Trouble With Finmin

Independent-minded regulators are finding ‘toeing line’ tough

Slugfests Galore...

RBI Vs Finance Ministry - FM announces setting up of financial stability council; RBI questions impact on its autonomy

FM announces plan for debt management office; RBI not keen to relinquish control - Conflict over growth and inflation; RBI's task of inflation management opposes government view on high growth

SEBI Vs Finance Ministry - SEBI attacks insurance firms’ Ulips; FM forced to choose between insurance, market regulator

FM wants SEBI to defer decision on takeover code; SEBI does not comply Extension to SEBI chairman C.B. Bhave denied after being offered to him; FM unhappy with his ‘non-consultative' approach

“One reason Subbarao was chosen was he was a finance ministry man and as such expected

to reduce the friction.”  Ashok V. Desai, Economist

Politicians have always sparred with regulators; pulls and pressures are part of the great game that is governance. But over the past few months, there have been far too many slugfests between the finance ministry and two key regulators—the central bank, RBI, and the market watchdog, SEBI—for it to be classified as run-of-the-mill. Sure, there is a lot at stake, with a beleaguered finance ministry trying to battle (and fathom) the unprecedentedly high inflation. But there’s more: a cocktail of egos, politics and agendas has raised disturbing questions about the independence of Indian financial regulators. Take the long-standing friction between the RBI and finance ministry. When former finance secretary D. Subbarao took over as the RBI governor a couple of years ago, the perception was that given his association with the finance ministry, he would largely toe the ministry’s line. “One reason why Subbarao was selected to become RBI governor,” says economist Ashok V. Desai, “was because he was a finance ministry man and as such was expected to reduce the friction.”  Initially, it did work according to plan. Most economists agree that Subbarao’s gameplan to withdraw from measures taken to manage the global financial crisis worked well, in tandem with the finance ministry’s objectives. “I think the RBI’s current stance regarding growth versus inflation, an independent debt management office, even moving towards a monetary policy council model is more positional than actual,” says a senior economist, arguing that there’s enough to show the RBI is “toeing the popular line”.  This view does have some followers. “If the RBI really had to put its foot down, there’d have been a more aggressive handling of inflation rather than the baby steps the banking regulator chose,” says an economist. However, in a recent speech, Subbarao made it clear that inflation wasn’t the RBI’s sole headache. “It is not practical for the central bank to focus exclusively on inflation, oblivious of the larger development context.”  Many financial sector experts in private say that they always knew the inflation and growth numbers being flashed by the ministry and the central bank would never be achieved, because the research they did and the economic trends didn’t support it. Of course, the RBI has taken a harder position on inflation more recently, but the question being asked is why it didn’t do so earlier. Similarly, some hold the view that Subbarao’s recent comments of a legally backed autonomy for RBI is not a sign of the governor trying to assert himself but merely someone making the “right noises”. The RBI insists it has more to do with transparency and accountability. In a statement to Outlook, the finance ministry says: “That each regulator has operated with full functioning autonomy is revealed by the fact that so far government has not issued any directive to any regulator in the financial sector.” As part of its consultative process, it goes on to say, “the RBI also consults with the Union government.” The problems started showing up when Union finance minister Pranab Mukherjee announced the plan to set up a Financial Stability and Development Council last year. This caught RBI completely by surprise. The FSDC was to oversee all financial regulators, purportedly to iron out differences or overlaps between them. Subbarao pointed out his concerns towards this to the FM several times till he was made to head the FSDC.  “The problem lies in the legislation, framed in 1934, which governs RBI’s role and definition,” says economist Ila Patnaik. “Unless we redefine the RBI’s role, these differences will continue as both have conflicting objectives.” With uncertainty looming large on whether Subbarao will get a second inning on the completion of his term next year, many see his airing of independent views as an attempt to emerge from the shadows of his previous finance ministry bosses and colleagues, for a possible global role. But there is another angle to this verbal to and fro. It was former finance minister P. Chidambaram who pushed for Subbarao’s appointment as RBI governor. It is believed that the differences of opinion between Chidambaram and Pranab Mukherjee have made RBI’s relationship with North Block even stickier. Given that Chidambaram has been facing some heat for “procedural irregularities” in the 2G scam, there could be an attempt within the finance ministry to distance itself from his former finance secretary Subbarao. As Dr M. Govinda Rao, member of the PM’s Economic Advisory Council, puts it, the discordant notes emerge as “everybody wants to safeguard their own turf and hold their own views”. A similar conflict has played out between former SEBI chairman C.B. Bhave and the finance ministry.  According to media reports, the idea of offering an extension (something Bhave had agreed to) was withdrawn after Omita Paul, advisor to the finance minister, sent a note stating that there was no need to take a decision on Bhave’s extension a year before. “Giving extension to SEBI chairmen is an exception and not the norm,” says the finance ministry statement to Outlook. The point to note here is that Chidambaram pushed for Bhave to take over as SEBI chief despite his having been the head of the National Securities Depository Ltd (NSDL) during the ipo scam in 2007. Although Bhave did recuse himself from the investigation of the case, the Supreme Court has recently raised questions about Bhave’s involvement with NSDL at the time of the IPO scam. More recently, after his retirement, the CBDT asked Bhave to furnish his tax records from before the time he took over as the SEBI chairman. Although CBDT called the matter “routine”, several market experts have questioned the timing of the move and pointed out that Bhave is coming under fire due to his rocky relationship with the finance ministry towards the end of his tenure.

Both these cases show how politics is undermining our regulatory agencies. And that’s not healthy. Remember, a lot of the credit for India emerging unscathed from the global financial crisis went to former RBI governor Y.V. Reddy holding out against the finance ministry.

Exim Bank negotiating $100-m loan from ADB

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Inflation a major challenge, says Pranab

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Stepmotherly Central Bank – Ashok Desai

The shortage of currency in eastern India can only profit its enemies who export fake notes into the country

The people of Calcutta probably did not notice their good fortune, but they were recently the object of specially warm feelings from the country’s central bank, no less. Shyamala Gopinath, the Deputy Governor of the Reserve Bank, descended upon the city and inaugurated an outreach programme designed for the city. Its subject was “Foreign Exchange for You”. Just why Calcutta was chosen for this honour is not recorded.  Maybe the Reserve Bank felt it had neglected the city. Maybe it noticed that Bengalis are inveterate travellers, but are not sufficiently attuned to holidays abroad. Maybe it found out that most travellers were perfectly comfortable dealing with whisperers in the alleys behind New Market and were not entering the portals of banks to buy foreign exchange. Or, more likely, the Reserve Bank decided that it had too much foreign exchange in its coffers and decided to do some market development. For on the day of her visit, the Reserve Bank was sitting on a pile of Rs 1,234 thousand crore of various foreign currencies, apart from gold in its underground vaults that it valued at Rs 102 thousand crore, Rs 20 thousand crore that it was entitled to take from the International Monetary Fund as Special Drawing Rights, and Rs 13 thousand crore that it could bring back if it decided to withdraw from the Fund. That is Rs 11,000 for every inhabitant of the country; if RBI invested the money wisely and shared the returns with the people who are supposed to own it, each of us would get a pink note worth Rs 1,000 every year. But since Mrs Gopinath was not handing out the cheques, no queues were seen outside the National Library before her talk or after. Since the ardent travellers of Calcutta took no interest in her visit, they missed the chance of asking Mrs Gopinath a question: why does it force banks to give Indians travelling out of the country currency notes for a fifth and travellers’ cheques for the rest of the foreign exchange it allows them to take? Why can they not take all the money in currency notes? The only reason can be that the Reserve Bank is a generous mother of banks, and likes them to make a profit on the travellers’ cheques they sell. But maybe its motives are less maternal, for the travellers’ cheques themselves are issued by a clutch of foreign companies such as Visa and American Express; just what kinship exists between them and the Reserve Bank is not known.  The man on the street in Calcutta does not go off to the beach in Hawaii or the ski slopes of Vancouver. He would have liked to ask Mrs Gopinath a different question. Why is it that no taxi driver in Calcutta gives change? Why are currency notes its shopkeepers hand out so filthy and stinking? Why is there such a shortage of currency in eastern India? Arguing analogically from the case of travellers’ cheques, it would seem that the Reserve Bank is in cahoots with all the petty traders in the east. Despite the Reserve Bank’s best efforts to feed paranoia, such an alliance is inconceivable. It is more likely that there are some people in the east who love to remove currency from circulation. Since currency bears no interest, their love would seem irrational. But it is possible that there is some shortage of currency in regions east of India, and that their inhabitants use Indian currency for lack of better options.  It is surprising that their preference has not come to the notice of the agency believed to be situated in Pakistan which is reputed to print excellent fake Indian notes and use them to finance terrorists, smugglers and simple cross-border traders. After all, maintaining former and future terrorists and saboteurs can be expensive, and keeping them secure from mullahs, jehadis and other religious entrepreneurs is difficult. It is better to send such useful seditioners to India and deliver to them every month a pension in brand new Indian currency. It is important that the Reserve Bank acts before the said agency and increases the supply of currency to eastern India, so that this hitherto patriotic part of India does not succumb to the profits of sedition.  More seriously, the shortage of currency is one symptom of the general shortage of credit in eastern India. Outsiders who visit it would notice the profusion of small shops; in some parts they are so numerous that there is no space for pedestrians to walk. But they would also have noticed how scanty and poor the stock of all these retail outlets is; if they ask, they will discover that none of the shops has a penny of credit from banks. The Reserve Bank should persuade its daughters to end their stepmotherly treatment of the east.

The author is Consultant Editor of Businessworld.

Malegam’s Microfinance: The Last Laugh

The priority sector tag for MFIs could become a contentious issue in the days ahead

Microfinance, for some strange reason, is suddenly on the receiving end. All these emanate from the priority sector lending tag. If only RBI had considered what was purportedly in the “confidential” V.K. Sharma committee report on Priority Sector Notes (of removing microfinance from the priority sector category), there was no need for Malegam Committee recommendations...............

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RBI is shooting itself in the foot over inflation

The #1 problem of Indian macroeconomic policy is the inflation crisis. From February 2006 onwards, in every single month, inflation has exceeded the target zone of four to five per cent. I’m measuring inflation as the year-on-year change of the CPI-IW (Consumer Price Index for Industrial Workers). The latter is the best measure of the overall price level in India today.  This macroeconomic instability is damaging the ability of economic agents to plan and invest for the future, because it’s hard to envision interest rates and prices when faced with such high uncertainty. High inflation thus damages growth.  Many people in India like to make excuses about inflation. One day, inflation is about the price of onions. Another day, inflation is about a global commodity shock. Many people like to open up the sub-components of WPI (the Whilesale Prices Index) and explain away inflation by saying “but it’s only concentrated in a few things which make up X percent of the overall basket”. And so on. While each of these idiosyncratic factors can generate relative price changes, they cannot explain sustained price rise of the overall household consumption basket. Sustained and persistent inflation is not an act of god. It is made by mistakes in macroeconomic policy. It can and should be contained by solving these problems of macroeconomic policy.  On 3 May, Dr Subbarao (the Reserve Bank Governor) announced a fairly good policy statement. It continued to talk about WPI while the best inflation measure is the CPI. But for the rest, it was the first time that the RBI was starting to take the inflation crisis seriously. And that was good. Also see an Indian Express column by Ila Patnaik on 6 May. Sadly, RBI’s commitment to the problem of inflation lasted for six days. On 9 May, Dr Subbarao did a speech in Switzerland which essentially robbed RBI’s stance of credibility. Ila Patnaik has a column in the Indian Express about the damage that this speech has caused. You might like to also see this old column of mine on the problems of RBI. Consider the date on which the rate hikes began. Compare two alternative worlds:• In one world, RBI says: “We care about inflation, we will do what it takes to get y-o-y (year-on-year) changes of the CPI-IW back to the target zone of four to five percent”. And the rate is hiked by 25 bps (100 bps make 1 percent). And this is repeated a short while thereafter. And so on. In this world, the expectations of economic agents get modified alongside the rate hikes. • In another world, every time RBI raises rates, RBI says “actually we are not so serious about inflation”. In this world, the expectations of economic agents do not get modified alongside the rate hikes. • Monetary policy works by directly crimping aggregate demand (e.g. driving up the EMIs that people pay (on housing loans), or the cost paid by firms for working capital) and by reshaping expectations and thus the decisions about wage/price hikes. By damaging the latter, the RBI has imposed more of the heavy lifting upon the former. What does it take for the RBI to persuade us that they are serious about inflation? Commitment to the floating exchange rate (thus removing this conflict of interest that can damage monetary policy), movement on the debt management office (DMO, thus removing another conflict of interest that can damage monetary policy), and sound monetary economics going into speechwriting (and future monetary policy formulation). By failing on all three scores, the RBI is generating a situation where there is no commitment that in the future, it will fight inflation.  Whether the RBI wants it or not, India will fight this inflation crisis, which is the #1 cloud on the horizon of India’s macroeconomic policy. The politicians require CPI-IW inflation to be back to the four-to-five percent zone by late 2013, well in time for the elections in 2014. The pressure is simply going to ratchet up. The only question is about how monetary policy will fight inflation. If the instrument of monetary policy is refashioned to fight inflation, then the amount of pain that has to be inflicted through rate hikes, that is required to get the job done, will be lower. If the instrument of monetary policy is mis-managed, then a bigger set of rate hikes are required to get the same thing done.  In the medium term, the RBI needs to build a team of top quality economists, who gain street cred by exuding knowledge of monetary economics. In the short term, the least that is required to be done is to stop the flow of low quality speeches.

Bats for financial inclusion

Union Finance Minister Pranab Mukherjee said on Saturday that one of the challenges in the financial sector that India faces today is the limited reach of financial services among the poor and vulnerable sections of the society. “Financial inclusion is a key determinant of sustainable and inclusive growth, which in turn is essential for building an equitable society. Financial inclusion is important as it provides an avenue to the poor to bring their savings into the organised financial system. It gives them an avenue to remit money to their families in villages, besides weaning them away from the clutches of the exploitative money lenders. It is essential to extend banking services to the rural hinterland at the earliest, so as to integrate those regions with the growing India,” said Mr. Mukherjee while launching social banking initiatives of Union Bank of India here. The Government has asked banks to provide banking facilities to habitations having a population of over 2,000 by March 2012. Banks have identified about 73,000 such habitations for providing banking facilities using appropriate technologies. A multi-media campaign, “Swabhimaan”, has been launched to inform, educate and motivate people to open bank accounts. During 2010-11, banks have covered about 29,000 villages. The remaining villages are to be covered during 2011-12.  Many a time lack of communication, awareness and language barriers creates a demand and supply gap for the financial services. This has to be addressed.

RBI must opt for soft inflation targeting

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Rising NPAs are a concern: Pranab