The SBI merger: is bigger always better?

The process increasingly looks like a shotgun wedding, with not enough opportunity to pause and ponder

The anticipated merger of the State Bank of India (SBI) with its five associate banks and Bharatiya Mahila Bank (BMB) finally got off the ground with the government sending a letter to all seven banks on 20 June. From thereon, the time taken for obtaining individual board approvals, appointing legal and accounting firms as well as investment banks, getting them to conduct due diligence and arriving at a fair share swap ratio, was under two months.

That should be some kind of a record. Deals involving smaller companies or banks have taken far longer. And this is the country’s largest bank, SBI, merging with six other pretty large banks. There are many imponderables involved in such negotiations: for example, the overlap in the combined physical network, the people question, or integrating disparate back-end systems and processes. Clearly, the government is in a hurry to complete this merger.

The merger is being pursued in the belief that larger automatically means better. Vanity is also a motivating factor—creating an institution that will make it to the list of the world’s largest banks confers bragging rights.

There are perceived gains as well: the government, as shareholder, feels it will have six less capital-hungry banks to worry about. There are also expectations that a larger institution will be better equipped to deal with sticky loans, thereby enabling fresh credit outflows to productive sectors. Productivity and efficiency gains are among other expected benefits. But these could turn out to be illusory given the SBI’s legacy and ownership structure. A former SBI chairman had once remarked that reforming SBI was like trying to make an elephant dance. Even after discounting for exaggeration, there are grounds for circumspection; a large and unmanageable bank is getting even larger.

What’s even more worrying is how the process increasingly looks like a shotgun wedding, with not enough opportunity to pause and ponder. Three issues merit wider debate.

One, the merger patently lacks shareholder democracy. Individual shareholders have been discouraged from objecting. Anybody wishing to oppose must own at least 1% of either bank’s share capital (for example, that amounts to 77.6 million SBI shares) or must marshal 100 shareholders irrespective of their shareholding. According to SBI’s annual report for 2015-16, only five shareholders owned more than 1% in the bank on 31 March 2016: the President of India (60.18%), Life Insurance Corp. of India (11.27%), HDFC Trustee Co. Ltd (on behalf of HDFC Mutual Fund, 2.08%), Bank of New York Mellon (as depository for SBI’s outstanding global depository receipts, 1.86%) and Reliance Capital Trustee (on behalf of Reliance Mutual Fund, 1.09%).

Similarly, chances are that mostly institutions own shareholding of over 1% in the three associate banks with public shareholding—the State Bank of Bikaner and Jaipur, State Bank of Travancore and State Bank of Mysore.

While it is safe to assume that the President won’t be objecting, it is also unlikely that any institutional investor will really challenge the process. The SBI owns 100% in the State Bank of Patiala and State Bank of Hyderabad, while the government owns 100% in BMB. Two other associate banks were merged with the SBI earlier: the State Bank of Saurashtra in 2008 and State Bank of Indore in 2010.

In the face of such power asymmetry, in which one set of shareholders has greater rights than another group, the predictable has happened. Left trade unions in Kerala have taken the deal to court; there it might languish for a time.

Two, the merger seems to overlook a critical, post-crisis concern—the too-big-to-fail (TBTF) question. Tremors of the 2008 trans-Atlantic financial crisis were felt all over the interconnected world. The TBTF theory posits that some institutions are so large and intricately interconnected with different parts of the economy that failure can create a systemic shock. This forced many governments to bail out large financial institutions with taxpayer money. It might also be instructive to note that many countries have been formulating preventive TBTF regulations. Australia, for example, has prohibited any merger between the country’s four largest banks. Switzerland, on the other hand, has the world’s most stringent capital norms.

The Reserve Bank of India (RBI)—in keeping with various multilateral agreements at the Financial Stability Board, G20 and the Bank for International Settlements—has designed a risk mitigation framework for dealing with “domestic systemically important banks” or D-SIBs. The framework recognizes SBI and ICICI Bank as D-SIBs, both of which must maintain higher common equity tier I (CET I) than their peers. It allows national authorities greater discretion in the selection and risk mitigation processes than what’s prescribed for global systemically important banks, G-SIBs.

But here’s the thing. Once the merger is completed, SBI could become part of the G-SIB club, ending RBI’s discretionary approach. What happens then? Will the current capital shield be adequate? If no, what impact will additional CET I have on expected efficiencies? Even if it doesn’t get clubbed with G-SIBs, RBI will perforce have to review its D-SIB framework.

Finally, a speculative thought. Rumours are China now wants in on plurilateral trade in services agreement (TiSA) and India has also expressed a similar desire. Leaked TiSA documents show nil barriers to financial services imports, including total freedom to overseas financial companies for acquiring local outfits. Is the SBI merger a pre-emptive move then?

Some of these conversations need to happen now, not post-merger. Especially whether bigger is always better.

This appeared in Mint newspaper on September 21, 2016, and can also be read here

Lost History: An encounter with the 'king' of Turtuk, a border village near Gilgit-Baltistan

The village is just 10 km away from Pakistan-occupied Kashmir and became a part of India as recently as 1971.

Entrance to the Royal Palace, Turtuk village

A guided tour of the Ladakh's Turtuk village, in the mountainous region of Baltistan that is on the border of Pakistan and India, ended at what is known in these parts as the Royal Palace. After a long walk down narrow and undulating lanes in the crisp afternoon sun, shepherded by a nimble 16-year-old, we had arrived at what was supposed to be the highlight of our excursion. At first glance, it was slightly underwhelming – the house is larger than its neighbours, but little else set it apart.

The palace doors opened into a colonnaded courtyard that supported a verandah with no visible access. A short flight of stone steps, which rose steeply through a hidden corner, brought us to a figure supine on a floor mat. Our guide gently nudged the figure – a man stumbled out of his afternoon siesta, disoriented by the sight of so many strangers. He was feeble and slightly bent.

Smoothing the creases on his shirt and patting his disheveled hair into place, he led us into a room, apologising for not according us a better welcome. He explained, somewhat diffidently, that working the fields in the morning sun had induced the mid-day torpor.

He then sat on a couch, but not before picking up a wooden sceptre, crested with a distinctive metal serpent head, and placing it pointedly on his lap. He then becomes Yabgo Mohammad Khan Kacho, the king of Turtuk and descendant of the Yabgo Dynasty of Chorbat-Khaplu, a region that now falls beyond the Line of Control and in the contested territory of Pakistan occupied Kashmir. Though he no longer enjoys the powers nor the official recognition as a past royalty, he is known in these parts as the king.

Yabgo Mohammad Khan Kacho, King of Baltistan.

Across the border

Turtuk is a quaint village perched barely 10 km from the Pakistan border, under the benign gaze of the K2 peak across the border. The village, located in the Sheyok river valley about 200 km from Leh, is a verdant relief amidst the spare and stark beauty of Ladakh’s landscape.

Turtuk, in Ladakh district, is in the Indian-administered part of the Baltistan region and borders Pakistan’s Gilgit-Baltistan area.

The Gilgit-Baltistan are has for years existed largely away from the glare of Indian and international media, but the spotlight has been on it for the past month, after Prime Minister Narendra Modi publicly promised – twice in quick succession, in his Independence Day speech and before that, in his concluding remarks at the all-party meet on Jammu and Kashmir in Delhi on August 12 – to highlight the plight of residents of Balochistan and Pakistan-occupied Kashmir to the world. While Balochistan is a province in Pakistan, which has been fighting for autonomy, Gilgit-Baltistan is a part of PoK.

The Gilgit-Baltistan territory is special – it is a crucible in which trade, culture, religion, languages and cuisines from Europe, Central Asia, Afghanistan and China have come together for centuries. India has made many claims over the province and many analysts have recounted its recent political history. Interestingly, a thin strip of this province juts into India.

The prime minister’s reference to the three disputed areas has got foreign policy and strategic experts parsing his words, as well as setting off a maelstrom of articles and Op-eds (examples are here, here and here).

Overnight, a new country

This prompted me to wonder: what would the people of Turtuk, just a stone’s throw away form Gilgit-Baltistan, make of Modi’s statement? Would they also be deconstructing his speech?

One thing is certain. Nationality or sovereignty are elusive, if not transient concepts for the king and villagers here. And there's a good reasons for this.

One night in December 1971, village residents went to sleep as Pakistan citizens. They awoke next morning as Indians. Turtuk, along with three other villages in the vicinity – Tyakshi, Chalunka and Thang – were occupied by advancing Indian armed forces during the 1971 war of liberation of Bangladesh.

Turtuk residents have only one grouse – the Indian army should have gone a little further and occupied the rest of Baltistan. The overnight change of sovereignty split many families along the Line of Control – parents on this side with children and grandparents on the other. Political conspiracies abound on why the Indian army did not move further afield when it was there for the taking.

Kacho, Turtuk’s king, also has some family on the other side. He traces his lineage to the Ghaz tribe from West Turkestan, a region today known as Central Asia. His ancestor, Beg Manthal, came to Baltistan in 800 AD from Yarkhand (which is part of modern-day China’s Xinjiang region) via the Saltoro ridge (which is to the west of the Siachen glacier) and conquered Khaplu, in modern-day Gilgit-Baltistan.

The Yabgo dynasty, Manthal onwards, ruled the Chorbat-Khaplu region of Baltistan for a millennium, expanding it over time to Ladakh’s frontiers on one side and to Ghizer district on the western edge of Gilgit-Baltistan. The dynasty ended in the first half of the 19th century when the Dogra empire, which had, in 1846 taken control of Kashmir, forming the princely state of Jammu and Kashmir, expanded its kingdom North and East.

A wall at one end of the room has the family tree painted on it, going back centuries.The king said the Indian army helped him document this. In the face of an elusive administration, the Indian army means many things to most Baltistan residents – employer; buyer of locally-produced vegetables, milk, fruits and meat; provider of healthcare and education as well as occasional source of telecom network and other basic infrastructure.

The king describes himself as a writer and said his father didn’t want him to work but just spread the word about their family. He was not trained in anything but made to read a lot. He read books written by local historians and decided that the best thing to do would be to tell his people what they were all about.

But, the Indian government banned his book based on complaints from a sect that saw blasphemy in his account of how their religious order was established, he said. He contested the ban in Indian courts and eventually won after years of litigation. But he rues the fact that he didn’t retain a single copy of the book – he doesn’t even remember the name of the Delhi-based publisher.

Connected, yet isolated

Turtuk is a microcosm of Baltistan’s inclusive culture: a multi-ethnic village, with around 4,000 residents speaking different languages and praying to different gods. Different denominations – Nurbakshi Shias, Sufis, Sunnis, Buddhists (and perhaps even Ahmadiyas and Ismaili Shias) – live peacefully, farming and trying to make sense of the burgeoning tourism business. Turtuk was opened up to tourists only in 2010. The chairman of the local school and healthcare committee remarked that many old Turtuk residents would long to see cities, but now, the cities were coming to see them.

Turtuk was an important junction on the Silk Route with ancient linkages to Tibet, Afghanistan and the steppes of Central Asia. A part of China’s One Belt, One Road initiative, an attempt to resurrect the Silk Route that connected parts of Asia, Europe and Africa, will now come close to Turtuk as it proposes to pass through Gilgit-Baltistan.

Turtuk residents fervently wish that the LOC opens up so they can meet family on the other side, re-establish social connections and perhaps even resume commerce.

The king is still recounting the region’s old linkages when his narrative is cut short with new arrivals, guests of a senior army officer posted in the vicinity. Yabgo Mohammad Khan Kacho apologises and rushes off to attend to the new rulers of Turtuk.

This article was originally published in www.scroll.in and can also be accessed here

Book Review: Repo And Its Masters

A RBI governor remembers his doughty fights, but cuts down on the math

WHO MOVED MY INTEREST RATE?
BY DUVVURI SUBBARAO
VIKING | PAGES: 323 | RS. 699

Central banks have been labelled exotic beasts: rarely seen in public, much less understood. Realisation of what central bankers do has been seeping in slowly. Over the past few decades, as bond and currency trading acquired gargantuan propor­ti­­ons, the arcane world of dealers kept a close watch on every statement coming out of central banks, parsing each phrase and analysing each nuance. Any action, or the faintest hint of a future one, had the potential to affect currency prices, bond rates and indi­vidual fortunes. This need for analysis and interpretation also produced a large tribe of writers called ‘central bank watchers’.

Over time, as societies overwhelmingly bec­a­me dependent on debt— for housing, education or buying their next television—larger sections of the population got interested in the central bank’s actions. Any increase or dec­­rease in interest rates, or liquidity conditions, had a direct impact on household incomes and lifestyles. And yet, despite this growing interface, cen­­tral banking remains shrouded in a mysterious and inscrutable cloak.

Former Reserve Bank of India governor Duv­vuri Subbarao makes a valiant attempt to lift this veil and demystify a central bank’s workings. This is a first and we hope this will enthuse others to share their views. But there are two ways of viewing the book’s purpose. One, in trying to explain a central bank’s operations, Subbarao creates an opportunity to justify his actions dur­ing 2008-13, a period of stubbornly high inf­l­ation, extraordinary exchange rate volat­ility and an unprecedented (and unbroken) spree of interest rate increases. A converse view is also possible: its primary function is to rationalise his actions and he uses it to dec­ode the RBI’s actions and working styles. Which set of lenses have been used? The narrative str­u­cture and the tenor seems to suggest it’s the latter.

This becomes clear as one ploughs thr­ough an otherwise eminently readable account. The book’s pre-launch publicity focused on the governor’s well-publicised conflicts with former Union finance ministers P. Chidambaram and Pranab Mukherjee. Central bankers have traditionally shared antagonistic relationships with fiscal authorities. The book dwells at length on Subbarao’s differences of opinion with Chida­m­baram and Pranab, and how rising prices and a slowing economy widened the rift between Mumbai’s Mint Street and Delhi’s Raisina Hill.

But, with due apologies to Shakespeare, met­hinks the governor doth complain a bit. This is not to imply he was wrong in his stand on interest rates. Subbarao stood up against the collective might of the government, Parliament, a misinfor­med finance sector and uninformed commentariat by defending his right to raise interest 13 times in quick succession. He explains quite expansively why the situation warranted such drastic action. The fiscal and monetary expansion post the 2008 trans-Atlantic financial crisis, without adequate investment in production and supply capacities, embedded inflationary tendencies in the economy. Given political leaders’ reluctance to tighten fiscal reins, it was left to the monetary authority to attempt demand compression through interest rate increases.

Face-offs between monetary and fiscal auth­orities are built into the design; Subbarao mentions as much in the book. In times of crisis, both work in lockstep, as was evident after the 2008 meltdown. But, the impact of an expansionary fiscal policy on inflation and economic growth was ignored by the political class and India’s cossetted business interests. Much of the book describes this clash of ideals.

But there are gaps in Subbarao’s acc­ounts—both when describing clashes with North Block or when recounting challenges faced during vital post-crisis moments. Here are two examples.

First, there’s no mention of his immediate predecessor’s track record. Subba­rao mentions Y.V. Reddy only in passing while mentioning how crisis forced him to rev­erse his predecessor’s string of interest rate increases. We are not asking for public display of dirty laundry. Reddy too had to contend with a frequently (and publicly) remonstrating finance ministry. Reddy’s interest rate increases, to burst speculative asset market bubbles, earned him unstinted praise from economists and observers worldwide.

But, here’s the thing. Subbarao was fin­ance secretary when Reddy was busy inc­reasing interest rates to stave off risks. Interestingly, even Chidambaram was fin­ance minister during that period and he made public his displeasures with Reddy’s insistence on rate hikes. It would have been interesting, and more honest, if the book also disclosed Subbarao’s role as Chidambaram’s finance secretary in his engagements with Reddy, and the lessons learnt from those interactions before moving to RBI. Subbarao limits his interface with Reddy to discussions on RBI’s balance-sheet; I am sure there must be more. If the governor is going to reveal all about his skirmishes with political authorities, his interaction with RBI as finance secretary should also be fair game.

Two, there’s not enough explanation about how the RBI managed its balance-sheet in the aftermath of the crisis. Or, enough inside dope about the crisis days following the closure of Lehman Brothers. Subbarao describes how the monetary tap was kept open at full tilt to give the financial sector confidence that funds were always available. This was largely a signalling and confidence-building measure to avoid payment imbroglios or defaults which get amplified into panic during crisis times. As part of the strategy, RBI kept repo rates (the interest rate at which RBI lends to banks against government securities) low; but the reverse repo rate (interest rate at which RBI accepts money from banks against securities) was always kept 1.5 per cent higher. This was particularly true of December 2008.

Interestingly, this rate difference converted RBI—usually known as a lender of last resort—into a borrower of last resort. Banks would occasionally use the repo window to smoothen temporary mismatches, but would dump far excess cash with RBI’s reverse repo window. Clearly, credit aversion in the immediate aftermath of the crisis forced banks to seek safe havens for their surplus cash. Given money’s fungible character, we also do not know if banks borrowed from the repo window, turned around and tipped over the same money at the reverse repo window, thereby earning a neat 1.5 per cent without breaking into a sweat. The central bank’s annual report for 2008-09 (June 30 year-ending) highlights this anomaly: outstanding repos shrunk to Rs 895 crore (previous year Rs 22,805 crore) and rev­erse repos swelled to Rs 88,335 crore (previous year Rs 300 crore). This surely had some consequences and it would have been interesting to know Subbarao’s views.

But, beyond this, Subbarao has done a superb task of shedding some light on a central bank’s specialised role, especially by making it accessible to a wider spectrum of readers. He uses simple language and infuses some humour when necessary. It stops short of being a complete masterclass because encounters with the political class keep intruding. But somebody needed to talk about these incidents because the public rarely gets to know how both institutions interact. Yet, it also doesn’t do full justice to the political economy of Indian central banking. So, what is it, a book on central banking or an expose? I see it as setting the record straight.

This book review first appeared in Outlook magazine and can also be read here

Book Review: The Wrong Idea of America

A former White House aide and economist makes a surprisingly sloppy appraisal of US’ problems

The Price of Prosperity: Why Rich Nations Fail And How To Renew Them
Todd G Buchholz
Harper, an imprint of HarperCollins Publishers
367pp; $29.99

Brexit has eloquently demonstrated what a terrible bummer nostalgia can be. Wallowing in a sense of persecution and aching for long-lost days of glory, British leaders ceaselessly campaigned to leave European Union; and, nostalgia made for a good tool to rouse, exhort and even to delude. But with “leave” leaders and campaigners increasingly abandoning ship, it is quite evident that nostalgia has limited currency in good governance.

Author Milan Kundera was rather cutting about it: “In the sunset of dissolution, everything is illuminated by the aura of nostalgia, even the guillotine.” When former empires and superpowers refuse to go gently into the fading light or remain steadfast in denial about reality biting their heels, nostalgia is a helpful analgesic that numbs the pain.

Todd G Buchholz uses this anaesthesia to quite remarkable effect. His latest adds to the growing list of works harking back to an imagined ideal period, keen to revive an illusory greatness. This sense of “greatness” is also quite unidimensional, with some of modernity’s post-War distortions embedded deep.Greatness of another kind

The author’s mission is simple: he sets out to diagnose what’s gone wrong with his great country — and here greatness is primarily a shorthand for prosperity — and how it can be revived. But do not be misled by the words “Rich Nations” in the title; this book is mostly about the US. His prescriptive analysis also betrays his politics, which often dips into partisan territory; ironically, he remains blissfully unaware of just how much this limited political worldview has eroded his “great’ nation.

For example, he laments how the Barack Obama administration has not taken advantage of current low interest rates by issuing long-tenor bonds of, say, 50 or 100 years’ maturity. Locking into long-maturity bonds at rock-bottom rates does indeed make sense. Instead, he sees White House opting for the shorter end of the yield curve because interest rates are usually lower at that end. And, here comes the conspiracy theory: lower interest rates help deflate debt-to-GDP ratios and provides an illusion of a lower budget deficit, “flattering the president’s fiscal profile”.

Strangely, the author ignores how a partisan Congress has dogged President Obama’s executive actions. Is there a possibility that the Obama administration issued short term bonds to avoid a combative and obstructionist Congress, which needed any excuse — including bonds longer in maturity and higher in interest rates — to trip up the president?

It’s also funny that Buchholz should complain about short term holdings: as former managing director of Tiger hedge fund, he should know a thing or two about them.The immigrant’s case

Buchholz’s starting hypothesis posits that as nation-states get prosperous, their birth rate drops. Consequently, there are more elderly than young working people. Who does all the work then? The immigrant, of course. And, then he remits his earnings home. Ergo: the immigrant should be integrated better into the American society, so that he can look up to George Washington as a forefather, even if he surrounds his Thanksgiving turkey with some ethnic dishes.

So there it is, Solution No. 1: a strange nationalistic formula that can cure numerous economic ills. His nationalism is also time-stamped: it must pay obeisance to only cultural icons adopted in the past 240 years; whatever existed before July 4, 1776, is not worth knowing. Nationalism also means regaining GMC — grit, mobility and confidence — which defined American exceptionalism in the past.

This is a strange salmagundi of suggestions, which flirts with patriotism without trying to sound too reactionary, strains to accept immigrants without sounding xenophobic. Anecdotal evidence makes up for actual facts, poor research leads to hypotheses, history is used to suit pre-determined conclusions.

Let’s look at poor research: “Traditional Hindu culture honours boys above girls, since the religion requires that parents be buried by a son.” Will somebody please educate Mr Buchholz on Hindu funeral rites, especially since Hindu Americans make up almost 1 per cent of the country’s population.Missing in action

And that’s exactly the nub of everything that’s wrong with this book. While dwelling upon patriotism and nationalism in good motherhood, apple-pie American style, Buchholz misses the US’ main fault-lines — growing inequality — or the myriad reasons behind stagnating real incomes.

It is glib to point fingers at outsourcing but how do you sort out Corporate America, with its flawed governance structures and undue focus on three-monthly profits (which rewards large-scale retrenchment if it helps nudge up stock prices)? Buchholz is silent. Not a single word about how strong, public institutions made the US a true liberal democracy and how their decay is perhaps an important cause behind the slip from “greatness”.

There is also no mention about the US’ hegemonic role in global negotiations, which has systematically eroded multilateralism. The US was one of the principal founders of the post-WWII global multilateral architecture which was then successfully subverted to suit narrow, partisan, private corporate interests. And, of course, Buchholz refers to the 2008 meltdown as a “global” financial crisis, which in itself is symbolic of how blinkers have narrowed the fabled American vision.

In trying to attempt a broad-brush future manifesto for the US, Buchholz may have bitten off a bit too much. There is a lot of research, but some of it fails to meet strict academic rigour and some of it is pointless. The book is readable, written in fast-paced prose and that is it’s only saving grace.

This book review was originally published in The Hindu BusinessLine. It can also be read here.  

Key GST Lessons From The World

The long march to implement the long-awaited Good and Services Tax in India has just begun. It is instructive to understand how other countries introduced this tax and cherry-pick lessons from their experiences

As India gets ready to celebrate the 70th anniversary of its independence, it is also preparing for another important milestone. Great hopes have been pinned on the Goods and Services Tax (GST), which will liberate Indian citizens from the tyranny of multiple levies and tax rates. This tax will unite almost all state and central indirect taxes into one single category, thereby creating a true single market in the country.

The passage of the Constitution (122nd amendment) Bill on 3rd August in the Rajya Sabha marks the crossing of the first hurdle in implementing the transformational GST regime. However, there is still substantial legislative work to be done – apart from the amendment (which will now travel to the Lok Sabha, the President’s office and state assemblies for ratification), Parliament will have to vote in two further bills to make GST a reality.

Beyond the legislative workload, Indian administrators and businesses will need to do their homework before this reality sets in. There are approximately 140 countries in the world that have introduced GST (also called VAT, or Value Added Tax), and there are manifold lessons to be drawn from their respective implementations.

Malaysia was the most recent country to implement GST in 2015, having announced its intention to do so in 2009. Malaysia’s experience highlights how inadequate preparation can hamstring the tax’s speedy implementation from the outset.[i]Malaysian businesses and tax authorities had a harrowing time adjusting to the new system, which was riddled with uncertainties and teething problems. The Malaysian government had to contend with street protests by small businesses and traders who were confused by the new system—whether in calculating the correct value-added rates, or in seeking tax credit refunds. Unsurprisingly, opposition political parties found it opportune to fish in these troubled waters, adding to the government’s mounting operational woes.[ii]

There was another layer of complexity. Malaysia had a multiple GST rate structure, much like the one proposed in India. A 6% GST (among the lowest in the world) was introduced, with some essential goods exempted and some goods attracting a zero rate i.e they were not exempt and could be taxed later. India too has proposed a multi-tiered structure, which will be finalised by the GST Council whenever it is set up.

Two clear lessons emerge from the Malaysian experience. Under pressure to launch GST as soon as possible, the Indian government must resist temptations to truncate the implementation process, which will include the training of tax officers and business executives. A presentation by revenue secretary Hasmukh Adhia estimates that 60,000 tax officials in both central and state governments will need to be trained.[iii] GST is a tectonic shift in the indirect tax architecture: the point of taxation shifts from producers to consumers, requiring a significant reorientation in philosophy and perspective. This overhaul cannot be completed unless the technology backbone is in place and all the relevant economic agents are registered. That alone is a mammoth task. There should, therefore, be no compulsion to implement GST by April 2017 if either the system is not fully tested or all the pieces are not firmly in place.

A related issue almost tripped up Malaysia’s GST experiment: the timely payment of input tax credit refunds.[iv] Unless the necessary technology infrastructure is installed, it can take months to refund tax credits, thereby creating cash flow problems for all links in a supply chain. This can easily convert GST supporters into detractors. Delaying tax credit refunds leads to protracted litigation and provides perverse incentives for the supply chain to stay outside of the organised system.

A second set of lessons can be drawn from Singapore. The city-state introduced GST in 1994 but witnessed a sharp rise in inflation soon after its introduction, mirroring the experience of many other countries.[v] Although inflation rates tend to moderate after a couple of years, the Indian government must be prepared for an initial surge because of India’s unique supply-side pressures, which tend to firmly embed inflationary expectations in households and businesses. India can consider what many countries did: initiate anti-profiteering measures at the retail level to protect consumers from price gouging.

Subsequently, the Singapore government faced other predicaments, like t the need to increase GST rates without stoking inflationary pressures. Eventually Singapore did increase GST rates (from 3% in 1994 to 7% currently), but simultaneously cut income tax rates (both at the individual and corporate levels) and accelerated the delivery of welfare benefits to lower income sections.[vi] While GST is efficient, it can also be regressive, especially for low income workers or pensioners. The Indian government therefore needs to be cognisant of this, and act cautiously.

The final set of lessons come from Canada, which introduced GST in 1991 amidst great internal conflict and disagreement. In fact, at the tax’s introduction, three provinces–Alberta, Ontario and British Columbia–even sued the federal government for violating constitutional agreements and limits. But over the years, Canada has pioneered a unique system that allows for three different models to co-exist.[vii] [viii]For example, Quebec is permitted to administer its own value-added tax alongside a federal GST. Quebec is responsible for all tax administration in the state, independently determining its tax base, independently fixing the state VAT rate, and even remitting federal GST collected in the state to the central government for a fee.

Compared to Canada, India has been able to forge a broad consensus among most states through a process of negotiation and compromises. The only point of disagreement remains the GST rate, which has been entrusted to the GST Council. This may lead to intense political manoeuvring with demands for special status or special rates. Tamil Nadu has already expressed its dissatisfaction with GST.

These examples clearly illustrate that the GST battle has barely begun: there are many mountains to climb, and multiple fires to extinguish along the way. The process of bipartisan consultation and consensus-building with states and various stakeholders must continue to make GST a cornerstone of successful and sustainable fiscal federalism.

This feature was exclusively written for Gateway House: Indian Council on Global Relations. You can also read it here.

References

[i] Pachisia, Vivek; Lessons from countries that have implemented goods and services tax; Financial Express; July 28, 2016;http://www.financialexpress.com/economy/gst-lessons-from-countries-that-have-implemented-the-goods-and-services-tax/331289/

[ii] Dey, Sudipto; Some Lessons From Malaysia That India Can Use; Business Standard; New Delhi; June 13, 2015; http://www.business-standard.com/article/economy-policy/gst-some-lessons-from-malaysia-that-india-can-use-115061300748_1.html

[iii] Adhia, Hasmukh; Goods and Services Tax: Next Steps; Department of Revenue, Ministry of Finance, Government of India; New Delhi; August 4, 2016;http://finmin.nic.in/press_room/2016/GST_nextstep_04082016.pdf

[iv] Beh, Yvonne & Tan Yi Lin; GST In Malaysia: One Year On; Wong and Partners; April 2016;http://www.wongpartners.com/files/Uploads/Documents/Type%202/WP/al_kulalumpur_gstmalaysia_apr16.pdf

[v] Ilias, Suhaimi with Zamros Dzulkafli, Ramesh Lankanathan and William Poh; Malaysia: GST- Early Impact Assessment; Maybank KimEng; April 2015;http://info.maybank2u.com.sg/pdf/investment-insurance/misc/misc-15-04-15-3.pdf

[vi] Singapore Government; How Is the Government Helping to Mitigate Inflation in Singapore; December 14, 2012; https://www.gov.sg/factually/content/how-is-the-government-helping-to-mitigate-inflation-in-singapore

[vii] Kumar, Sanjay with ML Sukhpal, Sandeep Rawal, Ashok Kr Pandey, Samar Nanda; Policy Paper on Role of Central Board of Excise and Customs in GST; National Academy of Customs, Excise and Narcotics;http://nacen.gov.in/inspire/uploads/downloads/569887ea212d1.pdf

[viii] Sharma, Radheshyam with JK Simte, MK Sarangi, KGVN Surya Teja, Sydney D’Silva and Manish Thapliyal; How to achieve administrative harmony between centre and states in the GST regime; National Academy of Customs, Excise and Narcotics; January 6, 2016;http://nacen.gov.in/inspire/uploads/downloads/56989a961d524.pdf

GST: Adding Edge to Exports

The GST will not only advance domestic market efficiencies but also add teeth to India’s economic diplomacy by improving the ease of doing business and enhancing competitiveness for exports.

The passage of the Constitution (122nd amendment) Bill, 2014, on Wednesday allows for the launch of the Goods and Services Tax (GST), a unified and pan-national tax structure. GST will create a common domestic market, remove distortions arising out of a multiplicity of levies and rates, and foster efficiency by minimizing the cascading effect of taxes in the manufacturing chain. GST will also have a beneficial impact on India’s economic diplomacy, including foreign trade.

The GST fits nicely into the Modi government’s drive to improve ease-of-doing business in the ‘Make In India’ campaign. Manifold taxes, with differential rates in different states, created hurdles for the smooth conduct of business and added costs at every stage, frustrating foreign investors. Foreign Investment decisions and the expected rate of return from projects often suffered due to these distortions, occasionally even deterring fresh investment plans. Most global value chains, with the exception of Foxconn, have avoided investing in India because of regulatory and bureaucratic tangles, especially those related to the multi-layered tax regime.

The successful implementation of GST will reverse this, helping to attract new investments especially from global value chains which often aggregate inputs from different constituencies.

The other immediate beneficiary will be Indian exports which have long suffered from lack of international competitiveness due to differential taxes and the energies expended on complying with the complex tax labyrinth. A 2010 report from National Council of Applied Economic Research had found that eliminating cascading taxes on exports could increase GDP growth by 0.9-1.7 per cent.[1]

For instance, a garments manufacturer and exporter has to depend on multiple suppliers of inputs – finished cloth (processed and dyed), threads, buttons, zips, sewing machines, ironing products, packaging, labels – for producing his finished good. These suppliers in turn, source raw materials from multiple sources, located in multiple locations, each party paying multiple taxes in different tax jurisdictions. At each stage, goods get delayed in transit for assessment and payment of varied levies – sales tax, octroi, excise, service tax. This fosters inefficiency and adds costs to each additional layer for the exporter. In addition, with each state legislating separate laws, meant that exporters couldn’t claim full set-off on the free-on-board price, rendering exports uncompetitive.

GST will alleviate this. The Foreign Trade Policy (FTP) for 2015-20 says: “The simplification and harmonization of the indirect tax regime of the country will reduce the cost of production and lead to a seamless, integrated Indian market, thereby making Indian trade and industry more competitive.”[2]

The benefit to services exports will become clearer in the next few weeks, but right away, the travel, tourism and hospitality sector is a clear winner because of its dependence on a wide spectrum of vendors and suppliers.

As the implications and impact of this simplifiying legislation starts to make itself apparent and the GST’s advantages for incoming foreign investment and out-going exports gain momentum, it will add veracity to Prime Minister Modi’s on-going economic diplomacy efforts.

This feature was exclusively written for Gateway House: Indian Council on Global Relations. It can also be read here.

References
[1] National Council for Applied Economic Research, Moving to Goods and services Tax in India: Impact on India’s Growth and International Trade, December 2009,<http://fincomindia.nic.in/writereaddata/html_en_files/oldcommission_html/fincom13/discussion/report28.pdf>

[2] Department of Commerce, Ministry of Commerce & Industry, Government of India, Foreign Trade Policy Statement, <http://dgft.gov.in/exim/2000/FTPstatement2015.pdf>

Credit guarantees attract investments

Indian infrastructure financing has for long suffered from rating concerns, but recent changes to credit enhancement are helping to plug this gap, enabling investment by foreign insurance and pension companies, and stimulating project exports.

A small refinancing deal in October 2015, followed by a similar one in January 2016, has supplied a critical missing piece, without which Indian infrastructure financing had been stunted for years. If this elusive financial instrument is now consolidated, it will enable infrastructure projects to attract strategic overseas funding as well as make Indian project exports more competitive.

The first transaction, of October 2015, involves power generator ReNew Power Ventures on one side, and the government-owned India Infrastructure Finance Company Ltd (IIFCL) jointly with the Asian Development Bank (ADB) on the other side. In January 2016, another energy company, Hindustan Powerprojects, concluded a similar deal with the IIFCL-ADB combine. Both ReNew and Hindustan Powerprojects have substantial investments in renewable energy projects.[1][2]

Both companies were refinancing existing bank loans with fresh bond issues—ReNew with Rs 451 crores[3] and Hindustan Powerprojects with Rs 380 crores.[4] The bonds were initially rated lower but were able to improve to AA+ due to “credit enhancement” provided jointly by IIFCL-ADB.[5] This enabled the bond issuers to lower their interest costs and, importantly, attract infrastructure-friendly international investors who have stayed away from Indian infrastructure projects because of rating concerns. The IIFCL-ADB’s credit enhancement has made their participation possible.

Credit enhancements (or credit guarantees) resemble insurance policies: a credible financial institution guarantees (for a fee) a bond issuer’s repayments. Such an assurance helps bond issuers obtain a better credit rating. Participation by multilateral institutions—such as ADB’s involvement in IIFCL’s credit enhancement—provides an additional layer of comfort and improves the rating by multiple notches. IIFCL plans to engage with other multilateral institutions (such as the World Bank) for future credit enhancement deals.

This crucial instrument has strategic geo-economic consequences: it can attract long-term overseas financing into fund-starved infrastructure projects as well as sharpen the competitive edge of Indian project exports.

Credit enhancement makes bonds issued by infrastructure companies eligible for investment by overseas insurance companies and pension funds. Both are custodians of long-term funds and thus ideal investors for long-gestation infrastructure projects. This has another advantage: since they invest for the long term, they remain rooted during periods of volatility.

A geo-strategic tool

Most Indian infrastructure projects were unable to tap into the global pool of insurance and pension savings because of rating restrictions. Indian infrastructure projects—public-private partnerships or completely private-owned—are typically executed through a special purpose vehicle (SPV, a separate company set up only to execute the project), with no recourse to the private sector parent’s balance sheet. In short, in times of crisis or default, SPV investors cannot dip into the parent’s resources. With no previous revenue track record, no visible safety net, and an extended project gestation period, SPVs usually got the lowest rating in the investment grade scale.

This deterred insurance and pension funds from investing in such projects. These long-term investors have strict internal regulatory and risk-management parameters, which includes the lowest credit rating that can be allowed for fixed-income investment. In most cases, it is fixed at AA. Incidentally, even Indian pension funds can invest in infrastructure bonds with a minimum AA rating.[6]

There is another collateral benefit arising from the credit enhancement programme. Deprived of long-term financing, most Indian infrastructure projects became dependent on bank financing, which is short-term. This inherent maturity mismatch has affected bank balance sheets adversely and choked off funding for other projects. According to Reserve Bank of India (RBI) data for March 2016, 16.7% of infrastructure loans advanced by banks have turned non-performing.[7] Credit enhancement now allows projects to replace bank loans with cheaper bond proceeds before they turn sticky; this also frees up bank funds for other greenfield/brownfield projects.

The RBI has also allowed commercial banks to provide partial credit enhancement, subject to certain conditions[8] for infrastructure projects that want to refinance their existing bank loans through bonds with lower interest rates. The availability of this facility will again improve the credit rating of the bonds, allowing a wider segment of investors to invest.

Credit enhancements will have the greatest impact on the infrastructure sector where projects have stagnated for want of long-term financing. According to the erstwhile Planning Commission, India needs approximately $1 trillion during 2012-17 to fix its infrastructure deficit.[9] A large chunk of this will be in the form of debt. But given the banking sector’s concerns on maturity mismatches, this debt has to be sourced from long-term investors at home and abroad. Without the rating upgrade mechanism, this was not possible.

Separately, Crisil Risk and Infrastructure Solutions Ltd and ADB have jointly recommended, in a technical assistance report[10] for India’s finance ministry, the creation of a separate bond guarantee fund. This fund’s shareholding pattern and capital structure should be designed with a AAA rating in mind.

A follow-up to their suggestion looks likely: the government-owned Life Insurance Corporation of India (LIC), India’s largest insurer, is planning to create a separate finance company that will provide credit enhancement to infrastructure bonds;[11]

Other kinds of credit guarantees are also falling into place. Project exporters have been able to lower their borrowing costs and improve their competitive appeal with credit guarantees from agencies like ECGC Ltd. Project exports by Indian public sector engineering companies are often guided by India’s geo-strategic considerations. Over time, many private Indian engineering companies have also started focusing on project exports as a revenue source. But since many of these projects were located in risky jurisdictions (for example, in parts of Africa), bank credit for executing these long-term overseas projects became expensive. Such guarantees therefore go a long way in easing such exports.

Exim Bank too has announced12 that it will focus on financing Indian project exports over the next three years. According to Exim Bank, Indian companies have a competitive advantage in project exports over some of their global competitors, such as China. This comes from years of executing large projects in developing and poor countries, which have demanding working conditions, which include rough terrain and fickle political climates.

Clearly a single critical financial instrument—credit enhancement—has the capacity to attract overseas investments as well as propel India’s strategic exports.

This feature was exclusively written for Gateway House: Indian Council on Global Relations. You can also read it here.

Reference

[1] Homepage, ReNew Power, <http://renewpower.in/>

[2] Homepage, Hindustan Powerprojects, <http://www.hindustanpowerprojects.com/>

[3] Sen, Amiti, ‘IIFCL Launches Renew Wind Energy’s Rs 451-crore “credit-enhanced” infra bonds’, The Hindu Businessline, 23 September 2015, <http://bit.ly/29DSsPs>

[4] Hindustan Powerprojects, ‘Clean Energy Arm of Hindustan Power first to place credit enhanced infrastructure bond’, Hindustan Powerprojects Blog, 5 January 2016, <http://bit.ly/29Di3XH>

[5] Schemes/Products, India Infrastructure Finance Company Ltd, Regular Credit Enhancement Scheme of IIFCL, <http://www.iifcl.co.in/Content/ceps.aspx>

[6] Pension Fund Regulatory and Development Authority, ‘Investment Guidelines for NPS Schemes’, Circular No PFRDA/2015/16/PFM/7, 3 June 2015, <http://www.pfrda.org.in//MyAuth/Admin/showimg.cshtml?ID=705>

[7] Reserve Bank of India, ‘Chart 2.9: Stressed advances ratios of major sub-sectors within industry,’, Financial Stability Report, Issue No 13, June 2016, p 24, <https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/0FSR2316BB76DB39BF964542B9D1EBE2CBC273E7.PDF>

[8] Reserve Bank of India, ‘Partial Credit Enhancement to Corporate Bonds (Notification to all scheduled commercial banks)’, RBI/2015-16/183, DBR.BP.BC.No. 40 /21.04.142/2015-16, September 24, 2015, <https://rbidocs.rbi.org.in/rdocs/notification/PDFs/P183165FFAB186FE4825A0FAD0E95739436F.PDF>

[9] Planning Commission, ‘Twelfth Five Year Plan (2012-17): Faster, More Inclusive and Sustainable Growth’, Vol. I, Sage Publications India, (2013), p. 18. <http://planningcommission.gov.in/plans/planrel/12thplan/pdf/12fyp_vol1.pdf>

[10] CRISIL Risk and Infrastructure Solutions Ltd and Asian Development Bank, ‘India: Preparing the Bond Guarantee Fund for India; Technical Assistance Consultant’s Report; Project Number: 44447’, Asian Development Bank, August 2014, <http://www.adb.org/sites/default/files/project-document/152971/44447-012-tacr-02.pdf>

[11] Laskar, Anirudh, ‘LIC-led NBFC may offer up to Rs1 trillion credit guarantee’,Mint, July 1, 2016, http://bit.ly/29wm5mX

[12] S, Arun, ‘Exim Bank’s African credit to boost service exports’, The Hindu, 12 June, 2016, <http://www.thehindu.com/business/Economy/exim-banks-african-credit-to-boost-services-exports/article8721312.ece>

A new trajectory for India-Africa ties

India now sees Africa as a promising market for Indian goods, services, and investments. This is evident in the government’s recent concerted focus on the India-Africa relationship—high profile visits by top leaders to African countries, a recasting of India’s development diplomacy, and an attempt to match action to past promises

India’s relationship with Africa has been through an unprecedented intensification in June 2016. In the first week of the month, Vice President Hamid Ansari visited Tunisia and Morocco. In the second week, President Pranab Mukherjee embarked on a tour of western and southern Africa, covering Ghana, Cote d’Ivoire, and Namibia. And in July, Prime Minister Narendra Modi is scheduled to visit Kenya, Mozambique, Tanzania, and South Africa.

The present renewed outreach is also unabashedly about business, and a good example of geo-politics combining with geo-economics. India views Africa as a promising market for Indian goods, services, and investments. So far though, any follow-up on promises had remained anaemic. Now, Indian leaders are seeking out fresh investment opportunities for Indian public and private sector companies in different African countries.

The vice president’s visits to Morocco and Tunisia are crucial because India imports phosphate—a critical raw material for fertiliser production—from these countries. Ansari also inaugurated an India-Morocco Chamber of Commerce during his trip to Rabat.

The president’s three-country tour provided an opportunity to further India’s business interests. At the India-Ghana Business Forum, Mukherjee said: “…the Indian Government would be ready to work with you in key sectors and areas of common interest and encourage Indian private as well as public entrepreneurs to bring more investments into Ghana.”[1] India’s cumulative investments in Ghana are over $1 billion and two-way trade during 2015-16 amounted to $3 billion.[2]

In Cote d’Ivoire, Mukherjee said: “…your country is blessed with fertile soil and abundant agricultural and mineral resources. Our public and private sectors are keen to join you in exploring these resources efficiently and in setting up agro-based industries.”[3]

At the same time, India’s development diplomacy for the continent has been through a strategic shift. Exim Bank, for example, is now likely to focus more on service exports, rather than compete with China for infrastructure projects in Africa.

The bank is looking to disburse close to Rs. 10,000 crores in Africa over the next three years as both commercial and concessional credit.[4] Service exports aim to build on India’s traditional strengths in Africa and will include healthcare, education, and information technology services. Exim inaugurated an office in Cote d’Ivoire during Mukherjee’s visit. The office is expected to widen the bank’s footprint in West Africa.

Exim Bank is also looking to sharpen its focus on another area of India’s traditional exports to Africa: project exports. It has requested the Reserve Bank of India to ease regulatory and compliance guidelines regarding minimum equity capital, leverage (the multiples—3X, 4X or 8X—of share capital that a company can borrow) and the maximum that the bank can lend to a single borrower.[5] These will be necessary if the bank is to make project exports one of its thrust areas.

These actions are in line with promises made during the Third India-Africa Forum Summit (IAFS) in October 2015. The first two editions of the summit—in 2008 and 2011—made numerous pledges but fell short on follow-up and delivery. Both sides were responsible for the indifferent implementation.

The last IAFS, held in October 2015, saw a strategic shift in focus—apart from the usual rhetoric, there was a better alignment of India’s global ambitions (both political and geo-economic) and traditional strengths.[6] [7] Importantly, the third IAFS created a formal monitoring mechanism to regularly review the progress of various projects at different stages of completion.

The summit aimed high—it also sought to create a global alliance of solar-rich countries.[8] Such an alliance will help create goodwill for India among Africa countries, and generate solidarity through collective bargaining when accessing IPR-protected technology from rich countries.

It’s starting with this summit that Modi has been building bridges with different African countries and soliciting support for a host of multilateral initiatives. These include backing for India’s membership of the UN Security Council along with a united front of emerging and poor economies at the World Trade Organisation.

The high-octane official Africa engagements will also help assuage concerns regarding India after recent allegedly racist incidents involving African nationals living in the country. But it is now up to India to ensure that its belated recognition of the critical role Africa can play in our strategic calculus, as well as in India’s trade and investment expansion plans, is not just a temporary spurt.

This feature was exclusively written for Gateway House: Indian Council on Global Relations. You can also read it here.

References
[1] Mukherjee, Pranab, ‘Address at the India-Ghana Business Forum Event’; Speech delivered at Accra, 13 June 2016, <http://presidentofindia.nic.in/speeches-detail.htm?531>

[2] Press Release, Ministry of External Affairs, Government of India, Visit of President to Ghana (June 12-14, 2016), 6 June 2016, <http://www.mea.gov.in/press-releases.htm?dtl/26872/Visit_of_President_to_Ghana_June_1214_2016>

[3] Mukherjee, Pranab, ‘President of India; Speech in response to welcome speech by President of Cote d’Ivoire’ Speech delivered in Abidjan, Ivory Coast, 14 June 2016, <http://presidentofindia.nic.in/speeches-detail.htm?534>

[4] S, Arun, ‘Exim Bank’s African credit to boost service exports’, The Hindu, 12 June, 2016, <http://www.thehindu.com/business/Economy/exim-banks-african-credit-to-boost-services-exports/article8721312.ece>

[5] Lele, Abhijit, ‘Commerce ministry, RBI to review regulatory norms for Exim Bank’Business Standard, 24 May 2016, <http://www.business-standard.com/article/economy-policy/commerce-ministry-rbi-to-review-regulatory-norms-for-exim-bank-116052400042_1.html>

[6] Documents, Third India-Africa Forum Summit, India Africa Framework for Strategic Cooperation, 29 October 2015, <http://www.iafs.in/documents-detail.php?archive_id=323>

[7] Documents, Third India-Africa Forum Summit, Delhi Declaration 2015, 29 October 2015, <http://www.iafs.in/documents-detail.php?archive_id=322>

[8] Speeches, Third India-Africa Forum Summit, Speech by Prime Minister Shri Narendra Modi at the Inaugural Ceremony, 29 October 2015, <http://www.iafs.in/speeches-detail.php?speeches_id=276>

The Legacy: Raghuram Rajan is leaving the battlefield just when he was getting the better of his rivals

India’s debonair central banker, Raghuram Rajan, leaves behind many broken hearts and disappointed souls. Chronicles of his legacy will list many achievements, but will also note that he left the battlefield just when he was getting the better of his rivals; what’s surprising is that the commander-in-chief agreed to his pre-mature withdrawal even though the general’s strategies could be seen bearing fruit.

Equally perplexing will be the choice of his replacement.

Both the government and Rajan personally have been advocates of an alternative global financial architecture. He has also been proposing for a while that it was time for a new Bretton Woods mechanism. And Rajan had taken the battle to the enemy camp. At the April 2016 spring meetings of the International Monetary Fund and the World Bank, Rajan observed how deeply multilateral financial institutions were in thrall of western economic orthodoxies. He even wryly remarked how ideas from emerging economies were dismissed as “crankiness.”

He was prescient about the trans-Atlantic financial crisis. He took on former US Federal Reserve chairman Ben Bernanke when US domestic monetary policy spilled over into the global economy and led to severe volatility in emerging markets. He is unlikely to have fond memories of the period: he had to douse this particular fire soon after his appointment in Sept. 2013.

So, here is question number one: Will his successor have the same zeal about promoting an alternative global financial architecture that is sensitive to emerging economy needs and is not partisan about any particular economic ideology?

Rajan also quits before another crusade could be brought to its logical end. He’s been battening down the hatches that allowed a cosy nexus between large corporate borrowers, bankers, politicians, and bureaucrats, to bleed public sector banks through questionable debt write-offs. Rajan had taken a large broom to bank balance sheets and forced them to take drastic action against defaulters.

Many large—and over-stretched—corporate borrowers have been carping about Rajan’s reluctance to reduce interest rates, which, when lowered, would have certainly helped moderate their interest burden. These same corporates also turned into quack economists on the matter of interest rates: in their collective view, only lower interest rates could bring back high rates of economic growth. This view is oblivious to the fact that the low interest rates in the US, or negative rates in Europe and Japan, have failed to promote any economic growth.

Time for question number two: Will Rajan’s successor have the stomach (or benign sanction from the government) to continue with the clean-up act? Or to hold rates steady when required?

So, what does Rajan’s legacy look like? Apart from the well-documented success in fending off volatility from the US Fed’s tapering in 2013, his tenure will be remembered for three systemic changes he fostered.

One will be the differentiated banking landscape that he designed and left behind. As RBI governor, he grandfathered the emergence of a new breed of universal, small, and payments banks. He was in the process of adding two more categories—custodian banks and wholesale (or long-term) financing banks—to the mix. We will now have to wait and see if his successor has the same enthusiasm for a differentiated banking model.

These new categories come in addition to existing myriad forms of cooperative banks, regional rural banks, local area banks, public sector scheduled commercial banks, State Bank of India group of scheduled commercial banks, old-generation private sector banks, new-generation private sector banks, and foreign banks.

Restive signs mark the payments banks space—three companies which received in-principle approval to launch payments banks (Cholamandalam, Tech Mahindra, and Dilip Shanghvi of Sun Pharma) returned their licences stating that the project was not economically feasible. Undeniably, and in true RBI style, the initial architecture is anti-profit and has flaws in it.

The second marquee item is his strict action against non-performing assets (NPAs) that continue to impair bank balance-sheets. This was viewed as his struggle to end Indian-style crony capitalism: large volumes of loans remain unpaid every year and yet defaulting borrowers manage to get fresh loans unfailingly with some help from politicians, bureaucrats, and complicit bankers.

The staggering amount of NPAs is a direct drain on taxpayers, since loss to state-owned bank balance sheets must be compensated with fresh equity infusion by the largest shareholder—government— every year.

Finally, the outgoing governor will be remembered for installing a new monetary policy framework, which uses inflation-targeting as its driving philosophy. It also includes a monetary policy committee comprising three government representatives and three central bankers, with the RBI governor getting the casting vote. This new structure overhauls the old belief that the economy’s fiscal (the government) and monetary policy (central bank) sides should remain out of each other’s hair.

While the government has been uncomfortable with Rajan’s public comments about governance and broader political economy trends—saying that central bankers should not interfere with the fiscal side—it has not shown the same restraint when trying to influence monetary policy.

It will have to be seen how future central bankers and monetary historians view Rajan’s acquiescence to large government presence in monetary policy making.

The article first appeared in www.qz.com/india and can also be read here.

What does Brexit mean for India?

On June 23, the United Kingdom will vote on whether they wish to remain a part of the European Union through the Brexit vote. The debate surrounding the vote has spurred many a heated and emotional debate. While the Indian government has not declared anything publicly - remaining in the EU would be beneficial to Indian businesses.

The Brexit referendum on June 23 — whether the United Kingdom (U.K.) chooses to stay on in European Union (EU) or to quit the mega regional agreement — has spawned its fair share of heated and emotional debates. Equities, commodities and currency markets have tossed and turned at either prospect. Indian markets have also been agitated at the likely outcomes. An impassive view, though, shows that Indian trade and business interests might benefit from UK staying in.

While the Indian government has not taken a public position on the issue, since it doesn’t want to be seen interfering in another country’s sovereign exercises, newspaper reports says Indian ministers have conveyed to their UK counterparts against exiting.[1]

This stand may have been informed by Indian business’s unambiguous and public support for UK staying on in EU. A statement issued by the Federation of Indian Chambers of Commerce and Industry (FICCI) says unequivocally: “…we firmly believe that leaving the EU, would create considerable uncertainty for Indian businesses engaged with UK and would possibly have an adverse impact on investment and movement of professionals to the UK.”[2] While the other leading industry association, Confederation of Indian Industry, has refrained from issuing any official statements, its representatives have expressed their reservations in different interviews.

There are valid reasons for Indian business concerns.

One, Brexit supporters say the UK will be able to sign new and better trade agreements — free of EU’s restrictive rules — with its strategic partners, such as India and China. They also cite the stalled India-EU trade and investment talks to buttress their argument. However, experience shows negotiating trade and investment pacts takes a long time. For example, the India-Korea Comprehensive Economic Partnership Agreement took five years to finalise[3]. There are concerns over the interim uncertainty for trade and investment flows.

There is another associated hassle. Assuming that Indian business tides over the interim uncertainties, it will still have to adhere to two different standards and rules when trading in the same geography. This entails additional costs.

Two, most Indian businesses use the U.K. as a springboard for their European operations, given India’s historical and cultural affinity with the country. If those favouring exit win, Indian businesses will have to install a parallel set-up on mainland Europe for conducting their operations. For instance, a portion of the Indian foreign direct investment (FDI) into the UK is to access the European markets. Now, Indian companies will have to separate their investments for the two distinct markets. This means additional costs, regulatory wrangles and legal complications. In addition, the complexity of negotiating new tax laws is likely to prove a nightmare.

Three, there are apprehensions that a Brexit success would inspire other EU members to explore a similar option. This would lead to fragmentation and the Indian government would then have to negotiate separate agreements with each country. This will add to the general confusion and add to regulatory and compliance costs for Indian business.

Finally, Brexit might raise myriad central banking problems. First, Reserve Bank of India (RBI) will have to re-calibrate its monetary policies to cope with the currency markets volatility. Additional liquidity measures might have to be implemented to stave off rupee volatility; this might temporarily derail the central’s banks monetary policy objectives for 2016-17.

But more importantly, if Brexit goes through, expect prolonged volatility in the currency markets and a sharp drop in both pound and euro values. This will not only mean a downward revision in valuation of RBI’s currency reserves, it will also require the central bank to re-adjust the composition of its ForEx reserves. Though not substantial, RBI’s volume of euro and sterling pound holdings are also not exactly negligible.

This feature was exclusively written for Gateway House: Indian Council on Global Relations. It can also be read here.

References
[1] Watch on Brexit, oil prices; The Telegraph; June 17, 2016;http://www.telegraphindia.com/1160617/jsp/business/story_91646.jsp#.V2TnN-Z96uU

[2] Singh, Dr Didar A; Ficci Secretary General; Ficci Comments on UK Referendum on Brexit; February 24, 2016; http://ficci.in/PressRelease/2293/ficci-press-feb24-uk.pdf

[3] Ahmed, Shahid; India-Korea CEPA: An Assessment; pages 45-98; Korea and the World Economy, Vol. 12, No. 1 (April 2011);http://www.akes.or.kr/akes/downfile/12.1.3_ahmed.pdf