Who is calling the money shots?

Who is India’s monetary authority? Is it RBI or Ministry of Finance? Traditionally RBI it is but of late the center of gravity is shifting more towards North Block. The pattern is too obvious not to be noticed—the real decision-makers are now in the central secretariat in New Delhi. Ideological divide, perhaps? RBI remains the statutory authority, but it is an open secret that the man in charge is P Chidambaram. A peskily independent RBI governor has retired, and a strong-willed finance minister has made sure that he will not be faced with another situation where his views are either ignored or not acted upon.

First, a new governor of Reserve Bank of India was appointed and, in a symbolic departure from past practice, the new incumbent went across directly from the finance ministry. Then, a new ‘liquidity committee’ was set up, chaired by the finance secretary. Now, a new economic advisor with a strong background in finance has been appointed in the Prime Minister’s office. A day later, the finance minister calls the heads of the state-owned banks with the intention announced in advance that he wants bank lending rates to drop. On cue, immediately after the meeting, one bank chief after the other announces interest rate cuts.

Critics of Dr.G.V.Reddy (Raghuram Rajan and Percy S Mistry) often argued the western orthodoxy that RBI should focus on a single objective of achieving a target rate of inflation. They usually oppose central bank interventions in the currency market, want quicker movement towards capital account convertibility, greater integration with global financial markets and the introduction of sophisticated financial instruments. But traditionalists supported Dr.Reddy with the counter-view that the financial crisis that has gripped the western world is not an advertisement for financial integration, that India can do without the periodic financial crisis that has consumed other developing countries with open capital accounts.
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I like a hybrid. Coming from a business family and community, one can understand why Chidambaram is hawkish on stock markets (except in matters of FDI ceilings where he surprisingly shoots down CCEA and DIPP moves seeking to allow FII to breach them). While RBI should indeed be the strategic authority, constructive suggestions from Ministry of Finance and other regulatory authorities can be heeded if not obliged. Controlling inflation is indeed the primary responsibility of RBI, but inflation is not the outcome of monetary logistics – it is rooted in market demand and supply imperatives. RBI can at best control money supply, hike or cut CRR, SLR or Repo rates but it can’t stop you from paying a higher price or ask you not to buy stuff. It could not even bring down the inter-bank call rates that hover around 11-12% as opposed to the normal 2-3%, despite the recent rate cuts. That can only be possible if the economy has multiple sources for fund flows. It can infuse or squeeze out liquidity to an extent, but it can never replace a generous flow of funds coming from a buoyant global sentiment. Over-indulgence by either would lead to catastrophic outcomes.

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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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Come hell or highwater

Come hell or highwater, private equity goes about its business.

During the first half of 2008 while public markets choked by a grisly hug, PE funds did 207 deals worth $10.4 billion , as against 178 transactions worth $6.69 billion last year same period. Average deal size increased to $59 million compared to $41 million during 2007 same period.

Standard Chartered topped the charts with its $830 million investment in property fund of DLF Ltd, followed by Providence equity’s $640 m in idea cellular. Others include Symphony Capital's $450 m investment in DLF Assets, L N Mittal and Farallon Capital's $399 million in Indiabulls Real Estate and investment firm J P Morgan's 300 million dollar investment in Tower Vision India.

I like the way they go about business as usual. Oil prices are slowly receding and Y.V.Reddy is bent on reining in inflation. That’s the way it should be. Growth is not the purview of Central Bankers, that’s for M/o.Finance to handle by accelerating pace of reforms. Now that the Left is out of the ruling coalition, Govt. has a lot of bandwidth to flex its muscles. Rate hikes hit back with a lag, so it’s important for us to brace up before we are blown all over the place. Pretend as usual and go about life, investment and all.

Things will fall in place. Or where they fall is exactly their place.
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Not bad being a contrarian

So RBI unveils credit policy and sends chill down the nation’s spine revising GDP growth expectation to 7.9% as against 8.1% earlier.

Repo rate up by 50 bps is now at a record 9%. CRR is up by 25 bps and it is at 9% too.

On the back of high oil and fertiliser subsidies, farm debt waiver and the implementation of the Sixth Pay Commission recommendations, how bad can things get? Let me mangle definition of optimism, true contrarian style - wait till things get so bad that the only way for them is to get better.

I should know. The stock markets have given a thumbs down by falling around 4%. The two sugar stocks I bet on have moved up by 7% and 8% today. My portfolio inched up by 2.6% too.

Not bad, huh!

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Sahara is too big for RBI to pull up

Sahara group has always been mired in controversy. With no clear lineage of its monumental wealth and sudden emergence into the league of rich and famous, interests spanning from Financial Services to Airline (now divested) to real estate to entertainment and broadcasting, its source of funds has always been questionable. The publicized information that it aggregated small amounts from poor workmen and hawkers on a daily collection routine certainly didn’t cut.

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And then the splash wedding of its Chairman Subrata Roy's two sons -

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Hardly the cashflow stream that enables its founder Subrata Roy to conduct his sons’ wedding so loud, with unabashed brazenness. Get yourself a rehash of the ostentation. Note the array of guests that lined up. A former Prime Minister (A.B.Vajpayee, despite his famous weak knee), Mulayam Singh, Amar Singh, Bal Thackeray(traveling out of Mumbai after 15 years) et al to celebrities from the world of business, sports and entertainment. If feeding thousands of guests and 140,000 beggars were not enough, the cost of transportation, Z category security and palatial housing of dignitaries (Roy put up three mock palaces) that assembled in small town lucknow should’ve cost a fortune. In fact, it gave credence to the rumors that Sahara group was a politician’s safe haven for their bribe collections and wealthy industrialists’ unaccounted wealth under cover of collections from poor people. With so much `at stake’, it brewed itself into a heady mix – something that can never fail. That should never fail. An untouchable (even by the long arm of law). So what can a poor RBI do? How far could it get?

On June 4, the RBI banned the seedy Sahara group from accepting public deposits on grounds that it was not following the prescribed norms. Yesterday, the regulator promptly changed its earlier decision following Supreme Court-mandated meetings with top Sahara executives on June 12 and June 16 and after Sahara Chairman Subrata Roy had "a meeting" (dressing down?)with RBI officials. The earlier order directing Sahara to stop accepting deposits effective end of this month have now been revised to - hold your breath - another 7 years. A new lease of life (for some of the RBI officials to peacefully retire than for invincible Sahara to sort itself out!) till 2015, leaving enough time for all those who have stashed their wealth to recoup them ;)

Sahara is a big tree; so RBI has to prop it up before it falls and shakes the earth. But not everyone get so lucky. What RBI couldn’t do with mighty Sahara, it does with other NBFCs. Here's RBI getting back with a vengeance. Message : Be big before you are in play ;-)
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"Not so much of crunch, really"

The global economy clearly slowing down, inflation inching up, oil prices showing no signs of a decline – normally investors should be keeping away, or so you thought.

You can’t be more wrong. India Inc witnessed the announcement of USD 640 million worth of PE deals in May this year, about six times over April deal volume and 12x May, 2007 record. The Jan-May 08 figure is $6.39 billion into India alone as against 159 deals worth $ 4.97 billion during same period in 2007 reports Grant Thornton.

This is the type of news that could pull in a lot of fence sitters – investors that got cash but not sure when to enter. “So, come on guys, jump right in. Let’s have some piece of action, have another ride. Last six months were boring.” RBI seem to want it too. It's throwing open the gates. See here.

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Don’t believe me? Here is a wave theory or is that Five?

So investors, the big rich guys are back. Soon stock prices will get back up. Go get some of those momentum jacks that look like value now, in case if you had the good sense to stay on cash :-)

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Differential CRR? That's financial racism.

Finance Minister Chidambaram has a pet peeve. When inflation goes up by a few ticks and he turns to RBI governor Y.V.Reddy for advise, the guv is equally clueless. He knows nothing more than to hike CRR by 25 bps.

A hike in CRR by two tranches of 25 bps each from 7.5% to 8.0% was announced recently by the RBI to suck out excess liquidity from the banking system. But is that enough? It is this predictability that erodes the significance of RBI moves on the economy itself. But stock market nevertheless looks to RBI for direction.

This morning I found Ashok Khemka arguing for nuanced CRR Policy. His key points –

a) Why impose a flat CRR of 8% on all banks’ deposits that looks like a virtual tax? It’s only the sinning few that is responsible for incremental foreign exchange that adds to liquidity. Deposits in domestic currency do not damage the economy. So why not switch to differential CRR on selective foreign exchange inflows (NRI deposits, FII / PE / Hedge Fund inflows) only?

b) Sterilization (mop up of foreign currency by RBI from open market) initiatives have become expensive as reflected by the rise in T-bill yields from 7.4-7.6% from 6.6-7% as was earlier. This taxes the entire economy for the sins of a few.

c) Levy the higher CRR in the designated currency itself. This obviates RBI having to go in for forex mop up later to maintain the exchange rates. RBI can also make that currency reserve available to the needy to buy assets abroad and negates any adverse effect from currency mismatches in international trades.

Great points. But I see those recommendations calling for containment of liquidity by slapping penalties. It is not equal to identifying a mature mechanism that uses the liquidity inflows which is the need of the hour. It amounts to saying `No’ and that is the easiest part. I would look for ways to use that liquidity into creating better infrastructure before foreign investors find another profitable destination outside India. Money is fungible and investors don’t waste much time if they feel they are not welcome here.

Differential treatment is bad. It will mean financial racism. Never do that. Get smart and keep giving them those incentives. You can make hay only while the sun shines on you. Now it is sunny days for emerging markets, especially us. Don’t get smug. Go build better roads, dams, bridges, airports whatever. Don’t slam the door shut on investors. Remember what made Dr.Manmohan Singh open up reforms gate in 1991? We were almost broke. Now don’t get to that point again!

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The Sound of Crash (is deafening)

RBI Guv Dr.Y.V.Reddy has heard us... Or is it the deafening thud of yesterday's market crash? Here he’s going soft on interest rates as opposed to his earlier tough stance against inflation. Ila Patnaik had argued that lower interest rates would help arrest inflation and the Rupee run since India would become a less attractive destination for foreign funds.

That report quotes RBI view calling for end-use restrictions for investments by foreign VCFs because of concerns on foreign capital inflows it is finding tough to manage. Ila Patnaik’s worst fears have come true - the central bank has been absorbing foreign currency inflows to check the rupee’s appreciation, but has ended up adding to the liquidity in the system.

I quote from that BS article. “Abundant rupee liquidity poses risks of higher inflation as it adds to the already high money supply. The year-on-year increase in money supply (M3) as on January 4, 2008, was 22.4 per cent against 20.8 per cent a year earlier and much higher than the central banks target of 18 per cent.”

With a crash like that, I’d rather the Guv comes up with some good news of lower interest rates, weaker Rupee or anything to perk up the market on 29th Jan, when he reviews the credit policy - and resuscitate the annual non-event that it has become lately.

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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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Do away with P Notes - Give us infrastructure

Has the recent crackdown by SEBI on P Notes issued by FIIs been effective? Will it yield the desired fruit – that of controlling copious flows of capital from unidentified or least regulated entities? Well, time will tell.

But RBI still has to deal with its daunting problem. The surging capital inflows continue to pose a policy challenge for the Reserve Bank of India (RBI), as it undertakes its mid-term policy review tomorrow, despite some measures taken to contain unregulated inflows. The central bank is unlikely to signal any easing of monetary policy with surplus liquidity in the system, as any lowering of interest rates at this point, could hold upside risks to inflation.

The Prime Minister's Economic Advisory Council had estimated that an increase in the forex reserves of the RBI of $26 billion in 2007-08 could be consistent with the current real growth of the economy, moderate monetary expansion ( 17.5 per cent) and a tolerable inflation rate (4 per cent). "In the current financial year up to early October 2007 itself, forex reserves have increased by over $50 billion and tackling this problem is the most crucial policy dilemma," S S Tarapore, former deputy governor, RBI has said.

I often wonder – why not RBI absorb the excess liquidity thro infrastructure bonds and divert the entire corpus exclusively to address India’s appalling infrastructure needs – better Airports, Ports, Dams, Roads and the like… Given the pathetic state of our infrastructure, no sum of money would be found to be `excessive.’ We pay humungous sums anyway by way of Airport tax, fuel surcharge, toll etc. Is it not time we expect something in return…?

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Clueless RBI opens flood gates

The rise of the mighty Rupee against a weak dollar has forced RBI to relax its currency regulations. It goes with the usual refrain - “one more step towards full capital account convertibility”. Gee, making a virtue out of necessity? Not so nice, Guv…! How many more steps left? Story behind the story is RBI just woke up and realized that they've lost control of their own industry. Now they're desperately scrambling to get back on their feet. Left with not many options, it opened the floodgates wider praying that some of the incoming dollars may flow back too. Now, know your limits –

- Individuals can remit up to $200,000 against $100,000
- Companies allowed to invest overseas up to 400% of net worth overseas against 300% till now

- Partnership firms also allowed to invest overseas 400% of net worth
- Ceiling on portfolio investments by companies raised to 50% of net worth from 35%
- The requirement of 10% reciprocal shareholding in listed Indian companies done away with for overseas portfolio investment
- Companies can prepay ECBs up to $500 million against $400 million now
- Mutual funds allowed to invest an aggregate of $5 billion overseas against $4 billion now

Will it cause a dent ? I doubt. There are not many parking bays available for the greenback than emerging markets. No other market in the world is yielding returns as do emerging markets (EM) like India. China and Brazil have become way too overstretched. Developed markets have been consistent underperformers. That leaves the dollar to leave Indian shores only when Indian companies begin repaying or foreclosing their ECB borrowings made earlier. That’s wheels-within-wheels scenario since prepayments shall be triggered only if there are significant dollar earnings from exports, which is too much to ask when every dollar of export is fetching less and less Rupees. Add to that the Fed rate cuts. The recent 50 bps rate cut by the Fed on September 18 has only accelerated the inflows - FII reacted by increasing their investments in India with $1.54 billion of investments in just 3 days between September 19-21. RBI may use its sponge to mop up dollars, but in July alone, it bought back $11.42 billion.

How much more can it suck in? And is it advisable? Well, I’ve dealt with that already.

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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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