Is monetary policy action enough for Economic Growth?

We are now facing a situation where we face inflation outside our confortable bracket of 2-6% on one side and on the other hand the supply side of the country is unable to meet the required demand on account of the Covid pandemic. The headline inflation has breached the required range, from 2 to 6 per cent consumer price index (CPI)-based inflation, in seven of the last eight months. Ajay Shah says this in the Business Standard:

 

Monetary policy impacts the economy with a lag of about 12 to 18 months. Therefore, a simple reading of the inflation crisis from December 2019 to July 2020 would suggest that the policy rate was too low in the period from June to December 2018, that the MPC in those months failed to anticipate this surge in inflation in the future. The policy rate peaked at 7 per cent in September 2018 and then the rate cuts began: Perhaps this timing and the scale of the cuts were excessive.

 

The monetary policy committee (MPC) of the RBI is unable to increase interest rates to control inflation, as this would suck money out of the system and further adversely affect production dynamics. The lockdown has had an adverse impact upon supply chains causing shortages of many goods. Hence prices have risen to clear the imbalance between supply and demand. The easing of the lockdown that began from April 18 is now well underway and the supply situation, which eased in August, will ease further. By September, headline inflation is likely to be lower and MPC cannot act on such transient situations.

 

The MPC is also unable to cut rates as this would pump more money into the market thereby further increasing inflation. Hence the monetary policy is in effective in managing the economic situation and spur growth at this point and we need to look at other instruments available to enhance growth and supply.

 

The bottlenecks lie in financial policy. When banks are stressed, they are loath to borrow at low rates and lend into the economy. The growth of bank credit peaked (YoY) in December 2018, at about 15 per cent and has declined to near zero since then. With better banking regulation, banks would not have been in the difficult state they are in terms of increasing NPAs and would have been in a better frame of mind to lend.

 

Similarly, the bond market is picking up offerings from a few good corporates and others have been cut off from the bond market. Even though the de facto policy rate is at 3.23 per cent, there are very few takers for corporate bonds even with their higher returns. With better regulation a good bond market would have helped push cash into the economy to spur growth.

 

We require big-ticket institutional reform in financial regulation to strengthen Banks and NBFCs and the learning over the past few years would better inform this effort.

Fiscal policy is the use of government spending, taxation and transfer payments to influence aggregate demand. The Government of India announced a fiscal stimulus package to support the economy. The Committee for a responsible federal Budget has quoted IMF research which says that response packages that included both revenue and spending reforms lead to faster growth in 60 percent of the cases examined and were also more likely to spur growth than ones that changed only one or the other.

 

The IMF report notes that high public debt hampers economic growth by "increasing uncertainty over future taxation, crowding out private investment, and weakening a country's resilience to shocks"; therefore, deficit reduction should help to alleviate these effects.

 

In addition, the authors find that budget-neutral reforms – for example, lowering tax rates while broadening the tax base – can also help to promote economic growth by improving incentives to work, encouraging investment, increasing human capital, and encouraging innovation. The authors' preferred methods for offsetting deficit-increasing measures include eliminating tax exemptions and preferential tax rates for certain types of income, shifting from direct taxes to indirect and property taxes, introducing environmental taxes to price negative externalities, and better targeting spending programs to those with the greatest need.

 

The study also found that the type of reform enacted affected the probability that it would accelerate growth. In particular, reforms to personal income taxes, health spending, and social security contributions were most likely to lead to growth acceleration while reforms to property taxes or capital spending had a low probability of doing so. In addition, the inclusion of fiscal measures in a package with other complementary reforms (such as deregulation) and social dialogue with relevant stakeholders was found to increase the likelihood of success.

 

Fiscal stimulus packages will fail to deliver desired results if not designed properly and if attention is not paid to necessary additional reform measures required to be taken. Growth seems to be possible only when monetary policy and fiscal policy measures are taken.

Why no Interest rate change in August 2020

 In the early August meeting the MPC of RBI decided to keep interest rates unchanged. Some expected the RBI to cut the repo rate (the interest rate that the RBI charges Banks borrow from it) as growth was falling and going negative. Due to Covid-19 disruption many predictors expect the economy to contract by as much as 10 per cent in the current financial year. Other expect that repo rate will be increased or maintained to control inflation (>6%). Finally, after three days of discussion, RBI’s MPC unanimously chose to maintain the status quo on the repo rate.

 

In a growing economy, incomes go up and people have more money to spend, meaning more money chasing same number of goods, as supply is unaffected initially. This increased demand for goods increases their prices, which is inflation. Reducing money available and spent by public can control inflation. Increasing interest rates causes people to save rather than spend, thus reducing money available in the market and hence leading to reduced demand. This prevents increase in prices.

 

When growth contracts, then people’s incomes also get hit, resulting in less and less money is chasing the same quantity of goods. This results in either the inflation rate decelerating or it actually contracting. In such situations, reduction in interests rate reduces desire to save and people spend more in the market, which boost economics activity. As more and more money comes into the market, growth and inflation get boosted.

 

Presently, GDP of the country is contracting due to the covid19 pandemic even while inflation is higher than 6%, the limit within which MPC of RBI is mandated to keep inflation within. This is happening because the pandemic has reduced demand, on the one hand, and disrupted supply on the other. As a result, we see falling growth and rising inflation. It is necessary to raise interest rate at this stage to cap inflation, which would however have a deleterious effect on India’s GDP growth.

Monetary policy and Growth

 Has the monetary policy committee (MPC) of the Reserve Bank of India (RBI) been able to deliver on its objective of keeping frontline inflation of the country under check? Has it been successful in spurring growth while keeping inflation under check? Has it been able to broad-base inflation targeting mechanisms (Given the fact that three members of the MPC are nominated by the Government of India (GoI), who, we may safely assume, would ensure protection of interests of GoI)?

 

Udit Misra of Indian Express attempts to answer some of these questions.

 

 

The first meeting of the MPC in October 2016 delivered a cut in the repo rate by a unanimous decision. It gave hopes of lessened friction between GoI and RBI and both operating in sync. Within a month GoI announced the demonetization of 86% of all currency in a bid to curb black money in the economy. From then on the growth rate of the economy constantly fell due to a series of events: demonetization, the Seventh Pay Commission award (which increased fiscal constraints) and the difficulties in implementation of the Goods and Services Tax (GST). These factors made it difficult to cut rates even though the economic growth started falling.

 

In the October 2017 policy, the MPC stated: “The implementation of the GST so far also appears to have had an adverse impact, rendering prospects for the manufacturing sector uncertain in the short term. This may further delay the revival of investment activity, which is already hampered by stressed balance sheets of banks and corporates”.

 

Again in April 2018, MPC stated: “(GST) implementation had an adverse, even if transient, effect on urban consumption through loss of output and employment in the labor-intensive unorganized sector”.

 

Even though the country’s economic growth was fast losing steam during 2017 and 2018 the MPC was unable to cut interest rates because there were growing fiscal pressures in the form of farm loan waivers, increasing crude oil prices etc. Between February 2019 and May 2020, though the MPC has cut the repo rate by 250 basis points (or 2.5 percentage points), there was no positive impact on the growth rate.

 

For a body that was supposed to solely target retail inflation and keep it at 4% (+/— 2%), the MPC saw retail inflation staying above the 6% mark on all months since December last year (barring March 2020 when it was lower by a whisker). What is worse, the MPC has no clear understanding of how inflation will pan out. It is not clear whether Covid-19 disruption will be inflationary, disinflationary or, even deflationary.

 

On the growth front, the picture is even worse. India is staring at a historic contraction of GDP. Almost all other factors one can consider are also in very bad shape — and not just because of Covid alone.

 

The question that arises is whether monetary policy is effective at all in spurring economic growth. If a 2.5% reduction in repo rate was unsuccessful in, where is the need tom use it as an instrument of spurring growth? We might be better of limiting repo rate cuts as instruments of inflation management. When the fiscal space is overstretched and when its flexibility is near non-existent, monetary policy action alone seems ineffective in moving up growth.

 

 

Trade and Globalisation: Whom does it Benefit

 Praveen Singh has a very thought provoking piece on trade in ‘The India Forum’.

 

He points out that trade theory suppresses the variations and complexities of real life to produce an unsustainable myth of ‘Trade is Good’. Such theories have produced global inequalities and tensions, apart from ecological damage.

 

Most economics concepts like market, trade etc. are introduced using simplified models of two people exchanging two commodities, or two countries producing and exchanging two commodities, or production requiring only labour and capital. These models are easy to understand and they appeal very much. Complex econometric models are also used to back up claims of the benefits of trade. However, they suffer from the same difficulties that result when important parameters are not factored into the understanding of an issue. In many cases, parameters that might not carry importance today turn out to be very essential and break the theory. In such cases of breakdown of theory, it is people with least resources that are affected the most. When manufacturing was outsourced from the US to China, middle class American jobs vanished. Under proper circumstances, people who get laid off might be retrained and re-employed.

This idea has difficulties like the kind of alternate employment that is possible, whether the previously enjoyed quality of life is still available to workers after re-employment, whether they can absorb the new thoughts and knowledge, the time it would take before equilibrium is restored, the cost of suffering in the interregnum, whether there is a structured mechanism to take care of such transition etc. In most cases, these displaced people are left to fend for themselves and suffer loss of income and dignity.

Trade theory might have temporarily given us ‘cheaper goods’, but it is the terms of this trade which are also clearly the reason for the US-China conflict today, which is fast sucking other countries into a potentially dangerous global conflagration.

 

Competitive-advantage based production and trade does not guarantee that all nations or all people impacted involved in this kind of a regime would necessarily gain from it. For many nations, the costs could far outweigh the benefits. This impact of trade is discussed:

In this light, the case of trade in economic theory is particularly contextual today. Trade theory tells us that everybody gains by trading more. The reality on the ground, however, is very different. A liberalized regime of lower import tariffs and of easy mobility of capital over the last four decades has led to manufacturing being concentrated in lower wage countries. The rich countries have lost jobs by the millions, especially of less skilled workers. The dream of working hard and moving into the middle class of society has consequently sputtered and died in these countries. It is the corresponding frustrations and misery of large sections of people in these countries that has led to the rise of Donald Trump and other such politicians. These politicians have tapped on to the real frustrations and misery of people, and touted ‘others’, often immigrants or vulnerable minorities, as the cause of the problem. Riding on this emotional frenzy, they have come to power. Trade theory might have temporarily given us ‘cheaper goods’, but it is the terms of this trade which are also clearly the reason for the US-China conflict today, which is fast sucking other countries into a potentially dangerous global conflagration.

When we are able to buy goods from another person/entity at lower cost than if we were to produce the same, it makes a perfect case for trade. This is the ‘absolute advantage’ aspect. This can be extrapolated to countries too.

The justification for trade has been taken further under the ‘comparative advantage’ theory. It is explained:

Even if England produces both wine and cloth cheaper than Portugal, if the ratio of per unit cost of production of these two products in each country is different, there is room for each country to specialise in the production of that good which it produces comparatively cheaper. It can then trade that good for the other. The theory tells us that as a result of this specialisation, the same resources would end up cumulatively producing more wine and cloth in the two countries. In other words, the total production of the two countries would go up. This is the famous ‘comparative advantage’ theory of David Ricardo, which the Nobel laureate Paul Samuelson, the author of the well-known and ubiquitous economics textbook, once claimed as the most elegant and non-intuitive result in economic theory.

The textbooks also tell us that while additional output would be produced, how it would be shared amongst the two countries depends on the bargaining power of the two countries, but that both would be better off after trade. Understandably so: if either country were to be worse off than before, it could just go back to its original (autarkic) production pattern.

Though several relevant aspects are not accounted for in this theory, the proposition of ‘comparative advantage’ makes the case for trade almost omnipresent. Some important aspects neglected include the ecological cost and externalisation of production, the impact of people who are displaced as a result of cheaper foreign goods entering the country, the iniquitous sharing of wealth created out of trading, consigning some countries to be producers of cheap raw materials (a kind of colonisation) etc.

 

It appears that some countries are advantaged due to trade. Or the rich in some countries benefit.

The real source of competitive advantage of nations, especially for developing countries like India vying for foreign capital, is now based on lower labour costs, poor environmental legislation, lower taxation and other such subsidies. Further, manufacturing keeps moving to the country which provides the lowest cost of production at the cost of its citizens and environment. This is a race to the bottom for poor countries.

 

This appears to be situation where disturbances in society are very likely and existing orders and theories would be overthrown.

Financial Stability: Viral Acharya

 The blog ‘Mostly Economics’ has a good review of the book on financial stability by Viral Acharya, Former Deputy Governor of RBI. I have reproduced some portions here as I see them to be very relevant today.

YV Reddy’s Foreword is a useful addition.

Coming to the book, one of its highlights is the Foreword by Dr. Y.V. Reddy who starts with a quote from Dr. B.R Ambedkar. Ambedkar in the Constituent Assembly (1949) had warned that if the Parliament does not make a law to limit the borrowing of the executive now, it is highly unlikely that any future Parliament will make any such law! Ambedkar had foresight on many political and economic matters and one could add fiscal accountability to the list as well.

Ambedkar’s words also preempted another economics principle of time inconsistency. Time inconsistency implies that if the government promises something in future, there are chances that it reneges on the promise when that future comes. For e.g. the central bank might promise that it will achieve lower inflation in future but enact policies which lead to higher inflation. Thus, central banks have to be bound by a rule-based policy such as monetary targeting, inflation targeting and so on. This is similar to what Ambedkar said years ago that if policymakers do not make a law to control their borrowing they are unlikely to make such a law in future.

The sagacity of Ambedkar seventy years ago shows him to be a visionary in terms of governance and economic matters. Very few leaders of the time could think so far into the future.

Today, the Union Government as well as all state governments are borrowing far beyond what the FRBM allows. This extra borrowing is on the books of the PSUs of the government and do not show up on the accounts of the State Governments. The issue is compounded by the fact that the purpose for which the PSUs borrow is in most cases not met and States arrogate money to themselves and use it for different purposes. Any Private sector entity indulging in such diversion would immediately be liable under various laws of the country.

YV Reddy believes that lack of Fiscal prudence is leading to financial instability.

The question is why YV Reddy quotes Ambedkar to bring home the point of fiscal stability when the book is on financial stability? Well, the answer is Acharya’s premise is that our fiscal imbalances are weighing on everything including financial stability. Reddy points how post bank-nationalisation, public sector banks were forced to buy government bonds at pre-fixed interest rates to support high government borrowing. Post 1991 reforms, the practice continued even when government bonds were auctioned on account of high SLR. The story is not very different for State Governments whose bonds were also pushed on public sector banks.

 

COVID Data Sharing and Impact on Patient Care

  Lambert Strether says that the missing piece in data interchange between disparate health care systems is a standard (and easily expansible) data schema, provided for the first time by the move to HHS. Necessary, but insufficient!

 

After terrorists slammed a plane into the Pentagon on 9/11, ambulances rushed scores of the injured to community hospitals, but only three of the patients were taken to specialized trauma wards. The reason: The hospitals and ambulances had no real-time information-sharing system. Nineteen years later, there is still no national data network that enables the health system to respond effectively to disasters and disease outbreaks. Many doctors and nurses must fill out paper forms on COVID-19 cases and available beds and fax them to public health agencies, causing critical delays in care and hampering the effort to track and block the spread of the coronavirus.

 

The Covid situation in India equally chaotic, if not more. Chaos reins on many fronts: People don’t know when they have contracted the disease, How to get a test done, when to home quarantine, when should they transition to Hospital care, Protocols to be followed by Doctors at different stages of the disease, Protocols after the virus disappears from the body but the aftereffects still persist etc.

 

As a country, we need to increase consistency and accountability in the heath system. Protocols for treating different diseases and different conditions need to be worked out and made available to prevent errors in treating patients. Such uniformity requires a good data system. We need to be thinking long and hard about making improvements in the data-reporting system so the response to the next epidemic is a little less painful. The present data system in the country is fragmented to the extent of being unusable and which cannot be analyzed for future learning.

 

We need to firstly frame the rules of data reporting and informing the medical profession (This can be sensitive and needs vetting). Secondly, the necessary hardware and reporting systems to electronically receive data also need to be put in place. Most importantly, this data needs constant analysis to provide useful information to improve healthcare.

 

Information presently available included details of Covid cases, their geographical distribution and progress of patients, but doesn’t include data on the availability of hospital beds, intensive care units or supplies needed for a seamless pandemic response.

 

Though the Central and State Governments have made some data sharing efforts, no comparable effort has emerged to build an effective system for quickly moving information on infectious disease from providers to public health agencies.

Trade Receivables Discounting System: Why is it important

This piece appeared as an editorial opinion in the print edition of The Economic Times. The online version can be accessed here.

Most central public sector undertakings are reportedly absent on Trade Receivables Discounting System (TReDS), an online factoring platform that connects buyers, suppliers and financiers. This is unacceptable. The government must make all its arms and all public enterprises join TReDS to ease working capital shortage of micro, small and medium enterprises (MSMEs). Non-compliance should be made an offence, with the liability pegged on the CEO and the members of the board.

Views on this appear very strong and they are not without sufficient cause. Most MSMEs suffer on account of lack of adequate working capital. They seem to be perennially short of working capital as larger entities make them supply for credit and also do not pay them in time. Being at the lower end of the system, they do not have adequate bargaining power and there and cannot dictate terms. The larger players in the market determine market access and hence have control over cash flows of their supplier MSMEs.

Around 10,000 MSMEs and 1,300 buyers (with a turnover of over Rs 500 crore) are now registered on TReDS. The total value of bills discounted (read: dues settled over the platform) is estimated at around Rs 23,000 Crore. The volumes must rise, given that TReDS improves liquidity in the entire chain. A vendor just needs to upload to TReDS the invoice, which shows the sale of goods and services by the MSME to the buyer. The buyer authenticates the invoice.

 

The financial intermediary brings cash into the transaction depending on the credit worthiness of the buyer. Buyers need to complete due diligence with their banks or financial intermediaries in advance.

Multiple financiers bid to take over the receivable from the supplier, the interest rate reflecting the creditworthiness of the large company on which the invoice has been raised, rather than that of the smaller supplier. The settlement file shows how much a financier has to pay an MSME seller and how much a buyer owes the financier on a particular date and time, bringing in credit discipline.

Most large companies use their large market presence to deny timely payment to their vendors. A mandatory TReDS arrangement takes away the power of larger buyers and prevents bullying of MSMEs.

Delayed payments happen in the case of Governments as well State owned enterprises and hence they need to be essential participants in TReDS. These entities are even more difficult to deal with than large Private sector players. There is no reason why government departments such as the NHAI, Railways, CPSEs and SPSEs large buyers from MSMEs with hefty outstanding payments, should not be part of TReDS.

What kind of 'Growth' does the Country need?

Gulzar has a presented a short summary of the structural issues with the Indian Economy here. This is what he says on the topic.

 

we had highlighted India's chronic human, financial, physical, and institutional capital deficiencies which holds the country back from realising sustained high growth rates.

 

In other words, in all these three, Indian economy has made little progress since 2007-08. In fact, it is clear that it did not recover from the crisis. The subsequent growth was not built on any sustainable foundation. In contrast, the growth spurt till 2007-08 appears to have been built on some solid financial capital foundations. A structural break appears to have occurred at the turn of the millennium, which moved the country into a high potential growth trajectory. The reforms undertaken by the government in 1999-2004 are an under-appreciated factor. 

 

We have not been able to reach economic growth as seen in 2007-08. Lack of adequate reforms is the stated reason by many political commentators. Things have been made worse for the country by the downturn in the global economy.

 

The question is, what should have been done to spur growth? Would the economy have responded to these reform moves in the desired manner? Would the costs of such reform be adequately compensated by the ‘gains’, assuming that they were realized? Why do we speak of big-ticket reforms only? The assumption is that such big-ticket reforms, whose benefits would flow to large corporates directly, are beneficial to the country as the topline grows? Why is that we do not discuss distributive aspects of economic growth in the same breath? Why is that we do not see any discussion on how to foster growth of our MSMEs? Why are we not speaking of improving ease of doing business as more important to promoting Indian industry and businesses? Why are we only focused on country level issues and not about numerous hurdles to economic activity at local level? Why are we bothered only about growth and not about the gini coefficient? Is it ok to sacrifice the country’s businesses and the country’s poor at the altar of so-called structural reforms, which seem to be far removed from most businesses in India.

 

Are the banks there to serve the rich and already existing businesses? Why is it that Banks we see regularly run into issues of NPAs? Why do Banks participate in Evergreening of bad loans given to the rich till such a time that they beyond redemption? Why is it that Banks throw the book at small businesses while they lend egregious amounts to the super-rich from whom they are unable to recover?

 

Many economic thinker and policy makers want to tell us that the country and we will benefit very much if large structural reforms to invite FDI are taken up? I am unable to see a direct link between the so called reforms in FDI and the growth in economy. Have interested parties made concurrent occurrence of reforms and growth appear to be correlation in order to push more of the same?

 

Why are we prioritizing growth? Growth does not seem to affect most of the country’s population beneficially. Only a patriotic feeling that the country is ‘Developing’ makes us happy with ‘growth’. We see a lot of protectionist barriers come up in the Developed world. We need to look at growth which affects a good number of our countrymen positively. Don’t we need to talk to Indian businesses, small and big to see what they need in order to do better and be competitive in the world?

 

I feel we need to redefine what we hope to achieve in terms of economic growth including its distributive aspects. Fundamentally, we should make it easy for our businesses to function with the protection of rule of law to meet these agreed objectives. I say this, as large investments have rarely increased employment opportunities proportionately. We cannot hope the people would find something to do and do little about it. All planning should prominently include elements of how people would be affected and should be less focused on some topline number.  

Tax Payers' Charter: Will it Deliver

Here is the full text of the Taxpayers’ charter released by the Hon Prime Minister on 12 August 2020. Does it make things better for the Taxpayer? For Tax Administration in the country?

 

Through the charter, the department is now committed to treating taxpayers as honest; providing complete and accurate information; giving a fair and just system; and, among other things, reducing compliance cost. The objectives are laudable and like most policy averments are idealistic. It would, however, be important for the department to ensure that these commitments don’t remain only on paper.

 

There are opinions that the new charter is less specific and more like a statement of good intentions. People hope that this would be followed up with concrete timelines to be followed by officials in delivering services. Even though the charter is to form part of the Income Tax Act, it does not give scope for justiciabillity as all the provisions are statements of intention.

 

The potential of the charter to beneficially influence Tax administration would depend on the success of similar reforms taken up by the Government. For example, the I-T Department had rolled out the faceless e-assessment scheme in October last year. The Department selects accounts for assessment based on criteria selected to ensure that only complicated cases, where potential for evasion is high, are selected. Communication to the taxpayer goes from the National e-Assessment Centre (NeAC) in New Delhi. The NeAC randomly allots cases to different assessment units. These assessment units do not correspond to the taxpayer directly, which eliminates physical interface between an assessing officer and a taxpayer. Faceless e-assessment has eliminated territorial jurisdiction and substituted individual discretion, thereby increasing transparency.

 

While faceless assessment is good, there would be challenges in terms of the appropriate explanation that were needed to be understood by the person assessing the tax liability. The system would need some time to stabilize and would be very useful in the long run to enhance a transparent system. However, a large number of tax officials are reported to have already started pushing back against the new faceless programme because they see problems in the lack of consultation and inadequate resources.

 

If teething troubles are left unaddressed, it might erode confidence in the new system. Hence, ownership at the highest level is very important for the system to fulfill its promise of transparence and ease of living, which the Finance Ministers hopes for by all such measures. Tax consultants and practitioners hope that government walks the talk on implementation and does not burden assessees with arbitrary assessment and harassment. Bureaucracy is likely to err on the side of caution and levy higher taxes in all such cases. The experiment should hopefully not remain just a pilot.

New Education Policy 2020: Rationalization of schools

 

The Business standard has a discussion here on the New Education Policy, 2020 (NEP20). They point out that:

 

The NEP 2020 promotes “rationalization” of schools, citing facts like these: 15 per cent of upper primary schools in India have less than 30 children attending. But students, especially after Class 8, need to travel long distances to attend school/college even now (chart 2). Reducing the number of schools may put children further apart.

 

The National Statistical Office’s 2017-18 report on education shows that less than 50 per cent students get education for free after Class 8 (chart 3). The NEP 2020 talks about curbing commercialization of education. While more than two-thirds of primary schoolchildren have access to government-funded education, the proportion reduces to half at higher levels (chart 4). Physical distance and financial problems are key reasons cited by students for discontinuing education.

 

I believe that this would need to be addressed differently. As in the US, government can provide free transportation to students when they travel, say more than 2 km for high school education. Cost benefit analysis of the two options: Having a school for less than 30 students or transporting the students to the nearest High school. I don’t believe that any state government has had a look at the option of transporting students to larger schools, which have many inherent advantages. Larger schools tend to be located in larger villages/ small towns and hence can attract teachers better. Monitoring of such schools also tends to be much better and peer learning of Teachers is also possible. A brief mention has been made about higher cost of private sector education without providing economic costs of the process.

 

Not that private education has inherent faults, but its cost variance with government-funded education is disproportionately skewed. Medical education is, on average, three times costlier in a private college than in a government-funded college. At lower levels, the fee difference is starker (chart 5).

 

Is the education really free? It might be free in the sense that the students don’t pay anything out of pocket. But the resources spent by Governments are public funds and should be evaluated for effectiveness of spending/service delivery. Is the free education of good quality? Is there demand for the same or do the poor send their children to these Government schools due to lack of options? This tendency to treat all government services as free prevents comparison of services provided by the Government and the Private sector. It takes the comparison process into emotional and political rhetoric. The rhetoric buries the need for effective service delivery to the poor and we see groups warring to take ownership of providing services and showing the private sector in a bad light. The emotional arguments that flow conveniently forget that the private sector in 99% of cases is an Indian national/Company and are all under the regulatory control of the government and follow the law of the land. People are willing to cynically say that the law is in the ‘hands’ of the rich, but are unwilling to do anything to remedy the situation.

 

 

 

 

Corporate Debt Restructuring

 

1. The Reserve Bank of India (RBI) has constituted a committee headed by Sri K.V.Kamath to suggest guidelines on one-time loan restructuring. Other members of the committee will be former State Bank of India managing director Diwakar Gupta, T N Manoharan, former chairman, Canara Bank; banking expert Ashvin Parekh; and Sunil Mehta, chief executive officer of the Indian Banks’ Association (IBA) as the member-secretary.

 

2. In view of the covid-19 pandemic it is expected that a huge number of firms are likely to seek relief under the proposed guidelines.

 

A Business Standard analysis of the companies that have announced their results for the April-June quarter indicates that companies which either reported operating losses or a poor interest coverage ratio (ICR) accounted for nearly 45 per cent of corporate borrowing. 

 

3. Mrutyunjay Mahapatra, MD and CEO of the erstwhile Syndicate Bank has felt that “A loan account shows signs of stress two quarters prior to becoming ‘default’. This is typically when ‘ever-greening’ happen. Evergreening is a practice whereby banks extend even more loans to debt-laden companies to help them repay previous loans and hopefully earn enough revenue along the way to get out of trouble. It has been a pretty common practice in India, contributing to the banking sector's mushrooming bad debt pile and this mainly comes out of reluctance of the officer/team dealing with the loan to bite the bullet and call the loan ‘bad’.

 

“It’s important to distinguish between a legacy problem and a problem that is Covid-related. Many units in India were having problems even prior to Covid, and so, March 1 is a good date from that angle,” said a former deputy governor of the RBI.

 

4. Banks also need to look at intra-group leverage of the companies at the time of restructuring debt. Intra-Group Debt means any money or liabilities, owing or incurred to one Group Company by another Group Company together with all accruing interest and costs. Companies lending to group companies for unproductive usage would have to service the debt of the lending and borrowing entity in the group leading to failure of the restructuring exercise. Hence the extend of leveraging in intra-group debt is important.

 

5. Bank officers are unwilling to allow any restructuring out of fear of failure of the restructuring process.

 

In a note to the Parliamentary Estimates Committee on bank non-performing assets in September 2018, former RBI governor Raghuram Rajan had said that the “risk-averse bankers, seeing the arrests of some of their colleagues, are simply not willing to take the write-downs and push a restructuring to conclusion, without the process being blessed by the courts or eminent individuals”, leading to an “endless” delay in the process. 

 

The restructuring might not actually take place in the case of companies who are otherwise eligible as per guidelines.

 

6. Many companies are so cash strapped that they might not have the money to service the initial requirements for the restructuring to kick-in. If they are unable to do so, they would be declared defaulters and bankruptcy proceedings could kick in. Experts feel that this might be the case for many companies.

 

7. It is said that a problem with the previous restructuring schemes was that the banks didn’t have a structure in place to do a thorough review of the proposals. Risk management and economic planning needed to be incorporated in the bank’s workflow and institutional as well as individual capacities need to be built up.

 

8.  The path that a company would take after the restructuring exercise is difficult to predict, for the promoters and much more so for Bankers. 

 

“The biggest problem with any restructuring plan is how I predict what my top line and bottom line are going to be,” said the former deputy governor. Banks engaged in the erstwhile mechanism of corporate debt restructuring (CDR) had no clue, so they used to “cook up things. They used to put their own revenue assessments and a discounting rate of their own discretion to calculate the net present value of their sacrifice”, said the former RBI official.

 

“There is no way even now banks will be able to calculate that and that is where the Kamath panel can set up the entry points and draw a benchmark based on sectors.” The panel doesn't need to look at individual accounts to give their approval of a resolution, but can set rules for sectors that were hit the hardest due to the pandemic and need restructuring, such as aviation, tourism, hospitality.”

 

9. It is also important to ensure that companies that do not need restructuring do not jump onto the Bandwagon. Companies and promoters would have to be more tightly bound by way of personal guarantees, increased collaterals, bringing in additional equity etc.

 

10. Finally, Banks would need to decide if it is better to take a company to the insolvency court today or at a later date after giving them one more chance.

Repo Rate Cuts and Bank Capitalisation

 

Here is a good explanation in the "Live Mint about why Government of India would love a repo rate cut, which is the rate at which the RBI lends to Banks. The article extracts from Viral Acharya’s latest book “Quest for Restoring Financial Stability in India”.

 

The Reserve Bank of India (RBI) on Thursday decided to keep the repo rate or the interest rate at which it lends to banks, at 4%. In his new book, former RBI deputy governor Viral Acharya explains why the government loves the cycle of repo rate cuts.

 

What does Acharya say in his book?

Viral Acharya writes in Quest for Restoring Financial Stability in India: “Rate cuts are preferred … whereas rate hikes are particularly disliked." Now, this is primarily because the government is a major owner of the public sector banks (PSBs).

 

What is the problem with repo rate cuts?

The government is trying “to keep the budgetary allocation for public sector banks’ capital needs low". Repo rate cuts help in doing that. When the repo rate is cut, the value of the government bonds held by the state-owned banks goes up. This is because when interest rates go down, bond prices go up and vice versa. When bond prices go up, the PSBs end up making profits. This profit is recognized almost immediately, and helps shore up the capital base of these state-led lenders. Also, the government does not have to dip into its budgetary revenues to shore up the capital of public sector lenders.

 

This might at best be a temporary fix and cannot substitute the need for prudential lending practices and for better recovery by Banks.

Consumer Protection Act, 2019: Practical issues

 

Here is a good write up in Business standard of 10 August 2020 about how the new Consumer Protection Act, 2019 would mitigate against quick disposal of cases at District Forums.

 

To get a perspective, let us consider the scenario under the old Act. The District Consumer Forums, with a pecuniary limit of INR 20 lakh, are located mostly in premises that are too small, especially in urban areas where more cases are filed and there is a scarcity of space. So, files spill over into the corridors and there is hardly any place for movement. The Forum is manned by just one or two clerks, who find it difficult to cope with the workload of accepting complaints, scrutinising them, preparing and dispatching notices, accepting deposits and investing the money during the pendency of appeals, issuing certified copies of orders, etc. Similarly, there is just one stenographer who has to take dictation of judgements get the judgment even after the case has been argued. Besides, when the clerk or steno proceeds on leave, there is no substitute to attend district level.

 

Even though the Act stipulates that cases must be decided within three months, or within five months if laboratory testing is required, the reality is that it takes between four and 10 years, and sometimes even longer, for a consumer complaint to be decided, especially in cities.

 

With a five-fold increase in pecuniary jurisdiction under the new Act, it is likely that a case may now take 15 to 25 years to get decided. A consumer whose fridge or television is defective cannot wait so long for his grievance to be redressed. He will prefer to abandon his rights rather than fight for them for so long.

 

The article also describes the difficulty in getting judgements enforced under the new dispensation.

 

Under the old Act, initially the procedure for enforcing orders was the same as that applicable to decrees of civil courts. It required the filing of a separate application before the Civil Court for attachment of property by the bailiff, publishing of newspaper advertisement for auction of property, etc. making it a tedious as well as costly procedure, and often not worthwhile for realising a paltry sum. The Act was amended in 2003 to make recovery proceedings simpler by adopting the procedure laid down for recovery of arrears of land revenue by the collector or other competent authority. Even though this procedure was working well, the new Act surprisingly reverts to the civil court procedure for execution.

 

The effectives of mediation, it has been felt, would be very little due to the fact of not allowing cases like medical negligence for mediation.

 

The new Act provides for mediation. There will hardly be any scope to mediate in a dispute pertaining to defective goods or services, which would have been filed only after attempts to redress the grievance failed. Mediation could be helpful in resolving cases where there are high claims for compensation, such as those dealing with medical negligence. Yet matters relating to medical negligence resulting in grievous injury or death are prohibited from being referred to mediation.

 

These changes in the law would, it appears, make it more tedious for the consumer to approach the forum. If cases were to take so long to dispose, only habitual litigants might use the provisions and the common man would not be able to get justice.