Treat, not kill

PSU banks are too important for financial inclusion to allow them to fail

In the early 1990s, Harshad Mehta exploited the manual transactions undertaken by banks to get rich. Fake bankers’ receipts, not backed by underlying assets, were issued by two little known entities to secure funds. Some banks transferred money that was to be used to buy government securities into his personal account to play the market so that they could get better returns. Shares were held in physical form. Long positions could be carried forward from settlement to settlement after paying a nominal charge. Brokers undertook proprietary trades using clients’ money. The scam triggered the transition to automation in banks and the stock market. If modern trading practices have increased the size of the market, the downside is limitless damage. The rollover of letters of undertaking by some employees of Punjab National Bank did not leave a trail despite using the Swift network to direct money into its accounts in foreign branches of Indian lenders since 2011. The fraud, estimated to be more than Rs 11000 crore, was detected when there was a change in personnel mid 2017. In 1995, a two-centuries-old British bank vanished into thin air due to unauthorized trading by a 28-year-old derivatives trader in Singapore.

If an individual’s greed brought about a great institution’s demise, the meltdown of the global markets in September 2008 stemmed from the financial markets’ insatiable hunger for profit. To capitalize on the housing boom, there was a scramble to buy and sell mortgaged-backed securities comprising a cocktail of low- and high- rated paper. Eventually, prices of homes reached bubble territory. Buyers dried up, leading to loan defaults. Not only Wall Street firms but even those in remote places such as Iceland ended up holding worthless instruments. Finally, the US government forced many of the too-big-too-fail financial services providers to merge and allowed some to die. A few smaller economies in the euro region had to be bailed out by the rich nations.  The first conclusion is that money skimming schemes can occur with or without digitization. Second, internal controls and risk management are invariably lax. Third, greed at every level contributes to the blowout. Fourth, due to global linkages, the fallout is across partners within and outside the border. The PNB money-siphoning scandal has come at an inopportune time. Credit growth is reviving. The period for recognition of non-performing loans has been shortened. Time-consuming restructuring processes have been junked. Borrowers are being shepherded to insolvency. The headwinds of demonetization and roll-out of GST are fading. Yet, the demand for privatization of the ailing nationalized banks is growing louder. The rise and fall of Global Trust Bank, one of the earliest new-age private banks, should silence the vocal proponents of wholesale selloff of government-controlled peers. Goldman Sachs owned 4% and the International Finance Corporation 5% when GTB suffered in the market crash of 2001 due to exposure to Ketan Parekh-boosted stocks in 2001. It was acquired by Oriental Bank of Commerce in August 2004. Shareholders received nothing.

Nonetheless, the grouse against political interference, from appointing top managers to influencing to whom and where to lend, cannot be dismissed, going by the fate of UTI. Flagship US- 64 scheme bought KP stocks even as their market value was plunging mid 2000.  Getting a whiff of trouble, there was a run on the scheme mid 2001. Units of Rs 10 were redeemed at Rs 14.20 when the actual value was less than Rs 8. In July, purchase and sale of units was frozen for six months. A 10% dividend was declared. Repurchase was undertaken at face value. The then NDA government had to spend Rs 3500-crore on recapitalization. PSU banks need to thrive as they are important links in the last-mile connectivity of various financial inclusion schemes. The strategy to revive the PSU asset management company can be copied to clean up the banking system. In August 2002, UTI was split into two. Tax sops were extended to US-64 and assured returned schemes. These were handed over to the Specified Undertaking of UTI, managed by a government-appointed team. The shortfall in US-64 scheme was Rs 6000 crore and of ARS Rs 8561 crore. UTI Mutual Fund got other net asset value-based schemes. Shareholding was offered to some PSU banks. When the market recovered, Suuti returned all the support provided by the government and was wound up in 2012. In the same way, the top 10 banks’ assets can be divided into good and bad banks. Bad loans can be disposed of at a good price as economic recovery catches speed and the bad banks dissolved. The government should remain a strategic investor, instead of owner, in good banks.

Mohan Sule

Yours sincerely

The last budget of the present government will burnish Modi’s legacy as a compassionate reformer

It will be a mistake to dismiss the Union Budget 2018-19 as a balancing act, giving away with one hand and taking with the other. It is a carefully crafted document with lot of thought. With the focus on widening the tax base out of the way, the attention has turned to ensuring social equity. The economy that was inherited four years earlier was beset with systemic weaknesses. As a result of crony capitalism in the garb of socialism practiced over the last many years, 1% of the population is holding more than three-fourths of the nation’s wealth. Demonetization, a uniform indirect tax regime and legitimizing insolvency over supplying unlimited credit are efforts in repairing the damage. The transition to a formal economy has commenced:  indirect and indirect tax collections have increased so far. It would have been surprising if the improved fiscal position had not emboldened the government to address the income inequality gap. The latest budget should be considered another step in the direction, following the Housing for All, Ujjwala scheme of last-mile electricity access without cost and the Saubhagya mission of free LPG connection. The last two programs get more allocation to increase coverage. These initiatives are not doles that the previous regime was known to distribute, the most infamous being the rural employment guarantee scheme promising predetermined minimum wages not linked to productivity. The budget for the current fiscal had in fact increased the outlay, with a rider that the work resulted in the creation of tangible assets.

The beneficiaries of universal healthcare and he recipients of 1.5 times the cost of crop production can be counted just like the outcome of the flagship Swacch Bharat by the number of facilities created. The prime minister’s horizon is never short term as is evident from the recall of high value notes and the roll-out of the goods and services tax. Their impact will reverberate over the long term. The target for the affordable housing scheme is 2022, the 75^th year of independence. Second, their irreversible nature ensures that Narendra Modi’s legacy survives. Withdrawing ModiCare or diluting the formula to calculate the compensation for farm output cannot be without severe repercussions. Importantly, the social outreach is not by printing more money. Two-thirds of the world’s largest medical insurance cover will be financed by budget allocation as well as the 1% increase in cess on income tax and one-third of the cost will be borne by the states. There are chances of PSU divestment exceeding the target of Rs 80000 crore for the next year if the current year’s experience is any guide. No wonder the slippage in the fiscal deficit target is just 0.3 percentage points at a time when crude oil prices have shot up to US$ 70 a barrel as against an average of US $50 a barrel for nearly half of the current fiscal year and the strengthening rupee is hampering export realization.     

The two areas of concern are inflationary pressure due to the slightly higher fiscal deficit and taxing long-term capital gains from equity instruments. Usually, the markets are the best indicators of the soundness of the budget math. Bond prices slipped, with yields going over 7.50%. The volatile stock market benchmark appreciated more than 250 points intra-trade after the announcement of medical reimbursement up to Rs 5 lakh per year per poor family and closed marginally lower. The more-than-4% plunge of the Sensex and the Nifty in the next three days was largely due to the fear that the US Federal Reserve is set to ramp up rates as US bonds fetched near 3% yields with the tightening of the labor market. US stocks plunged even more steeply. There is acceptance, particularly after the cycle of drought and normal and excess rainfall, that unless government spends on social welfare, rural economy and infrastructure, Corporate India will not be  in a position to generate revenues and taxes. Equity investors have enjoyed spectacular returns over the last year due to global liquidity. Structural changes leave the domestic economy in a fine form to sprint ahead unencumbered. The 10% tax on gains above Rs 1 lakh after a year across the equity universe is balanced by the dividend distribution tax on equity schemes. After aggressively pursuing to bring foreign investors registered in Mauritius, Cyprus and Singapore in the tax net, it was essential to erase the image of India, with a marginal securities transaction tax, as a place to dump laundered money. Hiking the turnover limit to be eligible for a lower corporate tax of 25% to Rs 250 crore is a nod to the animal spirits of the small and medium enterprises.  Undoubtedly, the last full-fledged budget of the current dispensation shows Modi’s compassionate side after cracking down on illegal wealth and encouraging tax compliance.    

-Mohan Sule

Feels good

With most macro indicators pointing to improvement, it is up to the market regulator to ensure the sanctity of the market

CY 2018 has begun on a cheerful note. Benchmarks are hitting new highs. The projections of India’s growth by multilateral agencies are optimistic. World Bank sees GDP expanding 6.7% and the United Nations at 7.1% in CY 2017 than the 6.5% estimate for FY 2018 of our Central Statistical Organization. After a six-month pause since the roll-out of the goods and services tax, reforms are back on track. Government approval will not be required for 100% FDI in single-brand retail.  Public sector banks are being recapitalized. The merger of SBI and associate banks has set in motion the consolidation process in the banking sector. Eventually, only a dozen or so PSBs will remain. Brimming with demo liquidity, banks are reducing their cost of borrowing by cutting deposit rates. Credit growth looked up in November, though on a low base caused by the recall of high value notes a year ago. Foreign exchange reserves have climbed up to over US$ 400 billion, the highest-ever. Foreign investors bought over Rs 148000-crore debt in the last calendar year as against a net pullout of Rs 43400 crore in CY 2016. Equity exposure of these investors is up three times over the year. Mutual fund inflows in stocks more than doubled over the period. There is unlikely to be a flight of capital, with the Federal Reserve dithering over rate ramp-up in the current CY as inflation in the US is still soft. Yet the rupee can be expected to decline moderately from the CY 2017 level as the import bill goes up to meet a resurgent economy as well as due to surging crude oil prices. Fuel prices can come down if brought under GST. There is determination to make GST user-friendly. A slighter weaker rupee might have the ability to boost exports, down by half in December over November.

The index to measure services activity crossed over to expansion from contraction and that of manufacturing improved to 54.7 from 52.6 in December over November, indicating that the worst might be over. Industrial production surged at a 25-month high pace of 8.4% in November 2017 over November 2016. Manufacturing hit a record high growth. Capital goods posted the fourth consecutive positive expansion. The infrastructure and construction sector spurted a sharp 13.5%. Net direct taxes grew 18.2% in April-December 2017, meeting over two-thirds of the target for the current fiscal. The buoyancy in tax collection has resulted in reassessment of the government’s borrowing program. Now only Rs 20000 crore will be required, down from Rs 50000 crore estimated earlier. Consequently, fears of increase in interest rates going ahead have subsided. Most likely the fiscal deficit will remain at 3.2% of the GDP for the current financial year. As a result, the fall in bond prices has been capped, offering huge relief to banks. Companies are reducing debt. Distressed assets are getting buyers. Transparency in real estate and interest subvention on first-home loans are bringing back buyers. With the buyout of HPCL by ONGC, the Rs 65000-crore disinvestment target for the current fiscal year has been crossed. The Niti Aygoy has recommended 22 PSUs for privatization.

The spurt in consumer prices to a 17-month high of 5.21% in December 2017 over a year ago due to increase in core inflation should cause satisfaction rather than alarm. The heating suggests pick-up in demand after the cold wave stemming from demo and GST. Yet the cumulative CPI inflation is lower at 3.25% in April-December 2017 compared with 4.85% in April-December 2016.  Also, wholesale prices are at a three-month low on softer prices of vegetables, pulses, egg, meat and fish. What can puncture the feel-good mood? Inability to maintain the market’s sanctity is a looming danger. Despite injecting significant transparency in trading and imposing accountability on issuers and intermediaries, the regulatory framework in India is a work in progress. The reminder of the fact was the market regulator’s decision to put off disclosure of domestic and international debt default by listed companies after making it mandatory in August. It seems the Reserve Bank of India is not comfortable with the information coming in public domain. The equity and bond markets often anticipate problems even before they occur. Better to let companies reveal than have stocks fluctuate on rumors. The concern of insider trading is real, particularly in the digital age. Shares of a financial services company went up 15% in a week before it announced merger with a new-age private sector bank. Another private sector bank’s quarterly results were leaked on WhatsApp groups days ahead of their dissemination. Unless a crackdown is visible in such instances, investors might hesitate to enter the market despite favorable tailwinds.

-Mohan Sule