Rx: Start With Consumption, Start Small

The trick to jump-starting the economy might lie in creating demand for basic goods, besides increasing liquidity and other revival measures

IN THE movie Batman & Robin, arch-villain Freeze gate-crashes into an antiquities exhibition and announces: “In this universe, there is only one absolute. Everything…freezes.” Credit markets across the world have frozen over, and though there’s no nasty piece of work yet (at least not on the scale of Freeze), there are no early signs of thawing. Spring may still be far away, but attempts by regulators and governments from across the world to end the economic chill don’t seem to be working. In India too, the government and the central bank, Reserve Bank of India, seem to be working hard to loosen winter’s cold grip over the Indian economy, but with little success.

The RBI has been infusing the economy regularly with large doses of liquidity ever since the system was beset with worries of money drying up. The RBI tried everything in the book — cut cash reserve ratio, freed up part of the statutory liquidity ratio, opened a special lending facility for banks to on-lend to NBFCs, housing finance companies and mutual funds, created a special refinance window from where banks could borrow without providing any collateral. Additional liquidity was pumped in by buying back bonds issued under the market stabilisation scheme. In all, since mid-September, the RBI pumped in Rs 300,000 crore through the sluice gates.

But, even that did not help hydrate the financial system. When banks were swamped with liquidity, they took the cash and dumped it with the RBI for a 6% return, even when lending it to prime borrowers might have fetched better returns. The central bank even cut its benchmark repo rate by 150 basis points (bps) to 7.5% on October 19 in an attempt to get some of that money moving out of the bank vaults. Still no go.

The RBI recently turned up the thermostat once more, this time to prod banks to start lending at reduced interest rates. It cut its benchmark repo and reverse rate by 100 bps. But, again, there’s hardly any movement. The banks are still carting their surplus cash over to the RBI and dumping it there for safe-keeping, for even as a low a return as 5%. Take a look at the money being tipped over at the RBI window.

For the first five days of the month, till the RBI cut the rates, banks plonked Rs 243,310 crore with the Reserve Bank, for a return of only 6%. Then on December 6 — a Saturday — it cut rates again. Over the next three working days, banks again deposited Rs 84,635 crore with the central bank, for a return of just 5%. The total — for just eight days — works out to over Rs 327,000 crore! In fact, the RBI was forced to comment, while announcing the new rate cuts, that the liquidity adjustment facility operated by the central bank, “has largely been in an absorption mode.”

In effect, this means banks are still wary of lending to corporates, despite the sea of liquidity and rate cuts unleashed by the central bank. This also then conveys how banks are still uncertain about the future and that they are doubtful about the ability of their corporate clients to pay up in time. In short, the vital glue of financial system — trust — seems to be missing and the authorities designing the various economic packages are unable to supply it in sufficient quantities.

Here's an example — a public sector unit was able to issue five-year bonds to banks with a coupon of 9.33%. Around the same time, one of the Top five India Inc companies also borrowed three-year money, but at 10.10%. Clearly, banks are willing to take a risk on the government, even if it is a subsumed sovereign guarantee, but not on even AAA-rated private companies. Banks have not forgotten the nightmares of the early 1990s, when bank NPAs ruled around 10-14%. This time, despite the prodding from the government and the central bank, they are unwilling to stick their necks out. The RBI has allowed banks to restructure loans — a euphemism for looking the other way when a loan turns bad — that might in ordinary times have been called for stricter treatment. But, the banks are still not biting.

The problem also seems to be in the system’s liquidity absorption capacity. Whatever steps the government takes at the moment — such as, providing cheap cash to corporates through a variety of refinance windows — not only are banks reluctant to lend, even corporates are loath to load up their balance sheets with fresh debt. Many of them are drawing down their existing credit lines with banks — emboldened somewhat by the new restructuring space — to finish existing projects but are unwilling to bet on new projects. With aggregate demand having fallen, India Inc is also contending with reduced topline and bottom line projections. In such a scenario, they may not be in a mood to pile up additional debt.

Therefore, the key to the current economic impasse might lie on the demand side. The government has tried addressing the issue by spending on infrastructure and by cutting taxes to boost demand. These are also not without their associated problems. Any investment in infrastructure will yield results only after a long lag, and the nature of improved technology does not allow for the higher employment generation that one saw a few years ago. Plus, to get an infrastructure project started is also time-consuming — financial closure in these days of clammy credit markets is a tough call.

Some economists say that the production orientation of the economy has changed in favour of expensive consumer products, a sector that might be slow off the blocks in reviving. In such a situation, reviving demand for wage goods might just do the trick. Even this hypothesis needs to be tested. The occasion might present itself soon — with experts forecasting a better-than-average winter crop, the government should facilitate hassle-free movement of the harvest to the markets and consumables to centres where the ensuing agricultural income can be spent. This may sound simplistic, but sorting the physical, infrastructural infirmities could be one of the first achievable steps on the long road to recovery.

Published as an Op-Ed in The Economic Times (December 15, 2008)

Good Intention, Bad Outcome

Overseas M&As are providing Indian companies with a new competitive edge. The Competition Act, instead of adding teeth to this new-found competitive advantage, might end up debilitating Indian industry

JUST when you thought India Inc had acquired the muscle to play the global sweepstakes, Indian lawmakers have struck back with attempts to rein in the corporate sector’s worldly ambitions. Prima facie, it seems to be the handiwork of a bunch of people who were nourished on the economic rent built into the licence raj system and are now desperate to restore their cash flows to the pre-reforms era.

They may have just hit upon the perfect system. The new Competition Act — first passed by Parliament in 2002, then amended in 2007 after going through a parliamentary standing committee on finance, but yet to be notified — might be their ticket to the gravy train. As things stand, once the amended Competition Act is notified, industry is scared that this will signal a return to the nightmarish days of Monopolies and Restrictive Trade Practices Act, which required every company, industrial group, entrepreneur to seek approval for every step they took, every move they made. In some ways, it was the MRTP Act of yore which not only stifled competition but also gave birth to the unholy industry-politician-bureaucrat nexus and provided India with a high-ranking berth in the global corruption league tables.

The intentions of the Competition Act are actually honourable. The Act aims to protect citizens from the ill-effects of concentration of power in any company or industrial group and their ability to influence market outcomes, through pricing muscle or market domination. The Act’s opening lines are: “An Act to provide…for the establishment of a Commission to prevent practices having adverse effect on competition, to promote and sustain competition in markets, to protect the interests of consumers and to ensure freedom of trade carried on by other participants in markets, in India…” Every developed country has a similar legislation in some form or the other. But, it is the design and the purport of this Act that promises to incapacitate industry. Here’s an example: had the Act been notified, the Idea-Spice telecom deal might still be languishing in bureaucratic muddle.

The Act has several grey areas, and the purpose behind leaving these gaps in the drafting is anybody’s guess. Given the country’s abysmal judicial and regulatory infrastructure, the first question that arises is whether the country is ready for it. The Competition Commission of India (CCI), a quasi-judicial body entrusted with enforcing the Competition Act, has no wherewithal to adjudicate on any of its mandates. It has a paltry budget, skeletal staff, a crummy office and none of the knowledge base that’s de rigueur for any regulator.

Let’s look at some of the trip-wires left in the Act. First, any M&A deal has to mandatorily notify the CCI. Then, under the Act, CCI gets 210 days to give its assent — a rather long period in today’s competitive environment. Assume the commission feels the deal is not inimical to any of its stated objectives and gives it a green signal. Now comes the fun part — any person can go on appeal to the Appellate Tribunal, which does not have any mandatory time limits. Imagine the scope for mischief. The Act states: “The appeal filed before the Appellate Tribunal…shall be dealt with by it as expeditiously as possible and endeavour shall be made by it to dispose of the appeal within six months from the date of receipt of the appeal.” What if the “endeavour” does not result in a verdict in six months? The Act is silent on the issue. But, that’s not the end. Even if the tribunal overturns the appeal, the appellant can still approach the Supreme Court which will then, in keeping with the tenets of natural justice, need to hear all sides before reaching a verdict. Which M&A deal can wait for so long?

The amended Act also requires all Indian companies bidding for overseas acquisitions to obtain a pre-deal approval first. In fact, all sellers will henceforth require that bidders get all their approvals in place first even before considering their bids. However, many sellers might not be willing to keep the deal in abeyance for 210 days. In addition, there is the issue of confidentiality. Government offices are notorious for leaks — not only to the media but even to business rivals. In comparison, many Indian companies which acquired European targets in the recent past, including some marquee names, not only obtained a pre-deal approval in less than 30 days, but also claim that not a word leaked from the European competition authorities.

Then, there is the threshold level of assets or turnover which is used to decide whether the Act should be made applicable to any company entering into an M&A deal, whether in India or abroad (it will also include two foreign companies merging overseas, if they have operations in India, subject to a threshold level as well). Section 20(3) of the Act requires the government to increase or reduce the threshold levels every two years, on the basis of either the wholesale price index or the foreign exchange rate.

There is a whole range of other contentious issues that is exercising industry, such as the large tracts of ambiguous drafting or the powers granted to the government. For instance, the government has reserved for itself the right of exemption: “The central government may, by notification, exempt from the application of this Act... (a) any class of enterprises if such exemption is necessary in the interest of security of the state or public interest…” While it is strange that the commission, as regulator, has been deprived of this power, the Act also does not include any provisions for exempting “any class of acquisition”, such as creeping acquisitions.

Of the three issues that the Act is expected to tackle, we have touched upon only one here, namely M&As. The other two — preventing cartelisation and abuse of dominant position — also contain enough landmines to trigger off a raft of disputes. But, all this raises one fundamental issue. Overseas M&As were providing Indian companies with a new competitive edge. Legislation, instead of adding teeth to this new-found competitive advantage, might end up debilitating Indian industry.

Published as as an Op-Ed in The Economic Times (August 20, 2008)