Arun Shouries Articles

‘Lower CRR further, have orderly transitions for lower interest rates’

October 20, 2008
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WALK THE TALK WITH ARUN SHOURIE

The Indian Express ::::Posted: Oct 20, 2008 at 0018 hrs IST

Transcript of the interview

My guest this week is an editor, author and economist, apart from being my friend and guide. Circumstances have changed quite a lot since we spoke last.

Thank you. There were great success stories. And the Maruti issues were oversubscribed 70 times. It has been a great success after that.

 

There is so much talk about buying us out of the market or selling us out of the market.

It is one of those ‘deaths foretold’. In the sense that for one-and-a-half years, many of us have been saying that the way the Government is handling things — especially the complete stoppage of reforms for the entire period — can lead to problems in production. Then, the problem of Inflation would arise, compounded by the fiscal profligacy of the government. The populist policy in which there was no accountability and then to rein in inflation is like trying to use the axe of monetary policy to swat a fly. 

When the successive round of tightening and raising of rates happened, the then Reserve Bank of India (RBI) governor Y V Reddy was asked in a press conference : “why you are making money expensive?” He said, “If dal and rice have become dearer why should the rupee not become more expensive?”

We are seeing the consequence today. Raising interest rates does not bring down the prices of dal and chawal. What happens is you further constrain production. One of the great achievements of Yashwant Sinha was that the administered interest rate was brought down to 6 per cent from 12.5 per cent.

 

But that was the global trend then…

Well, not really. But in India there was so much resistance. Even senior citizens were saying that their interest rate had been reduced (on fixed deposits), enabling firms to roll over their debts.

 

If you meet a bank chairman who wants to fly, he will be talking of air cuts…

To second this, it led to a housing boom. Now all that was choked up and one can see the effect on the cement industry today.

 

People who borrowed money at 7 per cent for housing loans have seen their rates going up to 13 per cent within seven months. It’s brutal.

The same thing is going to happen in the economy — this dal and chawal business of over-leveraged firms. Suppose a big company has borrowed a lot of money to acquire some big firms abroad… now with the prices of commodities falling, how will they finance their earlier commitments?

 

Do you think that Tata and Corus would face this problem?

Quite a few companies are over-extended. Look at the copper prices, for example. Sterlite (which specialises in copper production) made a great success of Balco (mainly in aluminium) and also brought Hindustan Zinc Ltd. But now with prices falling, you can see that Hindalco’s issues have been devolved. Similarly, for Tata Motors, it’s Tata Sons that have to put in money, probably by disinvesting TCS. These are interconnected issues.The Finance Minister recently said that it’s not of great concern if some firms’ share values have come down in the Sensex. But actually it is not just firms, it’s millions of investors. And it took a long time to persuade people to invest after Harshad Mehta and Ketan Parekh-type scams. Because of this blasé attitude that nothing is happening, we have landed ourselves in further trouble.The FM keeps saying that “fundamentals are strong”. But nothing happened to the “fundamentals” overnight when South-East Asian economies and currencies collapsed. That affected the real economy, nothing had happened to the fundamentals.Has anything happened to the fundamentals of American and European economies overnight? But they realised that liquidity crisis leads to a fundamental crisis… investment institutions backing firms. Therefore, they are more desperate to save the situation. We think that if we ignore the problem, it’ll cease to exist.      

 

But the presumption is that there is a global crisis. You have to live with it and you have to do a little course correction. What else can you do?

I do not think that it is a global crisis in that sense. The crisis in India is not a reflection of what is happening there. Here, it is fiscal mismanagement that sucks out liquidity from the market. Our liquidity difficulties have nothing to do with the world equity crisis and what you now see in the index of industrial production. This is what all of us have been forecasting for quite some time. I hold not only the Government but the media responsible, since it did not adequately take up these issues. Then there are some industry people who are more interested in making deals with individual ministers instead of lobbying for reforms. They (industries) should have woken up and explained the impending situation to the PM and FM, but nothing was done.

 

Do you think that we have crossed the hump?

Not yet. In the world, there can be four to five rounds. First comes the subprime crisis that is the trigger and then the institutions exposed to the problems, then the banks. Then, that will be compounded by the real firms that were leveraged, firms that are dependent on continuous orders, firms in other countries that are dependent on export. Our IT companies for instance. The real problem will come when everyone starts losing jobs. I fear there will be strong pressures from protectionism. Non-tariff barriers will be put up, leading to a ‘beggar-my-neighbour’ policy. That is when sovereign funds may move in to buy companies at lowest prices . This will be followed by another round of protectionism against the capital flow.

 

These are the countries which have large sovereign funds — China has $1.8 trillion of reserves, Singapore probably $750 billion. The small Abu Dhabi has more than a trillion dollars in sovereign funds. You can imagine the reaction if Qatar starts buying up companies: “No, no we cannot sell to Middle Eastern countries.” Then everybody puts up barriers… this was the occasion for India to show leadership.

    

Do you think that India could have taken advantage of it?

We need to keep our economies more competitive and show leadership to the world by giving them good ideas and participating in it.  For instance, I feel that Gordon Brown has shown leadership to Europe. In fact, his methods are being adopted by Americans who are overturning their own plans in favour of his suggestions.

 

You will agree that this is not the time for name-calling, particularly between the BJP and Congress. Are there ideas you can give to the Government and market consistently?

I think the BJP statement did not blame anybody. It was issued with constructive ideas that did not blame anybody. We felt that immediate relief was required for liquid mutual funds. That is what the people in the market told us. Second is to lower the Cash Reserve Ratio (CRR) much further.

 

A CRR of 9 per cent was brutal?

Yes. It should be brought back to 5 per cent as was the case earlier. Third, you must have orderly transitions for lowering interest rate. Because bank rates had become 23 per cent, banks were lending to each other. Government-owned banks were not lending to government-owned Oil companies.

 

Rather banks lend to the government?

Therefore, you lower the rate of interest and by March 2009, you could bring it down to manageable limits.

 

What figure is prudent now? If it would come down by 200 basis points, then with CRR cuts and some other liquidity measures, the interest rate should come down at 300-400 basis points between now and March 2009.

Yes. That is one of the many things that needs to be done.

 

Do you think it is desirable — with a combination of measures — for the interest rate to come down by 300 to 400 points by March 2009?

It is better that way. You should stimulate investment because it is drying up. Second, when government-owned banks are not lending to government-owned oil companies, just imagine who would be lending to small and medium enterprises.Even credit for kisan credit cards have been frozen and outlays that are required for the National Rural Employment Guarantee Scheme are not reaching the banks for making payment. These avenues for purchasing power going directly to the people should be opened. There are many opportunities in this. For instance, a suggestion was received that there is a cap on the amount of interest that can be given to NRI deposits. The cap is Libor plus 75 basis points.

 

It has been raised now

Citibank in the US can get funds at Libor plus 400 basis points. So, who will put it here?  But NRIs are scared we’re told. So remove this cap. Let the banks decide.

 

Instead of putting money in foreign banks they’d rather put in Indian banks.

Yes, because NRIs know these are government-owned banks, take advantage of it.

 

You would prefer the rates given to NRIs become Libor plus 400 basis points.

No. Why have a limit? If they want to deposit here, banks will pay them whatever they can afford. Remove these artificial constraints.

 

You do not see an exchange risk tomorrow?

No. Today the rupee is under great pressure when inflows from NRIs come. This is what happened in the case of the Millennium Deposit Scheme and Resurgent Indian Bonds. We had begun to lose $200 – 300 million every month because of the decision of the previous government and the previous RBI governor told Dr C Rangarajan that he would try to hold the rupee at a particular level. We started losing the reserves. So it was then that former FM Yashwant Sinha decided to have these bonds. It eased the pressure.

 

You want the government to go to the world with another bond issue of that kind.

Yes. Get the depositors here.

 

In the Indian establishment nobody wants the banks to set their own rates for NRIs’ deposits. So give them a range of 400 to 450 basis points.

Let the five banks decide. This financial crisis is an opportunity in for India. For instance, Yashwant Sinha, in one of his first Budget speeches, said that banks’ equity should be brought down to 33 per cent, even as the public sector character of the banks is maintained. Even then that was not possible. It is not possible now. So the idea is to use the occasion for rights issues of banks and strengthen the banks and enlarge their capital base. Let them get out and compete in the world.

 

So enlarge their equity with rights issue but the government does not go below 51 per cent holdings.

But because of the problems of the legislation in Parliament, nobody will support it.

 

So you can do rights issues by keeping the government at the same level up to 50 per cent.

Let’s assume it’s around 60 to 70 per cent. So in the rights issues of $10 billion. their total market capitalisation is $40 billion. Young economists have suggested that you do $10 billion. It is a brilliant idea. You do this, the government infuses money, they get liquidity.

 

The government is infusing some money now.

Under desperate circumstances after sucking it all out. For instance, for the oil bonds they did not compensate oil companies, naturally they had to take cut on banks

 

That is the funny part – one of failure to not sell oil companies (referring to the NDA rule). I see so much fighting between aviation and oil companies. Were these not public sector companies, would they have been allowed to build these outstandings?

No way. Today banks are saying that we cannot lend to oil companies, while oil companies are saying that we cannot give aviation fuel to aviation companies

 

The whole system has become distorted.

I think because of one of the key reverses of reforms was that the NDA government, under great difficulty, had to fight to get back from the Administered Price Mechanism in the petroleum sector. Because as you know every 50 paise hike in diesel prices means an agitation.

 

It was not easy.

It was a real fight. It was to the credit of Yashwant Sinha and Jaswant Singh that they advanced towards that. But Mani Shankar Aiyar maintained that the government must determine prices. He started dictating prices to the oil companies. Then the oil prices started rising. They inflicted enormous losses on oil companies. The oil companies were told that the government would give them bonds, but P Chidambaram did not include these bonds in the budget, so it was a deficit.

 

We have made paupers of our children and are now borrowing from grand children.

It is Rs 1,50,000 crore of non-items which were excluded from the budget that were actually deficit. That is the basis of the current problem. Then you will say that you will raise interest rate to deal with the problem.

 

So create liquidity by cutting CRR. Second, bring down interest rate so we see a fall of 350 to 300 basis points by March. This will allow banks to raise more capital through rights issues, which the government also subscribes to, so that its equity does not come down. Fourth, if you take one bond on budget what would happen?

Then you can use it for Statutory Liquidity Ratio (SLR).

 

Then they became SLR compliant.

This allows the banks to be aggressive in market operations. Today you are squeezing them from all sides.

 

They do not want the CBI around. They’d rather lend to the government.

This is a crisis with an opportunity in this sense.

 

But constructive dialogue has died down. Nobody believes it can happen particularly with Congress and BJP.

Yes, that is true. But it is also necessary to move over discussion into some ideas. I would appeal to everyone. People do not need to be reminded of their problems. They need to be told that you have ideas to solve the problems.

 

It’s not enough to abuse the government of the day and carry on.

Important institutions are not working. We cannot expect the reforms to come down from the political arena, since those in it are beneficiaries of the system.  So it would either be the middle class or personalities like us who can inform the public discourse.

 

You said that the PM is too busy to meet you. I hope he has time to meet you or read the text in The Indian Express…

Usse to apne guldaste ki raunaq se hi maksad hai/ kahaan gulchin ko fursat hai ki dard-e-gulistan samjhe.

 

Transcript by Rupali Das

 

 

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