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

An Infrastructure Road Map

What should and should not be done by a new government in this crucial sector

Shyam Ponappa  | May 1

, 2014

Let's hope a newly elected government has the coherence and leadership to begin to deal right away with the mess in infrastructure, learning from what has gone wrong before. There are problems galore with our infrastructure, but a couple of examples stand out for what to look out for and avoid in future initiatives. There's little doubt that we must improve our approach to projects and undertakings in terms of functionality and efficiency, and that digital infrastructure is a key requirement.

While this article is on prioritising digital infrastructure, let us not underestimate the problems of deficient infrastructure. For sustained high growth, equally critical needs relating to power and logistics, with its interdependent linkages between transportation - by road, rail, air and water, and the associated holding/staging areas of terminals, airports and ports - need to be addressed with organisation and capital for capacity and de-bottlenecking.

One example is the multiplicity of schemes to register individuals, including the Unique Identification (UID) orAadhaar scheme, the National Population Register (NPR), the multipurpose national identity card, the voter identification card, and so on.1 Another example is the National Optical Fibre Network (NOFN) by Bharat Broadband Network Limited (BBNL). Accepting for the moment that these projects are well intentioned, there seem to be flaws right from the design stage, and on through execution. While the fallout from past errors has to be dealt with, it's most important to avoid these mistakes in fresh initiatives.

The UID and NPR projects apparently began without sufficient care in defining their purposes; they did not mesh seamlessly with each other and with other objectives and processes. This disjunction has carried through in implementing their design and execution.²

The NOFN aims to extend a countrywide network on the foundation of the existing fibre networks of state-owned entities Bharat Sanchar Nigam Limited (BSNL), RailTel and PowerGrid. This was to link over 245,000 village panchayats by the end of 2013, but is still undergoing limited trials. Given its magnitude, this requires vast capital investment that is unrelated to likely revenue generation in the short run. This critical infrastructure project is apparently behind time and over budget despite its reduced scope.3 That said, such monumental undertakings and changes can't be expected to go like clockwork, and the considerable efforts being made should eventually contribute to positive outcomes. For instance, a Confederation of Indian Industry report prepared with the help of KPMG in 2013 outlines possible business models and ecosystems in four areas, namely, education, health care, banking and agriculture.4 It's just that a thorough, comprehensive approach from the outset would be most beneficial.

In hindsight, what's lacking in both instances is proper organisation and co-ordination, the discipline of sound project management; and this is a missing piece in most areas of deficiency in governance, including infrastructure development. While a great deal of opprobrium is directed at corruption, there's little focus on these disciplines related to competent design, execution and delivery. Both depend on digital infrastructure. This is where real efforts must be focused to fix things, quite apart from dealing with corruption.

The "plumbing" of hardware, software, communications lines, and systems that enables effective use of information and communications technology is a critical necessity for our economic growth and well-being. While a balanced availability of energy, transportation and water supply/sewerage is required, in the short run, it is ICT that is likely to yield the broadest overall benefits and economic returns through multiplier effects, provided the others come up to minimum requirements. According to the World Economic Forum's (WEF's) Global Information Technology Report 2014 issued last week, the top 10 countries embracing information technology are Finland, Singapore, Sweden, the Netherlands, Norway, Switzerland, the United States, Hong Kong, the United Kingdom, and South Korea, in that order. The report includes a "networked readiness index" that ranks countries based on an assessment of their digital infrastructure and ability to use information and communications technologies to grow, foster innovation, and improve the well-being of their citizens.

Between 2012 and 2014, India dropped in networked readiness from 69th to 83rd out of 144 countries. By comparison, China dropped from 51st to 62nd, and Brazil from 65th to 69th. The WEF report says that India continues on its declining trajectory - and, among other things, that despite competitive markets (24th) and the availability of the latest technologies (58th), its difficult business environment and lack of digital infrastructure (119th) reflect in deprivation in education, resulting in limiting the creation of a wide skill base (101st). Our information technology and business process management (IT-BPM) sector is still largely oriented to external markets. For the financial year 2014, export revenues are expected to have grown 13 per cent to $86 billion. This is almost five times domestic revenues, estimated to have grown at 10 per cent to Rs 1.15 lakh crore (just over $19 billion).

Clear, convergent objectives and task-oriented processes and systems are not really part of our culture or vocabulary, barring sectors oriented to external markets like IT-BPM, and some corporations and professionals. There are, of course, rare individuals who excel, such as the former head of Delhi Metro, E Sreedharan, who maintained his reputation from the Konkan Railway and before that, Indian Railways. But it's not as if getting it right is a foregone conclusion for countries with a far better record of good systems and high-quality delivery - as evidenced, for instance, by Germany's increasing problems after turning away from nuclear energy. So, the incoming government needs to focus on starting to do things right, and that is the best way to create opportunities that can make the most of our demographics, and the potential of our large and increasing markets. It must view any scheme as part of an integrated, overarching system, and apply itself from the very beginning with care and understanding to defining the aims, objectives, and detailed processes so that they mesh and converge with what else is there.

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                                                                    Shyam no-space Ponappa at gmail dot com

(1) An explanation of Aadhaar and NPR: http://egov.eletsonline.com/2012/04/there-is-actually-no-conflict-between-uid-and-npr/
(2) A discussion on systems aspects such as authentication and data security: "Do we need the Aadhaar scheme?", February 1, 2012, Business Standard (http://goo.gl/j3P5vf)
(3) "Reality check on the broadband dream", April 27, 2014, Business Standard(http://goo.gl/C9h4im)
(4) "Creating viable business models for inclusive growth through the National Optical Fibre Network": http://www.kpmg.com/IN/en/IssuesAndInsights/ArticlesPublications/Documents/KPMG_CII_Broadband_Report_Final.pdf

What's Needed Is User-Centric Design, Not Good Intentions

Designing goal-oriented, end-to-end integrated systems is critical to delivering what Indians need.

Shyam Ponappa / Jan 03, 2013

The inadequacy of essentials and conveniences around us results from a slack approach to both design and execution. We know we are deficient in execution, but we need to be more aware of deficiencies in approach and design. Good intentions, while important, cannot substitute for good systems design and execution.

Things That Work…

Simple aspects of everyday living that actually work in India can leave one wonderstruck. Like the daily newspapers, organised and delivered seamlessly, reasonably early in the day, almost regardless of where one lives provided it’s a city or town. Or the availability of milk, eggs, bread, vegetables, fruit, and whatever else for daily provisions. And this despite the supposed shortcomings of our logistics and organisation in the context of wholesale and retail markets. Some of the revolutions that we’ve lived through in the last two decades include the manifestation of such wonders, like the phenomenal and ubiquitous growth in the supply of dairy and poultry products.

On a different plane, as it were, are the changes in the quality of automobiles and the improvements in India’s roads, although patchy and considerably lagging. Likewise, there have been revolutions in mobile communications and in air travel, disregarding anomalies such as the horror of Mumbai airport on private airlines, with its incompetent cab mafia on arrival, and a disorganised and demeaning crush on departure, squeezing past crowded boarding gates. (This is the state of the commercial capital? Woe betide us — but I digress...) Another source of wonder is the performance of the Indian Railways. Much abused by exploitative politicians, given short shrift on everything from cleanliness and toilets to much else, overloaded by hapless passengers in desperate need of transportation. One can only marvel at these services.

…And Things That Don’t

And yet, there are debilitating areas that seem utterly intractable, like sanitation, water, power supply and communications services for data (apart from voice).

Comparing the state of sanitation or power with the railways, one might say the latter had the benefit of being set up as an integrated system since the 1850s, although deprived in recent times of systematic development and investment, and so reduced to decrepitude. By contrast, sanitation has been playing catch-up on our old, established society, behind the curve for hundreds of years, never having had the advantage of installation as ab initio systems. Open drains are an Indian feature, even in Delhi. A similar situation obtains in power supply, where the contradictions and inequities of piecemeal, encapsulated interventions that tried to address power generation first were followed by sporadic efforts to address transmission and distribution, with realpolitik all the while playing to the users’ self-indulgence of having it all without paying for it. This sense of entitlement without accountability has resulted in the vicious circle of “free power” that leads to no power, annihilating possibilities for improvement.

In communications services for data (broadband), we have a different kind of problem. For one, governments, citizens and activists don’t seem to get it that these services are as essential to infrastructure as energy and transportation. There is no logic to their exclusion, but it has taken the National Telecom Policy of 2012 (NTP-2012) to announce the objective that telecom is part of infrastructure, although the associated benefits, such as lower interest rates, are yet to follow.

User-Centric Systems

The malady with sectors such as power, communications and transport is that solutions seem to be designed without an integrated, end-to-end, goal-oriented perspective favouring users. For instance, otherwise successful initiatives like the Delhi Metro provide services from an islanded “product perspective” that is simply not user-centric in its orientation. This results in insufficient feeder buses, inadequate parking at the Metro stations, a gaggle of disorganised cycle-rickshaws at stations like Mayur Vihar, and so on. Instead of being an unadulterated blessing, a Metro station in the neighbourhood becomes a curse, because user needs are not treated as being central to the delivery of the service. Passengers are left floundering while people in the environs (like the denizens of Mayur Vihar) are left to fend for themselves. There is also the question of capacity and demand. Again, the “product perspective” results in overcrowding and other inconveniences. On the flip side, well-meaning though misguided critics attack attempts to build capacity in anticipation of demand, as was the Metro by proponents of a Bus Rapid Transit system pushing for the latter as a silver bullet instead of as an adjunct.

What Could Have Been, But Isn’t Yet

The Unique Identification Authority of India’s Aadhaar augured a potentially revolutionary electronic enabler. In practice, however, its design has been baffling. A brilliant concept – abstracting a smart identification number from a smart card – has been reduced to an identifier for cash transfers to bank accounts. The question is, why to bank accounts and not to transactions, whether for retail or for services, activated by a mobile phone? Kenya’s M-Pesa was the pioneer for mobile money transfer, subsequently enhanced to include interest earned on virtual accounts.* Introduced in India by ICICI Bank with Vodafone in November 2012 and State Bank of India in January 2013, not only would this be much more practicable as the majority of our population doesn’t have bank accounts, it would cost far less, while being much more convenient for users. It would obviate setting up millions of physical micro-accounts at relatively high cost at banks, as well as giving users proximate access to products and services.

Another puzzling aspect is the contradictory, sometimes changing signals about Aadhaar. It is supposedly voluntary, yet reportedly mandatory now for marriage registrations, yet not accepted by banks for account opening, nor by some mobile phone operators, nor for passport applications, nor for driver’s licences. And inexplicably, except as a ruse to garner votes from non-citizens, it is for all residents (who choose to apply?), and although it could include citizenship information, it doesn’t.

It is best to start out right, recognising that we need user-centric, end-to-end systems design and execution, and apply this approach across the board going forward.

shyam ponappa at gmail dot com

* http://blogs.ft.com/beyond-brics/2011/11/11/kenya-to-india-exporting-the-mobile-money-model   

http://www.indiainfoline.com/Markets/News/ICICI-Bank-and-Vodafone-India-announces-strategic-alliance-to-launch-m-pesa/5539284905