The Risk of Trade Wars Becomes A Reality

Trump’s trade actions and its contagion effects could theoretically lead to a slow erosion of the global rules-based trading system

Names can reveal a lot. The recurring cold waves buffeting Europe are called “beast from the east” because of their origin in Siberia. It is unlikely that the trade chill arising in the US and threatening to freeze global commerce will be given a similar sobriquet. US’ controversial decision to levy import duties—25% on steel and 10% on aluminium imports—has given rise to martial terms like trade war, with many countries threatening to retaliate. But truth be told, this is one winter that is unlikely to thaw any time soon.

But all credit to US President Donald Trump for not deviating from script. Multiple risk forecasts for 2018 had predicted a ratcheting up of trade protectionism. The tariff order—purportedly for national security purposes and to save jobs in the US steel industry—fulfils these prophesies. It now becomes necessary to see how the ripples left behind have an impact on India. Below the currents lies another trade development which is taking shape slowly but with potential to affect India.

As numerous reports show, US’ steel and aluminium import levies do not harm India grievously. India’s exports of steel (raw and finished) and aluminium into the US do not exceed $2 billion: it’s less than 5% of the $42 billion exported to the US in 2016-17. The effects will be felt elsewhere: Intermediate goods that originate in the US and form part of the global supply chain will become more expensive and could slow down wheels of trade. A study by Christine McDaniel, former senior economist with the White House council of economic advisers, has shown this is the US’ trade war with itself, given that industries consuming steel to manufacture other products (such as automobiles or washing machines) employ more workers than steel mills.

There will be some indirect consequences for India as well, with many countries threatening to erect their own protectionist walls. According to a Standard and Poor’s publication Global Trade At Crossroads, the strong undertow will be felt globally: “The retaliatory spiral could lead to a breakdown in the global rules-based trading system and raise the risk of an all-out trade war, eventually hurting exporters both in the US and globally.” At risk is India’s incipient export growth momentum: exports during April-February 2017-18 were $273.73 billion, 11% higher than the corresponding period of previous year.

Many commentators were critical of India’s higher import duty rates, presented during budget 2018-19, especially since they were introduced soon after Prime Minister Narendra Modi’s speech at Davos cautioned against growing protectionism. While the new tariffs do seem to contradict India’s stand on free trade, they are broadly consistent with its World Trade Organization (WTO) commitments and are within the bound rates fixed for India.

Trump’s trade actions and its contagion effects also do not violate WTO norms but, by bringing in a national security angle, could theoretically lead to a slow erosion of the global rules-based trading system. The WTO mini ministerial scheduled in Delhi from 19 March might provide a window into the future of the multilateral trading system.

As things stand, US has often been accused of subverting the WTO system when the going gets tough. It has been holding up the appointment of judges to WTO’s appellate body, actively preventing a satisfactory closure to the food security discussions and openly supporting bilateral deals over a multilateral solution. Its unilateral approach to trade—naming and shaming countries through Special 301 or its WTO-plus intellectual property laws—are regarded as openly contemptuous of multilateral systems.

On the sidelines, another global trade development is quietly challenging its predominance. On 8 March, 11 Asia-Pacific countries signed the Comprehensive and Progressive Agreement for Trans Pacific Partnership (CPTPP), an improved version of the earlier Trans Pacific Partnership (TPP) from which the US walked out. What makes the new agreement interesting, apart from 11 nations opting to go ahead without the US, is the relaxation of certain clauses specifically introduced by the US.

The new agreement puts on hold 20 provisions from the old draft, 11 of which relate to intellectual property rights (IPR) included at the US’ insistence. Among the changes introduced are a truncated patent protection phase for innovative medicines, or narrower data protection rules for new pharmaceutical products or biologics. Gone also are some of the onerous investor-state dispute settlement clauses.

India should be concerned about what remains on the books because some clauses could indirectly put pressure for an overhaul of its domestic policies: the chapter on state-owned enterprises is one example. By adopting these rules for trading within themselves, the 11 CPTPP members—Canada, Australia, New Zealand, Mexico, Japan, Singapore, Brunei, Malaysia, Peru, Chile and Vietnam—might demand other trade partners to follow some of these rules. They are unlikely to have one set of rules for TPP members and another set for other trade partners.

It is also quite likely, though not definite, that CPTPP will have a benign influence on other trade pacts involving India, such as the Regional Comprehensive Economic Partnership, which has many common members with CPTPP and is currently being negotiated. India will have to be prepared for this eventuality.

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

Why Banking Frauds Are So Frequent At PSU Banks

The terrain that is Indian banking turns tricky when government’s shareholder action in PSU banks starts impinging on RBI’s regulatory regime

It’s difficult not to detect a sense of déjà vu in the Nirav Modi scam, especially in all the hand-wringing and ex post facto zeal in setting up committees and investigations. Scams are a recurring motif in Indian banking, and the Punjab National Bank (PNB) case fits into the broad template of all previous stings.

In the search for solutions, a steady crescendo of drum-beats has been advocating whole-scale privatization of public sector (PSU) banks as a cure-all panacea. Implicit in the suggestion is the assumption that scams are the exclusive preserve of PSU banks. While it is true that the extent of scams and corruption is highest in PSU banks, data shows Indian private banks are not entirely immune.

The history of Indian banking over the past 50 years is littered with examples of failed private banks that were forcibly merged with stronger public sector banks (and with even stronger private banks recently—such as Bank of Rajasthan with ICICI Bank Ltd). This was done to safeguard depositors’ monies and to avoid systemic disruption. Here are a few random examples: Bank of Bihar was merged with State Bank of India in 1969; Hindustan Commercial Bank with PNB in 1986; Bari Doab Bank Ltd with Oriental Bank of Commerce in 1997; Kolkata-based United Industrial Bank merged with Allahabad Bank in 1989-90; Bank of Karad with Bank of India in 1994. The word merger has a volitional ring to it, but truth be told, there was nothing voluntary about these mergers.

Private banks have no special genes making them immune to scams and frauds. Global Trust Bank had to be merged with Oriental Bank of Commerce after its net worth was wiped out due to systemic fraud perpetrated by insiders. Even voluntary mergers in the post-reforms era are designed to escape distress and seek shelter with a stronger bank.

On balance, though, the larger proportion of scams in PSU banks does beg the question: why do they recur? One immediate reason could be the blurred lines of control and command. The government is the owner of PSU banks and exercises its shareholder rights capriciously: random appointments and transfers of chief executives, influencing appointment of board members, rationing out capital allocation in the name of fostering efficiency are some of the arbitrary control levers. The terrain turns tricky when government’s shareholder action starts impinging on Reserve Bank of India’s (RBI’s) regulatory regime. Bank senior executives, politically seasoned in picking up conflicting signals, reflexively align with the government even if it means contravening RBI’s regulatory framework.

For example, in the PNB fraud case, the bank’s core banking system (CBS) was not linked to its SWIFT system, thereby allowing officers to clandestinely issue letters of undertaking to Modi’s companies and confirming them with counter-party banks overseas through the SWIFT system.

This is despite RBI exhorting banks to link CBS with SWIFT; yet, PNB chose to violate these orders. It is, therefore, odd that none of the members of PNB’s governance troika—board, RBI or its all-powerful shareholder—pulled up the management or even sought an action taken report.

Former RBI governor Raghuram Rajan writes in his book, I Do What I Do: “Today, a variety of authorities…monitor the performance of public sector banks… It is important that we streamline and reduce the overlaps between the jurisdictions of the authorities, and specify clear triggers or situations where one authority’s oversight is invoked.”

RBI is tasked with detecting infirmities, but has no authority to enforce its own orders, administer remedial measures or even deliver swift punitive action. The central investigative agencies are tasked with following up on investigations and pursuing legal recourse. The political pulls and pressures on these agencies, as well as the Indian legal system’s long-drawn processes, provides swindlers with enough escape routes (pun intended), and is never a deterrent.

There is a likelihood that diminished incentives to regulate and supervise could be leading to weakened supervision and vigilance: most of it has become detection (after the event investigation) rather than prevention, which is to create systems and processes that raise alarms before the event or while transactions are taking place.

Flawed risk-mitigation design, which puts excessive focus on credit or market risks, has taken away attention from operation risk, leaving it susceptible to breaches. In addition, there is excessive dependence on manual supervision, at both external and internal levels. The sheer volume of transactions makes it impossible to manually control and supervise.

In the end, no matter what the design, somebody will always attempt to finesse the system. Blame corrupt politicians and bureaucrats, or the steadily disintegrating moral fibre of Indian businessmen, bankers and other white-collar professionals (as pointed out in this article), but scams are here to stay. The trick will be to construct a process design that prohibits anybody taking advantage of the system for sustained periods. And that will require dismantling some of the entitlement rights of the majority shareholder.

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

One Local and Three Global Risks Facing India

As India lurches towards the 2019 general elections, it might be appropriate to list some of the risks that confront the country

The beginning of a new year usually sees think tanks and insurance companies list their version of perceived global risks over the next 12 months. As India lurches towards the 2019 general elections, it might be appropriate to list some of the risks that confront the country.

India’s numerous direct and indirect geopolitical challenges are well known. Some of these are: problems with a mendacious neighbour on the western border; China’s aggressive expansionism and its belligerent posturing in the South China Sea; smouldering conflicts between Saudi Arabia and Iran and Qatar aggravating; the proxy war in Syria coming to a boil; and tensions further escalating in the Korean peninsula.

War and geopolitical conflicts have persisted throughout modern history and 2018 is unlikely to be an exception. But, India’s primary concerns spring from geo-economics, traditionally neglected in future risk scenarios and risk mitigation frameworks.

Three large risks dominate the landscape and they all impinge on both the fiscal and current account deficits.

The first one is uncertainty over oil prices and India, a large net importer, is directly exposed to this volatility. Slow but certain recovery in the global economy has pushed oil prices from the 2015 lows of $30 per barrel to over $60 now. The future direction of oil prices will be decided in a power play between USA-based shale producers and the informal alliance between the Organization of Petroleum Exporting Countries (Opec) and Russia.

The unofficial Opec-plus arrangement has been successful in cutting oil production and slashing overstocked inventories. As oil prices have risen, record volumes have gushed from the US, threatening to eclipse production from the world’s two largest producers—Russia and Saudi Arabia. There are apprehensions that as prices further appreciate, some other South American oil producers might add to the US flood. This might force the Opec-plus grouping to push for further production cuts which could eventually threaten the agreement. Added to the mix is the risk that energy prices and flows might become the next weapon in the renewed US-Russia conflict.

As things stand, the Opec-plus agreement is scheduled to be reviewed soon and is likely to be extended. Even if they agree to wind down the arrangement, it has to be done in an orderly fashion, without disrupting markets. India is exposed to these volatilities through its reliance on oil imports, and its recent agreement with the United Arab Emirates to construct strategic oil reserves might be a bit too late.

India’s second geo-economic risk emanates from the wave of protectionism that threatens the global economy, particularly the ongoing trade war between the US and China. Apart from real and threatened tariff measures affecting India’s exports to the US, there are indirect consequences also.

The Economist Intelligence Unit notes in a recent publication, Cause for Concern: “Any ramp-up in protectionism would certainly have repercussions beyond North America and China. Prices and availability for US and Chinese products in the supply chains of companies from other nations would be badly affected. Consequently, global growth would be notably curtailed as investment and consumer spending fall back.”

India’s third geo-economic risk originates from a person: Jerome H. Powell, the Federal Reserve chairman. Based on his recent testimony to Congress, markets are sensing greater aggression compared with his immediate predecessor (Janet Yellen) and, consequently, expecting three to four interest rate increases during 2018. This could inject a new degree of turmoil in the markets, especially in the face of what many find unsustainable asset markets. The Reserve Bank of India’s sixth bi-monthly monetary policy statement noted: “Financial markets have become volatile in recent days due to uncertainty over the pace of normalisation of the US Fed monetary policy…The volatility index (VIX) has climbed to its highest level since Brexit.“

India, like many other emerging markets, is particularly vulnerable, given that recent asset market developments are predicated on global capital flows. Any reversal of these flows could spell trouble for not only asset valuations but also future capital raising. The World Economic Forum’s The Global Risks Report 2018 states: “…economic and financial risks are becoming a blind spot: business leaders and policy-makers are less prepared than they might be for serious economic or financial turmoil.”

It would be negligent not to account for risks on home terrain: various state assembly elections in 2018 and general elections in 2019. Governments, on the eve of elections, are tempted to loosen policy restraints, succumb to populist forces and spend more. Another election-related threat looms. Risk Map 2018 from specialist risk consultancy Control Risk states: “A political environment in which parties leverage emotive and controversial social issues for electoral support could foster the spread of adverse nationalist rhetoric, potentially posing risks for foreign businesses in 2018.”

That said, with 16 general elections already under India’s belt, the next one also falls in the business-as-usual category. Therefore, in the balance of risks confronting India, the beyond-border challenges remain trickiest as they run the risk of derailing India’s twin deficits and, as a consequence, critical macro variables like inflation and growth.

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

Fault Lines in the Indian Banking Industry

Both the PNB fraud and the Rotomac case underline how fund diversions were overlooked, but what’s distressing is how no alarm bells were sounded, no red flags were raised

Two things occur with metronomic regularity in the Indian banking sector: scams and committee reports. One, perhaps, follows from the other.

The Indian banking story, whether pre- or post-nationalization, has been an unfortunate hostage to a long catalogue of scams and frauds. The discovery of each scam is usually followed up with a flurry of committees and reports, rule reversals and a systems overhaul. A few years lapse in all this frenetic activity, a sharp light is focused on the scam area and just about when everybody starts getting complacent, another scam hits the industry. The entire round-robin league is replayed all over again.

The modus vivendi is common: exploit the system’s weakest link. There is another common thread in all the scams: diversion of funds. Both the Punjab National Bank (PNB) and Bank of Baroda (BoB) scams—the Nirav Modi and Rotomac cases, respectively—underline how fund diversions were overlooked; what’s distressing is how no alarm bells were sounded, nor red flags raised, despite an obvious piling up of operational, human and market risks that have debilitated two of India’s stronger public sector banks. Unfortunately, this seems to have become the default template for Indian banking scams, underscoring wide gaps in the regulatory framework. A cursory glance at scams since 1990 show how each episode methodically leveraged regulatory and supervision gaps.

The Harshad Mehta scam coincided with the dawn of India’s economic reforms. Mehta exploited the manual and antiquated settlement systems in trading of government securities. Taking advantage of a few pliant bank officers, Mehta conducted gilts trade between different banks using forged documents and diverted proceeds to prop up untenable equities positions. The scam-tainted large public sector banks (State Bank of India), foreign banks (Standard Chartered), small private banks (Bank of Karad, now extinct), corporate behemoths and sundry securities markets intermediaries.

A decade later, Ketan Parekh—ironically Harshad Mehta’s protégé—replicated almost the same methods: divert funds from the banking system through fraudulent methods to sustain equity market positions. KP would obtain pay-orders from Ahmedabad-based Madhavpura Mercantile Cooperative Bank without providing sufficient collateral. He would discount these pay-orders with Bank of India in Mumbai and use the proceeds to ramp up shares. The house of cards eventually collapsed when bear traders hammered KP’s favourite stocks and Madhavpura’s outstanding pay-orders exceeded its ability to repay Bank of India.

Here’s another familiar story: Sanjay Agarwal, former CEO of Lloyds Brokerage, created portal Home Trade in 2000 but was forced to go on the run a year later. Agarwal had inserted himself into the world of cooperative banks, promising to invest in gilts on their behalf and delivering lucrative trading returns. Instead, he diverted the money without delivering the securities or providing the promised returns. The charade continued till one of the cooperative banks complained about not receiving the promised securities.

In recent times, Winsome Diamonds and Jewellery Ltd allegedly used standby letters of credit to divert Rs7,000 crore. Winsome Group promoter Jatin Mehta shares another common strain with Nirav Modi: both have ostensibly become citizens of Saint Kitts and Nevis islands in the Caribbean, which does not have an extradition treaty with India.

Many more similar banking scams have occurred and gone undetected for long periods till the final moment of denouement. One trend is unmistakeable: money is diverted out of the banking system with the active connivance of either the bank’s senior management or a couple of rogue officers. This is what makes both the PNB and BoB cases incredulous: with Reserve Bank of India (RBI) putting so much emphasis on anti-money laundering mechanisms, and with an increasing number of prosecutions against either money laundering or diversion of bank funds, it is indeed curious how both the banks persisted with lax risk mitigation and supervision frameworks.

This also then begs the question: how is it that so many similar scams occur with such frequency, especially when RBI is such a hands-on regulator and supervisor? Every small action needs RBI approval, be it a CEO’s annual bonus, bank management’s decision to nominate a senior executive to the board or to open a branch in a city. Yet, copycat scams continue with ineluctable monotony.

Each time a scam occurs, committees are set up and numerous studies take place. Even now, post the PNB scandal, RBI has set up a committee under chartered accountant Yezdi H. Malegam to examine the increasing number of frauds in the banking system, the measures that will be needed to prevent them (including technological solutions), the role and efficacy of various audits currently conducted in banks to mitigate such frauds and the growing divergence between RBI and bank assessments on asset quality.

Many similar committees were set up earlier and voluminous reports submitted; yet, sadly, they are never enough to prevent future scams.

Next episode: what could be the probable reasons for the recurrence of such scams.

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

Hierarchy Of Rights: Citizens vs Institutions

The state, its myriad institutions and the corporate sector—both in private and state-owned spaces—have been provided a hierarchical status greater than citizens

The large hole discovered recently in Punjab National Bank (PNB) has got people asking: How did a diamantaire take out so much money from the banking system, so easily, when ordinary customers are made to jump through several hoops or provide copious documentation for a simple transaction?

The incident has once again highlighted the asymmetrical and uneasy relation between institutions and ordinary Indian individuals, in which the dice seems to be loaded against ordinary citizens. As examples later illustrate, this unequal relationship is not restricted to a few isolated cases but is endemic and, in some senses, also epitomizes the mistrust between state and citizen.

On paper, all Indians are created equal but inequalities have been stitched into the nation’s variegated relationships and transactions, such as deep-rooted gender inequalities or caste-based social discriminations. In particular, the state, its myriad institutions and the corporate sector—both in private and state-owned spaces—have been provided a hierarchical status greater than citizens. It seems the Indian republic, with its all modernist aspirations, is unable to shake off its feudal legacy and provide an equitable balance between institutions and individuals. The state’s role as a patron (or mai-baap) seems to rub off easily on various other institutions.

The mistrust is underscored every time there is a fraud, anywhere and by anybody, in the banking system. The Reserve Bank of India (RBI) insists all banks re-initiate the know-your-customer (KYC) process afresh, forcing all customers to compulsorily re-submit identity documents. Past submissions of same documents are disregarded. This process seems to indicate all citizens are guilty till they provide KYC papers repeatedly. The tyranny of Aadhaar, unleashed by all financial sector participants, has magnified the state of wariness. Hopefully, champions of Financial Resolution and Deposit Insurance (FRDI) Bill, specifically using depositors’ funds to bail out shaky banks, will now have occasion to rethink their position.

The unequal relation between state and individual is extreme in taxation. Tax notices routinely sent out by the income tax department start with the premise that the individual assessee is guilty and leave no room for doubt that the department could be mistaken; the tenor of these notices is intimidating, and the onus for proving oneself innocent lies with individual assessees. Even the redressal mechanism is loaded against the individual and mainly designed to deal with large corporates.

Apart from the PNB incident, examples abound of how such inequalities have become institutionalized. Assume a customer owes the electricity company money for consuming power. There is a tariff structure for consumers that is decided between power supplier and power regulator. If for some reason the consumer is unable to pay for one month, the power company’s representative arrives at the door and demands immediate payment or threatens disconnection. Logic and economic sense suggests that user charges must be paid. Otherwise, utilities cannot function. But, what happens when the same power company (or any other company) defaults on bank loans? In the language of RBI, the loan is recognized as overdue only when “interest and/or instalment of principal remain overdue for a period of more than 90 days”. Which means any company can afford not to repay its loans for 90 days without getting penalized. The question begs itself: if companies can avoid repaying loans for 90 days, why are ordinary citizens hounded at the end of 30 days?

A citizen’s helplessness is best manifested through the healthcare system. A division bench of the Bombay high court recently instructed the Maharashtra government to balance the rights of patients with the rights of hospitals and doctors while bringing in legislation to regulate clinical establishments. The court was hearing a 2014 petition, which it has converted into a public interest litigation, on hospitals detaining patients over disputed bills. As mentioned in earlier instalments of this column, public-private-partnerships in healthcare have benefited mostly the private entrepreneur, with active connivance of the state, and squeezed individuals.

On occasion, the regulator has had to step in to correct an inconsistency. Credit bureaus till recently did not allow citizens to access their own credit records without paying a fee. Credit card issuers and all other economic agents submit data on a citizen’s creditworthiness to credit information companies and could access the same before granting a loan or a credit card. But the individual could neither access the submitted data nor dispute the data, without paying a fee. In September 2016, RBI decreed that all credit information companies had to provide a free full credit report to individuals once a year. But the process remains cumbersome.

Globalization’s annual summit has over the past couple of years focused on social themes—from inequality to this year’s “creating a shared future in a fractured world”. Last year, discussions on how to eradicate inequality ranged from higher taxes on the rich to universal basic income; the World Economic Forum piped in with its own solution: “Move away the focus from plain wealth creation towards accomplishing a combination of other goals, producing more inclusive development.” Next year’s theme should be on redrawing the balance of power between individuals and all institutions.

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

Feels Like Scam Season Once Again

The belated discovery of a moon-size crater inside Punjab National Bank (PNB) opens up many fronts and leaves multiple questions unanswered. What’s more, the extent of damages is still evolving and could multiply as individual strands of the multi-layered transactions are extricated.

The overall outlook is also not that encouraging: the spaghetti bowl of interconnected transactions could result in a number of tangled legal disputes that could take some time to unravel. India’s largest commercial bank, the public sector State Bank of India, has just disclosed it has a $212 million exposure. In all, it feels like scam season once again!

The PNB episode seems to replicate all the steps observed in previous bank scams and carries echoes of similar collusions and cover-ups; what remains to be seen now is whether there is a flurry of post-scam reports from Reserve Bank of India (RBI) or Joint Parliament Committees, reminiscent of the Harshad Mehta scam.

To be sure, there will be much hand-wringing and chest-beating, new rounds of regulatory measures, additional layers of risk management processes and documentation followed through with an endless stream of circulars, guidelines and rules. And yet, all this will be secondary to human ingenuity which will always find a way through this thicket of paperwork and red tape.

The PNB incident highlights the problems of over-reliance on systems, processes and paperwork, indicating that if somehow some boxes are ticked, the problems will go away. While it might be too early to conclude that senior management was involved in the scam, it is clear that there were multiple failures at various levels. It might be informative to try and disentangle this skein of multiple threads.

First, and most baffling, how did the senior management members, the board directors and the auditors (external and internal) miss something of this size? Agreed that the liability was contingent but the liability was over `11,340 crore; that is over 25 per cent of the bank’s total capital. Any contingent liability of this size to one client or single entity should have set alarm bells ringing. At the least, it should have merited an examination of the account.

It also transpires from documents filed by PNB officials with CBI and with stock exchanges that Nirav Modi’s diamond firms—Diamonds R Us, Solar Exports, Stellar Diamonds—were caught out on 16 January 2018, when they went to seek buyer’s credit to make payments to overseas suppliers. Their calculations did not include the possibility of having to deal with a new set of bank managers.

The company management apparently bristled when the new manager asked them to provide 100 per cent cash margin for availing the facility because they did not have a sanctioned limit with the bank. In simple language, the new manager wanted Nirav Modi & Co to keep cash equivalent to the loan amount since they had not gone through the usual process of submitting to due diligence from the bank’s credit appraisal team.

This raises two questions. One: How did they manage for so long without obtaining a formal sanctioned facility with the bank? But more importantly, how did they manage to raise so many loans in foreign currency for so long without providing any security? Many institutions are known to provide a one-off facility based on business judgement and yield calculations. But Nirav Modi’s companies seemingly had unfettered access to the bank’s facilities. This does indicate some level of senior acquiescence.

Second, the ignorance is all the more appalling because Nirav Modi used PNB’s instruments to construct a web of multi-layered liabilities. This again could not have been possible without somebody up and down the chain noticing it. The notion that the PNB officers colluding with Nirav Modi kept the deals off the books also seems difficult to swallow since the counter-party banks on which the Letters of Undertaking (LoUs) were raised (Allahabad Bank or Axis Bank in Hong Kong) would have sent multiple deal stubs back to various parts of PNB’s risk management matrix—front, middle or back offices—for settlement and reconciliation. Even if we discount the possibility of complicity, it is a colossal systemic failure, one that has ripple effects across the industry.

In its letter to the stock exchanges, PNB claims: “The bank liability is contingent only. The liability shall be decided based on the law of land.” In other words, the liability is not known till there is legal clarity on who owes how much to whom. This seems to indicate that PNB senses a long-drawn legal battle ahead. But a cursory look at PNB’s website seems to indicate it’s business as usual—it is difficult to find PNB’s own press releases, the MD’s message to assuage investors and customers, or even the reports filed with stock exchanges. It is perhaps this lack of communication within the institution that kept the scam going undetected for so long.

But when all is done and dusted, two crucial questions remain unanswered. One, how all those accused of money laundering—Vijay Mallya, Nirav Modi, arms dealer Sanjay Bhandari—are able to leave the country just before a first information report is filed, or the enforcement directorate carries out raids on their homes and offices? Second, and this has national security implications: if Nirav Modi was not accompanying PM Narendra Modi to Davos as part of his official delegation as the government said, how did he photobomb a group portrait? He is standing an arm’s length away from Modi; is the PM’s security so lax that anybody hanging around in the vicinity can be allowed to stand in an official group photograph with him?

This article was originally published in New Indian Express newspaper. You can also read it here

Poll Khol: Farmers, Women, And The Elderly: Jaitley Readies Modi’s Votebank For 2019

Pre-election budgets are all about understanding the political economy and delivering a sharp message. Finance minister Arun Jaitley seems to have dipped into his party’s successful electoral playbook to design his budget for 2018-19. And his manual of choice seems to be the Uttar Pradesh (UP) elections, compelled by the erosion of margins during the recent Gujarat state polls.

A new paradigm for categorising voters helped the Bharatiya Janata Party (BJP) sweep the UP elections in 2017. Apart from using the conventional tools of mass appeal and deploying a predictable Hindutva message, the BJP changed the rules of the game by slicing voters horizontally along socio-economic backgrounds and gender. This was a marked departure from the opposition’s shop-worn tactic of vertically dividing voters along caste lines or as Hindus and Muslims. As part of the exercise, the BJP converted the autocratic demonetisation decision (which inconvenienced millions of citizens) into a virtue as a battle against the wealthy. And this seems to have worked.

In contrast, Gujarat voters expressed scepticism about the party’s message of successful economic management in the face of visible disruption, stagnant incomes, and growing unemployment. So, seemingly, it’s back to the UP formula for now.

Jaitley’s last full budget, and opportunity to showboat before the next general elections, focuses on three large socio-economic cohorts: those engaged in farming and allied professions, women, and the elderly. There are the customary paeans to the middle-class and salaried individuals as well, but those don’t amount to much.

The aged

So let’s start with the last category first because it’s not only the most interesting but also counter-intuitive. In a country that boasts of a demographic dividend, with 50% of the population below 35 years of age and viewed as an engine of economic growth, a policy bias towards senior citizens seems to go against the grain. Jaitley has announced numerous benefits for the elderly: A 400% rise in the tax-exemption limit on interest income, an over 60% increase in tax set-off limits for health insurance, an increased deduction limit for medical expenditure, and other benefits.

These benefits are more like corrections and have been long overdue; it is the timing that attracts attention.

The choice is all the more interesting because the number of senior citizens in India is not very high—between 100-110 million, less than 10% of the total population. While the population census of 2011 put the number of Indians above 60 years of age at 104 million (8.4% of total population), the registrar general of India’s 2014 sample registration system estimated the number closer to 107 million. Peeling down the group data from the 2011 census further reveals some interesting highlights: Rising literacy rates (44% in 2011 against only 27% in 1991), a gender divide born out of varying life expectancy rates (53 million women against 51 million males), 41.6% still engaged in some occupation and earning (with a higher working population in rural areas), and a predominantly rural bias with only 29% based in urban centres.

The surprise lies in the electoral data. According to the election commission’s annual report for 2016, there were up to 868.6 million voters registered as on Jan. 01, 2017. According to the commission’s Electoral Statistic Pocketbook, 2017, only 11.5% of the total registered voters—or slightly below 100 million—are above 60 years of age. It is not a sizeable chunk but could be a decisive voting bloc if husbanded and harvested strategically.

Jaitley’s budget perhaps takes the first step in that direction.

Apart from its innate significance, the focus on senior citizens also marks a pivot from the BJP’s pronounced courtship with the youth in 2014. In the run-up to general elections, the party promised jobs for the youth by reviving investment in manufacturing and making a decisive break from past style of governance. While the jury’s out on the last issue, promises of more jobs and higher incomes have not materialised.

The Gujarat elections provided a brief glimpse into the youth brigade’s frustration and disillusionment. It is, therefore, logical for the party to search for newer pastures.

It is unlikely that the BJP will give up totally on the youth—though it will be interesting to see the nature of messaging adopted and the varying degrees of chauvinism built into it—but it doesn’t harm to hedge one’s bets.

The women

The second interesting population segment is women, a vote bloc that over the years has proved to be exceedingly influential. During the 2014 general elections, women voters constituted 47% of the turnout. While it was quite high in the UP polls, even outnumbering males in many seats, it was significantly lower in Gujarat (about 10% lower than men). This might have given the BJP reason to believe that women voters required special treatment.

And so Jaitley duly opened the budget tap, with special emphasis on rural women: 30 million free LPG connections to be added to the earlier 50 million, some 40 million more rural households to get free electricity, 20 million toilets, and close to 14 million affordable houses. What rings odd in all this is a mechanical positioning of broad livelihood proposals as women-centric proposals, treating the household and women as synonymous. While free electricity, affordable houses, and toilets benefit all household members, they have been pitched as women-centric.

The farmers

Finally, the farm sector deserves many structural reforms.

With close to 60% of the country’s population dependent on farming and allied occupations—directly or indirectly—continuing distress in the sector has been affecting income levels and livelihoods across a broad swathe of rural India. There is an additional sense of disenchantment, given the widening gap between expectations raised and actual benefits delivered. It was widely expected that Budget 2018 would undertake some course correction, especially after the Gujarat electoral rebuff.

It might be instructive to parse Jaitley’s budget speech: “For decades, the country’s agriculture policy and programme had remained production-centric. We have sought to effect a paradigm shift. Honourable prime minister gave a clarion call to double farmers’ income by 2022 when India celebrates its 75th year of independence. Our emphasis is on generating higher incomes for farmers.” The last two sentences seem to indicate Jaitley is injecting a dose of reality into the PM’s lofty promises: PM Modi may want to double farmers’ incomes, but let’s just generate higher incomes first. Or, perhaps, we’re reading too much into a simple statement.

Jaitley has also provided the BJP with ammunition to wage a faux class war: tax on long-term capital gains.

Even though there is merit in such a progressive tax, the undertone suggests that this tax is likely to be showcased as the government’s attempts to reduce economic inequities, and position itself as a champion of the poor. There is also a passing gesture to the oppressed castes in a somewhat curious turn of phrase: “…the present top leadership of this country has reached this level after seeing poverty at close quarters. Our leadership is familiar with the problems being faced by the SC (scheduled castes), ST (scheduled tribes), backward classes, and economically weaker sections of the society. People belonging to poor and middle class are not case studies for them, on the other hand they themselves are case study.”

Make of it what you will. One thing is clear: The BJP does not seem so sanguine any longer; it’s all hands to battle stations.

The above article was written at the invitation of quartz and can also be read here 

Budget 2018: What Equities And Bond Markets Tell Us

While the equity markets seem to have comprehensively disapproved of Jaitley’s last full budget, the response of bond prices indicate the likelihood of hardening interest rates in the future

Two needles moved decisively after Union finance minister Arun Jaitley announced his budget for 2018-19. Both movements provide some clues on how to read the budget.

The first needle—indicating stock market health—oscillated wildly during Jaitley’s speech and continued to fluctuate thereafter. The BSE Sensex started floating downwards soon after the finance minister began reading his budget speech on Thursday morning, disheartened by the heavy overload of social sector announcements. It then dropped further on news of a new long-term capital gains (LTCG) tax, recovered slightly and ended the day marginally below opening levels. But, on Friday, it capsized as the full weight of the budget sank in. By the time markets closed on Friday, Sensex had lost almost 900 points, or close to 2.5%, over its Wednesday closing.

This sell-off can be read in multiple ways. The charitable justification is that the stock market was over-valued and investors needed an excuse to make a correction. The moderate explanation is that investors are unhappy with the budget maths, the expenditure programme, the lack of visible funding sources, lack of clarity over the generous spending programme and the red light flashing over the fiscal deficit levels. The extreme view is that the sell-off revealed a marked distaste for the new LTCG levy, an inexplicable 42% jump in the securities transaction tax collection next year (raising fears that the tax rate might be increased in the interim) and the inclusion of equity mutual funds in the dividend distribution tax net.

The Sensex started floating downwards soon after Jaitley began reading his budget speech, disheartened by the heavy overload of social sector announcements. Photo courtesy: AFP and Mint.

In short, whatever the reason, it does seem that the equity markets have comprehensively disapproved of Jaitley’s last full budget. It’s perhaps also an expression of the market’s scepticism with the numbers.

For example, there is no accounting for many of the grandiose spending schemes. Analysts are clueless how either the minimum support price programme for farmers, or the ambitious health coverage scheme, will be financed. There are doubts even about some of the capital expenditure schemes. Many of these are likely to be launched in conjunction with states, giving rise to a fresh wave of cynicism about their viability.

In most cases, the policy architecture is yet to be worked out. Making announcements before finalizing the policy contours is a curious practice, somewhat like a nervous sentry shooting first and asking questions later.

Some disingenuous measures on the personal tax front might have also left a bad taste. For example, a standard deduction of Rs 40,000 that was announced as relief for the salaried taxpayers was negated the next moment by an increase in cess from 3% to 4%. In fact, the budget relies heavily on cess collection, a revenue source which the centre does not have to share with states, betraying signs of nervousness not only about revenue collection but also about the impending political battles that lie ahead.

The second needle—bond markets—is providing a far more layered story of what lies ahead. Reacting to budget arithmetic, especially the government’s spending and planned borrowing programme for 2018-19, 10-year government bond prices fell and yields rose, indicating the likelihood of hardening interest rates in the future. The Reserve Bank of India (RBI) announces its sixth bi-monthly monetary policy on 7 February and it will be interesting to see what emerges.

One thing is certain though: the prospect of a rate cut now seems to have receded. On the contrary, RBI is likely to adopt a tightening stance, with oil prices rising globally, bank credit picking up, money supply growth clocking 10.7%, the government’s borrowing programme looking unrealistic and poised to breach the budgeted target (just like the current year) and general uncertainty over how the government’s proposals will impact the price line.

For example, there are questions over whether the 50% increase in kharif minimum support price will impact the consumer price line or whether it has already been priced in.

Pressure on yields will emerge from another front if Jaitley’s plans for the corporate bond markets take off. Jaitley’s speech stated that securities markets regulator Securities and Exchanges Board of India will soon come out with rules that will compel large corporates to source 25% of borrowings from the corporate bond market. In addition, he said many sectoral regulators will be asked to relax investment rules in their respective industries; for example, the insurance regulator might henceforth allow insurance companies to invest in A-rated bonds when the current rules draw the line at AA-rating. To facilitate growth of the corporate bond market, Jaitley also promised to reform the stamp duty regime in consultation with states.

Even if we leave aside the oddity of telling corporates where to borrow, the development has the potential to affect government bond yields and, subsequently, interest rates. While the government has kept its FY19 borrowing programme largely the same as FY18 (Rs6.06 trillion against Rs6.05 trillion), any additional borrowings over the budget target is likely to have consequences for interest rates.

And as the ruling Bharatiya Janata Party gets into election mode—as was evident from the budget speech’s tone and tenor—and spending gets subjected to realpolitik, the likelihood of a bloated borrowing programme and deviation from the fiscal deficit glide path cannot be ruled out. It’s election season after all.

The above article was written for Mint newspaper. It can also be read here

Are Promises Meant To Be Kept?

What you expect is not what you always get. But Budget ’18 seems to have lived up to its promise: effusive praise for its own policies, some grandstanding and lots of signalling. In short, Finance Minister Arun Jaitley’s Union Budget for 2018-19 is custom built to prepare his party for hectic political action over the next 12-18 months. Jaitley’s avowed focus is on improving ease of living in modern India; if the economy benefits, that will be a bonus.

This may sound a bit cynical but Jaitley joins a long list of illustrious finance ministers who grapple with this problem every Budget: How to ensure that the policy design satisfies all economic interests? This gets aggravated during pre-election years when neglected constituencies need handouts and aggrieved voters require hand-holding. Most FMs have settled upon a common formula: showboating, grandiloquence, throwing in a few quotes, data smokes-and-mirrors, and a string of policy announcements that sound good and feel good but might forever remain on the drawing board. The earlier government mastered this art and this government is showing no signs of giving up on it.

This Budget focuses on select voter segments: agriculture and rural voters, women, infrastructure and health, salaried employees and MSMEs (micro, small and medium enterprises). Many schemes have been announced, money allocated and pious intentions announced; time will tell whether these translate into tangible benefits on the ground.

For example, Jaitley has announced a 50 per cent increase in minimum support prices (MSP) for the kharif crop. So far, so good. However, it is common knowledge that MSP does not cover all crops and that most farmers are unable to take advantage of MSP due to a variety of reasons—corruption at procurement sites; paucity of information about MSP; lack of linkages between farms and markets; coercive tactics used by local moneylenders and politicians to buy crop from farmers at sub-MSP.

The government also recognises that most farmers do not have access to MSP levels when market prices often slide below MSP. To remedy this, Jaitley’s Budget speech promises: “Niti Aayog, in consultation with central and state governments, will put in place a foolproof mechanism so that farmers will get adequate price for their produce.” Going by the statement, it seems that it will be a while before Niti Aayog can construct a policy paradigm, launch it and then correct it for bugs. This raises concerns: Can Jaitley honour some of these promises?

Predictably, agriculture and the rural economy occupy the centre stage this Budget, given the imminent political compulsions. Outlays have been announced for agri-market infrastructure, rural roads, food processing, dedicated funds for developing infrastructure in aquaculture and fisheries as well as for animal husbandry, among others.

But here’s the problem: these announcements fall short of ensuring that funds reach the farmers. The Budget paradigm remains stuck in legacy mode, unable to shift from theatrics to improved, on-the-ground delivery mechanisms. For example, the much-vaunted crop insurance scheme has failed to settle claims in a year of severe farm sector distress.

While many commitments have been made to improve the lot of the poor, some existing schemes are being tapered down; the Mahatma Gandhi National Rural Employment Guarantee programme is a good example. Against an originally budgeted Rs 48,000 crore expenditure for the scheme during 2017-18, the government actually spent Rs 55,000 crore during the year. But the expenditure budgeted under this head for 2018-19 remains fixed at Rs 55,000 crore.

This Budget contains another path-breaking announcement: a move towards universal healthcare. As a first step, Jaitley has promised that 10 crore poor families (comprising roughly 50 crore beneficiaries) will be provided coverage (up to Rs 5 lakh per family per year) for secondary and tertiary care hospitalisation. This is a major step forward. But as earlier, there is little information on the details of the scheme or how it will be rolled out, giving rise to scepticism.

The Budget was also expected to provide some stimulus to manufacturing and employment generation. Jaitley has, thus, increased customs duty on imported mobile phone components to encourage indigenous manufacturing. However, even though the announcements are in line with the phased manufacturing programme (launched by Ministry of Electronics and Information Technology), there is no clarity how it will stimulate a move from assembling to manufacturing, which is what currently plagues mobile phone manufacturing in India.

The cynicism gets heightened because of the Budget arithmetic. Jaitley promises to exercise fiscal rectitude by accepting key recommendations of the Fiscal Reform and Budget Management Committee (which was chaired by bureaucrat-turned-politician N K Singh) and to bring down government’s debt-to-GDP ratio to 40 per cent. Consequently, after breaching the fiscal deficit target for the current year (3.5 per cent of GDP against 3.2 per cent promised), Jaitley has now committed to restrict fiscal deficit for 2018-19 to 3.3 per cent of GDP.

This is where the math starts getting tricky. Are the revenue projections in step with spending promises? For example, the Budget assumes a nominal GDP growth of 11.3 per cent during 2018-19 but projects income tax collections growing by 20 per cent, corporate tax growing by 15 per cent and GST collections rising by a whopping 67.3 per cent. As the proverb goes, this is where rubber will hit the road.

The above article was written at the invitation of New Indian Express. It can also be read here

Read Between The Lines: Arun Jaitley Can’t Just Spend His Way Out Of Trouble

The Union budget, to be presented by finance minister Arun Jaitley on Feb. 01, has engaged everybody’s attention for multiple reasons. Primarily, though, it’s because this is his last full budget before the 2019 general elections and everybody anticipates a political-economy imprint. But, mainly, it will be judged for its ability to create conditions leading to asset and job creation. So far, so logical.

Job creation will need large dollops of investment in fresh capacity or augmenting existing capacity—whether it’s manufacturing, services or infrastructure. Investment as a percentage of gross domestic product (GDP) has been falling for a while now, primarily because of private sector withdrawal, and the only way to move the needle is for the government to invest in large projects. This hit a roadblock because resident economic orthodoxies drew a thick red line on fiscal deficits, limiting the government’s capacity for public expenditure.

This hit a roadblock because resident economic orthodoxies drew a thick red line on fiscal deficits, limiting the government’s capacity for public expenditure.

Thankfully, chief economic advisor Arvind Subramanian may have found a way around the ideological obstacles through the economic survey for 2017-18.

“Invest, and savings shall follow”

The ingredients necessary for asset and job creation—investment and its raw material, savings—have been in trouble for some time and need remedial measures. Ideally logic—and received economic wisdom—would have then said that higher savings need to be generated to catalyse investment. This is where Subramanian makes an important deviation: He says, forget savings for now and focus on increasing investment first. That will get you growth which in turn will take care of savings.

What he seems to be saying is that it’s okay for the government to breach the year’s fiscal deficit target, if government investment can crowd in private investment and spur another virtuous cycle of economic growth. The economic survey doesn’t seem to be saying this explicitly but it’s there. With regard to fiscal performance in 2017-18, the document states: “Reflecting largely fiscal developments at the centre, a pause in general government fiscal consolidation relative to 2016-17 cannot be ruled out.” While discussing the prospects for 2018-19, the survey is cautious: “…setting overly ambitious targets for consolidation—especially in a pre-election year—based on optimistic forecasts that carry a high risk of not being realised will not garner credibility…”

So, Subramanian seems to be bestowing investment with some kind of primacy. Investment is important because government and private sector investment into new factories, infrastructure facilities, or services will be necessary to create jobs for the armies of young, able-bodied youth joining the workforce every year.

But the investment rate, measured through gross capital formation (GCF), has been declining: from a peak of 39% of GDP in 2011-12 to 33.2% now. A decline in investment rate means a slowdown in fresh capacity being added to existing manufacturing, infrastructure, or service capacities. That also means a diminished ability to absorb employable youth.

All eyes on private sector

Private investment is a key engine that drives the overall investment rate, contributing between 65% and 75%. The government has already been spending substantial amounts in public expenditure in the hope of “crowding in” private investment. The centre’s capital expenditure has increased from 2.6% of the GDP during 2014-15 to 3% in 2016-17. According to data from the controller general of accounts, till November 2017, the government had already spent 60% of its budgeted allocation on capital expenditure. In some sectors, such as the ministry of road transport and highways, 73% of the budgeted outlay on capital expenditure had been spent till November 2017.

Yet this has failed to catalyse private investment. The private sector’s GCF has dropped from a peak of 29.2% of the GDP during 2011-12 to 23.9% in 2015-16. Going by the first advance estimates of national income for 2017-18, GCF is unlikely to improve. While the government may have to continue focusing on capital expenditure, it has simultaneously taken action on other fronts to spur private investment: resolving the non-performing assets overhang in public sector banks’ balance sheets, recapitalising these banks, and improving the ease of doing business.

Key to accelerating private investment, though, will be stability and certainty in the policy environment. An overnight, unilateral decision to demonetise high-denomination bank notes, without first arranging for adequate replacement and replenishment, resulted in considerable hardship for both firms and households. Before the economy could re-adjust to the new reality, the government introduced the goods and services tax (GST) which, ideally welcome in normal circumstances, added to the confusion and chaos.

No escaping savings

But, much as Subramanian may want to take his foot off the savings pedal, the economy will need increased savings for investment to materialise. Perhaps not immediately but soon.

Data for India’s gross savings rate is available only till March 2016 but provides some general trends for analysis. So, here’s the bad news: India’s gross savings rate has been falling for the past few years. It reached a peak of 36.8% of GDP during 2007-08 but has steadily declined thereafter to 32.2% by 2015-16. It will be interesting to see how it behaves during 2016-17, especially since it will take into account the effects of demonetisation.

On a disaggregated basis, the household sector still accounts for the largest share of savings at 19.1% of the GDP, a sharp drop from its high of 25.2% in 2009-10. Traditionally, the household sector has contributed the bulk of savings, with the private sector and the public sector bringing up the rear. The government, which forms a part of the public sector, has traditionally shown negative savings, thereby bringing down the overall rate by 1-2% of the GDP. The household sector’s savings rate, despite its decline, has one redeeming feature: Over the years, it has been slowly moving away from physical assets (such as land or bullion) towards financial assets, with the ratios decisively flipping in 2015-16.

The household sector’s savings in financial assets have been further bolstered by the after-effects of demonetisation and apprehensions over deposits being used for “bailing-in” wobbly banks. The recent rush of savings into equity markets, via mutual funds, is testimony to that phenomenon.

Disaggregated gross savings data shows that the private sector’s savings, especially in the non-financial segment, has been going up—from 8.3% of the GDP in 2011-12 to 11% in 2015-16. This means many non-financial companies in the private sector, in either manufacturing or services, are sitting on cash and waiting for the right opportunity to invest these surpluses.

Budget 2018, therefore, must incorporate a policy nudge to not only increase the overall savings rate but to also channel private non-financial corporate savings into investments.

There are many expectations from the budget which, oddly, is the most-awaited economic event in the policy calendar. Nowhere else in the world does a budget offer such mass anticipation or allure; its appeal in India, perhaps, springs from its ability to make annual changes in personal tax rates and levies on consumables. With the GST introduced from July 2017, some of the yearly variations in prices of goods will now cease.

Yet, the excitement persists because of the political action expected over the next 12-18 months. Given past tumbles and future challenges, one of budget 2018’s big themes is likely to be job creation. And, for that, it may first need to sort out how to stimulate savings and investment.

The above article was written on invitation from quartz. it can also be read here