. By end-April, the rupee had also appreciated by almost 6.5% from the lows of 24 November.

The rupee’s appreciation has hurt exporters. But, more importantly, a 6.5% movement in such a short time is a sign of untreated volatility and should have been countered by the RBI. But, tackling the demonetization-led liquidity surge has probably left the RBI with little or no fire-power. Ordinarily, faced with such a predicament, the RBI would have used another weapon: talking the market down. But, neither the RBI governor nor his deputies has spoken a word over the past few months.

Two conclusions arise: either the RBI agrees with the current rupee value (which most economists think is over-valued) or it is scared to speak out. The government’s distaste for former RBI governor Raghuram Rajan’s public speeches was well publicized. RBI’s top brass has delivered only nine public speeches between January and May this year, compared with 23 last year.

Management of stressed assets is another example where the RBI seems to have abandoned characteristic central bank detachment. The RBI is stepping into the mud-pit of stressed assets to help banks recover sticky loans; this includes even taking commercial decisions regarding selection of credit rating agencies. This could expose RBI to serious risk, including reputational risk.

It might be instructive here to recall how Rajan spent his last days in office staving off pressure from the finance ministry, which insisted that the RBI use its balance-sheet to recapitalize public sector banks. At that time, deputy governor Viral Acharya (then professor with Stern School of Business) had criticized it in a Bloomberg story, saying, “At a minimum, it looks opaque and devious…could be perceived as an attack on central banking independence.”

At a time when globalization is in peril, the RBI seems to be voting for a dubious global trend: ceding autonomy to the political executive without a fight.

The above article was first published in Mont newspaper on May 31, 2017, and can also be read here

No Quick-Fix Solutions for Accumulated NPAs

The amendment to the Banking Regulation Act has failed to provide relief from the government’s latest scheme for cleaning up accumulated NPAs

Those expecting immediate relief from the government’s latest scheme for cleaning up accumulated non-performing assets (NPAs) might have to wait some more. Going by some statements and interviews to media, it may have seemed that a quick-fix was at hand. Nothing could be further from the truth: what has accrued over so many years is unlikely to vanish with the mere snapping of fingers.

The government’s latest weapon against NPAs is an amendment to the Banking Regulation Act, 1949, which is expected to invest banks with some freedom in resolving bad loans without inviting the prosecutorial gaze of central investigative agencies.

NPAs have become a stumbling block in all attempts to re-ignite the economy. Bank credit growth has slowed, affecting capacity creation and expansion—bank credit grew only 5.1% during year to March 2017, against 10.3% in the previous year. The Reserve Bank of India’s (RBI’s) latest Financial Stability Report shows stressed assets (sum of gross NPAs and restructured assets) at 12.3% of assets by September-end 2016. After factoring in demonetisation’s adverse impact and the prolonged economic stasis, this ratio would have further deteriorated by March 2017. This has forced banks to turn risk-averse.

The amendment to the Banking Regulation Act is therefore expected to provide some relief. Unfortunately, the measure has failed to generate unstinted optimism as expected. The reason is that some bugs exist that could slow down progress in the short run.

At one level, the entire exercise is designed as a signalling system, indicating the government’s and the central bank’s resolve to straighten out what seemed like an intractable problem. It also signals that both parties are prepared to support banks’ attempts to resolve this crisis.

But the government itself nullified this confidence-building exercise with another adverse signal—two senior bankers heading two large public sector banks (PSBs) were transferred to smaller entities, signalling a demotion. This was done overnight, without informing either the individual bank boards or the autonomous Banks Board Bureau. Trust plays a large role in any signalling exercise and the latest order just chipped away at the first step to building trust with bankers.

The second crimp is PSBs’ lack of balance-sheet muscle to tackle the volume of NPAs. The International Monetary Fund’s (IMF) 2017 Article IV report on India shows that while aggressive NPA recognition by PSBs turned their return on assets negative in 2015-16, aggregate provisioning coverage ratio still remained low, indicating weak capital bases. The IMF report also shows that PSBs are content writing off loans rather than recovering them—a commentary on the numerous, though deficient, stressed asset resolution mechanisms. The short point is this: banks are unlikely to get aggressive with NPA resolution unless there is capital within sight.

The government, on its part, has drawn up a three-pronged plan to meet its capital infusion responsibility: limited capital infusion depending on performance criteria, merging some of the larger banks, and asking banks to source balance capital from capital markets. All these measures are time-consuming and the pace of capital flow is likely to determine the speed of resolution.

The third problem lies in the wording of the amendment. The government has inserted Section 35AA in the Act, which states: “The Central Government may by order authorise the Reserve Bank to issue directions to any banking company or companies to initiate insolvency resolution in respect of a default, under the provisions of the Insolvency and Bankruptcy Code, 2016.” This is followed by a paragraph stating, “Without prejudice to the provisions of section 35A, the Reserve Bank may, from time to time, issue directions to the banking companies for resolution of stressed assets.” The RBI will also create committees of experts to advise banks.

Two issues spring to mind immediately.

First, the amendment does not explicitly insulate bankers from future persecution, nor is there any implicit signal. The Prevention of Corruption (Amendment) Bill, 2013, which includes provisions for such a shield, is stuck in Rajya Sabha. Therefore, till there is clarity on where the buck stops—the Centre, the RBI, the committee of experts appointed by RBI or the bankers—progress is likely to be slow.

Second, the amendment is unclear about how the Centre proposes to take the resolution forward: will the government monitor each individual asset resolution or provide an umbrella order enabling the RBI to calibrate its action depending on the merits of each case?

Both possibilities have consequences. In the first instance, there are risks of government being accused of cronyism. In the second, the central bank (or its appointed committee) will be exposed to scrutiny from investigative agencies, which may be detrimental for any central bank.

Finally, if all the above do fall into place, there is still one snag: capacity constraint at the National Company Law Tribunals. Of the 700 cases filed with the tribunals, only 70 have been admitted. Moreover, the National Company Law Appellate Tribunal has ruled (as reported by this newspaper) that the 14-day deadline for admitting or rejecting a proposal is not binding, though once admitted, the case has to be resolved in the mandatory 270-day period.

Make no mistake: there is definite movement towards resolution. But, as mentioned earlier, do not expect miracles.

This article was originally published in Mint newspaper on May 17, 2017, and can be read here

Rising Trade Walls and Shrinking Standards

Country after country, especially free trade evangelists, are erecting walls to stop the flow of professionals and human capital

Indian professionals are finding doors across the world shutting, shrinking opportunities to ply their trade. Weaned on a diet of free markets and globalization, they are finding that promise now ringing hollow. Country after country, especially free trade evangelists, are erecting walls to stop the flow of professionals and human capital.

US President Donald Trump carried out his campaign promise on 18 April by signing an executive order overhauling the H-1B visa regime, a programme allowing foreign professionals to work in the US for six years. Indian infotech companies such as Infosys, Wipro and Tata Consultancy Services (TCS) are among the biggest beneficiaries of this programme.

In less than 24 hours, Australia followed suit by revamping the immigration law which allows entry of professionals, titled “Subclass 457 visa”. Australian Prime Minister Malcolm Turnbull’s abrupt about-turn was unexpected. He was in India less than a week earlier, waxing eloquent about India-Australia ties and dispensing homilies about trade between the nations. He even signed off on a joint declaration with Prime Minister Narendra Modi which, among other things, welcomed “…progress in the flourishing knowledge partnership…building on the strong links in higher education, skills development and science, technology and innovation”. The icing was a memorandum of understanding signed with TCS for opening a new innovation lab in Australia, the fate of which could now be uncertain.

What could have happened in less than a week to force such a transformation? Could it be a follow-up to the now-infamous Trump-Turnbull telephone call? Turnbull’s measure, ostensibly designed to undermine rising nationalist right-wing forces at home, has now jeopardized progress on the Comprehensive Economic Cooperation Agreement (Ceca) being negotiated between India and Australia. A Ceca is wider in scope than a free-trade agreement—apart from trade in goods and services, a comprehensive treaty also includes issues like investment, government procurement and competition policy.

Three other prosperous nations have erected barriers of varying degrees—New Zealand, Singapore and the UK. New Zealand’s new work visa rules came a day after neighbour Australia’s. The UK has been tightening its visa rules for some time now. UK Prime Minister Theresa May recently further tightened visa rules for professionals by mandating minimum salary thresholds and language requirements.

India has a Ceca with Singapore which provides for trade in services between the two nations; to avoid breaching the agreement, Singapore has not denied work permits outright but has kept them in extended limbo.

This pandemic of border and behind-the-border barriers to services trade has compelled even World Trade Organization (WTO) director general Roberto Azevêdo to undergird his 2017 cheery trade prognosis with a caveat: “At the domestic level, policies are needed to help support the workers of today and train the workers of tomorrow. Closing the borders to trade would only worsen the situation—it would not bring the jobs back, it would make more jobs disappear.” WTO estimates world trade in 2017 will grow between 1.8-3.6%, but might settle at around 2.4% if world gross domestic product (GDP) growth sticks to projections. WTO also recognizes existence of multiple downside risks, including the sort of knee-jerk protectionist measures implemented by the US and Australia.

There could be a charitable explanation for why these countries are banding together against professional Indian talent. Australia, New Zealand and Singapore may have responded reflexively to the US and UK’s restrictive immigration laws; apprehensive of a spillover from these countries, the three countries might have responded impulsively and hastily.

The more plausible justification is that these moves—particularly by Australia and the US—are perhaps designed to blunt India’s attempts to introduce trade facilitation in services (TFS) agreement, somewhat identical to the trade facilitation agreement (TFA) in goods which came into force in February. According to India’s concept note—introduced in the WTO on 27 September 2016—like the TFA is intended to “…expedite the movement, release and clearance of goods as well as cooperation on customs compliance issues…”, the TFS can result in “…reduction of transaction costs associated with unnecessary regulatory and administrative burden on trade in services”.

India followed up the concept note with an “element paper” in November 2016 and a draft legal text in February 2017. The TFS is also now pitted directly against TiSA, or Trade in Services Agreement, currently being negotiated outside the WTO by 23 members comprising mostly developed countries. It is aiming for an ambitious overhaul of the General Agreement on Trade in Services (GATS), which it hopes will attract more members and eventually be ratified in the WTO. Both India and China (as well as many other emerging nations) are not members. It is, therefore, safe to expect that trade politics and diplomacy will probably focus a lot on services trade in the immediate future, especially at the WTO’s December ministerial in Buenos Aires.

Coincidentally, TiSA was initiated by the US and Australia. Which brings the discussion full circle: Is Australia’s long-term destiny to remain cat’s paw of the US? Its desire to also be identified as an Asia-Pacific community member will call for some tough balancing act then.

The above article was published in Mint newspaper and can also be read here