Are Interest Rate Subventions a Cure to Improving Financial Health of SME & Small Agriculturists?

Prof. Pulapre Balakrishnan’s article, Independence and accountability published in The Hindu, dated 9^th November 2018 is well written and a balanced exposition. However, his suggestion (“If, in the spirit of contriteness as it were, the government wants to reach out to them, the right course would be to provide interest rate subvention”) for providing interest rate subvention for improving the financial health of medium and small enterprises seems to be dictated more by emotions than by either logic or empirical evidence on such interventions.

Interest rate subsidies, which such subvention would entail, creates various distortions and negative consequences for the economy and society. These include,

a)      It is available only to those who have taken bank loans, ie a small minority of the populace.

b)      Such policy generates excess demand for bank credit, which gets rationed essentially through exercise of political and economic power. That is, those with political and economic muscle corner a greater proportion of bank loans.

c)      This in turn leads to growing levels of income and wealth inequality. First, because the rich and powerful now have larger capital at their disposal. Second, they get it at cheaper rates than the market clearing rate. Third, their incentive to repay is lower.

d)     The excess demand for credit cleared through extra-constitutional means, also leads to generation of humungous amounts of corruption – affecting  politicians, bureaucrats, and banks.

e)      The losses on account of bad loans in turn make the banks weak / sick.

f)       This in turn forces banks to give lower returns to their depositors. (Incidentally, the Governor of RBI has gone on record in his speech dated 26th July 2016 stating, “Many middle class savers value the high nominal interest rates on their fixed deposits, not realizing that their principal is eroding significantly every year”!). A direct consequent of lower interest rates on deposits is that it reduces the savings rate of the economy, making the country rely more on foreign capital.

g)      Since the benefits are concentrated and the resultant pain extremely diffused over the entire society there is little concentrated efforts to counter it. These aspects of negative consequences of cheap credit is hardly visible in the media or policy documents.   

Furthermore, interest rate subvention would have to be substantial if it is to make a difference to the financial viability of any project, especially considering that total interest costs may not be a very large proportion of overall costs for any but the most profitable projects.

As such, with large amount of the interest rate subvention all the negativities and distortions associated with using interest rate subsidy in promoting trade / industry would very well come into play. 

As an underdeveloped country, higher levels of capital in all forms (physical, financial, human, technological etc.) are required. Making it cheap, but difficult to obtain is not helping anyone, least the intended beneficiaries. It just salves middle class conscience and converts us into a society of alms-receivers. Availability of credit is much more important than cost. Pushing cheap credit does not solve problems of connectivity (roads / telephone lines), irrigation, power, social equality, lack of information, lack of basic skills which make people productive, good health etc. Not having ability to usefully employ credit, is like giving an illiterate man a book on religion or philosophy with the hope that it would do enlighten him! Credit given to persons without ability to utilize it helps in driving borrowers into a debt trap.

A better way to promote accumulation of financial would be by focusing more on the deposit side of the banking business. Especially using technology and redesign of process to make it  easier to open and operate simple depository accounts. Presently, the processes we have implies that for a daily worker to operate his account he / she has to forego a full day’s earnings. Is it any wonder that there are so many dormant PMJDY accounts or that the level of operations in the non-dormant accounts is low?

Governance in PSUs

Prof. T T Ram Mohan’s is a well-known and respected academic, who regularly publishes his views on various banking and financial markets related subjects in established newspapers and journals. In his article, The RBI concedes a vital principle, carried by The Hindu, dated 22^nd November 2018 makes a number of valid observations and deductions. However, I would like to differ with him on the following issues: 

a)      The need for the Board to exercise its powers so as to overrule management decisions would not arise if the Board has being giving meaningful strategic direction and the management is up to its responsibilities. Therefore, for a well-functioning organisation the need for Board to exercise its powers so as to overrule management decisions should rarely arise. This is where the criticality of composition of the Board comes into play. Considering the composition of the RBI Board, it is anybody’s guess as to how independent it is in taking considered, non-partisan decisions, and giving broad strategic direction. The composition and functioning of Boards of PSUs, especially PSU Banks, is a readily available glaring example.

b)      Prof. Ram Mohan states that, “The RBI management may or may not accept the inputs of the Board”. Would this not amount to insubordination? If the management of RBI (or any other corporate body howsoever organised) differs from the opinion of the Board, the options available to it are (i) re-represent with cogent arguments (ii) accept Board’s decision and implement, failing which (iii) step down from the management. The luxury of not accepting inputs of the Board is just not available to the management under any circumstances.

c)      If RBI’s revaluation reserves have arisen due to changes in rupee value of its gold and foreign currency holdings, will it not violate the matching concept accounting principle by netting it off against government securities? And if such netting is done, would it not amount effectively to “stealing” from Paul to pay Peter? Well one of the qualities which make money valuable is its “fungibility”!

d)     Prof. Ram Mohan also suggests and justifies need for relaxation in PCA norms. Which is in other words nothing but support for regulatory forbearance - one of the principal contributing factors to present mess which is Indian banking industry. The concern for adequate, timely, and reasonably priced credit flowing to various economic agents is not just valid but extremely pressing and critical. However, regulatory forbearance (by any name / form including loan write-offs, directed and cheap credit, Mudra Loans, 59 minutes loans etc.) does not address the issue and as has been repeatedly seen contributes in making the problem even more complex and intractable, ultimately adversely affecting all and sundry.

In this context, I would like to mention that the lending procedures / standards which are followed in Indian banking primarily evolved to address financing of trade. Credit risk in terms of Moral Hazard was covered by having security charge over the commodity being financed (preferably under banker's lock and key) and risk of Adverse Selection was addressed by stipulating margins and periodic valuation. This was further supported by stock statements / inspections and worked fine as long the lending was restricted to financing trade in commodities, valuation of which was fairly well predictable. For commodities with high volatility in valuation, suitable higher margins were stipulated. However, once financing of manufacturing is considered there is no way the borrowing entity can continue as a going concern without both long and short term debt. As such, the dichotomy of working capital finance vs term / project finance is not just anachronistic but also illogical. There are several other conceptual inconsistencies in the existing lending framework used by the Indian banking industry.

For example, coming to the financing of services (which now constitute more than 50% of the Indian economy) with virtually no tangible primary security, the existing processes fail all together leaving the financing of this sector to the ministrations of the equivalent of quackery.

The conceptual framework under which lending is done in India is therefore in my considered opinion no more relevant to cater to Indian conditions - agriculture, manufacturing, trade, or services. Therefore the difficulties in accessing bank credit, prolonged delays, and the high levels of NPAs arising periodically should not be surprising. 

In the absence of a suitable, coherent, workable, conceptual framework for lending, bankers have fallen back primarily on provision of collateral security. This in turn brings other complications. First, collateral security does give comfort but hides the nature of risk being taken on by banks on their lending book - in terms of debt risk versus equity risk. Now since both debt and equity risk is indistinguishably mixed up in the overall portfolio of Indian banks, while the pricing is wholly debt related, it is but natural that NPAs arise since the overall portfolio is sub-optimally priced. Second, provision of collateral blinds banks to the basic fact that their primary security is a going concern generating surpluses, which can be pre-empted for debt servicing. No bank can survive by resorting to foreclosure of security especially since they are highly leveraged entities, work on wafer thin operating margins in the lending business, and therefore have very little margin of safety in making mistakes. Let alone relying wholly on rectification of past mistakes.

The lack of coherent conceptual framework for lending is also amply displayed by the decision making process in banks, with extremely long appraisal notes, multiple iterations and queries which prolong the time for decisions to be made, stipulation of all kinds of irrelevant and unworkable loan covenants etc. All these aberrations are essentially insurance policies being taken by officials involved in taking lending decisions. Poor guys are just trying to protect their backsides with the ever present vigilance sword hanging over them.

The present situation of Indian banking is the direct result of mis-governance practised by different governments over the past 50 years plus. Irrespective of persuasion or ideology, the political class has strongly entrenched perverse incentives to control the financial markets – it helps in getting votes by controlling rural elites with promises of cheap credit and lone waivers and at the same time helps in garnering funds for fighting elections from the large capitalist class. Over and above all this, the icing on the cake is the ability to twist the arms of PSUs for financing pet projects through resort to CSR funds.  The strategy is especially endearing since the benefits are highly concentrated, while the consequences are highly diffused over the entire populace and prolonged over time.

To achieve this state of affairs, the first step was emasculation of management – which has been largely achieved for nearly all PSU organisations. Maybe RBI is one of the remaining bastions to be overcome!

GUJARAT FILES – A Review*

I am quite sure that Maithili Tyagi, a Kayastha girl from Kanpur, would be an extremely unique person. For that matter, any man, woman or child belonging to the Kayastha community, hailing from any part of India (the Kayastha community is quite widespread over Bengal, Bihar & Jharkhand, UP, Rajasthan, Madhya Pradesh, and parts of South India such as Hyderabad & Aurangabad) with the surname of Tyagi would be a particularly rare exception. I have not met anyone or heard of any Kayastha with such a surname. Though I am sure, so many seasoned, senior IPS officers many of whom had had successful stints with RAW and IB and were thick skinned diplomats would have been easily hoodwinked into believing that Maithili Tyagi, was a Kayastha girl from Kanpur.

I am also surprised as why Maithili Tyagi, a Kayastha girl from Kanpur and daughter of a conservative Sanskrit teacher, could not and should not have been familiar and comfortable with the Urdu language (page 83 – The urge to reply to Ashok Naraya in an Urdu couplet was strong but I had to refrain from doing so). The Kayastha community is known for its long association and erudition in Urdu and Persian, with local lore in UP & Bihar often referring to them as adha-Mussalman (semi-Muslims). Prominent Kayasthas such as Munshi Premchand wrote in Urdu and Firaq Gorakhpuri was a very famous Urdu shaiyar. Babu Rajendra Prasad, mentions in his autobiography that he learned Hindi after the age of 24-25 and had started his law practice. Prior to this, the languages in which he had had his formal education and in which he was comfortable were English and Persian. That is, apart from Bengali, having picked up that language on shifting to Calcutta for his education from his middle-school onwards. Hyderabad is famous for its Kayastha connection with prominent members of their nobility being from this community. Incidentally, Wikipedia informs that there is a fairly large Kayastha Muslim community in India (and Pakistan)!

If Maithili Tyagi, as a good investigative Kayatha journalist, had done some background check, she would have come to be aware that as per some modern (and much respected) academic work on social change in India, the Kayastha community owes its formation to those Indians who associated themselves with Muslim rulers in helping them run their administration, which could not be done without local help. While caste Hindus, would lose their caste by associating themselves with the Muslims, this left only those locals for this purpose who were outside the caste system – the Outcastes (referred to variously as Depressed classes, Scheduled Castes, or Dalits) and who had no caste to lose! Therefore, while Kayasthas remained Hindus by religion, they are not part of any of the four varnas – they are neither Brahmins, Kshatriya, Vaishya, nor Sudra. The community is essentially formed of those dalits who moved up the  social ladder by associating themselves with the Muslim rulers and in the process picked up various Muslim cultural traditions such as love for non-vegetarian food and partiality to Persian, Arabic, and Urdu language. By the way, a friend informs me (and I have no reason to disbelieve him) that  Tyagis are a sect of Brahmins who have given up (tyaag diyaa) presiding over pooja and yagya.     

By the way, yours truly (another Kayastha) had his aksharabhyas (a child’s initiation to formal education) on Basant Panchami in front of image of Goddess Saraswati by writing alif, be, the with a piece of chalk on a wooden slade and not ka, kha, ga. For the aksharabhyas of one of my cousins, the Moulavi Saheb, was an intrinsic part of the ceremony!  

For a book with an arm long list of endorsements (at least 16 in the edition of the book with me) and acclaimed by among others, Caravan, The Wire, and Scroll who published chapters of the book, it has too many mistakes - typographical, grammatical, syntactical, and conceptual. For example, Rajan Priyadarshi, moves from being an OBC (page 38 – Priyadarshi, he informed us, also belonged to the OBC class) to being a Dalit (page 43 – I met Rajan Priyadarshi, the person you had asked me to speak to as a Dalit; and page 44 – I am a Dalit). Similarly, Girish Singhal’s surname suggests that he is from the bania caste, ie, which would make him from the OBC community and not a Dalit. I little more serious, careful proof reading might have helped.  

Like any respectably Bollywood potboiler, the book inserts an item number in the form of Usha Rada (with all due respect to this lady). There is virtually a whole chapter (Chapter 5) devoted to her, though her only connection to the subject matter of the book seems to be that she was an IPS officer of the Gujarat cadre and as such a professional colleague of most of the other dramatis personae around whom the book revolves. There is absolutely no rhyme or reason as to why she should find mention in the narrative.

One aspect of the author’s personality which is surely to be lauded is her sense of self-importance verging on the psychotic. Statements such as, “That I was the journalist who had sent the Home Minister of Gujarat behind bars” surely seems to suggest something like that.  

Justice B N Srikrishna mentions in the Forward to the book that, the nature of truth has baffled philosophers all over the world for ages. He goes on to mention, “As to whether the material presented in this book represents facts, or mere perspective events, is for the reader to judge.”  After reading the book, cover to cover, twice over, I have a dirty hunch that he might be hinting to the hapless readers, who would be investing their time and money in wading through the tome in the hope of finding some gems, that it could also be a piece of hallucinatory outpourings or its more sophisticated version, magic realism. I have no hesitation in confessing that I am neither a philosopher, nor omniscient, nor an award winning investigative journalist of national and international fame. I am just a semi-literate, schizophrenic, unemployed kabbadi player

If, the basic rule of journalism is evidence, the wealth of ‘evidence’ presented in the book should surely have resulted in a string of convictions by now. 

Overall, the book lacks both focus and credibility – it just seems to be a product of some slick marketing.

* Notes:

         

         My views are based on the Second Edition of the book.
         Direct quotations from the book are in italics.