Magical or Menace

This article was originally published in Postnoon on September 28, 2012

http://postnoon.com/2012/09/28/magical-or-menace/76337

Dr. Raghuram G. Rajan, former chief economist of the International Monetary Fund (IMF), and currently the Chief Economic Advisor (CEA) in the Ministry of Finance, Government of India, a proponent of Foreign Direct Investment (FDI), supported the recently announced 51% FDI in retail by the Indian ruling government, calling it (FDI) the 'safest form of financing' because it is 'long-term' and brings in 'competition'. He is also hopeful that the FDI would result in improvements in the logistical infrastructure.

The ruling United Progressive Alliance government has also claimed that the FDI in retail will change the supply chain and infrastructure at the farm level and will reduce wastages. On the other hand, the opposition claims that the FDI in retail will wipe out the so-called mom-and-pop store.

The infrastructure is needed. But, the so called proposition that the infrastructure landscape will change due to FDI, it's a misnomer. Why is it that the large retail chains like Reliance and the Aditya Birla group have not been able to do it? They have deep pockets and the best talent in the world. The answer lies in the bottlenecks and the systemic problems that are there in the sector. Such infrastructural projects are not financially viable.

The cost of funds are typically around 16-17% for such projects. At this cost, a simple agricultural warehouse, without land, costs between Rs 400-500/- per sqft to construct. And the going rentals are Rs5-7 per sqft. The return is less than the cost of funds. How will investment come into this sector? And this is without land. If you don't have land, if you include the cost of land, the costs will go up to Rs1200-1300sqft. Even if you take the best of rentals (10-15 sft) at the most prime locations, it is still a negative NPV project.

It is often said that food is being wasted due to lack of infrastructure. Yes, the food does rot in the Food Corporation of India's (FCI) warehouses. Have you seen any trader's stock rotting? No. That's because FCI has a populist mandate. FCI is supposed to be a trading organization. It is supposed to buy the grains depending on the capability to sell, based on the demand from the Public Distribution System. It should have storage space, only then buy. They don't do it and hence the grains get damaged.

The mom-and-pop stores too will survive. They offer a different kind of paradigm and value proposition in comparison to the large stores. Another allegation is that the foreign retail companies have very deep pockets and can afford to make losses for 3-5 years. By then they will wipe out the mom and pop stores and then they will monopolize the market. It seems baseless. While the theoretical possibility is there, the cultural and systemic nature of India makes it a very remote possibility.

Well, the reality is that FDI is neither a magical wand, nor a menace. It is about giving choice to the people of this country.

CRR and Repo explained

This article was originally published in Postnoon on September 21, 2012


http://postnoon.com/2012/09/21/crr-and-repo-explained/74537

The Reserve Bank of India (RBI), announced on Monday, that they with keep the policy repo rate unchanged at 8% and cut the Cash Reserve Ratio (CRR) by 0.25%, to 4.5%. What does this mean for you (the readers)?

The repo rate is the rate at which RBI lends money to the commercial banks. Using this rate as the benchmark, the banks decide their Prime Lending Rate (PLR). PLR is the rate at which a bank lends to its most credit worthy customers. They add basis points (one basis point is 0.01%) to PLR, if a customer's credit worthiness is lower.

The credit worthiness of a customer is determined by the repayment capacity of the customer, repayment of both interest and principal. It is also determined by the past record of the customer with respect to payments. For example, does the customer pay his credit card bills on time, does he pay his loan installments on time etc. There is an agency called Credit Information Bureau (India) Limited (CIBIL), which assigns a credit score to each individual depending on the past payments records. Banks use this score when determining the creditworthiness of an individual.

Now back to repo rate. So when repo rate goes up, our loans get more expensive as the banks will raise the PLR and if the repo rate goes down, our loans will get cheaper. RBI has kept this rate unchanged at 8% this time.

CRR is the percentage of money that the banks are supposed to keep with the RBI to meet the withdrawal demands for fixed deposits or any other time liabilities. The CRR is a percent of the Net Demand and Time Liabilities (NDTL) of the bank. When CRR is high, banks have lesser money with them to lend out. On the other hand, when CRR is reduced, the banks have more money with them to lend. This brings in more money supply in the market. Since RBI has reduced the CRR, the money supply should go up in the market.

What is meant by money supply going up? It means that the banks will have more money to lend, and hence more people may be able to get loans. This means that more money will be circulating in the economy. A few banks may decide to decrease the interest rates for auto or home loans. Though it is unlikely as the repo rate is same.

Why did the RBI not reduce the repo rate as well? That's because they are being cautious. They are worried about inflation. If the repo rate is reduced, people will be able to borrow money at a cheaper rate. This will encourage them to borrow and spend. If they borrow and spend, the demand for goods and services will go up. If demand goes up, prices will further go up.

Hence, the RBI has kept the repo rate unchanged.

Is Inflation Good for Growth?

Published in the business section of www.rediff.com on 21 September, 2012


http://www.rediff.com/business/slide-show/slide-show-1-column-is-inflation-good-for-growth/20120921.htm

In a G-24 Policy brief (2012), Anis Chowdhury (UN-DESA) and Iyanatul Islam (ILO) sum up the Inflation Targeted as well as non-targeted)-Growth debate. From their brief, it can be said that monetary policies targeting inflation may not result in better growth than countries that do not have a policy of targeting Inflation.

They quote Friedman (1973): “Historically, all possible combinations have occurred: inflation with and without [economic] development, no inflation with and without [economic] development”.

A little bit of Inflation is good. But too much is bad. Empirical Analysis of inflation and growth over the past 50-60 years, in multiple nations, have concluded every possible combination of the two variables is possible, which ratifies Friedman's statement.

The monetary policy announced on Monday, left the interest rates unchanged at 8%. However, in a surprise move, the cash reserve ratio (CRR) of scheduled banks were reduced by 25 basis points from 4.75 per cent to 4.50 per cent of their net demand and time liabilities (NDTL) which according to RBI is expected to infuse approximately Rs170 billion of primary liquidity into the banking system. While the move will give greater freedom to the banks to lend, the unchanged policy repo rate, may not bring in many takers for the loans.

The Reserve Bank of India has maintained that Inflation is too high for their comfort. The point to note here is that the correlation between interest rate and inflation, in India, in the past 10 years, taking September to September rates, is a very small 0.16 only. On the other hand, they are highly correlated with GDP (-0.31) and stock market performance (-0.60).

In a research done by Muneesh Kapur and Harendra Behera (2012), who were both with the RBI at the time of doing the research, they concluded, " the evidence for both India and other countries suggest that the impact of monetary policy actions on inflation is modest and subject to lags... Despite the monetary tightening by Reserve Bank of India during 2010 and 2011, inflation remained high and this could be attributed to the structural component of food inflation as well as the surge in international commodity prices beginning the second half of 2010 and continuing into the first half of 2011".

Inflation can be controlled by controlling budget deficits and by easing bottlenecks to improve supply, as well. But burgeoning subsidies expenditure by the government and inefficiencies have resulted in an expected fiscal deficit of more than 7%; and if the government fails to raise money by divesting the proposed public sector undertakings in the coming year, it will be a reality.

Because of this, the entire onus of controlling the inflation has fallen on the RBI. Which is having an impact on the growth rate.

The stock market rejoiced on Friday, with the benchmark index (SENSEX) moving up by 443 points as the government, led by Dr. Manmohan Singh, announced a subsidy cut on Diesel and easing the FDI norms for the retail and aviation sectors. Monday was not to be the icing on the cake.

Corruption and Money Laundering

This article was first published in Moneylife on September 20th, 2012, co-authored with Khemchand H Sakaldeepi


http://www.moneylife.in/article/corruption-and-money-laundering/28564.html

First the Gandhian, Anna Hazare and then the yoga guru, turned social activist, Baba Ramdev; India has witnessed two major voices against corruption in the last year. While Anna and his team's movement primarily focused on bringing a strong Lokpal Bill, Baba Ramdev has been crusading to bring back the black money stashed away in Swiss banks, to India.

Corruption has assumed unprecedented proportions with the Coalgate allocation scam running into billions of dollars and everyone from the erstwhile Bhartiya Janta Party government (now the main opposition party), led by Atal Bihari Vajpayee to the current United Progressive Alliance (UPA) government, led by Dr. Manmohan Singh, being under the scanner. The Indian parliament hardly worked in the monsoon session, with the ruling party and the opposition at loggerheads with each other.

A ray of hope, in the midst of the political circus, seems to be the Indian banking system, that has been resilient in the past, conservative and cautious. The recent cases of laxity in vigilance and violation of regulations at the HSBC and the Standard Chartered banks, have resulted in trillions of illicit money gaining access to the US markets. This raises questions about the steps taken towards the prevention of money laundering by countries across the globe.

India became a full-fledged member of the Financial Action Task Force (FATF), an inter-governmental body which works towards combating money laundering and terrorist financing in the year 2010. Since then, India has been co-operating with the other member nations in sharing information regarding suspicious, money laundering and terrorist financing activities.

According to FATF, "corruption has the potential to bring catastrophic harm to economic development, the fight against organized crime, and respect for the law and effective governance". Early this month, both NSE and BSE, the leading stock exchanges of the nation, urged the investors to exercise caution in dealing with entities linked to Iran, following warnings from FATF.

The question is, being a member of FATF and at the same time struggling with corruption at home, is India doing enough to combat money laundering? A survey on Anti Money Laundering by KPMG in India (2012) revealed that about 11 percent of the respondents find that more than 25 percent of their SWIFT messages have incomplete originator information. The survey also finds that more that majority of respondents found the client screening, handling of filter hits and maintenance of sanction lists was either moderately challenging or challenging. And less than 50 percent use either internal or external sophisticated IT systems to identify potential money laundering cases.

In the US there exists a list of Specially Designated Nationals and a list of Countries identified which should be screened for identifying potential risky transactions, better known as OFAC (Office of the Foreign Asset Control) List. US people and companies are banned from dealing with entities in this list.

In India too, Financial Intelligence Unit - India (FIU-India) along with the RBI, has been working towards making the screening system more rigorous. If the processes are implemented in letter as well as spirit, financial companies like Banks, NBFCs and Insurance companies, who collectively control the flow of money in the economy can directly hinder the plans of rogue elements by making their financial life miserable.

Also, there exists Know Your Customers (KYC) and Customer Due Diligence (CDD) guidelines in India, which can be easily flouted due to the multiple ways in which one can fulfill these requirements. India still does not have a single identity for its citizens, on the lines of the US Social Security Number. Same person can have multiple address and identity proofs in the form of state issued passport, driving license, ration card, or the most recent being the Aadhar card.

Going by the KPMG report, while India is taking baby steps in the right direction, there are major milestones to be covered in terms of training, reporting and technology to be able to use some of the most sophisticated algorithms involving abnormality detection, predictive models and social network analysis. In fact, it is said that if Facebook was a country then it would be the 3rd biggest in the world. The combination of data from social network and technology can help us create sophisticated bad behavior detection tools.

The recent technological advances have helped many institutions to harness the power of large datasets. The companies can process and collect data at close to real-time and with the help of certain algorithms, classify and detect malicious behavior instantly. This is like any other antivirus system found on computers, but different in terms of target units i.e. money laundering and terrorist financing.

The existing systems in India have clearly not prevented black money and the proceeds of corruption from leaving the country. Hopefully the next generation revolutionaries can actually use technology to bring about the change we want to see instead of relying on the old fashioned political rhetoric. Next time when someone says “Hum bahar ka paisa vapas layenge” (Read: Baba Ramdev claiming to bring back the black money stashed in Swiss banks) then we must ask “What’s your analytics quotient?”

CRAs wake up Singh

This article was first published in the Free Press Journal on September 17th, 2012


Prime Minister, Dr. Manmohan Singh, the architect of India's liberalization policies and the person credited with ending the license raj, had slipped into oblivion in the last few years. He has been often criticized of being a puppet at the hands of Mrs. Sonia Gandhi, the President of UPA. Increasingly so in the past year when the Indian Economy has experienced a slowdown and loss of investors' confidence. Dr. Singh seems to have reincarnated himself in the light of the downgrade threats from Credit Rating Agencies (CRAs).

Empirical analysis of credit rating downgrades conclusively point towards a fall in benchmark indices across the world, by 0.3% to 1.2% on the day of the downgrade and the next day. Research also shows that the CRAs do provide new information to the market, and the information is especially significant in the case of downgrades.

However, the failure of CRAs to warn the investors of many a recent events (both at company as well as country levels), have raised questions on the worthiness of the CRAs itself. Marwan Elkhoury, Economist and Mathematician, writes in the Compendium on Debt Sustainability and Development (UN, 2009), "Ratings tend to be sticky, lagging markets, and then to over react when they do change. This over reaction may have aggravated financial crises in the recent past, contributing to financial instability and cross country contagion".

But the point of interest to us in India is the next line written by him, "Moreover, the actions of countries which strive to maintain their rating grades through tight macroeconomic policies may be counterproductive for long term investment and growth". To the credit of RBI, they have resisted any efforts of bowing out to the calls of a decrease in interest rates by the industry.

The UPA government though has bowed down to the fear of a credit rating downgrade, to junk status. They have announced a hike in Diesel prices and unleashed the reforms to bring in FDI in retail, aviation, power exchanges and broadcasting services.

The thing is, bowing down is not always bad. So the question is are these reforms really good for India? Are the reforms enough? Is it too little, too late? While a downgrade will have adverse impact on the stock market, FII inflows, credit and growth, the reforms announced will not have much of an impact if the entire ecosystem to do business is not made more favorable. Delays in projects due to multiple clearances required at the state and centre level and rampant corruption will only keep the investors at bay and push the exports, industrial output and GDP further down.

Dr. Singh, if you have really woken up from your slumber, go all out, leave no stones unturned. You do want to be remembered as the "Reformer" and not the "Underachiever"!

Commitment Rewards

This article was originally published in Postnoon on September 14th, 2012

http://postnoon.com/2012/09/14/commitment-rewards/72810

I saw Abhi waiting for me again near my office. He had applied for a home loan about two weeks back. I had explained the process of applying for the home loan and also how the EMI's work. I wondered what's brought him back to me so soon. I didn't have to wait long. He had his papers out, even before I could open the door to my office.

Abhi: Nicky, the bank has sent people over to my house to check if I actually live there. They even called and visited my office.

Nicky: That's routine. Nothing to be worried about. They are just doing their job. Due diligence.

Abhi: Yeah, yeah. I understand. I am not here for that. Yesterday, my friend told me about a scheme that Axis Bank has come up with. He told me that if I take a loan for a period of 20 years and keep paying all my EMIs on time, without any defaults, the bank will waive off my last one year installments (that is last 12 months' installments).

Nicky: Oh yes, I heard about that. You need to be locked with them for 15 years time to avail of that offer.

Abhi: How does that matter?

Nicky: Oh it does. Because it means that you cannot avail this benefit if you decide to prepay your loan before 15 years. It also means that you cannot avail this benefit if you transfer your balance to another bank, if they offer to charge a lower rate of return.

Abhi: Does this mean that the scheme is useless?

Nicky: Not at all. I'll explain this with an example. A person taking Rs 50 lakhs as loan, for a period of 20 years, at 11%p.a. interest, will need to pay an EMI of Rs 51,609 per month. According to this scheme, he will be able to save Rs6,19,308 after 15 years, the equivalent of one year's EMI.

Abhi: That's quite a lot of money!

Nicky: Well. So it seems. But then, you see, the value of money 15 years down the line, is not the same as the value of money today. So its present value, after accounting for an average inflation of say 7%, is just Rs 2.24 lakhs. The value could be lower if you take a higher inflation or a higher opportunity cost.

Abhi: You are getting into a lot of jargons. Just tell me what should I do?

Nicky: Take an informed decision. All other terms being same, with no intentions to default, or switch your lender and if you are sure that you will keep the loan for at least 15 years, then this scheme is for you. The benefit in present value terms is not as big as you think. But it is definitely a benefit.

On the other hand, if you think you might want to repay earlier or might want to change the lending bank sometime in the future, then this scheme may not benefit you and this scheme should not be the deciding factor for choosing a home loan provider.

Understanding EMIs

This article was originally published in Postnoon on September 9th, 2012


http://postnoon.com/2012/09/07/understanding-emis/71082

A week after our first set of discussions about home loans, Abhi came back to me for further assistance with understanding home loans. He told me that he had approached his bank and started the process of getting a loan sanctioned. He had already submitted self attested copies of four months pay slips, six months' salary bank statements, past three years Form 16s, ID proof, address proof, PAN Card and the employee ID.

Abhi: Nicky, tell me, what are EMIs and how are they calculated?

Nicky: Equated Monthly Installment or EMI, as they are popularly known as, is a fixed amount of money that you return to the bank, on a specific date of each month. The EMI consists of part repayment of principal and the interest. It is calculated in such a way that over a period of time, if you pay all the EMIs on time, your loan will get completely repaid.

Abhi: Why don't we just pay the interest every month and repay the principal after the term of the loan is over?

Nicky: Well, you could do that. But that would mean that you pay interest on the entire principal throughout the term. Also, when the term gets over, you may not have enough money to repay the principal. In EMIs, because you are also repaying a part of the principal every month, the interest component keeps decreasing every month. Every month, you pay interest on a lesser principal.

Another advantage is that the principal repayment is spread over many months, typically 240 or 120 months, relieving you of the burden of paying a very large amount at one time in the end. For example, if you were to take a loan of Rs10 lakhs at an interest of 11%, you will need to pay an EMI of Rs10,322 per month. This is equal to Rs1,23,864 per annum. If you look at the Table, you can clearly see that every year, your payment towards interest is coming down, as the interest is calculated only on the balance of the principal amount. If you keep paying Rs10,322 every month, for 20 years, you would have cleared your entire loan, along with all the interest.

Year Principal Repayment Interest Paid Outstanding Principal

Abhi: That's very comforting.

Nicky: And that's not all. You can also avail of tax benefits on both the principal as well as the interest paid.

Abhi: Hmmm...I just wish that my sanction letter comes soon and we are able to move into our new home as soon as possible!

Paperwork Check Must

This article was originally published in Postnoon on August 31st, 2012


http://postnoon.com/2012/08/31/paperwork-check-must/69584

My recently married cousin, Abhi, was contemplating buying a home. After putting all his savings together, he was still short of around Rs20 lakhs to buy the house that his wife and he liked. Being an engineer by education and by profession, he always found it difficult to handle financial matters. It is more a mental block than the capability to understand or deal with finances.

He came to me to understand the home loan process.

Abhi: A lot of the banks advertise that the home loan will be processed, sanctioned and made available within a week or 10 days. Is it so simple?

Nicky: Abhi, that's what they say. But you have to be realistic. It's not so simple. You first need to get a whole lot of documents in place like your recent bank statements, salary slips and job offer letter, Form 16 issued by the company, passport sized photographs, Pan Card, Address Proof, Agreement of Sale etc.

After you submit these to the bank's sales team, they will then send it to their loan processing officer. Who will, rest assured, ask for more documents. You provide those, they will ask for something else.

Abhi: But why does this happen?

Nicky: That's because of inadequate training to the sales team and their half hearted efforts. They do not give a complete list to begin with, to the customer. They do not check the documents properly and take it from the customer. If they did, they would know that the photo in the ID proof is not clear and hence the loan processing officer will not clear the file. Or, the amounts in the bank statements showing the down payment to the builder do not add up to at least 20% of the value of the property.

Once they collect the cheque for the processing fees, their motivation to help you is lost. So they keep coming back to you and asking for more and more documents. And they will always justify by saying that the 'regulations have changed'.

Abhi: This is de-motivating. If the process is so tiresome, why would anyone take a home loan?

Nicky: Do you have any other choice? Can you get a loan from somewhere else? Well, the answer is No. For most of us. So, whether we like it or not, we are stuck with this system. And then look at it this way, after you get the loan, you will be the owner of your dream house. So keep your cool. Patience is the key. You will get your loan.

Abhi: That's true. How about the interest rates and the EMI?

Nicky: Ah that! Can we do it later? I have a class now...