The Telecom Crisis Is An NPA Problem

After interim relief for telecom, structural reforms must follow.

Shyam Ponappa   |   November 7, 2019

The Committee of Secretaries to mitigate financial stress in telecom must act quickly on interim measures for the sector to survive. But is its mere survival sufficient for India’s development and growth? Is it possible to fix telecom in isolation?

Our communications needs are very poorly served, although at rock-bottom prices. Is it even possible for our hapless citizens and enterprises to get past shoddy services and productivity foregone, to trade with other countries on a more even footing? Yes, if we succeed at major structural changes, starting with telecom. But to transform telecom, the government and all of us have to come to the stark realisation that just as finance drives the economy, digitisation and communications have to be at the heart of production and delivery. Telecom and digitisation are strategic enablers for all infrastructure and in all sectors. Leading countries are so far ahead and functioning so effectively that it is difficult for us to imagine. We must want that path, plan for it, and put in the requisite effort. Simply tweaking overdue payments, tinkering to reduce charges, and plugging along as before isn’t going to get us there. In this sense, the Committee’s charter is too limited. All it can do is assuage the pain, whereas our need is for a revitalised industry to serve our purposes.

If the Committee’s scope were broader, could we actually adopt digitisation as our core strategy for development and growth? A study on China, “Telecommunications reforms in China”, about the transformation in policies to make digitisation its development priority, is instructive.1 Their approach to reforms was to balance the government’s aims of universal coverage, governance and control, and efficiency; industry’s profit-seeking; and the people and enterprises’ needs for freer, more rapid communications. This is what we need to do, in a way that works for us.

Also, the government, the judiciary, the press and users need to understand and accept that the telecom crisis is part of the larger non-performing assets (NPAs) problem. It has systemic links to NPAs and banking, which links to real estate and construction, electricity and roads, and stable and predictable taxes. Government payment delays and tax terrorism must stop. Business as usual will not resolve NPAs soon to enable growth. These two articles explain why and deserve attention.2 Essentially, entities that take deposits need Reserve Bank of India (RBI) regulation. In a crisis, people with domain expertise and capacity must be appointed to take immediate steps to protect assets and operations, as with Satyam or IL&FS, because seizing/freezing assets often hurts depositors and creditors. A bureaucratic process as with the Punjab & Maharashtra Co-operative bank is likely to result in yet another zombie bank, burning depositors’ money just to stay alive.

The Committee’s focus should be on cash flows, modelling cash flows and their timing, not just the present value of discounted flows, or other extraneous emotional, political, or judicial/administrative reasons. Employment is a legitimate consideration, but has to be sustainable, with timely cash generation. Else, other sources of timely cash support must be arranged, because without sustained cash flows, no gambit or subsidy can succeed (and maintaining unproductive employment will not be possible). Some fixes need major legislative changes to policies.

BSNL & MTNL

On BSNL and MTNL, a recent article sets the context and explains why the revival plan is unrealistic.3 In short, these poorly supported and much-abused enterprises have so much debt that earnings before interest, taxation, depreciation and amortisation would have to be at least 35 per cent. Governments have used them as market spoilers as with Air India, precipitating unsustainable price wars that gutted the industry.

An alternative is to downsize, re-skill as needed, and retain the public sector entities (as one or both) in the role of security-and-public-interest-anchors in infrastructure consortiums. These must be run by the private sector (and in strategic areas, by defence). This will facilitate policies such as assigning spectrum for payment on usage without auctions, and extending Wi-Fi to 60 GHz and 6 GHz (details at: https://organizing-india.blogspot.com/2019/10/extend-tax-cut-logic-to-infrastructure.html, and https://organizing-india.blogspot.com/2018/11/a-great-start-on-wi-fi-reforms.html).

Weak Financial Systems

The Committee needs to apprehend and convey the need to strengthen financial institutions. Financial systems provide second-order infrastructure for productive activity and wellbeing. They need an adequate underlay of first-order, basic infrastructure, comprising communications, energy, water, waste, sewerage, and transport, leaving aside housing and the basics of security, and law and order. While most of us take these for granted, there should be no doubt about how critical these attributes are, and that they are being eroded and increasingly at risk because of social disorder and economic inadequacies. In addition, basic health care and education are essential adjuncts for the supply of trainable people to operate these sectors.

Until some years ago, despite weak infrastructure, financial systems were among India’s real strengths, although eroded periodically by disruptions resulting in NPAs. However, there was strength in the professional capacity of this sector that held up in spite of the pressures. Over time, these institutions have been severely degraded, through laxity, complicity, pressures for evergreening, the abrupt imposition of credit quality and NPAs, the extent of frauds because of lax or complicit supervision and the reputational damage, the buffeting from demonetisation and pressures to cross-sell products such as insurance. Governments need to understand this and support building professionalism, avoiding melas and waivers.

The scope of the Committee could be expanded to set the objectives of telecom and digitisation in the interests of governance, industry, and users, and to outline next steps. They could consider the experience of China and others such as Sweden for this vast effort, while addressing linkages and NPA issues. Perhaps, they could be exemplars by setting the tone for a national approach that is not departmental and becomes bipartisan, and helps to move away from our abrasive, confrontational politics that leads to deadlocks.

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Shyam dot Ponappa at gmail dot com

1: Becky P.Y. Loo, October 2004: https://www.researchgate.net/publication/227426547_Telecommunications_reforms_in_China_Towards_an_analytical_framework

2: Debashis Basu, October 27, 2019: https://www.business-standard.com/article/opinion/how-to-fix-the-pmc-bank-crisis-119101400006_1.html October 13, 2019: https://www.business-standard.com/article/opinion/lessons-from-pmc-why-govt-is-responsible-for-co-operative-bank-crises-119102700620_1.html

3: Rahul Khullar, October 31, 2019: https://www.business-standard.com/article/opinion/don-t-bet-on-bsnl-mtnl-s-revival-119103100040_1.html

Delayed Cash Flows and NPAs

We need to rid ourselves of a tolerance of delayed payments to avoid their consequences.

Shyam Ponappa   |   April 4, 2019

Many of us in India become inured to a laxity in standards and to the implementation of laws. There may be good reasons for targeting one of these for a start, and that is delayed payments. These are broadly tolerated by citizens, farmers, corporates, small businesses, and government agencies. Perhaps this is because payment delays are merely one among several instances we encounter of mediocre standards, indifferent quality, or shoddy performance. Delayed payments are the inception of process flow problems that lead to non-performing assets (NPAs). Perhaps delays in cash flows are a fundamental flaw in our processes that we need to fix as a root cause that drives much else, to begin to address a gamut of inadequacies.

To see why, consider delays in government payments. Central and state government payments are often delayed, apparently even more than in the private sector. Even government payments related to high priority IT systems, for instance, are notoriously delayed. Major IT companies complain of losing money on large projects for this reason. Nasscom estimated a couple of years ago that government dues to the IT industry could be more than Rs 5,000 crore.

Some factors that render domestic projects attractive to the IT industry are the large domestic IT market, projects of significant size from state and central governments, and slowing exports over the last several years. The disincentives, however, are lower margins, long lead times for government contracts, payment delays, and a history of disputed payments and litigation. Also, IT majors complain that government processes often don’t accommodate changes in the terms of contracts when there are changes in the scope of projects. This is why IT companies are averse to domestic government projects.

Quite apart from these opportunity costs, delayed payments create serious cash flow problems for the economy, with outstandings running typically for many months, and sometimes for years. While the instances above are about the IT industry, there are similar problems in other sectors as well. In the construction industry, for example, estimates of private contractors’ dues held up by delays including disputes range from Rs 1 trillion to Rs 3 trillion.

While some bank NPAs undoubtedly result from fraud and malfeasance (which are outside the scope of this article), disruptions in cash flows in commercially sound projects can result in the creation of NPAs. This aspect has to be addressed as a precursor to stressed assets in resolving NPAs, as is evident in considering the problems of power generating companies.

A Ministry of Power portal (http://www.praapti.in/) shows that overdue payments from electricity distributors to power generating companies at the end of January 2019 amounted to Rs 28,504 crore. Meanwhile, in the Supreme Court, 34 power generating companies with NPAs of Rs 1.4 trillion were battling an RBI Circular of February 12, 2018, that consigned their entire investment of double the NPA amount (Rs 3 trillion) to bankruptcy proceedings under the Insolvency and Bankruptcy Code (IBC). The reason was that their dues had not been resolved within the RBI-mandated 180 days by August 2018. The RBI insisted on bankruptcy as a time-bound consequence, regardless of the cause of default. By contrast, the Ministry of Power and the supplicants objected to the RBI Circular, attributing loan stress in several cases to factors beyond the borrowers’ control. These factors included reasons such as payment delays by state distributors, problems in the supply of coal, or in some cases, because consortiums of lenders were close to restructuring loans, whereas declaring bankruptcy would not resolve the underlying causes.  A number of bankers suggested that the 180-day rule for bankruptcy in the RBI Circular was impractical. Major banks consider restructuring as the appropriate solution when defaults are caused by factors outside the borrowers’ control, such as delayed payments from state electricity boards or by government agencies, state government overdues, or major adverse changes such as the unexpected imposition of duties by supplier countries on coal.

The Supreme Court quashed the RBI Circular of February 2018 on April 2, 2019. This will likely pave the way for more constructive outcomes for many of these projects, provided the RBI and the banks follow through with feasible restructuring. The alternative of selling stalled projects that were unworkable because of reasons such as there being no fuel supply or power purchase agreement, or overdue payments by customers (state or central agencies) were outstanding, if indeed buyers could be found, would hardly solve these problems. The projects would remain stalled or unproductive until the underlying inadequacies were made good, whether by providing fuel, power purchase agreements, collecting overdue payments, or enabling realistic tariffs to yield viable margins. Until these deficiencies are made good, the problems will remain.

Popular opinion, however, seems to favour “selling off bankrupt projects” regardless of extenuating circumstances, even when owners have no control over them, although selling them will not rectify the conditions that created the default. This approach of attempting to sell off projects to get rid of problems without addressing the underlying issues for otherwise sound projects is best abandoned. To be flip, it’s like an “Off with his head!” approach.

What’s needed

Standards for on-time payments are the real requirement, with penalties, e.g., double the SBI rate, enforced strictly for non-performance. Central and state governments need to take the lead on this as an essential aspect of governance. These difficult steps will be a real bear, but are necessary if we are to eliminate NPAs. Is this a realistic expectation? As realistic as it is to expect to eliminate the resulting NPAs.

The RBI will need to provide regulatory oversight, instituting real-time monitoring and reporting systems, and taking prompt action as necessary. Properly designed and deployed, such systems would prevent one form of ever-greening of loans at inception. Separate systems for loan renewals could be designed and deployed to prevent other aspects of ever-greening. These coordinated steps could prevent good assets from turning into NPAs.

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Shyam dot Ponappa at gmail dot com  

NPAs & Structural Issues

To fix one you need to fix the others.

Shyam Ponappa 

  | October 5, 2017

An aspect of financial services often overlooked is that they serve as second-order infrastructure, essential for commerce, industry, and daily living. A disruption in the financial sector slows everything by cutting productivity. Other reasons for decline, such as structural issues in power supply, telecom/broadband, and in farming, are accepted as part of the landscape. That is why devising corrective measures is not so simple. Setting aside political considerations, misattribution does not help in problem-solving. Resolution needs root causes to be identified and addressed. 

Consider the example of the guillotine approach to non-performing assets (NPAs). Imagine if an inspection of water and sanitation in your locality were to result in the shutting off of the water supply because conditions are deemed unsanitary. There would be a scramble for sourcing water, while economic activity and productivity would tank. What if it were a metropolis, or the whole country?

This is what happened with the abrupt change in booking NPAs. From around 2.5 per cent between 2006 until 2011, they began to rise in 2012 (see Chart 1). 

Chart 1: NPAs as a Percentage of Gross Advances

Source: RBI - dbie.rbi.org.in

Public sector banks in particular responded to the government’s accommodative efforts after the 2008 crisis. As growth fell, NPAs rose, especially for long-gestation, regulation-dependent infrastructure loans. In 2015, the Reserve Bank of India (RBI) adopted a hard line as the economy was gaining momentum after slumping in 2014 to 6 per cent. Earlier, the RBI was faulted for allowing the ever-greening of loans. An abrupt change without a gradual coming to terms to manage cash flows resulted in a crisis.

Leaving aside malpractice/fraud, NPAs resulted from factors such as aggressive, unsustainable lending, regulatory delays, the domestic and global slowdown, and commodity price shocks, as when export duties were imposed in Australia and Indonesia on coal. Cash flows drive demand, and a weak economy can make or break a business. 

Apart from crippling banking and financial services, the consequences of the NPA shock were enormous, especially for sectors such as iron and steel, construction, power, telecom, transport, and agriculture, with knock-on effects on MSMEs across sectors. Could a phased, more gradual, differentiated approach have yielded better results? Probably, just as when water supply fails, interim arrangements involving pipes, equipment and tankers have to be made to tide over the crisis.  For stressed loans, the requirements were for a differentiated approach to the category of wrongdoing, including overreach, and support for stressed sectors undergoing a downturn.   The need was and is to prevent disruption in cash flows from a systemic perspective, conserving employment and assets in untainted enterprises with the potential for recovery.  This also retains momentum and market sentiment to the extent possible.

Ways Out?

1. NPAs in the mid-90s were outrageously high. Yet, what followed especially after 2003 was high growth until the global financial crisis of 2008. The NPAs were reduced and ceased to be a problem (see Chart 1). One explanation is that banks did significant NPA provisioning from profits in bond trading, as interest rates on 10-year government bonds fell 8.1 per cent from 1997 to 2003. A booming economy from 2003 did the rest, although there were no changes in the underlying causes that led to the NPAs. Hence, bond trading could be a way out provided interest rates fall, and so could economic growth. 

2. Regarding interest rates, the dilemma is of high rates for domestic savings because people save with banks in India, and for foreign investors in bonds, against low rates for consumer demand and for capital investment. Given our acute need for growth and misaligned real interest rates, this needs rectification (see Chart 2). 

Chart 2: Real Interest Rates-India, China, Indonesia, Thailand , South Korea – August 2017

Source: https://www.bloomberg.com/news/articles/2017-08-02/india-s-real-interest-rates-compared-with-other-asia-economies

3. There’s a need to insulate banking from political influence, while ensuring rigorous procedures for evaluation and monitoring. Any system can be gamed, however, and to work well, players need competence, integrity, and the freedom to exercise both. Banks are not well suited for funding long-gestation infrastructure because their deposits are more short-term. This is an institutional and market deficiency that needs to be bridged through developing bond markets, and channeling long-duration funding from pensions and insurance.

4. There are compounding effects from imposing the Aadhaar/UID without the requisite connectivity, processes and safeguards, likewise the hasty imposition of the goods and service tax (GST). There is little doubt of benefits when properly applied, but that needs time and support for thorough implementation; meanwhile, the immediate need is for relief. Rescue measures are needed to lighten the burden of the GST and its reporting requirements on MSMEs (up to a higher ceiling?) over a long period. Interim solutions could be flat rates for a larger set, augmented by support for implementation.

5. Meanwhile, structural issues resulting in NPAs need to be fixed. Three obvious areas:

a) Farming, with its large population, small holdings, outmoded practices, low productivity, and the issues around pricing. Pricing is an essential aspect, as are direct benefits, for example, subsidies through cash transfers depending on income. But simply increasing farm prices addresses only one aspect of a multifaceted problem. What’s needed is to change the way production and marketing are organised. Practicable strategies are needed for produce, perhaps like the approach in dairy farming for milk production and marketing. Systems need be designed (worked out) and implemented properly, with design elements to promote and safeguard honest, competent, disciplined behaviour.

b) Telecom and broadband services need policies based on a complete change of mindset and market structure, such as shared networks and equipment including spectrum, protection from anti-competitive action, and revenue sharing instead of auctions.

c) Electricity supply: Power generation and distribution are both stressed by low economic activity, while many states continue with lax practices of under-recoveries for electioneering.This cannot be resolved as long as profligacy and indiscipline continue.

Fixing NPAs alone won’t do. Changes are required in key sectors for genuine resolution.1

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Shyam (no-space) Ponappa at gmail dot com 

1. “Indian Banks – Perception and Reality”, Ashima Goyal: www.epw.in
http://www.epw.in/system/files/pdf/2017_52/12/SA_LII_12_25032017_M_and_B_Ashima_Goyal.pdf

Bullet-Proofing the Balance Sheet - Interest Rates 4

          A strong balance sheet needs reasonable profits and, therefore, reasonable interest rates.


Shyam Ponappa  |  New Delhi  

October 3, 2013

Several analysts lauded the Reserve Bank of India (RBI) governor's announcements on interest rates on September 20. Others rued the lost opportunity to capitalise on sentiment, especially after his dramatic entry statement stopped the collapsing rupee and markets in their tracks with what seemed like a magical swish of his cape.

Is sentiment all that important? And are these merely differences in subjective perceptions, or are there objective reasons that explain these differences? Analysing this quote on easy money tapering may provide some answers: "We must use this time to create a bullet-proof national balance sheet and growth agenda...."

Reasonable profits are a prerequisite


How are balance sheets strengthened? Barring external events like third-party equity investments, strengthening happens through building assets of good quality, or reducing liabilities and debts. To do this, profits are essential from activities in the "P&L", or statement of profit and loss; these give rise to the flow through the balance sheet to the cash-flow statement. Only profits (up to a reasonable level) in the ordinary course can make the balance sheet strong - although there can be productivity gains from other means, such as speeding up receivables or reducing inventory/debt. Extraordinary gains from selling assets or intangibles could also help.

Our excess of imports over exports also makes us vulnerable. This is aggravated by events like the mining crisis, which lowered power generation and exports, while increasing coal imports. This is why the timing of cash movement is critical. When foreign investments slow, excess imports become unfunded, and the rupee weakens. Other off-balance sheet actions also strengthen or weaken our balance sheet position - for example, the currency swap with Japan expanded from $15 billion to $50 billion. Conversely, investments in unproductive assets that immobilise capital, like gold, worsen it.

The essential fact is that India is short of capital, and has to rely on foreign investment. This is why higher price-earnings (PE) multiples and investments by foreign institutional investors (FIIs) are preferable to a more conservative approach, and why we need more locally manufactured high-quality products.

The growth agenda


It is the central and state governments that have a great deal to do to remove obstacles to investing and functioning here, as spelt out by the Damodaran Committee recently (http://www.mca.gov.in/Ministry/annual_reports/DamodaranCommitteeReport.pdf). It will take much more than governments, however, because a major reason for our inability to act in concert is our fractious, adversarial approach that extends to corporate interests as much as to our politics.

There is one important aspect to which the RBI can make a real difference: perceptions and sentiment. It can lift sentiment and facilitate performance. Better returns are required for higher domestic investment. According to an RBI report, returns also have a positive influence on foreign institutional investment ("QE-II and FII inflows into India - Is there a Connection?", Anand Shankar: http://rbi.org.in/scripts/PublicationsView.aspx?id=13973).

In our circumstances, functioning below capacity with high interest rates (State Bank of India's prime lending rate is 14.55 per cent), lower interest rates can help close the output gap in the short term, although major structural changes have to be addressed for the medium and long term. Some opine that high inflation prevents this; others cite India's supposedly negative real rates. Consider these facts before reaching your conclusion:

• According to the RBI, real lending rates were positive over the last two decades, as shown in the graph.
   

• The RBI apparently didn't reduce the repo rate because the inflation based on the wholesale price index (WPI) rose to over six per cent in August. This happened because onion prices rose 244.6 per cent. Higher rates have not reduced food inflation so far, as the problems, mostly in vegetables, are supply-related. It couldn't possibly bring down onion prices or overall food inflation, but it destroyed positive sentiment. Instead, it would help if the RBI could be persuaded to act on inflation when it is appropriate, as in the case of interest-rate-fuelled asset bubbles. It could institute policy-driven, real-time sectoral dampers to deflate funds diversion and excessive speculation, and leave supply problems, as in the case of vegetables, to the government.
   
• After the rate increase, sectors like banking, real estate and automobiles fell sharply because of anticipated lower earnings. Bank securities holdings fell immediately, marked to market at lower prices.
   
• Some think that higher rates make bonds attractive to FIIs. Typically, if there's high uncertainty, FIIs don't look to emerging market bonds for returns, whereas they may consider this if they perceive less risk. In the last 12 months, FII bond holdings went down by Rs 18,000 crore, while holdings in equities increased by about Rs 1.48 lakh crore. There will be far higher investment in stocks if profits improve.

The opportunity: Our markets


India's economy is near a chasm because of a convergence. This convergence gave India a rising economic tide, and feeds the aspirations of an increasingly larger number of people. Together with this, demographics over the next decade will create the largest proportion of working-age population in India's history. To the extent that they can be educated, trained, absorbed and productively employed, India is likely to flourish. The alternative - if their potential is squandered through actions leading to economic stagnation and societal disorder - is simply unthinkable. We face an enormous threat which, if we get across successfully, will turn into a tremendous opportunity. Yet, large sections of the political leadership including of the ruling party, and of the press and media, seem oblivious of how close we are to real danger.

Our markets are also our greatest attraction, ranging from being large but potentially weak, if we do badly, to large and strong, if we do well. This is why investors put up with our obstacles; why Japan Inc, for instance, is struggling to replicate the success of Maruti-Suzuki. This is a strength that we can use to achieve more of our potential, with a judicious combination of governance, positive sentiment and monetary policy, instead of being bypassed as we are now.

shyam ponappa at gmail dot com

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The public can only wish banks would provide more credit and at lower rates; the RBI, however, can and must ensure that they do.

Shyam Ponappa / New Delhi May 7, 2009

Consider this:

a) In the fourth quarter of 2008-09, interest costs to companies were 41 per cent higher than for the same period in 2007-08. Prime lending rates were between 11.5 and 16.75 per cent, while inflation dropped considerably. This indicates how exorbitant lending rates have been. Corporate net profits were down to 11.7 per cent of revenues for the quarter, compared with 12.7 per cent for the previous year. Imagine what those fourth quarter profits could have been if loan rates were 4 to 5 percentage points lower, ie, at least a third less, with the concomitant effects on demand and revenues.

b) Credit growth slowed from 23 per cent in the third quarter to 17 per cent in the fourth quarter.

c) Small and Medium Enterprises pay interest at an unsustainable rate of 16 per cent. Banks play out this vicious downward spiral by withholding loans, or lending at higher rates to ‘compensate for higher risk’. A totally fallacious rationale: Higher rates do not reduce risk, they increase it; all they do is provide higher compensation for the exposure (ie, they pay more but the risk remains unchanged).

d) The IMF said in April: “Policy rates remain high in real terms in India, and further rate cuts would help bolster credit growth.”*

e) While anecdotal evidence suggests slowing investments, the CMIE reports a steady rise. However, CMIE’s conclusion is based on only two-thirds of investments citing no data available on the rest, so it is possible that fully one-third comprising 40 per cent of projects have been shelved.** This is the opportunity cost — the one-third-empty glass missed out — as is the difference between potential and realised GDP growth (ie, between 5 and 9 per cent).

It’s a simple matter of numbers. Surely the RBI knows this, as also that the proportion of term deposits has been growing in public sector banks, increasing lending costs. The RBI must be aware that reduced cash reserves lower average lending costs, as also of its charter to ensure the availability of credit for economic growth.*** Let’s see if we have it right, spelling it all out:

The Problem

Despite the cuts in the CRR and the apparent excess liquidity evidenced by large bank deposits with the RBI (up to Rs 1,50,000 crore a day at the reverse-repo rate), the problem is that banks continue to be wary of lending. The reasons for this, apart from their being stung by the financial crisis, are that:

Demand has fallen, thereby reducing project/enterprise revenues, and Some costs — particularly the cost of money — are staying high. Therefore, when banks do lend, the interest rates are very high. As a result, demand is constrained, while growth in sales and profits is also declining. The solution: Policy Rate Cuts→Bank Rate Cuts→Higher Demand + Better Project Economics→Higher Production + Profits The logic is as shown in the header. The RBI apparently thinks it has taken adequate policy measures. However, if we accept that India’s growth potential is 8-9 per cent as in recent years (or higher than at present), there should be no doubt about the need for higher growth, and further steps to achieve this. Higher growth also provides more employment. If production and profits grow faster, so does the economy. Sectors like construction, engineering, and services, including travel and leisure services, can provide considerable employment opportunities to capitalise on India’s demographics. (A separate and orthogonal issue is the need for education-and-training initiatives to build the skills of the employment pool, as also to improve work processes and practices. We can only hope this will happen when a government provides direct subsidies to end-users, and the money saved from the PDS and other misguided schemes can be channelled to effective education and training. However, that is unrelated to the pressing need for credit at low interest rates.) For both employment and growth, the RBI must act quickly. There is no use pontificating about poor monetary transmission when the actions taken are inadequate, like the recent 0.25 per cent cuts in the repo and reverse-repo. Talk about reducing India’s policy rate to zero is also irrelevant, diverting attention from the fact that policy rates can be cut significantly and still not be near zero. Banks’ cost of funds: The CRR and savings rate In the last several months, public sector banks experienced a surge in deposits with higher growth in term deposits. This has added to the problem of deposits taken in a higher interest rate environment. Meanwhile, many private banks have lost their cheaper savings deposits. This makes it all the more necessary to cut the CRR further. Why? Because when the CRR is cut, loanable funds increase without any increase in costs. In other words, the average cost of funds is reduced, because the same costs are spread over a larger amount of loanable funds. Banks might still park these additional funds with the RBI or in government bonds, unless constrained to do otherwise by a lower reverse-repo rate and limits on investment. Action is also needed to improve project economics for sound activities by (a) reducing interest costs to enterprises, and (b) increasing their revenues by providing cheaper finance to increase demand. In addition, initiatives are needed — eg, to revive construction — so that stalled projects start moving again. Equally, the RBI needs to devise disincentives to discourage excess investment in government bonds. Finally, the savings rate needs to be lowered in line with lower lending rates. It is necessary for sustained growth and employment to achieve a lower interest rate environment. The gains from a 3 to 4 per cent increase in the GDP would greatly outweigh small depositors’ notional loss from a reduction in interest income. This is why the RBI needs to take immediate action on these issues. shyamponappa@gmail.com * ‘IMF: interest rates remain high in real terms in India’, Reuters, Apr 22, 2009: http://in.reuters.com/article/businessNews/idINIndia-39188420090422 ** BS April 27, 2009: http://www.business-standard.com/india/news/mahesh-vyas-investment-story%5Cs-still-alive/356308/ *** Banking Regulation Act, 1949, includes ‘sound economic growth’ among the RBI’s responsibilities in banking policy: http://www.legalhelpindia.com/bareacts/BANKING%20REGULATION%20ACT%201949.doc