A monetary fix for inflation - Rajiv Lall

Confusion remains over the reasons why inflationary pressures in India have not abated. The spread of inflationary pressure from just a basket of commodities and food items to general manufacturing seems to have caught even the Reserve Bank of India (RBI) by surprise. What has caused this acceleration in “core inflation”? Answering this question is key to evaluating RBI’s response and to understanding the desired future course of policy action.  There are at least four hypotheses doing the rounds. The first is that supply shortages led to a spike in food prices that is now baked into inflationary expectations. In this view, the solution lies in dealing with supply bottlenecks, not in raising interest rates. The second is that there is an inflation growth trade-off such that higher growth is sustainable, but at a higher equilibrium rate of inflation. For a shining India, an inflation rate higher than its historical average is the new normal. The third is that the impact of rising oil prices has been transmitted to the Indian economy. In this view, there are no good monetary policy choices— should high international prices of oil persist, we are headed for a period of stagflation. The fourth is the great QE2 theory. In this view, waves of international liquidity crashing into emerging markets in search of superior returns are causing currencies to appreciate and/or economies to overheat.  None of these hypotheses is fully credible. The evidence that supply bottlenecks were widespread enough in 2008-09 to cause a sharply elevated inflation rate for a broad basket of food items is not compelling. There is also no reliable evidence that we can buy higher sustainable growth with a higher equilibrium inflation rate. While domestic inflation rates and international oil prices appear correlated, domestic controls on petroleum prices make the pass-through effect less obvious than it seems. As for the impact of capital inflows from abroad, these did contribute to a surge in domestic liquidity in the run-up to the 2008 Lehman crisis, but have not been a factor since.  A good old-fashioned monetarist framework is the most useful for understanding what is happening. The simple premise of the quantity theory of money is that for a given velocity of money, the higher the growth rate of money supply relative to the real gross domestic product (GDP) growth rate, the higher the inflation rate. In this framework, ensuring that monetary aggregates stay within an estimated equilibrium growth rate is key to controlling inflation. But estimating this target growth rate depends on the predictability of the demand for money, which in turn depends on the stability of velocity.  Most emerging markets experience prolonged periods of financial deepening, which is to say, periods of declining velocity of money such that the non-inflationary equilibrium stock of broad money (M3) relative to GDP keeps rising over time. Thus in India, between 1997 and 2010, the ratio of bank deposits to GDP rose steadily from about 40% to more than 75%; inflation at the same time was a reasonable 5%, even as bank credit grew at an average rate of 19% a year. But something changed in 2010. Even though credit growth remained within the historical range deemed compatible with non-inflationary GDP growth, the average inflation rate accelerated to 9.5%, well above the average of the previous decade. Something has caused the predicted relationship between M3 growth and GDP to break down. Starting in 2010, the M3/GDP ratio came down for the first time in over a decade (see chart). It seems that the economy was experiencing a bout of financial shallowing. Since then, the income elasticity of demand for broad money has fallen instead of rising, suggesting a degree of disintermediation from the formal banking and financial systems.  But what could have caused this? I think the culprit is the type of fiscal stimulus unleashed in the wake of the 2008 crisis. In response to the crisis, the government aggressively expanded social spending through schemes such as the Mahatma Gandhi National Rural Employment Guarantee Scheme. There is no data on how much “leakage” there is in such spending. But by all accounts, there has been substantial diversion of funds, which over a period of 12-18 months have found their way into the cash economy rather than being intermediated through the banking system. This phenomenon has caused a liquidity shortage in the formal banking system, even as currency in circulation has grown at a faster pace than commensurate with the demand for cash balances. This is what has caused inflation to accelerate.  Under the circumstances, as long as the government remains unwilling to rein in its subsidy-related spending and reduce the associated leakages, the burden of action will fall upon RBI. Ideally, RBI would want to reduce the growth in currency without choking credit off-take. In this context, raising the interest rate on savings accounts was exactly the right policy measure. This should attract more deposits into the banking system from the cash economy, making more liquidity available for banks to lend. But should the behaviour of small depositors prove to be rate-insensitive, RBI would have no choice but to further drive down the demand for credit. They would be forced to crowd out private investment demand to accommodate lower quality government funded consumption spending. That would be unfortunate. I hope the finance minister takes note.

Rajiv Lall is managing director and chief executive officer IDFC Ltd

UID-enabled bank accounts in 2-3 months

These accounts assume significance as govt, in future, may implement direct transfers of subsidies through banks.

 New Delhi: India will see at least five million bank accounts being opened in the next two to three months, mostly in rural areas, thanks to the government’s ambitious Unique Identification (UID) or the Aadhaar programme, according to Ashok Pal Singh, deputy director general, Unique Identification Authority of India (UIDAI).  The programme, which gives out unique 12-digit UID numbers and maintains a database of the personal details of individuals, including biometric information, has thus far given out 6.58 million numbers. While enrolling people, one option it gives them is to open a bank account to which the UID number will be linked.  The UIDAI has empanelled a total of 64 banks of which 25 are state-owned banks, 12 private banks and one foreign bank. The rest are regional rural banks and cooperative banks. These banks—State Bank of India, ICICI Bank Ltd and Citibank are among them—will be given access to data of customers who have enrolled for Aadhaar and want to open a bank account.  According to Singh, around 80-85% of the people so far enrolled by UIDAI don’t have a bank account and have asked for one. According to the Reserve Bank of India data, only 40% of the country’s population has access to banking facilities. Singh and another UIDAI official, who also did not want to be named, said the banks would have to open the accounts within the next two to three months. “Once the data is shared with the banks, they will have to open the accounts within one month,” said Singh.  A senior official from State Bank of India said the bank will be able to open accounts within the stipulated time frame. “We already open bank accounts in rural areas through our own branches. The only difference will be that volume of accounts will be higher when opened through Aadhaar. But we should be able to manage it using a mix of our branches and banking correspondents,” he said.  Aadhaar-linked bank accounts assume significance also because the government has set up a committee to look at the issue of direct transfers of subsidies and benefits. The committee is headed by UIDAI chairman Nandan Nilekani and is expected to submit its report by June. Indeed, UIDAI told the banks it was empanelling that their systems should facilitate direct transfers to the accounts of beneficiaries. “Apart from the clear benefits from the cash transfers of subsidy, Aadhaar-enabled bank accounts will bring large masses of people into the net of banking services; banks were earlier incapable of doing so (opening accounts) for the want of proper documentation,” said Sunil Chandiramani, partner and national leader, government services, at audit and consulting firm Ernst and Young, an adviser to the project. His reference is to so-called KYC, or know your customer norms that banks need to follow while opening an account. The government has since mandated that an Aadhaar number will suffice.  The Reserve Bank of India (RBI) has said that banks will have to cover villages with a population of 2,000 and above by March 2012; this adds up to around 73,000 villages.  It asked banks to cover 20,000 villages in 2010-11 and the remaining 53,000 villages in 2011-12. In 2010-11, the banks covered 29,000 such villages.  People opting for a bank account while enrolling with UIDAI may not always be able to choose the bank that serves them. If a bank adopts a village under RBI’s financial inclusion plan or only one bank is empanelled in that area, then that is the bank that will serve customers in that area. In other areas, customers can choose between banks which are empanelled for that particular district.

Subbarao spars with Montek on policy approach

The audience for Montek Singh Ahluwalia's lec ture at Mumbai's Indira Gandhi Institute of Develop ment Research (IGIDR) was in for a rare intellectual treat with Reserve Bank of India Governor D. Subbarao exchanging words with the Planning Commission's Deputy Chairman on the Plan panel's ambitious tar- gets and the means to finance these.  In his speech, Ahluwalia highlighted the need for a $1 trillion investment in infra- structure creation for India to continue to grow at 9% over the next five years. Ahluwalia's speech on the challenges in the 12th Five-Year Plan was the second foundation day lecture at IGIDR. Subbarao, the chairman of the board of IGIDR, responded to Ahluwalia's comments, and said, in his concluding re- marks, that government and bank financing could generate only half the $1 trillion re- quired over the course of the 12th plan that starts in 2013. India's central planning pro- cess is done in five-year phases. In the current budget, less than $150 billion has been al- located to capital investments and it will not be easy for the government to scale up finance needs of infrastructure, the country's top central banker said.  “Our regulation governing infrastructure finance is among the most accommodative in emerging markets,“ said Subbarao. Bank lending to infrastructure is already stretched and more loans to the same sector might affect financial stability, he added.  Subbarao also differed with Ahluwalia when it came to the government's ability to cut spending. In his speech, Ahluwalia indicated that a 9% target was achievable and outlined the government's efforts at raising plan expenditure over the 12th Plan period while consolidat- ing its finances by cutting down on non-Plan expenditure.  Subbarao questioned the government's ability to do so and said it might not be feasi- ble to cut down non-Plan expenditure. He pointed out that a significant part of non-plan expendi- ture is used to pay salaries to teachers, doctors and for maintenance of irrigation projects - all of which are needed for development. In the annual credit and monetary policy review re- leased on 3 May, RBI projected a less optimistic growth target of 8% for fiscal 2012, compared with the finance ministry's tar- get of 9%. Finance minister Pranab Mukherjee recently ad- mitted that a 9% target could be difficult to achieve. The governor didn't spare the finance ministry either and took issue with the latter's arguments, presented in the Economic Survey, that a high in flation rate may be the new normal and an acceptable outcome of high growth; he re- affirmed his commitment to an inflation rate below 5% over the medium term. This year's Economic Survey had pointed out that in evaluating the trade-off between lower inflation and lower growth, policymakers often fail to take into account the impact that inflation control measures could have on unemployment. Such an argument does not hold true in most parts of the world and certainly not in India when inflation is as high as it is, said Subbarao, citing research by the central bank's economists.

Microfinance after Malegam – M.S.Sriram

The new realities, predicated on RBI’s acceptance of the Malegam framework, are yet to hit microfinanciers.  By accepting the spirit of the Malegam panel report, the Reserve Bank of India (RBI) has taken a step away from its regulatory approach towards the financial sector and from its approach towards microfinance. This step, of controlling interest rates and margins, has been introduced at a time when RBI governor D. Subbarao has indicated his “bias” for deregulation of interest rates on savings accounts (Mint, 4 May). For once, RBI has put the brakes on microfinance institutions (MFIs), after having allowed them to grow at an uncomfortable pace. While the central bank has removed the sting from the Malegam recommendations by moving the interest cap to 26% and the margin cap to 12%, the step is myopic. These controls are applicable to organizations that want to avail resources from the priority sector lending window. For others, it could be business as usual.  In accepting this framework, RBI has only partially addressed the issue of client protection that led to the Andhra Pradesh crisis. The central bank’s notification gives choice to the borrowers on repayment periodicity; it remains silent on coercive recovery practices.  It protects clients by putting Rs. 50,000 as an upper ceiling for credit—a measure that freezes the poor households’ enterprise at one buffalo and a fraction of the price of a good hybrid cow. Given that there are no mezzanine institutions that can fill in the gap after this limit, RBI is in effect punishing poor households emerging out of poverty under the guise of protection. It would have been desirable to peg the limit at Rs. 2 lakh, which is RBI’s definition of small borrowal accounts. This would have given MFIs the scope to innovate and cross-subsidize between their large and small borrowers. MFIs which are on the treadmill of small finance, quick turnaround, efficient operations and scale, will benefit from the move. The regulation is loaded against small MFIs that cannot negotiate cheap finance and maintain costs in the 12% band. If this regulatory framework continues, we will see substantial consolidation in the industry.  One recommendation—that MFIs should have a minimum capital of Rs. 15 crore—does not appear in RBI’s notification. The central bank is known for its bias for large organizations, so that regulation becomes viable. We will see action on this front after the Usha Thorat committee submits a report on the comprehensive review of the legal and regulatory framework of non-banking financial companies. With the interest and margin caps, there are implications. The margin cap would push MFIs towards automation, efficiency and cost cutting. The first to face the brunt will be the credit officers whose alternatives at this time are limited. They would see a drop in their incentives.  Also, with so much of chatter around profiteering from the poor, MFIs may limit the shareholder returns to benchmark with the banking industry. The benefits of the efficiency gains will disproportionately move to the top management, as current compensation rather than equity options. The exuberance of the investors will be moderated. Microfinance is no longer a hot destination for private equity/venture capital/hedge funds. The possibility of diversified income is limited by the other conditions, and we can expect private sector investments in MFIs to slow. With an income condition for the client (upper ceiling of annual income of Rs. 60,000 in rural areas and Rs. 1.2 lakh elsewhere), MFIs that fall within the priority sector ambit will move away from rural locations. While this difference appears to recognize the difference in the purchasing power and income opportunities in urban locations, it is negated by the common upper limit amounts and the tenor of loans.  While openly welcoming the new regulation, several actors may not have internalized the implications in the way the details are tucked in:

i) The loan amount cannot exceed Rs. 35,000 in the first cycle and Rs. 50,000 in subsequent cycles;

ii) Loans exceeding Rs. 15,000 should have a tenor of more than 24 months;

iii) 75% of the loans are to be given only for income-generation purposes.

The exposures of MFIs usually carry a one-year tenor, effectively putting an individual loan-size cap of Rs. 15,000. The chief beneficiaries of this policy are the auditors who would certify that:

i) The income of the borrowers representing the “qualifying asset” is less than specified limits;

ii) At least 75% of the borrowers’ indebtedness is on a productive loan;

iii) That 85% of the assets are “qualifying assets”.

RBI might not have had the time to see how much the auditors would charge to give these certificates, and whether these verification costs (over and above high delivery costs) can be covered within the ceiling of the 12% margin limit between borrowing and lending rates that the central bank has fixed.  The benefits of the priority sector loans may not be commensurate with the costs of complying with the conditions. Even if the average cost of borrowing is around 14%, and an MFI gets an yield of 26-30%, it may not want loans under the priority sector. However, the question is whether the banks will lend to these institutions if they shed the microfinance tag. Even if they do, will the pricing be attractive? We have to wait for the bullishness of MFIs to wane and the reality to hit them. That is a while away. 

MS Sriram is an independent researcher and consultant, and former professor at the Indian Institute of Management, Ahmedabad.

For a good central bank

The Economist once wrote that the only good central bank is the one that can say no to politicians. On Monday, the cautious D. Subbarao, governor of the Reserve Bank of India (RBI), came as close as he could to saying that. In his comments at the meeting of the central bank governance group in Basel, Subbarao, among other issues, argued for creating a formalized monetary policy committee (MPC) architecture. The situation today is that while the governor is advised by a technical advisory committee, the final call on setting the policy rate is his alone to make. A proper MPC—which should include the governor, the four deputy governors along with outside experts—would give binding advice on setting of policy rates to the governor. The RBI chief said a precondition for this was to get legally backed autonomy for the central bank, something that the RBI Act 1934 does not provide.  While RBI’s ability to steer independent monetary policy is, by and large respected, there is, however, a catch. Between the arm-twisting by the Union government that the RBI Act enables and legally backed autonomy, there is a wide and opaque space for jousting between the government and the bank. The exact balance depends on circumstances. This is hardly the stuff of rule-based monetary policymaking. The case for independent central banking rests on one fundamental economic reality: in the long run, there is no trade-off between inflation and growth. And the conclusion is that there is no case for political decision making in this domain. In India, there is disbelief among politicians that this is so. It is only for the past 14-15-odd years that the central bank has been allowed to set policy rates without extraneous considerations. Left to their devices, finance ministers would stitch together a patchwork of short-term trade-offs between growth and inflation and call it policymaking. With frequent elections at the state and Central levels, this can only lead to economic chaos and it has for long. So far, the Union government has never seriously implemented rule-based fiscal policy. The Fiscal Responsibility and Budget Management Act was jettisoned at the first opportunity in the name of crisis management. If, however, the central bank were to have an MPC framework with formal autonomy, things could change. Once the central banks set policy rates only with a view to fighting inflation, it could potentially nullify the gains the governments hope to make politically by reckless spending. The short-term growth inflation trade-offs could become history. The Union government is unlikely to listen to Subbarao, but a future reform-minded government could well undertake the necessary steps.

WHY THE HURRY TO HIKE LOAN RATES

Quite a few banks last week raised their loan rates. Unlike in the past, this time around, the quantum of hike is half a percentage point. This should make Reserve Bank of India (RBI) governor D. Subbarao happy as he has been harping on faster transmission of the monetary policy. The central bank raised its policy rate on 3 May by half a percentage point. Normally, banks take time to pass on the higher cost of borrowing to consumers and there have been instances in the past when despite RBI hiking its policy rate, banks did not raise their loan rates. Apart from raising its policy rate, RBI also raised the rate of interest that banks pay to savings bank account holders by an identical margin. This has pushed up the cost of savings deposits immediately. When they raise rates on their term deposits, it takes time to feel the impact as only the new deposits earn higher rates while the existing deposits continue to be priced at old rates till they mature. While the industry’s savings account portfolio is roughly about 22% of the overall deposit kitty, the impact on individual bank’s cost varies between 10 basis points (bps) and 15 bps, depending on their composition of deposits. One basis point is one-hundredth of a percentage point. This apart, higher provision requirement for bad loans and restructured loans will also affect banks as they need to set aside more money for such assets. The combination of all three—a hike in policy rate, savings rate as well as higher provision of bad assets—has made money more expensive and banks have no choice but to raise loan rates instantly. Following this, their loan growth will probably slow and quality of assets, too, may deteriorate as some firms may find it difficult to service higher interest cost. The Indian banking industry’s loan book grew 21.4% in fiscal 2011, higher than RBI’s projection of 20% growth. In 2012, RBI wants banks’ credit growth to be 19%. A drop in credit growth will bring down banks’ interest income and, on top of that, if their bad assets grow, they will have to set aside more money to provide for them. This will affect their profitability unless they find ways to bring down their cost of operation and become extra-sensitive to the quality of assets. This means a close monitoring of all loan accounts and a very strict appraisal of new loan proposals. They can earn high interest rate from a loan given to a relatively weak corporation but such an exposure runs the risk of loan default. If that happens, a bank not only stops earning interest on that loan but also is required to set aside money for such an asset. RBI allows banks to restructure bad loans (so that they do not need to provide for them) when there is an economic downturn but no such concession is given when loans turn bad because of indiscreet lending. So 2012 could be a year of conservative banking with a hawk eye on quality of assets, operating cost and fee income. The impact of the policy rate hike is sharper on short-term money. For instance, the yield on 10-year benchmark government bond rose from 8.14% on 2 May, a day before the announcement of monetary policy, to 8.25% on 5 May, but the three-month treasury bill yield, during this time, moved from 7.52% to 7.95%, and that of one-year treasury bill from 7.76% to 8.20%. Bond yields dropped on Friday, 6 May, as a sharp fall in commodity prices encouraged the market to bet on a lower inflation. The price of crude dropped around 12% last week. A bond auction on Friday, the first after the policy rate hike, saw good demand from buyers and no dramatic change in yields. This is good news for the government as there will not be any drastic rise in its cost of borrowing. The Indian government plans to borrow Rs.2.5 trillion from the market in the first six months of the fiscal year till September, 60% of its Rs.4.17 trillion annual borrowing programme. The February budget has pegged the government fiscal deficit for the year at 4.6%, and the money raised from the market will bridge the gap. Analysts are sceptical about the fiscal deficit target as the budget has not made adequate provision for crude oil, fertilizer and food subsidies, and a lot will depend on the crude price movement. For the time being, though, the government is tiding over its short-term cash mismatches by raising money through cash management bills. It raised Rs.32,000 crore in the first five weeks of the fiscal year through such bills and also raised the size of weekly treasury bill auctions. This extra borrowing has, however, got nothing to do with fiscal slippage. It’s just to take care of cash mismatches due to changes in the government’s spending pattern. It is making income tax refund faster to corporations, which, till recently, used to take around six months. Indian firms pay advance tax every quarter on their projected profits and in case the payment turns out to be higher than what they should have paid, the government refunds the difference. RBI will have wholesale price inflation data of April and May, and factory output data of March and April, apart from the gross domestic product figure for the January-March quarter to look at before taking a call on yet another rate hike when it announces its mid-quarter review of monetary policy in mid-June. Of all these, the most critical data to watch out for is non-food manufacturing inflation, which rose to a two-and-a-half-year high of 7.1% in March. The policy rate will probably be kept at a higher level than non-food manufacturing inflation.

Did You know ? | Soon, you’ll get online alerts for all types of card transactions for all amounts

Earlier banks were mandated to send online alerts to cardholders for all credit as well as debit “card not present” transactions for values of Rs 5,000 and above. As per the Reserve Bank of India’s (RBI) circular, you will soon get online alerts for any transaction you make through your debit/credit card, irrespective of the amount, at various channels. RBI has asked all commercial banks to take steps to put in place a system for such online alerts by 30 June 2011. This will make tracking payments a lot easier for you.  Until the guidelines were issued, banks were mandated to send online alerts to cardholders for all credit as well as debit “card not present” transactions (when you are not physically present for the transaction such as during online shopping) for values of Rs. 5,000 and above. So if you used your credit or debit card at an online shopping website and the transaction amount was Rs. 5,000 plus, you got an online alert. As per the latest guideline, irrespective of the fact whether it is a “card present transaction” (where you are physically present such as at the automated teller machine or ATM) or a “card not present” transaction, you will get an online alert. This alert is applicable on transactions made over the interactive voice response (IVR) and point of sales (PoS) as well. The mode of sending online alerts has been left to the banks. So you could get email alerts as well as SMS alerts if your email address and mobile number are registered with the bank. The good part is that most banks are already sending alerts to their customers. For instance, ICICI Bank Ltd and Axis Bank Ltd.  Many customers have direct debit facility activated on their credit cards—to pay utility bills or even insurance premiums. In such cases, too, the bank will send an online alert. A few banks are already providing such a facility.  There is no doubt that online as well as offline financial fraudulent deals are on the rise. In fact, according to RBI, unauthorized and fraudulent withdrawals at ATMs have also been noticed recently. This step will help arrest possible fraudulent activities on your cards, besides helping you track your payments.

Why the delay in new bank licence norms?

The delay, it seems, is deliberate, and neither the government nor RBI is too keen to welcome a new set of private banks in a hurry.  India’s banking regulator is yet to release draft guidelines on licensing norms for new banks. Finance minister Pranab Mukherjee first announced the government’s intention to allow a set of private firms in the banking space in his February 2010 budget speech, surprising the Reserve Bank of India (RBI), which was till such time pushing for consolidation in banking. More than a year later, there is no sign of the draft rules even after Mukherjee said in this year’s budget speech that RBI would issue guidelines on new banking licences by 31 March. This has not happened because the finance ministry is not happy with the draft prepared by the central bank. It wants too many changes. RBI first prepared a discussion paper on the subject in August and sent the first draft guidelines to the ministry ahead of this year’s budget. But the ministry has not cleared the guidelines yet. It is pushing hard for the regulator to make some changes—big and small—and RBI is willing to accommodate some but not all. We don’t know when the regulator will be in a position to release the draft guidelines. Let’s take a look at the suggestions of RBI. I have not reviewed the draft guidelines prepared by the central bank, but from various sources who have direct and indirect knowledge of what it contains, I understand that RBI is ready to allow big industrial houses to set up banks if it gets the power to supersede boards of banks that are not being run properly. It also wants the right to oversee the operations of the promoting company and any affiliates that will have business relationships with the bank. This is being done through an amendment of the Act that governs banking in India. Mukherjee in his February 2011 budget speech promised the changes in the Act, and the proposed amendment to the Act was tabled in Parliament during the budget session itself. Currently, RBI does not have the power to dismiss a bank board, but under section 45 of the Banking Regulation Act, 1949, it can force the amalgamation or merger of a bank with another, and force a reconstruction of the board to protect the interests of depositors, shareholders and employees. RBI is also in favour of an industrial group setting up a holding company to own the bank and other financial services companies of the group, keeping the manufacturing and trading business out of it. This will help the Indian central bank regulate the group better. The so-called wholly-owned non-operative holding company, according to the draft, should be registered with RBI as a finance firm and governed by a separate set of prudential guidelines. Those industrial groups that will be allowed to set up banks will have strict restrictions on exposures to other group firms. The regulator is not comfortable giving a licence to any industrial group that gets 10% of its income from real estate or the broking business. The minimum capital a new bank would need is pegged at Rs. 500 crore, and the RBI paper that is lying with the finance ministry also insists that the new banks need to be listed within the first few years. Among other things, the draft guidelines outline how much the foreign shareholding should be in a new bank, and how fast the promoter needs to pare its stake from 40% to 15%, and says rural branches should constitute one-fourth of the branch network to ensure the spread of banking services. Although the new private banks that have been functioning are required to have at least 25% of their branch network in rural and semi-urban India, most have focused only on semi-urban centres and have ignored rural India. This time around, RBI does not want to take any chance, and it wants the new banks that will be given licences to spread banking services in even remote and thinly populated villages. I am told that the finance ministry is not comfortable with RBI’s suggestions on paring the promoter’s stake within the first few years as well as capping the foreign stake. It also does not want RBI to be bluntly saying that no industrial house with exposure to the real estate sector will be allowed to set up banks, even though it appreciates the spirit behind it. Similarly, it is not very excited about the central bank’s insistence on rural banking and tough talk on superseding bank boards. I don’t know when the finance ministry will finally give its green signal. After its nod—and necessary changes—RBI will release the draft guidelines, seeking public comments. It will take a few months more to prepare the final guidelines. And all applications seeking banking licences will be examined by an external group before RBI considers them. I will not be surprised if we hear Mukherjee in his February 2012 budget speech reiterating his commitment to allow new private companies to establish banks. What is not clear is: why did RBI have to send the draft guidelines to the finance ministry? After all, it’s a mere draft, and it will be finalized only after receiving comments and feedback from various quarters. Couldn’t RBI have gone ahead with the draft guidelines and taken into consideration the government’s feedback before finalizing it?  There are various theories doing the rounds. One is the regulator’s reluctance to be solely responsible for drafting the guidelines for the most critical segment of the financial segment when the second-generation spectrum licensing scam is emerging as the largest political corruption case in India. For the same reason, the government also is not in a hurry to push new banking licences, many in Delhi say. The delay, it seems, is deliberate, and neither the government nor RBI is too keen to welcome a new set of private banks in a hurry.

Why India overheats

The finance ministry has left something conveniently unsaid: 9% growth at what inflation rate?  The inflation problem continues to fox economists and unsettle ordinary Indians. However, the metaphorical man on the street seems to have had a better sense about the soaring arc of prices than the men and women with econometric models.  A year ago, the overwhelming consensus among Indian policymakers and private sector economists was that inflation would begin to decline to more reasonable levels in the quarters ahead. For example, the Reserve Bank of India (RBI) had said in April 2010 that inflation would be at 5.5% by the end of the fiscal year. Meanwhile, the 4,000 urban households that the central bank surveys each quarter to assess their inflation expectations were more pessimistic. They had indicated in December 2009 that inflation would be in double digits in the first three months of 2011.  The latest inflation numbers for February show that the man on the street was closer to the correct estimate than the economists. Prices continue to surge. Inflation hovers around double digits. The revised inflation number for January is 9.4% and the first estimate for February is 8.98%.  One explanation why households have got a better handle on the trajectory of inflation than the experts is that information distributed in a complex system such as an economy is better captured by a large group of people than a single model: the wisdom of the crowds. A less Hayekian explanation is that the man on the street was just plain lucky, a factor that has a greater role to play in the prediction game than most participants would accept.  It is the third possibility that is the most worrying. The wide gap between official inflation forecasts and the expectations of ordinary citizens could be an indication of a serious problem—the lack of institutional credibility. In short, common wage earners and consumers discount the guidance given by the finance ministry and RBI on inflation. And they have diminishing confidence in the ability of these authorities to control prices.  To be sure, the entire blame for the surge in inflation cannot be laid at the doors of the government and the central bank. There is a structural element in the inflation trend, as higher incomes have raised demand for fruit, meat, vegetables and milk. Some inflation has also been imported, as global oil and commodity prices have shot up thanks to the strong economic recovery in emerging markets and loose monetary policies in most Western economies. But domestic cyclical factors are undoubtedly a big part of the story as well.  Higher global commodity prices are already pushing up input costs for most companies. High inflation expectations could fuel demands for higher wages as well. Whether these two factors have an effect on final prices depends on the ability of Indian companies to pass on higher costs to consumers. The International Monetary Fund said this month that the output gap has closed; companies are operating close to full capacity. The ability to pass on higher costs to consumers is usually strong at such points in the business cycle, since there is little excess capacity to ramp up production.  The usual short-term response to an outbreak of high inflation is by cooling demand. RBI will have to raise interest rates far more aggressively than it has till now. The government has already announced a fairly ambitious plan to cut the fiscal deficit. Higher interest rates will weigh down on private demand and less red ink in the national budget will keep government demand under control. Both strategies will mean that some economic growth will have to be sacrificed. The closest we have had to an official recognition of this hard fact is when Montek Singh Ahluwalia, deputy chairman of the Planning Commission, said after the release of the new inflation data on Friday, that the economy is unlikely to grow at 9% this fiscal.  However, as this column has pointed out earlier, demand management can work only in the short term. Further, it will involve sacrificing some growth. The more sustainable response will have to come from the supply side, through more investments and higher production capacity in farm and factory. I fail to see how such supply side effects can kick in without policy clarity and more economic reforms.  A final point: the Economic Survey released by the finance ministry in February used simple calculations to show that the Indian economy is quite capable of growing at 9% a year. India has an investment rate of around 36% of gross domestic product. India requires four units of capital to produce one extra unit output. But what the finance ministry left unsaid was: 9% growth at what inflation rate? The recent past reiterates an old truth. The Indian economy cannot grow at over 8% for more than a few quarters without overheating.

Banking licence draft guidelines in next 15-20 days: FinMin

New Delhi: The Reserve Bank of India (RBI) will bring out a second draft of the proposed guidelines for issuance of new banking licences in the next 15 to 20 days, the finance ministry said on Thursday. “Second draft guidelines for new bank licences in next 15 to 20 days,” Financial Services secretary Shashikant Sharma told reporters here. The finance ministry will have a look at the draft guidelines and comments will be invited before the final guidelines are notified. In the Budget 2011-12, finance minister Pranab Mukherjee had said the RBI plans to issue guidelines for the grant of new banking licences before the close of the last financial year, by 31 March, 2011. In the last Budget, it was announced that the Reserve Bank of India would consider giving traditional banking licences to private sector players, he had said. Following the announcement made by the finance minister, the RBI had brought out a discussion paper in August, 2010, on giving out new banking licences to business houses and non-banking finance companies, besides regulations for the same to foster greater competition. The RBI also sought to know “whether industrial and business houses could be allowed to promote banks.” Furthermore, it sought stakeholders’ views on whether NBFCs should be allowed to convert into or promote banks. The RBI has received comments on its discussion paper from all stakeholders. Various entities like Reliance Capital, IndiaBulls, Religare, IL&FS, IDFC, IFCI and Aditya Birla Financial Services are reported to be mulling an entry into the banking space.  At present, India has 26 public sector banks, seven new private sector banks, 15 old private sector banks, 31 foreign banks, 86 regional rural banks, four local area banks, 1,721 urban cooperative banks, 31 state cooperative banks and 371 district central cooperative banks.

Options to shop with your mobile increase

Plastic money has helped wallets shed a lot of weight. Technology has taken a step ahead and enabled you to get rid of the wallet completely.  With the Reserve Bank of India (RBI) taking a proactive role in popularizing mobile payments and beginning to issue the necessary licences, and mobile banking becoming popular by the day, you may soon get hooked on to the facility if you haven’t already.  Last week, Corporation Bank launched a mobile wallet, known as YPayCash, a mobile payment platform along with eMudhra Consumer Services Ltd. At the launch function, Ramnath Pradeep, chairman and managing director, Corporation Bank, said, “Mobile banking has become very popular as it creates a convenient and fast financial transactional channel. We are glad to provide this secure mobile payment platform.”   A few other banks also offer mobile wallets. These include Yes Bank Ltd and Union Bank of India. Airtel is the only telecom company to have been granted the licence by RBI to provide a similar service through Airtel Money.  The facility being provided by Corporation Bank is currently restricted to person-to-merchant establishment payments. In other words, it cannot be used for person-to-person fund transfers but only to make payments to retailers. The payment solution has currently gone live in Mumbai and Bangalore where the bank has almost 16,000 point of sales (PoS) terminals. However all these PoS have not gone live with the facility and the bank expects them to do so in the coming months. Existing Corporation Bank account holders who have signed up for the payment solution can make use of the facility at merchandise outlets that have gone live with the system.  If you are an existing Corporation Bank account holder, just walk into a bank branch and apply for the facility. Once your number is added to the system, you will get an SMS with a link in it. Click on it to install the client application. The first time you log in, you will be prompted to create an alphanumeric password. You can either ask the bank to maintain a fixed amount in your mobile wallet, request for periodic transfer of a fixed amount from your savings account or do a top-up through your cellphone same as in a prepaid connection. Currently, the limit is Rs. 5,000. In order to initiate the transaction, you have to log in to the client application installed on your cellphone and key in the amount to be paid. The application will then generate a unique 2-dimensional bar code. This bar code captures your personal data such as your account number, phone number, time scan and certain other details. The merchant will then photograph the bar code from the bank’s client application installed on his cellphone and the payment is complete. Both you and the merchant will get an SMS alert, stating the amount paid and that the payment has been successful. The best part is while transacting, you don’t need to share any personal details such as your account number, user identity or name with the retailer. You can use this to make payments at retail outlets. Eventually, you would be able to use it to pay utility bills and for other transactions. Says Ravi Jagannathan, managing director and CEO, eMudhra Consumer Services, “What we are looking at is a whole ecosystem that will allow you to do a host of transactions as it evolves. In fact, we are also in talks with several other banks to get them on board. We expect three of them to go live by June-end.” More banks coming on board could also mean inter-bank transactions, he adds.  Says Jagannathan, “You will receive an SMS alert for each and every transaction, so in case you have been unable to track your expenses, then you also have a record of your transactions and expenses.” So now you need not worry about having to count the exact change when shopping.

Central bank rebuffs SBI on home loans

India’s banking regulator has rejected State Bank of India’s (SBI) appeal to waive the additional provision requirement for its special home loans, two persons familiar with the development said. This means the country’s largest lender will have to set aside around Rs.400 crore to provide for such loans which, according to the Reserve Bank of India (RBI), carry more risk of default as they are priced at relatively lower interest rates for the initial two-three years before the rates are raised. Setting aside money for making extra provisions dents a bank’s profits. The Indian central bank has also turned down SBI’s request to revise its decision to downgrade its rating, following an inspection of the bank’s books for the fiscal year ended March 2009. The rating, based on the six parameters—capital, asset quality, management, earnings, liquidity, and systems and controls (CAMELS)—has been brought down by one notch, from B to B minus, as RBI found the bank had underestimated bad assets and inflated its capital by not making provisions or setting aside money for certain assets. The CAMELS rating of a bank is highly confidential and neither the bank nor the regulator ever discloses it. RBI’s inspection for fiscal 2009, completed in January 2010, also pointed out corporate governance issues with the bank. SBI had a few months ago moved the central bank, asking it to reconsider the revision. It argued that its large loan book is being continuously monitored and minor deterioration in the quality of assets is no cause for worry and does not call for the downgrade. The size of its loan book was Rs.7.4 trillion in December. The banking regulator, in its communication, made it clear that it has taken a serious view of the bank’s failure in making adequate provisioning and underestimation of bad assets and stuck to its decision of downgrading its rating. RBI has also made the on-site inspection of a large bank like SBI an annual affair and not once in two years, which had been the case till recently. An SBI executive confirmed receiving RBI’s communications on home loan provisions and the bank’s rating.  Another official said the banking regulator’s inspection for fiscal 2010 is just getting over. No one was willing to be named considering the sensitivity of the issues and involvement of the regulator. In its mid-year review of monetary policy in November, RBI had raised the provision for standard assets of special home loans fivefold—from 0.4% to 2%.  According to RBI, such loans impact the quality of assets as chances of defaults by the borrowers are high when the rate rises and, hence, the directive for higher provisioning, which will discourage them from selling such loans.  While SBI calls the product a special home loan, RBI dubs it a “teaser loan” as it carries a relatively lower rate of interest in the first few years, after which it’s reset at a higher level. RBI’s concern is some borrowers may find it difficult to service the loan once regular rates become effective. The regulator is willing to bring down the provision rate from 2% to 0.4% for those loans that do not turn bad one year after the loan rates go up.  Former SBI chairman O.P. Bhatt strongly contested RBI’s perception of risk and had said that while giving such special loans, the bank takes into consideration a customer’s capacity to service the loan when the rates go up. His view was that, in the absence of any risk of default, the bank does not need to make extra provisioning as directed by RBI.  The audit committee of SBI’s board, headed by chartered accountant Dileep C. Choksi, endorsed the chairman’s decision, and did not make any provision for the December quarter. Armed with the audit committee note, Bhatt had moved RBI seeking a waiver of the extra provisioning. Incidentally, SBI has also been raising provision requirements for its bad loans in phases unlike other banks that have already done this in conformity with RBI’s norms. There are three types of bad loans—substandard, doubtful and loss assets. Till recently, banks were required to set aside the entire amount of loss assets, or those assets which can never be recovered, while provisioning requirement for other two categories varied, depending on their age and quality. RBI, in 2009, made 70% provision mandatory for bad assets for all banks. SBI has so far made close to 64% provisioning for its bad loans and sought time till September 2011 to raise it to 70%. Bhatt had called the RBI move “arbitrary” and argued that since money has already been set aside for different categories of bad assets, there was no need for 70% provisioning. No SBI official is willing to speak on the rating downgrade on record, but in private, SBI executives said all concerns of the regulator have been addressed and many of the issues raised by RBI’s inspection team have been resolved. SBI raised its provisions in the September quarter and as a result of this, net profit was flat at Rs.2,501.37 crore.  In the December quarter, net profit rose 14% to Rs.2,828 crore, taking the profit of nine months in fiscal 2011 to Rs.8,243.64 crore.  With Bhatt having retired in March, new chairman Pratip Chaudhury will sign off on the bank’s annual accounts.  SBI closed at Rs.2,803.30 on Friday on the Bombay Stock Exchange. Since January, it has remained flat, as has the banking index, Bankex, while the bellwether equity Sensex has lost 5.47%.

An inflationary fire in the mind

The question posed by RBI deputy governor Subir Gokarn earlier this month no longer seems rhetorical: is a high rate of inflation the new normal?  High inflation expectations are getting embedded into the Indian economy—a danger that is not been given its due in discussions about economic policy.  The Reserve Bank of India (RBI) on Monday released its latest inflation expectations survey of households. The average Indian now expects prices a year down the line to be 13.1% higher than their current level. Inflation expectations have been climbing for quite some time now.  Why is this a problem? Families fearing the ravages of inflation on their purchasing power will push for higher wages and could set off a price spiral. Companies could find it difficult to assess the profitability of new projects when prices are bouncing around.  The new inflation expectations number comes a day after the International Monetary Fund asked whether India is in danger of overheating, even as it cut the country’s growth forecasts for 2011 and 2012. The question posed by RBI deputy governor Subir Gokarn earlier this month no longer seems rhetorical: is a high rate of inflation the new normal? Ordinarily, this might be interpreted as posing a dilemma for a central bank. Any further hikes in policy rates may “kill” growth while not raising them may lead to higher inflation in the months ahead as inflationary expectations appeared to have been unhinged. The assumption behind this dilemma is the usual trade-off between unemployment and inflation in the short-run. In reality, such a trade-off is illusory at the moment: the possibility that at higher rates of inflation, investment growth may be hit is very real.  Even a cursory look at components of gross domestic product figures from 2003-04 to 2010-11 shows this clearly. Barring 2008-09, when the global financial and economic crisis hit India and 2010-11, investment demand has often outstripped consumption as a source of growth. If care is not taken to ensure the right conditions for fuelling this source of growth—and they are not right at the moment—it will surely hit the overall rate of growth. RBI must avoid this.  The growth-inflation trade-off has been overstated for too long. If anything, evidence from China and India (the latter especially after 2002-03) shows that low inflation and high growth are not mutually exclusive. To say that Indians must learn to live with high inflation if they want to enjoy the fruits of growth is a cruel argument.

INDIA’S PAYMENT GATEWAY TO BE LINKED TO UID NUMBERS

The move will allow customers to use their 12-digit Aadhar numbers and fingerprints as banking passwords.  The National Payments Corp. of India (NPCI) plans to link Rupay, its soon-to-be-launched domestic payment gateway on the lines of global gateways such as Visa and MasterCard, with the unique identification programme Aadhaar. The move will allow customers to use their Aadhaar identity - a unique set of 12 numbers that would be issued to all residents of the country - and their fingerprints registered under Aadhaar as their banking password. “Just like a bank gives a gold or a platinum card, Aadhaar Rupay cards will be offered by the banks,” said A.P. Hota, managing director and chief executive officer, NPCI, which is overseeing the Rupay project. The Rupay will be on the lines of China’s UnionPay, which allows domestic transactions to be routed through a national card system. Although China has made it mandatory for all local transactions to be routed through the national card system, it will not be compulsory in India.  Rupay is expected to be launched this fiscal. The Reserve Bank of India has already approved the Aadhaar-enabled payment system. “In the second phase, we are also mulling enabling the Aadhaar number to be printed on the card, so that there are no mistakes while punching the 12-digit number,” Hota said. A pilot programme is currently running in Jharkhand with the help of Bank of India, Union Bank of India and ICICI Bank Ltd. “The pilot is restricted to non-financial transactions for the time being. We are fine-tuning the system so it can be ready to handle financial transactions,” Hota said. The payment system and software are in place, said a Bank of India executive, requesting anonymity. “This is a new concept and needs to be recognized and accepted. The challenge for the banks will be to create the necessary infrastructure,” the executive said. It will take time for Aadhaar numbers to reach people, and for the hand-held terminals with biometric readers to be distributed - two measures critical for the project to succeed, he said. The Unique Identification Authority of India (UIDAI) has so far enrolled more than 4.5 million people and targets issuing Aadhaar numbers to 600 million people by 2014. The Aadhaar-enabled Rupay system will also allow correspondents of one bank to offer payment services to customers of another bank, Hota said. The Bank of India official, however, said, such interoperability will take some time. “Interoperability is allowed, but only in theory. There needs to be a payment and settlement system, which defines how participating banks will settle the payments,” the official said. “Till a payment-clearing house is put in place for this micro-payment system, interoperability cannot be implemented.” He said banks will wait until the intra-bank system stabilizes before moving to the inter-bank transactions. “Once more Aadhaar numbers are given, it can be scaled up to a pan-India level.” “Though MasterCard and Visa have already announced their intentions to support Aadhaar-enabled payment system, it will be easier for Rupay to launch it as they can make it a part of their system from the very beginning,” said a government official who is privy to UIDAI’s plans, but did not wish to be named.

Banking on credit growth

The latest numbers from the Reserve Bank of India (RBI) show that while credit growth has eased a bit, it is still strong, up 21.4% over a year ago. That, combined with the low base for three months ended March 2010, will drive earnings for banks in the fourth quarter of fiscal 2011.  However, the tougher macroeconomic environment in the form of higher interest rates, tighter liquidity and an inflation rate that RBI is still uncomfortable with, means that net interest margins for banks will be under pressure. Indeed, many banks had indicated as much after their third quarter results. Brokerages reckon net interest margins may decline by up to 20 basis points from the third quarter levels, especially for smaller banks that don’t have the luxury of a large bank network and, hence, a lower proportion of low-cost current and savings deposits. One basis point is one-hundredth of a percentage point.   Despite banks hiking deposit rates by up to 1.25 percentage points in the past few months, the credit-deposit ratio is hovering around 75.6, not much different from a quarter ago. However, the key question is whether banks still retain the pricing power to raise lending rates.  Sure, liquidity concerns may ease in the next couple of quarters; liquidity adjustment facility borrowings averaged Rs. 70,000 crore in the last week of March compared with Rs. 1 trillion at the beginning of the fourth quarter. However, deposit rate increases operate with a lag and higher funding costs are likely to hurt net interest margins over the next couple of quarters as well, even as RBI continues to hike rates to keep inflation in check. Still, asset quality has generally improved for the whole system in the last fiscal. Angel Broking Ltd calculates that the net non-performing assets (NPA) ratio has declined to 0.99% for the December quarter from a peak of 1.15% in the year-ago period. With RBI extending the deadline to move to a new system of recognizing NPAs, there might not be any surprises in this metric for the fourth quarter, at least for private sector banks. For public sector banks, there is also the googly of pension liabilities after new settlement packages were finalized in the third quarter. While banks are allowed to amortize these liabilities over five years, the portion that goes to retired employees has to be provided for in fiscal 2011. This can be as high as 26% of public sector banks’ post-tax earnings in the fourth quarter, reckons Prabhudas Lilladher Pvt. Ltd.  Overall, the consensus is that private banks will post more robust results than their public sector peers in the fourth quarter.

Cardless banking with Aadhaar number may soon become reality

Some banks and the Unique Identification Authority of India (UIDAI), which is spearheading the ambitious Aadhaar project, are looking to allow customers operate ATMs armed with only their 12-digit Aadhaar number; the access will be facilitated by a biometric scan.  New Delhi: Soon, it may be possible for customers to operate ATMs without cards. And, eventually, shop without credit cards. Some banks and the Unique Identification Authority of India (UIDAI), which is spearheading the ambitious Aadhaar project, are looking to allow customers operate ATMs armed with only their 12-digit Aadhaar number; the access will be facilitated by a biometric scan. Experts say the move could reduce cost of operations for banks and also reduce instances of debit card fraud. Even while UIDAI is still working to fine-tune the model, state-owned Corporation Bank is readying to implement the new model. “We will be launching this service in the next three-four weeks for our customers in Delhi,” said an official of the bank, asking not to be named.  With a mere 58,000 Aadhaar numbers issued in Delhi (4.2 million have been issued across India), the number of customers using Corporation Bank’s service will be limited at first. But it will increase. UIDAI hopes to issue 600 million numbers by 2014. The number of credit and debit cards as on January stands at over 230 million in the country, according to the Reserve Bank of India (RBI); the issue cost of each card varies between Rs. 20 and Rs. 80.   For cardless transactions to become a reality, customers will have to link their bank accounts with the Aadhaar number. At the time of enrolment, UIDAI is giving people the option of either opening a new bank account, which will be Aadhaar-enabled, or linking to an existing one.  UIDAI has already done field tests in Jharkhand and is readying its infrastructure to support bulk transactions. “The servers and systems are currently being tested to see if they can take at least 100 million transactions simultaneously... UIDAI is working to ready them by July this year,” said an official familiar with the development, who did not want to be identified.  Both the officials independently confirmed that the approval from the regulator is in place. “The Reserve Bank of India has given an in-principle approval for the plan, but the final go-ahead will be needed closer to the actual launch,” the second official said.  “RBI’s main concern is safety... This will take care of all the safety aspects,” added the Corporation Bank official. “It is one of the safest ways to do banking... It will make sure that the right person is using the right account,” said the second official.  The move to cardless banking will take quite some time. And the move to cardless shopping some more. That’s because banks will have to install a biometric reader in all their ATM machines and will also have to upgrade the applications on them to make them cardless. There were at least 43,000 ATMs across the country as of March 2010, according to RBI. Moreover, the core banking solution, through which banks integrate all transactions across branches, will also have to support the new model.  According to Alpesh Shah, partner and director at Boston Consulting Group, the cardless banking model would have a large impact, but over the next three-five years.  “Banks will have to upgrade their infrastructure, which may take a few years. So there will not be much impact in the next six months to one year. But over a longer term, once the concept catches on, it could change the way banking is done,” he said.  A Union Bank of India official, who also did not want to be identified, said that while Aadhaar will provide sufficient authentication for transactions, it will take some time for banks to adapt to the new system and put in place the necessary infrastructure. Interestingly, UIDAI is hoping banks will rapidly upgrade their technological infrastructure as a sort of quid pro quo for pushing more business their way. The Aadhaar initiative will be facilitating the opening of several million new bank accounts during the enrolment process. UIDAI is already in the process of empanelling banks for this.  Aadhaar has so far enrolled around 4.2 million people in the country and around 80% of them want a new bank account, according to UIDAI estimates. To make cardless banking work, UIDAI will have to link its servers at one end to the banks and on the other to the National Payments Corporation of India (NPCI). Each bank has its own financial switch, which is connected to the national financial switch (NFS). NFS facilitates routing of ATM transactions through connectivity between the banks’ switches. NPCI does the settlement under this network.  “If banks agree on such a model, NPCI has no problems in switching the transaction,” said A.P. Hota, managing director and chief executive officer of NPCI.  Cashless transactions at retail establishments pose a challenge.   “A card is not built only for use in ATMs. It is meant to be used in other devices also, such as point of sale terminals used in retail outlets... So a bank cannot completely do away with issuing the card,” said an official at IDBI Bank Ltd, who did not want to be identified.   UIDAI does have a plan to enable micropayments even at retail outlets through what it terms micro-ATMs, essentially low-cost hand-held devices with a fingerprint reader.

Who is to blame for inflation?

Mumbai: After two weeks, India’s food inflation is back again in double digits. Weekly fluctuations in food prices may not be always be very material but as last month’s WPI numbers show inflation has become generalized and is no longer restricted just to food articles.  Doubtlessly, this will put the spotlight on the limited success of the Reserve Bank of India (RBI) in combating inflation for well over a year. Subbarao’s reluctance to deviate from a gradualist approach to tackling inflation led the Wall Street Journal to wonder aloud after the January policy review if he is a hawk, dove or chicken. This is indeed a dramatic shift in perception about RBI from the heydays of 2009, when India and its central bank were the toast of international policy makers, as a 23 March Economic Times article by MC Govardhana Rangan points out. Rangan argues that Subbarao’s policy stance has a Greenspan-like touch in its predictability. Comparisons with Greenspan would probably be the last thing any central banker would want to hear!  But is it fair to judge monetary policy without taking into account the role of fiscal policy?  In a recent post on iMFdirect, celebrated macro-economist David Romer writes that one of the key points of reasonable agreement among economists after the crisis is: The impact of a change in fiscal policy is extremely dependent on whether monetary policy is able to respond, and on how it responds if it can.  We would like to invert the argument to point out that the success of monetary policy depends as much on its own stance as it does on fiscal policy. The fiscal deficit target for next year at 4.6% is by all counts commendable and if realized would be a big step to combat inflation. However, many doubt if the target is actually achievable as Jehangir Aziz puts it eloquently here. If oil prices stay at current levels, Pranabda would probably need Harry Potter’s wand to achieve that target. Now consider growth: a target of 9% is not exactly anti-inflationary. Supply-side bottlenecks may be partly responsible for inflation but faster growth without easing those constraints will cause only more, not less inflation. And if budget projections are to be believed, capital expenditure by the government is going to come down from 13.4% of total expenditure to 12.7%. It is like a car with a fraying engine that is trying to speed faster. So why does the government not acknowledge this and aim for a moderation in growth till it is able to ramp up investments? Kaushik Basu’s argument in this year’s Economic Survey was: In designing inflation control measures it is important to be aware that sudden, sharp policy induced contractions in demand can cause unemployment to rise.  He goes on to argue that the trade-off between inflation and employment escapes public awareness as employment statistics come with long intervals unlike inflation numbers.  Basu’s point that a hard landing would cause unemployment and misery is true but it actually makes the case for a moderation in growth to avoid a hard landing later.  Besides, one can argue that the cost of unemployment has to be balanced against the cost of inflation to evaluate whether on balance the welfare loss of employment is still greater.  Secondly, high inflation often leads to what is termed as ‘demand destruction’, exactly what oil prices are threatening to do to the global recovery. If high inflation erodes purchasing power and could slow down consumer demand as some surveys indicate, then inflation rather than policy tightening becomes a bigger threat to growth and employment.  Basu also argues that prices tend to be higher in economies where growth is higher. Empirical evidence for such a simplistic relation (which economists term the Balassa-Samuelson effect) has been hard to come by. Casual empiricism also suggests otherwise — we need not even look beyond our immediate neighbourhood to find such evidence.  Justin Yifu Lin, chief economist at the World Bank cites China’s example in a recent speech to illustrate how high growth is attainable with low inflation. A fiscal stimulus aimed at increasing railroads, port facilities and other infrastructure allowed China to raise its annual growth rate to 10.9% in 2003-10 from 9.6% in 1979-2002. They achieved it without raising inflation beyond 5% unlike earlier decades when 2-digit growth rate was always accompanied by a 2-digit inflation rate, said Lin.  Basu’s contentions may be debatable but the elaborate justification of high inflation could perhaps be an indication that the fiscal stance would be tolerant of high inflation. One reason for this could be that though politically inflation is a problem for the government, financially it is not. As long as nominal GDP is going strong, tax revenues would grow. More importantly, the government being a net borrower would benefit from inflation, at least in the medium term. Not for nothing do they call inflation a tax! However, as the government’s stance is known only once a year unlike RBI’s policy reviews that have a six-weekly frequency, fiscal policy’s contribution to inflation might continue to escape public awareness, slanting discourse on the subject.

ATM in your cellphone

Forgot your wallet at home? No worries. Book tickets, pay for groceries and settle your coffee bill with just a few clicks on your mobile phone. Money on your phone sets you free,” philosophizes 20-year-old business student Lalit Ramsisaria. “I don’t need to be in front of a computer to book train tickets or buy a gift for my girlfriend. All I need to do is to launch an application on my phone, make a few clicks and my shopping is done.” Ramsisaria, who has a Nokia E71, is an avid user of a mobile wallet service called ngpay (www.ngpay.com). “All I need is GPRS on my phone and my debit card details,” says Ramsisaria.  Ngpay is one of the many applications launched over the last few years in the fast-growing sector of mobile wallet services. Also called m-banking, these services are an initial step towards a world where you can replace your wallet and credit cards completely with your phone. “Mobile banking is a form of cashless banking that enables you to access and use your bank account, debit or credit card through an application on the mobile phone,” says Gautam Shiknis, chief executive officer, mChek (www.mchek.com), another mobile wallet service.  These services connect you to vendors—merchants, retailers, cinema halls, restaurants, etc—and allow you to make payments using debit or credit card details. All you need is either a GPRS-enabled phone or the ability to send simple SMSes. If you are not comfortable with third-party applications, you can take a wallet from your mobile phone operator. Recently, the Reserve Bank of India (RBI) cleared the way for a second kind of mobile wallet service—called the “semi-closed mobile wallet”. In this service, you can load money into your cellphone from a licensed company and make payments with it, but you can’t use it to withdraw money, which is what a full-fledged mobile wallet aims to do.  In a pilot, Airtel has launched semi-closed mobile wallet services in Delhi, Gurgaon, Faridabad and Chennai. Called Airtel Money (www.airtelmoney.in), it is a free service that allows you to load up cash in your phone, making your SIM a prepaid account as it were, and use it with partnering vendors to pay bills. Airtel Money has, for instance, tied up with around 40 vendors in Haryana and Delhi, including coffee shops, restaurants and cinema halls. Some semi-closed mobile wallet services, such as Mobile Money Services from Nokia and Yes Bank, even allow you to withdraw cash from specified ATMs.  Furnishing your bank account details to an unknown application when there’s so much fraud going on is never easy. But mobile wallets are as safe as any other online transaction. “The technology which drives the mobile wallet is quite secure and mostly works on two-way authentication,” says Ashish Sinha, founder of www.pluggd.in, a website on start-ups. It means that every time you make a transaction, the program will automatically ask you for your PIN, which only you know. “Transacting like this is as safe as an ATM transaction. You need to enter a six-digit PIN to complete the transaction,” says Sourabh Jain, CEO of ngpay. Though most of these services are at a nascent stage, especially when you look at their list of vendors, it’s a fast-growing market. After Airtel, Vodafone is in the process of tying up with ICICI Bank to launch a semi-closed mobile service called m-paisa, which it has floated successfully in countries such as Kenya and Japan. Services such as ngpay have over one million users across the country, while mChek boasts of over two million customers, with a network of more than 100 partners that offer a variety of products and services. This is tiny when compared with the number of mobile users in the country, which currently stands at around 650 million.  “The system is very simple for the masses to adopt. I think Indians will adopt m-banking much more efficiently once they figure that with an SMS they can transfer money to their loved ones. It’s like a move from no phone to mobile phones which Indians did, skipping the landline completely,” says Shiknis.

RBI to enforce most Malegam panel proposals from 1 April

The Reserve Bank of India (RBI) is set to implement most of the recommendations of the Malegam panel to regulate India’s Rs.22,000 crore microfinance industry from 1 April, but existing loans of microlenders will be exempted from the new norms initially, according to three persons familiar with the development. This means that microfinance institutions (MFIs) will be unable to give fresh loans to anyone whose household income is more than Rs.50,000 or credit of more than Rs.25,000 to a single borrower.  MFIs will not be able to charge more than 24% interest. Besides, they will have to cap their margins at 12%.  Two of the three persons are bankers and one the head of a leading MFI. All three declined to be named. At a meeting with bankers on Thursday, RBI made it clear that the industry should be prepared to accept most of the suggestions of the panel, including the cap on family income, size of loan and interest rate from 1 April.  The regulator had held discussions with top bureaucrats of state governments in February. It will meet MFIs next week in the last round. Once the new regulations come into play, all MFIs will have to lend 90% of their total loans in compliance with the new rules and if they fail to do so, such loans will not be treated as priority sector advances.  Priority sector status for such loans is crucial for MFIs as banks mainly lend to them to cover their mandatory lending requirement. Under current norms, Indian banks are required to lend 40% of their loans to agriculture and other weaker sections. If banks fall short of this target, they can buy the loans of MFIs to meet the level.  MFIs are engaged in the business of giving tiny loans to poor borrowers. Typically, they lend at 24-32% or even a higher rate, citing high operational costs. They get money from banks at 9-12%. The existing loans of microlenders will be exempted from the new regulations, which will be offered “grandfathering” to facilitate a smooth transition. Grandfathering implies allowing their continuation in compliance with the old rules, after these are changed, for a certain period.  At Thursday’s meeting, banks told RBI they were not keen to launch an industry-wide loan restructuring for MFIs and this can be done only on a case-to-case basis.  “Banks said they are ready to restructure loans of those MFIs which have majority exposure in Andhra Pradesh, but those having (relatively) minor exposure can seek alternative means to overcome the crisis,” one of the bankers said. RBI has also mandated the Indian Banks’ Association, the national bankers’ lobby, to take stock of bank funding to the microlending sector since mid-January when it had asked banks to resume lending to the crisis-ridden microlending industry and recycle loans to enable the sector tide over the crisis, until new regulations are in place. The Malegam panel was appointed in October to review microfinance industry regulations after the sector plunged into a crisis following the Andhra Pradesh government restricting operations. Andhra Pradesh accounts for more than a quarter of India’s total microlending loans. The state law barred weekly collections and made government approval mandatory for every second loan to a borrower.  The regulation hit MFIs, causing a sharp fall in collection rates and forcing many of them to stop fresh lending. Banks, too, stopped fresh funding to the sector. The Malegam committee, which submitted its report on 19 January, recommended that MFIs with a loan portfolio of Rs.100 crore should not keep a margin of more than 10%. For the smaller MFIs, the margin is capped at 12%. According to the panel, the number of outstanding loan accounts serviced by MFIs in the country between March 2007 and March 2010, rose from 10.04 million to 26.7 million, while the outstanding loan amount increased from about Rs.3,800 crore to Rs.18,344 crore.  Senior officials of the microlending industry said they will argue against the Rs.50,000 family income cap the panel has  recommended as it is impractical to assess this. Besides, this will also disqualify 70-80% of the existing borrowers of MFIs from accessing microcredit. “It is unrealistic to limit the annual family income at Rs.50,000 and a large part of the market is going to be excluded from the fold of microfinance. Also, assessing the annual income of the borrower is extremely impractical,” said Alok Prasad, chief executive officer of Microfinance Institutions Network.