Stimulus ain't free nor funny

It’s a busy season for stimulus packages that run into billions of dollars and sometimes even a trillion or two. (Suddenly `a million' sounds like small change!) For the announcers perhaps it gives them a few fleeting moments at the grandstand, but the global economies and its constituents including the stock markets are hardly pleased. The doubts don’t just linger around the quantum and quality of diligence behind these initiatives, it harp more on its viability – because they know their governments just don’t have so much money.

We thought Tim Geithner will be an improvement over Hank Paulson, at least in terms of practicality as he began by distancing himself from the `tentative steps’ of his predecessor even though he had been consulted upon. Anyway, the first vibes fail to soothe. For all the tough talk, however, the new plan, which will deploy the second half of the $700 billion Troubled Asset Relief Programme (TARP), was frustratingly light on detail.

Cut to home. Yesterday, the Government of India announced fresh borrowing program. As against Rs.2,22,154 crore raised in the ten months to January 2009, it intends to raise further Rs 46,000 crore (almost 21% of debt to date) between February 20 and March 20. Predictably, bond market reacted, sending yields higher (the additional supply will depress prices and push up yields). Though the RBI, the government’s debt manager, made haste to say the additional borrowing would be conducted in a non-disruptive manner, markets are not convinced.

So why do I say it’s not boding well for the economy? Government borrowing being seen as risk free, the rate at which it borrows gets set as the floor rate for all commercial lending. As such, borrowings by all other entities are seen as risky and so the mark up on interest rates go up. That drives the cost of funds up and hence the government cannot push banks to keep lending rates low to stimulate the economy.

Yet they call it stimuls. Now, isn’t that funny?

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Way to go, Guv

Is it upstart flamboyance or anticipatory bail application? I am not too sure as I read into RBI guv D.Subbarao’s statements barely three days into office.

While sticking to 8% growth peg (bravo!), he uses terms like “mathematical inevitability” – now what does that mean? Does he believe the economy could outwit slowdown advocates or does he swear by the efficacy of statisticians at his disposal to bring up that magic number or does he put the onus on the fickleness of number games?

Early days anyway. But he did mention “shared responsibility of RBI and all other regulators” – now that’s an inclusive statement. Even if his faith in the economy (or his statisticians) holds out or not, he will not take it in his chin, alone.

Can’t think of a better way to begin the innings ;-)
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Why not let go ?

Why is the Government so much bent on micromanaging individual company financing decisions? Take ECB rate ceilings for one. They say for accessing foreign loans of 3-5 year tenor, the current interest rate cap is 200 bps over six-month LIBOR. For loans maturing beyond five years, the ceiling is 350 bps above LIBOR.

[Today 6 month LIBOR is 3.10 %. RBI wouldn't let Indian companies borrow at rates in excess of 3.1 + 2.00 =5.1% for loans of 3-5 year tenor. Contrast this with Indian bank PLR of 14-16%. Now which is beneficial to a borrower? Do the math.]

I have a client that is badly in need of funds to complete its commercial complex that is in its last leg. We have identified a willing lender in a foreign bank. But regulations stand in the way.

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Now why would RBI strangle business plans? Well, I can understand the borrowing risks borne by individual companies do translate into an overall country risk. But this problem is already addressed by the overall annual cap on foreign commercial borrowings. Within the overall quota, the government must accommodate smaller companies, which may have to pay somewhat higher interest rates. Currently the bias clearly appears to be in favor of big corporate houses and, in fact, 30 per cent to 40 per cent of the foreign borrowing quota every year is cornered by three to four big industrial groups. The small- and medium-size companies suffer the most in an economic slowdown as they do not have the muscle of big businesses to withstand the pressures of business cycles. The Government by its diktat prevents them from borrowing at a higher cost, slamming the only way they can get lenders interested in them. In these times, policy must provide them succor rather than make things more difficult.

A company is best placed to assess its own risks. If a small company can manage its business efficiently even after borrowing a little dearer, so be it. Take the case of my client. Even if it borrows at 500 bps above 6m LIBOR, it would still be borrowing at just 8.1%, which is a good 600 bps below Indian bank PLR! But RBI says it's ok if you sink deep into high cost Indian debt, but says no to significantly cheaper foreign loans. Isn't this ridiculous? That too when we have a problem of surplus foreign currency reserves at about $300 billion at the last count! The industry is demanding this be relaxed in view of the general uptrend in interest rates globally. To the extent interest rates have moved up globally, it makes sense to relax the interest rate ceilings.

Will RBI relent? It will have to, soon. The Prime Minister’s EAC read the tea leaves and is confident of the ability of the financial sector, as also the maturity of the corporate sector to support the higher growth process. But for that to turn real, RBI should let loose all those strings.

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Something is gotta' give

As I sat listening to that lilting Phil Collins number – "One more night...."



"Please give me one more night, give me one more night
One more night cos I can't wait forever
Give me just one more night, oh just one more night
Oh one more night cos I can't wait forever...."

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Something rhymed deep inside... A chime....?

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Yeah, got it! My friends working in I-banks have just one prayer these days - God, give us just one more bubble - like that famous Phil Collins song... First, some M&A deal stats –

No. of transactions - 663 in the H1-07 to 467 in H1-08, with a sharp slump in deal value dipping by over 40% from US$38.4 billion in H1-07 to US$21.4 billion in H1-08. The active sectors include Pharmaceuticals, IT&ITeS, Banking & Financial Services (BFSI) and Real Estate. The outbound investments accounted for US$ 8.2 billion of M&A activity spread over 96 deals.

Financing overseas acquisitions has been tougher owing to the global market conditions and high interest rates. The global crisis sprang from expanding credit squeeze, high oil prices and rising inflation and now they cause slowdown in M&A activity in H1-08.

Even the macro numbers aren’t giving room for hope. The Prime Minister’s Economic Advisory Council (EAC) has revised the growth rate down to 7.7% for 2008-09 from its earlier estimates of 8.5% (and last 4 year average of 8.9%). Rubbing salt in the wound, It also expects inflation to scale 13% soon. Takeaways –

Trade deficit is likely to widen to 10.4% of GDP in 2008-09 compared to 7.7% in 2007-08. Merchandise imports would grow to $332 billion, Exports would grow to $205 billion, leaving a deficit of $127 billion. Export growth could be $22.5% while import growth would be higher, thanks to high crude prices.

High oil import bill and a decline in capital flows are pushing current account deficit to an all-time high of 3.2% of GDP during 2008-09. The estimated deficit for the year is $41.5 billion. In Q1/Q2 of 2008-09, deficit could be over 4.5% of GDP. The estimated 3.2% current account deficit for 2008-09 is more than double the deficit of 1.5% in 2007-08. The only year when it crossed 3% was 1990-91 — when it touched 3.1%, as we were facing a major foreign exchange reserve crisis. The silver lining now is that forex reserves stand at over $300 billion — far above the comfort level.

Capital flows would decline to $71 billion in 2008-09, far lower than the previous year’s $108 billion. Despite the decline, the net addition to forex reserves would be $30 billion.

Now to fiscal mismanagement. The government comes down heavily on private sector for not being transparent about its currency losses. But when it comes to its own affairs, it sweeps a lot under the carpet – think off budget Oil / Fertilizer subsidy funded by bonds that pose serious risks to the extent they are unfunded in the budget. But then you can’t speak much about that.

Just hope something is gotta’ give! Another bubble...? I don't mind... ;)
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The charity incentive

“The Inflation can drop below 8 % if confluence of factors like fall in global crude oil followed by a good monsoon work”, says Prime Minister's Economic Advisory Council (EAC) Chairman C Rangarajan.

It touched 11.98 per cent for the week ended July 19.

And then? The improved fiscal conditions would be used as an excuse to pursue populist schemes in an election year. The government already have to fund the generous farm loan write offs ($18 billion at the last count) and the liberal pay hikes to the government staff ($5 billion in arrears and $2.5 billion annual outgo). The latter is now deferred (a bungling government waking up to the folly?) emphasizing the thoughtlessness of the award. Now I think of the majority tax paying tribe that gets no benefit from any of it - the non-government employee citizen or a farmer with no loan outstanding. You think I am biased? Here is Moody’s rating, for the record !

I might rather donate all my taxable income to the Red Cross. That will make me feel a lot better.

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Make it 100 "Big" steps, Dr.Rajan !

So, Planning Commission's Committee on Financial Sector Reforms Chaired by Dr.Raghuram Rajan is out with its report for comments. Looks like it suggests a primary shift in focus. Instead of mouthing cliches like Bank privatization, Capital account convertibility and priority sector norms that usually make a lot of noise and end up in a whimper, it gets down to micro issues like easing restrictions to open up bond markets for foreigners, tradeable warehousing receipts to collateralize farm credit, securitization of SME receivables and the like.

I see opposition from traditionalists citing meltdown in the US debt markets. They will argue that India has been pretty much resilient because we never had liberal bond markets. As usual, wrong reading of the situation that misses the point - the crisis have been in high yield mortgage paper or subprime (junk) bonds where regulation was lax ; the US equity, treasury and corporate debt markets, despite being close to the epicentre of the crisis, have remained far more resilient than markets in faraway countries.

Liquidity is the key, there is no denying that. Here India has a lot of ground to cover. NBFCs today pass on the credit/ default risk to Banks and Financial Institutions indirectly because they are not allowed a free play by themselves in certain areas (IPO financing, CLO, factoring, hedging etc.). So why not let these risks be absorbed by investors in NBFCs rather than by their creditors/benefactors? That will be an additional line of credit, a far better way to channelise savings to productive avenues instead of locking them up in time deposits.

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The Government and the RBI should quit micro managing investment decisions – exposure norms of Banks, Provident Funds, Superannuation funds and other statutory collections that are now forced to invest in very low yield T-bills or AAA paper. Worse, they manage even PSU bank pay scales! Put in place regulations that ensure a close watch over ROI, encourage “stop loss” culture. Aberrations may occur, but in the long run, focus on optimal returns take the load off the back of government itself, when it’s time to pay back. In that, the government does a great service to itself, in whittling away all that contributes to the escalation of our budget deficits.

Who ever said conservative markets and regulatory caps on participation guarantee protection from risks? In fact, they go to cap rewards than containing risks. Try ceding control and stick with selective yet effective macro regulation for a change. Let RBI target inflation, not exchange rates. It’s an illusion to believe the world can regulate its way out of crises.

I would welcome Dr.Rajan’s 100 small, sorry, Big steps. Indeed in gathering political will and scale of execution, it is bigger still.

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"CYA guys.. Now..!"

Ila Patnaik makes her case why RBI should be cutting interest rates right now. (hat tip : Ajay Shah)

Her theory goes so long as there is scope for arbitrage between interest rates in US and India, dollar inflows will continue to drive the inflation and Rupee up. This relationship between Rupee rise and inflation (owing to upsurge in dollar flows) in the Indian economy – where interest rates are higher than that in the US - creates an anomaly in that a cut in interest rates will not only help rein in inflation by slowing down $$ inflows, it will also arrest the surge of the Rupee.

Ms.Patnaik has this view that since US economy is sliding into recession, Fed has more reasons to cut US interest rates. I see that move could further sex up high interest destinations like India (for not just FII/FDI/ECB flows, but also to NRI remittances) and the deluge will only accelerate. Traditional methods that soak up liquidity viz. OMO by RBI, CRR hike etc., meant to rein in inflation and arrest the rupee rise will only add to inflationary liquidity in the system. In effect, a higher interest rate regime instead of containing inflation will end up exacerbating it.

So here you have a paradox. Normally when you cut interest rates, it could lead to inflation propelled by higher credit off-take. But in our peculiar economic situation driven by excess liquidity and a rising rupee, cutting interest rates can effectively arrest dollar deluge as well as the Rupee rise – the twin goals that RBI is struggling to achieve.

Sound argument. But I say the Indian borrowers of foreign currency (ECB/FCCB) in recent times have large bets on a falling dollar to benefit from the exchange rate arbitrage. I doubt whether our CFOs are equipped with rate sensitive AWACS that scan early symptoms… A sudden reversal in RBI stance could wreck many a business and could rock the stock market sentiment as well. So RBI should give out early warnings.

The least that RBI Guv Dr.Reddy could do is to signal them “CYA guys… Now !”

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What will RBI do now ?

The sign of maturity of any economy is in its attainment of functional automation without having the need for frequent policy interventions. In that sense, if central banks gradually loosen their grip and reduce the frequency and magnitude of their intervention and monetary control, the economy should reflect a fair sense of its health through its currency exchange rates in relation to that of others.

But TCA Srinivasa Raghavan in his article has observed that the balance of opinion is in favor of intervention, for some reasons. One is that no central bank chief wants to be held responsible later for not warding off a recession. So he or she does the popular thing. The other reason is perhaps that everyone has learnt from the Asian crisis that when the going gets tough, the credit flow must start going. To choke off the tap is to invite disaster where people who had nothing to do with the problem lose their jobs and property.

So do Bankers that expect the Reserve Bank of India to soften its view on interest rates in the light of the US Federal rate cut. Domestic loans and overseas borrowing may become cheaper, they say.

But I go if central banks intervene, are they not defending or even protecting the bad guys who were indiscriminate in their processes (like subprime lenders that overlooked creditworthiness of borrowers) and screwed up not just themselves, but everyone in the end? Do they deserve to be bailed out? How different is it from the tax amnesty schemes that ridicule many an honest taxpayer?

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