Tag: Ananth Narayan

Everyone was willfully blind to the NBFC mess. The financial ecosystem is now paying the price

KV Prasad Jun 13, 2022, 06:35 AM IST (Published)

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For the past few days, some members of India’s financial services ecosystem have been demanding relief from the powers-that-be, while pointing a gun to their own head.

Ensure funding for the system, they say, or we could spiral down and drag the broader economy along with us.

The immediate trigger is a trust deficit around the true nature of non-banking financial companies (NBFCs) balance sheet asset-liability mismatches, and more importantly, around the true quality of NBFC assets. In the post-monetary policy committee press conference earlier this month, RBI itself indicated that all is not well with all NBFCs.

In this context, the focus is on Rs 2.5 trillion of NBFC debt that will mature with mutual funds by March 2019. There is a fear that a chunk of this debt may not roll over. While banks are looking to buy assets from NFBC, this might not suffice to bridge the funding deficit.

The suggestions and entreaties to prevent a vicious spiral, range from encouraging banks to fund NBFCs, to the government readying a financial institutions bailout fashioned after the extraordinary 2008 US troubled assets relief program (TARP).

It’s ironical that just months ago, NBFCs were the darlings of the capital markets.

How green was my NBFC

Per RBI’s last financial stability report (FSR), as of March 2018, all NBFC put together had 22.9 percent capital risk-weighted adequacy ratio (CRAR), 5.8 percent gross non-performing assets (GNPAs), and 3.5 percent net non-performing assets (NNPAs).

By comparison, banks as a class were much worse off, with only 13.8 percent CRAR, alongside high 11.6 percent GNPA, and 6.1 percent NNPA.

In fact, the RBI FSR devotes 20 pages to analysing how banks can impact financial stability, and barely one-and-a-half pages to NBFCs.

Not only were NBFCs ostensibly safer than banks, they were also growing their assets twice as fast. No surprise, therefore, that NBFCs were the stars of the capital markets till recently.

Why are we suddenly obsessing about NBFC balance sheet risks and asset quality now? Why have some large NBFC stock prices fallen by 20-40 percent in the past one month? Has the IL&FS default made such a big difference?

The explanations

As ever, there is no shortage of arguments to explain market behaviour post-facto. Here are a few sound bites and factoids that we now hear.

–      RBI’s asset quality review (AQR) process since 2015 focused solely on banks. As a result, reported GNPA of banks increased from 4.6 percent in March 2015 to 11.6 percent in March 2018. For NBFCs, which were not subject to the same AQR process, GNPA rose from the same 4.6 percent in March 2015 to just 5.8 percent in March 2018. Is this really believable?

–      In fact, 15 percent of Rs 22.1 trillion of NBFC assets are real estate or capital market exposures. These are riskier areas that banks are restricted from lending to. Look at the mess in real estate, with all the unsold inventory and builder distress. How have NBFCs managed to lend more, at higher rates, and yet managed to keep NPA ratios much lower than banks?

–      RBI’s regulatory oversight over the 405 key NBFCs —let alone the 11,402 registered NBFC as of March 2018 —is not of the same intensity as that of banks. It gets even worse with housing finance companies (HFCs) – the supervision process of National Housing Bank (NHB) is even less comforting.

–      Of course, regulatory oversight is not the first line of defence. There is frontline management, internal risk management, the board, external auditors and credit rating agencies, which are each charged with keeping things honest. And we believe each one of them is doing a great job – yeah, right!

–      Mutual funds now hold about Rs 12 trillion of debt securities, of which a significant majority is non-sovereign debt. Total traded volumes in corporate bonds are about Rs 1.5 trillion a month. Given this illiquidity of secondary markets, largescale mutual fund redemptions in any crisis of confidence can severely push up credit spreads.

Of course, all this begs the question – if this (and more) was or should have been well known, what were we doing all this while?

The trap – eyes wide shut

There are many excuses to shut our eyes to such signals.

As a first excuse, we believe forbearance (a more complicated word for closing one’s eyes) is a good way of letting the system naturally adjust to issues. After all, we argue, Basel III norms do not really apply in the Indian context – which is why we criticise RBI’s AQR drive, culminating in the February 12^thcircular.

On the contrary, history shows that besides coming back to bite us, forbearance has often delayed and postponed real reform – in our case, areas such full recapitalization of banks and true reform of the banking system (PJ Nayak Committee recommendations, anyone?).

As a second excuse, we argue that a growing ecosystem can never be perfect, and this will be a journey with its inevitable ups and downs. So why be the party-pooper, as long everyone is having a great time?

Ups and downs are of course inevitable – but the downs should come from the unknown unknowns, rather than from issues that are staring us in the eye.

As a third excuse, we also use a patriotic “greater good” argument. If we classify the power sector as NPA, what will happen to all the people employed there? If we value all corporate bonds in MF schemes adjusting for the illiquidity of the secondary markets, how will the Indian debt ecosystem ever grow? If rating agencies, auditors and boards start sticking to the rulebook, how will industry and commerce ever take off in India?

These are important questions – and there are genuine, core, difficult reforms that can answer these satisfactorily, and none of them call for anyone to play the ostrich, or wink and nod.

In the financial services industry, trust is all-important. Painful regulators, auditors, boards, credit rating and valuation agencies are true allies in fostering that trust. By sticking to their respective individual mandates, all stakeholders — frontline and support — fulfil both their patriotic and professional duty.

The regulators and the government need to do their own bit by undertaking true reform, addressing the core issues that check-and-balances highlight.

The government has done well in implementing the Insolvency and Bankruptcy Code, for instance. We now need to understand how recapitalization and reform of financial services and secondary debt markets can be speeded up.

The price of gun-on-head negotiations

We will get out of the current situation – notwithstanding the now public spat between regulators and the government.

Things are not as bad as feared – NBFCs do have good assets, and the financial ecosystem is not all bad. In any case, even if things start to go out of hand, we will find a way. We have ample intrinsic buffers, and we always get by.

But all of us guilty of willful blindness – whatever the pretext – will have to held accountable. There has to be a price to pay for pointing a gun to one’s head.

Going forward, we need a financial ecosystem that fosters trust with conservative, eyes-open checks and balances – alongside the willingness to undertake hard, true reform of institutions and markets.

Reforms are obviously difficult to undertake – but that should not justify us closing our eyes.

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KV Prasad Journo follow politics, process in Parliament and US Congress. Former Congressional APSA-Fulbright Fellow

RBI’s stand on financial stability: Here is what experts have to say

KV Prasad Jun 13, 2022, 06:35 AM IST (Published)

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In a surprise move, the Reserve Bank of India (RBI) o Friday kept the repo rate unchanged at 6.50 percent – the rate at which it lends money to commercial banks. The reverse repo rate was also retained at 6.25 percent.

Markets were caught off guard as RBI maintained status quo on the benchmark interest rate. However, the central bank warned that rising oil prices and tightening of global financial conditions pose substantial risks to growth and inflation.

It also changed its policy stance to ‘calibrated tightening’ from ‘neutral’.

Meanwhile, RBI governor Urjit Patel on Friday reiterated that the domestic currency is still better than its emerging market peers and that the apex bank does not have a target for it.

Watch: Here’s what experts have to say about India’s inflation targeting framework

A majority of the analysts and bankers were expecting the six-member Monetary Policy Committee (MPC) to raise interest rate by at least 0.25 percent, while the developments over the last few days, especially the weakness in the rupee, had led to speculations that it could be even as high as 0.50 percent.

CNBC-TV18 caught up with C Rangarajan, former governor, RBI, Ashima Goyal member, Economic Advisory Council to the Prime Minister (PMEAC) and Ananth Narayan Professor, SPJIMR, to discuss the outcome of RBI mpc and the central bank’s inflation target framework.

Edited Excerpts:

Do you think inflation targeting is an inadequate mandate given the multi-tasks the central bank has to perform?

Rangarajan: Let me say that I favour flexible inflation targeting, I consider it appropriate but it is also equally important how one interprets inflation targeting.

To me, inflation targeting implies that when inflation goes above outside the range that is permitted, particularly on the upper side, the RBI has no option but to control inflation and use policy instrument exclusively to control inflation. There are no excuses or no other considerations which would come in the way of the central bank is acting.

But I do take the view that when inflation is within the comfort zone that is within the range, it should be possible for the central bank of the country to look at other considerations as well and I would not rule out, the central bank of the country taking action like raising rate of interest if other circumstances demand it.

Therefore, I would make a very clear distinction between whether the inflation outlook is within the range that is permitted or whether it is outside and when it is outside the mandate is very clear, the RBI has to act and must act to reduce inflation.

Of the many reasons that were adduced in favour of inflation targeting to present two – the first one is that even when it is operating within the band, the RBI has to be on the alert to ensure that it doesn’t go above the band and governments usually arm-twist them into favouring lower rates, so that we are able to encourage growth. Therefore, it is important to stick to the mandate even when you are within the range?

Rangarajan: Yes, even when the inflation rate or the expected inflation rate is within the range, the RBI or the central bank which has this particular mandate must act to ensure that over a long period that inflation mandate is maintained.

Therefore, that is part of inflation targeting mandate but that does not preclude the central bank when the inflation rate is within the range to take into account other considerations. That is my interpretation.

If we go back to the 2008 crisis, as far as the advanced countries were concerned they were seeing the inflation rate well below what was considered to be appropriate and, therefore, they did not act. There is still a considerable amount of debate regarding whether the failure is a monetary policy failure or it is a regulatory failure.

At best, monetary policy did not act and the interest rate was low and it led to high risk-taking on the part of many participants. But to come back to the point, when asset prices were rising the authorities looked at only the consumer price index (CPI) and did not act.

I think that was a wrong interpretation of inflation targeting. The inflation targeting does not preclude the monetary authority to raise the interest rate even within the comfort zone if you think that there are other factors operating which will push the inflation up.

Q: So, on hindsight, if the rupee continues to depreciate the RBI could also be held guilty of looking only at its inflation forecast and not acting proactively to control the current account deficit which has probably led to this fall on the rupee?

Rangarajan: The monetary policy statement is somewhat very cryptic about the depreciation of the rupee. There are only one or two references to it. If the opinion of the MPC or the RBI was that the deprecation of the rupee will have only minimal impact on prices and they are not acting they should have stated it.

If they had stated it then it would have become clear that this particular consideration has been taken into account. Now it is somewhat silent and one is not very clear whether this factor which is clearly within the mandate of inflation targeting has been adequately taken into account.

After all the rise in crude prices coupled with the depreciation of the rupee has impact on prices. One cannot ignore this aspect of the problem and it is incumbent on them to state very clearly what their view is in terms of the impact on prices of the depreciation of the rupee.

To be fair the governor in the Q&A did say that the risks of currency depreciation had been baked into the Reserve Bank’s forecast and its decision of not hiking but only changing the stance from neutral to calibrated tightening. But let me come to another issue do you think we need to write new rules or do you think the RBI could live with the current monetary policy legislated framework and still include financial stability as its goal?

Rangarajan: If you go by the interpretation that I have given perhaps that is not the interpretation on inflation targeting which is given by everybody. If you go by that interpretation there is really no need to make any change because many of these things are established by convention and tradition.

There is certain statement regarding what the level of appropriate inflation is and where should we stand. But it should not be interpreted that other considerations are irrelevant at all times.

When you go beyond the top, beyond the upper limit then don’t bring in other considerations and excuses not to act. But once you are within the band then you do take into account other considerations and perhaps I do not know it must have been in the back of the mind of the monetary policy committee members as well as the RBI. Some of these considerations that we are talking about not only the depreciation of the rupee but also the problems faced by the financial markets, non-bank finance companies and so on and their impact on the prices.

The price level is not only determined by the expected growth rate and liquidity considerations. There are many other considerations which have an impact on prices. I would be happier if the policy statements had gone into all those considerations. But to come back to the point that you made, I think that completely excluding all other considerations when the inflation outlook is within the range is not appropriate and we should establish some tradition in terms of how to operate the flexible system of inflation target.

The rupee market got terribly rattled after the RBI did not favour it with that expected rate hike. Do you think that this is a good time to visit the topic of inflation targeting altogether?

Narayan: I have always felt that flexible inflation targeting which essentially looks only at CPI inflation and the instrument of interest rates to control it is kind of blinkered because whether we like it or not monetary policy impacts a variety of issues and particularly the currency markets and capital flows.

This is not something for debate, this is known. Even the economists on the monetary policy committee will acknowledge this.

When you are using an instrument which you know has an impact on multiple factors and then you say I am not going to consider the impact on other factors and solely concentrate on one factor which you prefer, there is a lacuna in that system and we have to revisit this entire premise.

I think we have seen a problem arise because of this in the past and we are seeing a different kind of a problem arise now because of this completely blinkered inflation targeting approach.

The RBI stood true to its mandate and that mandate has also served the country well. We have seen inflation drop lower from double digits from 2011 to 2014-2015 and has stayed low for a goodish bit. Yet the markets were expecting that the current account deficit problem will need to be addressed and the fact that the rate hike did not come has led to a fairly deep cut in the rupee on Friday and on Monday. Do you think we need to expand the mandate of the RBI?

Goyal: Since we have just started on this inflation targeting and we have adopted it at a high inflation time, the thing is what we have adopted is flexible inflation targeting.

If you see the academic literature on inflation targeting, the idea is that you communicate something simple which helps anchor inflation expectations. How do you implement it? You have a lot of freedom there, especially if it flexible inflation targeting.

The problem is that we have been implementing it too rigidly. If all the flexibility which is available were used – for example when it was first adopted in Brazil, Armínio Fraga was the central bank governor and he communicated very clearly the supply shocks, what the central bank can affect, what it cannot and helped guide expectations down.

In India also we have seen inflation expectations falling. So, what we need is to realise that instruments in a country like India – a very different market, not so thick market, the big problem was not so much that interest rates have not risen because 25 basis points cannot affect currency markets that much.

The problem was that it was communicated that the central bank has nothing to do with the exchange rate or inflation targeting means that the central bank has nothing to do with the exchange rate, that is not correct because we have a managed float, we have reserves, we can increase reserves, we can take oil companies’ to demand out of the market, we can do many things.

You have had countries like Turkey and Argentina raising rates steeply to 60 percent and 25 percent without affecting depreciation. So, it is not that a rise in interest rates will soothe currency volatility. We had two back to back rises and volatility continued despite that. The point is that under inflation targeting, if inflation is within the band, it means excess demand is not high, it is not creating inflation and so you do not need to reduce it. You can do other things such as increasing exports.

Are you saying that there was nothing wrong with the RBIs decision or its theory but it perhaps should not have communicated it that way? It should have said that they are keeping inflation under control and that eventually is going to anchor the currency? Should it have been just communicated differently?

Goyal: Right, absolutely. If there is no inflation the value of your currency is protected, it depreciates if your inflation is higher than your partners.

So you would say that it is more a communication issue?

Goyal: Yes it is communication and also using your instruments flexibly, you must not communicate that the only instrument I have is the interest rate. You are communicating on inflation but you are free to use a number of instruments.

We have done some research recently which shows that the money supply matters because there is an informal sector and so liquidity, money supply, intervention, all that can be used and if you have theoretical models that throw up inflation forecast, all these variables enter. So you are absolutely right to address all these variables.

To be fair the governor did say that cheaper currency and crude have all been baked into the forecast. Narayan, we cannot deny that inflation targeting at least over the last two and half years have served us well. Ever since we have embarked on it, we have had inflation falling and remaining benign through most latter 2016 and 2017 and early 2018. The spikes that we have seen in crude and more particularly in food inflation did not become generalised inflation which was perhaps because of inflation targeting central bank, so should we just keep it as it is and add financial stability as a mandate for the RBI?

Narayan: I think it is worth a proper study on its own to see how much of this benign inflation that we enjoyed was on account of the sharp fall that we saw in oil and commodity prices and on the sharp and noticeable fall in food prices over the last few years, I think making that distinction is important.

Second, I do think that inflation targeting has also led to the current currency volatility that we have seen.

If we look at the last fiscal year, FY18, which ended on March 31, 2018, we already had a current account problem surfacing at that point in time – $49 billion of current account deficit (CAD) and FTI was only $30 billion dollars on net basis, so we had net outflow of $19 billion at that point in time and yet rupee appreciated.

In fact, the RBI intervened in the forex markets and brought $44 billion in that fiscal year. So where did that $63 billion come from? It came from FPI in debt, it came from net exporter selling, it came from unhedged ECBs, it came from NRE deposits, it came from speculative long rupee positions.

Each of these positions was at least partly if not wholly determined by the level of interest rate differentials. Therefore, monetary policy did beget this kind of reversible flows and that in turn caused rupee overvaluation, probably contributed to the morass in exports and the fact that we were importing too much. It also caused other kinds of vulnerabilities.

Over the last five years it has been $120 billion of such reversible flows which have come in chasing our high-interest rates and now all those flows are looking to reverse because our macros have turned.

So, I would say that at least to some extent the inflation targeting framework that we have followed has aggravated the vulnerability on the currency front. On all these counts, I do think we merit a full review of the framework. It might not be the right time to do it now.

I think we are facing too many problems on the macro front to worry ourselves about the inflation targeting and the review right now. But when the dust settles we definitely need to open this chapter. I think having blinkers on when you know interest rates impact currency and external markets, it just completely reduces the quality of the debate. We have to be aware of all the consequences and then make the choice. You might still choose to do what MPC did on Friday. But at least do it with eyes open rather than eyes blinkered.

This is a very different point that Ananth is making. He is saying that actually inflation targeting and keeping high-interest rates created a current account deficit problem that we refuse to see the emerging current account deficit problem which was just getting financed by huge debt flows which were at attracted to our high-interest rates. Now, this puts the debate in a very different context. You think we need to debate inflation targeting altogether and say that, no at all times inflation is only one of the goals, current account deficit, stability etc. are also goals?

Goyal: I agree with Ananth. Our interest differential is too high and it did attract inflows. In fact, these kinds of debt inflows made a huge killing because they got 4 percent returns, excess returns as well as 4 percent from currency appreciation. So, they were just flocking in. However, keeping interest differentials too high, was not mandated by inflation targeting, it was too over strict an interpretation of inflation targeting because remember inflation had crashed with the oil prices.

RBI did not correct the interest rate downward because they said we foresee that it will rise in the future. They were being extra cautious and conservative.

The second issue is they allowed debt caps to rise. They let more inflows come in, they had a graduated path to allow because we still have caps on debt inflows. So they are still a small percentage of our overall inflows.

It is still very good in India, we compare ourselves to Indonesia. Sometimes debt investors say Indonesia gave so much of a rise but debt inflows are very large percentage of their market. It is less than 5 percent of our market. So just as in equity market you don’t see much volatility when FPI goes out because domestic MFs are coming in. We need to develop our domestic debt market more.

Even 5 percent, the cap that was listed in Raghuram Rajan’s time and Urjit Patel’s time they gradually raised the cap that becomes too high percentage of foreign inflows because our debt market is quite large. So, that cap should not have been lifted. The interest differential would not have led to such a rise in inflows if the cap had not been lifted. The third point is that those inflows that came in could have been absorbed as reserves because they were excess inflows – arbitraging the interest differential.

So, they should have been absorbed in reserves and our reserves should have been even higher and healthier today to tackle outflows.

Q: Short point are you finding fault with the framework or you finding fault with the interpretation of the framework?

Goyal: I am finding fault with the interpretation and implementation of the framework.

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Rupee hits historic low: Experts discuss the road ahead

KV Prasad Jun 13, 2022, 06:35 AM IST (Published)

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For a month the Indian government has weighed in with statements and steps every time the dollar threatened to go above Rs 73. But today, the currency couldn’t hold back.

The rupee hit a fresh record low of 73 against the US dollar on Wednesday as steady capital outflows against the backdrop of tumbling local equities, ongoing global trade war concerns and surging oil prices kept forex sentiment under stress.

The rupee recovered sharply from record low levels on Wednesday after reports that the government was in talks with RBI for a special dollar swap window with some state-run fuel retailers.

It closed at 73.34, down by 43 paise or 0.59 percent at the interbank foreign exchange.

Since the start of 2018, the Indian rupee has depreciated around 15 percent making it one of the worst performing currencies compared to its Asian counterparts.

Even in the emerging market basket, it is only hapless Turkish lira has depreciated more. Many have called this fall a necessary depreciation but panic bells are ringing nevertheless in some quarters.

Indranil Pan, chief economist, IDFC Bank, Ananth Narayan, professor, SP Jain Institute of Management and Research (SPJIMR), Alvin Tan, director, Fx strategy at Societe Generale, Gareth Leather, senior emerging market economist, Capital Economics and Kamal Mahajan, general manager and head of treasury and global markets, Bank of Baroda discuss the issue.

Pan said that the overall financial market atmosphere globally also remains quite weak.

“Today, we saw the INR falling on the back of emerging market currency weakness. So India is broadly participating in an overall currency weak atmosphere given that oil prices have moved higher which obviously creates a lot more risk in terms of the current account and the fiscal and also the inflation dynamics,” Pan said.

“The reason why rupee depreciated and some of us were calling for the rupee to depreciate is not because we wanted here but the flows simply weren’t stacking up,” Narayan said.

The trade data for this fiscal year, the first four months, the entire deterioration we saw in the trade numbers was because of the oil, he added.

Our exports need to be improved, our manufacturing has to improve so that we can make more in India, Narayan said, adding that a lot of reform has to be done around that ecosystem before we can truly say the balance has been achieved.

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RBI’s move to ease cash requirement should help assuage market sentiment: Ananth Narayan

KV Prasad Jun 13, 2022, 06:35 AM IST (Published)

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The Reserve Bank of India (RBI) on Thursday eased mandatory cash requirement rules for banks amid fears of liquidity crunch in the system.

The RBI said it had eased the liquidity coverage ratio norms by allowing banks to account for up to two percentage points more of government securities, held in their statutory liquidity ratio reserves.

The development comes after the government on Wednesday hiked import duty on various products that include footwear, washing machines, diamonds, jet fuel air conditioner to reduce current account deficit (CAD) and strengthen the rupee.

To discuss the impact of these developments, CNBC-TV18 spoke with Soumya Kanti Ghosh, chief economic Advisor at SBI and Ananth Narayan, Professor at SPJIMR.

“It seems to be a positive move but at the marginal level it may not impact liquidity to a significant extent because the banks already have excess SLR … more needs to be done on an incremental basis,” Ghosh said.

“However one of the long standing demands of the banks have been to treat this as securities so that it doesn’t convert to MTM. So if anything is done on this front over a point of time will help ease banking pressure on MTM cover,” said Ghosh.

With regards to the import duty hike measures, he said, “It will help sentiment but again not sure how it will help at a margin level on the current account deficit front.”

According to Narayan, “It is a clear positive and should do a lot to assuage market sentiment. The RBI seems to be reiterating that is ready to provide ample short-term liquidity but there never has been a shortage of liquidity, it is the tenure of the liquidity which has been a point of contention. However, RBI is not providing durable liquidity”.

“The current development does not directly address the stress related to corporate bond markets and redemptions there. At some stage, the RBI and Sebi might have to provide as they did in 2008 a window for providing liquidity against quality corporate bonds,” said Narayan.

“It is true that the banks would now have the ability to raise money from the RBI against excess SLR but they necessarily may not immediately want to lend against corporate bonds. All these measures help but does not solve the problem and need a separate solution,” said Narayan.

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KV Prasad Journo follow politics, process in Parliament and US Congress. Former Congressional APSA-Fulbright Fellow

Rupee & financial services market calling for different policy response, says Ananth Narayan

KV Prasad Jun 13, 2022, 06:35 AM IST (Published)

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Ananth Narayan, Professor at SPJIMR, spoke to CNBC-TV18 about the rupee depreciation and liquidity stress in the financial system.

“There is one level of confusion within the market with the rupee market and the stress in the financial services market calling for different policy responses,” said Narayan.

“The currency market is calling for higher interest rates, tighter liquidity, frugality on the fiscal side, austerity, less spending, so the current account deficit (CAD) does not blow out. While, on other side give the stress seen in liquidity, debt and some extent in equity market as well as stress in financial services system, I am sure North Block is inundated with calls for liquidity, lower interest rates, bailouts, all kind of reliefs. So the two are pulling in different directions,” said Narayan.

Talking about the liquidity situation in the market, Narayan said, “What the financial system requires is not money market liquidity but bond market liquidity, which can be provided separately. So, the currency market requirement for higher rates should prevail.”

With regards to what is transpiring in the MF market, he said,”The RBI would have to provide liquidity window for MFs like it did in 2008 because there could likely be large redemptions in debt market there is no liquidity in secondary markets to sustain that, said Narayan.

“It is important to reiterate that the overall fund debt quality is not bad, it is good, and any rumours need to be squashed,” he said.

“The nervousness in the market could continue as long as the RBI does not come and formally announce this special window,” he said.

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KV Prasad Journo follow politics, process in Parliament and US Congress. Former Congressional APSA-Fulbright Fellow