Sunday, November 23, 2008

Seeing the Whole Elephant

Shyam Ponappa / New Delhi November 23, 2008

While the world scrambles to prevent chaos, we seem to be moving in a dream...

The accompanying graphic has six opinions on how to assure growth, from economists and industry association heads at the India Economic Summit 2008, sponsored by the World Economic Forum and the CII.

These views give some idea of how much dissonance there is on what should be done for growth. Five of the six agree on investment in infrastructure (the top row). Thereafter, only two-at-a-time agree, on (a) regulations without stifling markets, (b) stimulating consumption: one through tax cuts, another through rate cuts, and (c) incentives to banks to lend.
Is infrastructure spending a good solution? Consider the evidence: our problem from even before the economic crisis was not funding for infrastructure, but inability to get projects implemented. For instance, there are the highway projects that started off well enough, then slowed over the last couple of years. In the last few months, many have been given up by our top constructors. A report in this newspaper attributes this to unrealistic project estimates and/or high interest costs.* Other instances are the steel and aluminium projects stalled because of land acquisition policies and practices. Therefore, efforts to spend on such projects are likely to have little immediate effect until the structural problems in their award and execution are resolved. What it will do is help anchor better expectations — one peg to raising confidence — because it will signal better developments for the future. But we have to survive the present in good enough shape to be able to enjoy the future…
In such circumstances, one would expect a certain alignment between the opinions of the industry chambers and of bankers, but this coherence is missing. Is this getting lost in the cacophony of a typical Indian dialogue-of-the-deaf, where everyone talks while no one listens, so there is no discernable common thread, let alone harmony and symphony?
However, three of the six opinions do address the immediate crisis of profits, revenues, and of continuing investment and consumer spending, the necessary ingredients to keep growth on track. This is what needs attention: the logic and urgency of time lines — what needs doing now, to keep from falling over the cliff.
From the perspective of a time line, let us distinguish between what can be done quickly for immediate effect in this crisis, as against what can be done for the medium- and longer term. First on our list, most likely, would be rate cuts, because of the impact and ease of execution. These would be in the SLR and CRR to provide a massive psychological cushion of liquidity, and in the repo and reverse-repo rates to bring down the tide of interest costs. Combined with the announcement of a redefined ‘priority sector lending’ which would include rollovers of loans except where there is demonstrated bad-faith, and a system (to be developed and introduced in the near-to-medium term) of online monitoring for compliance, with incentives and penalties. This would lead to credit availability for projects and businesses, now made profitable by the repricing of funds and projects. Real estate and property development, however, will need rescheduling with major asset re-pricing.
In terms of urgency, these would be the first steps to alleviate the situation immediately. Followed by steps to rationalise taxes, e.g., on petroleum products (Kelkar Committee recommendations). The objective: to reduce input costs and multiplier effects on the overall cost structure. Keep our steel mills, automotive companies and airlines running, our airports building… What this would achieve is continuing domestic-demand-driven growth, encouraging reasonable levels of consumption, and retaining employment. As for government revenues, the logic of profit-sharing, so clearly understood for petroleum exploration and some aspects of telecommunications after NTP ’99, would ensure that government makes much more from fat geese that lay many golden eggs, than from strangulating the few that are presently scratching about to eke out a living.
If this is not done, in all likelihood we will have escalating bankruptcies of capital-intensive enterprises, which, because of increasing repossessions and collapsing prices, may lead to a risk we have been spared so far: bank failures. If these events occur, the likely consequence is a severe recession in India as well — not for six months, but for many years — because both investment and spending will dry up, as will growth. And the great benefit of having become an attractive investment destination will, instead, become a frightful return to the uncertainties of pre-2003.
Those inclined to see a glass always half-full would say (next year and the next): But growth is 4-6 per cent in catastrophic global times. The rest of us will see it as running at half-speed, with all the attendant consequences for a talented people, once again held down by our collective inability to work things out for the common good.

* ‘Few takers for highway projects’, BS November 17, 2008:

Monday, November 10, 2008

Ambivalence Adds To Uncertainty

Shyam Ponappa / New Delhi November 06, 2008

We need decisive action on credit and interest rates.

The rate cuts together with steps like the RBI giving enterprises access to foreign exchange are welcome initial steps. They are too tentative, however, and more urgent action is required.

The present developments are like a less severe precursor. After a total loss of economic momentum, remedial actions will have less effect. The economy is staggering under a liquidity crisis from inappropriate tightening and high interest rates, leading to stalled projects and spending, with businesses floundering on the brink of distress sales, bankruptcy and layoffs. How can India’s domestic market-driven economy with its fundamentally sound banks be revived?

Simple Arithmetic

The logic is simple: banks lend to enterprises only when they see profits and expect to recover loans. Profits have tanked, and must be revived. Profits will rise with adequate liquidity, low interest rates and strong disincentives not to lend (ie, a low reverse-repo rate — which banks earn for deposits with the RBI), together with rationalized taxes as for ATF for aircraft provided revenues can be maintained. Revenues will sustain and grow only if there is confidence; otherwise, there will be no spending. Hence the urgency for the government to orchestrate its actions with the RBI, banks, businesses and industries, to apply a concerted strategy for building profits.

At present, the strength of our economy built in the good years in healthcare and pharmaceuticals, airlines, hotels, banks and financial services, metals and manufacturing…is being squandered in battling a recessionary spiral. What’s worse, that spiral was induced and is now aggravated by self-inflicted high funding costs (global rates are lower) and tight credit. This is why enterprises sought external borrowings, and are now suffering with the depreciation of the rupee.

Reversing The Downward Spiral

The negative trend can be reversed by addressing four drivers of the present economic crisis: confidence, liquidity and its sibling, credit, and interest rates, ie, costs. Instead of dithering with half-measures — small rate cuts, ambivalence between keeping rates high to attract remittances, or low to promote growth — the RBI and the government need to act decisively to make India a high-growth market and attractive investment destination. Radically increased liquidity and decreased interest rates (and rationalized taxes) can improve profits dramatically. While global cues will affect foreign investment, convergent action could temper this. These steps are needed urgently, before there is irreparable damage.

* Confidence: All or Nothing

In a crisis, confidence is an all-or-nothing holding action. Tweaking a few props is like putting some timber in the path of a massive flood: it cannot avert the damage. Therefore, instead of business-as-usual, there must be well-orchestrated actions affecting liquidity, credit and interest rates, together with a resolute stance, such as assured access to foreign exchange (as has been done). The restoration of confidence is needed before there is further damage from stalled projects, distress sales of assets, bankruptcies, and massive layoffs.

* Liquidity

A goal-oriented approach is advisable, taking cognizance of the facts, with objectives defined to converge. In the case of liquidity, the issue is the extent of shortage. An assessment of needs must cover the events leading up to the crisis, including the strangulation of liquidity and credit to enterprises because of escalating CRRs and interest rates over the last two years and early this year, coupled with high government and PSU borrowings, eg, the oil and fertilizer subsidies through banks. This ‘backlog’ is one component of liquidity needs. The disappearance of international trade credit is another. Funding needs for enterprise activities and projects is the third, FIIs repatriating when stock prices rise is the fourth, and a revival of consumer spending the fifth. This is the demand for which the RBI should provide. The order of magnitude required may be two to three times what was done last week, achievable by a further cut of 2 per cent in the CRR (presently 5.5 per cent), to signal a ‘liquidity bank’.

* Credit Availability

Once there is liquidity, banks must be encouraged to lend based on acceptable criteria. This needs more than admonitions from the Finance Minister. The most direct signal is a disincentive: a low reverse-repo rate, so that banks cannot simply park funds profitably with the RBI (they may still opt for government bonds for safe returns, for which other disincentives need to be devised to discourage excess). True, given our risk-averse bias, there are many reasons for bankers to hesitate in making lending decisions according to their business judgment. This bias will take time to grow out of, but the process needs to be helped along by structuring systemic support that rewards productive lending over unduly risk-averse behaviour. Unfortunately, that isn’t all: structural support also needs to be devised to guard against arm-twisting by predatory politicians, and to protect bankers from them.

* Cost of Funds

To rid ourselves of unnecessary, self-imposed constraints, we need a further cut of at least 2 per cent in the repo rate. There is no conceivable reason for imposing high costs for money. As for attracting foreign remittances, their incentive is the spread between offshore deposit rates (low in many places) and Indian rates. Some economists argue that high demand for funds keeps India’s rates high, but finance professionals — finance and economics are different domains — will tell you that the demand for funds is always high in an active economy, while a major component of the cost of funds is a regulatory construct. It is bankers who ration supply on the basis of their criteria, unless compelled to do otherwise.

Also, high rates inflate India’s cost structure unduly, as the cost of money has an input multiplier effect on other prices, ie, interest costs as a percentage of revenues, or of total costs, understates the detrimental effects of high interest rates.

With lower interest costs, Indian enterprises will earn higher profits. If growth is nearer potential, enterprises will attract more from investors, including foreign investors, as was the case in the last few years. This is why the RBI and the government must act decisively on building confidence, liquidity and credit, and cut interest rates.

For recent views that support these measures, see:

'There's no need for irrational pessimism', Deepak Parekh
interviewed by Shobhana Subramanian:

However, Dr. Rangarajan says the RBI has done enough:

'The financial crisis and its ramifications', C. Rangarajan:

Added later (November 11, 2008): As a matter of fact, it turns out that the government has again done too little in cutting duties and taxes on ATF. A piece in the Business Standard titled, 'Taxes, costing methods make Indian ATF prices highest in Asia-Pacific', by Rakteem Katakey shows that despite a 36 percent cut, prices in India at Delhi and Mumbai are 60 percent higher than in Singapore and Kuala Lumpur.