Business and Economy

India-US Bilateral Defense Trade To Reach $18 Billion By Year End: Pentagon

According to the Pentagon, the bilateral defense trade between the two countries is expected to reach USD 18 billion by the year end. The relationship marks a slow but sure drift in India’s sourcing of defense procurement on one hand and defense partnership on the other. This is expected to get further fillip in the forthcoming ninth India-US Defence Technologies and Trade Initiative or DTTI group in New Delhi next week. This trend is clearly reaffirmed by a recent statement of Ellen M Lord, Undersecretary Of Defense For Acquisition And Sustainment that  the US is committed to strengthen its partnership with India while furthering military-to-military relationships and cooperation.

India –US bilateral defense trade shows a rising trend since 2008, rising from a negligible level to an estimated $18 billion by the end of 2019. This indicates diversification in the source of defense procurement of India. India had been traditionally procuring defense related products mainly from Russia. This is also an evidence to India’s increasing realism in military partnership given fast changing geo-political scenario. This is also an evidence of India’s interest in acquiring state of the art modern technology based defense equipment. In the quest for increased military partnership with India, the US granted the India Strategic Trade Authority Tier 1 designation in  August 2018, providing New Delhi with greater supply-chain efficiency by allowing American companies to export a greater range of dual-use and high-technology items to India under streamlined processes. This is said to have granted India the same authorisation as NATO allies Japan, South Korea and Australia. Earlier the Pentagon in its defense policy related documents substituted “Asia-Pacific” by “Indo-Pacific” clearly Indicating that United States is interested to give more importance to India in its Asia policy and interest in working together in the Indo-Pacific region.

The Indo-US partnership, however, requires a clever balancing its relationship with its traditional partners like Russia. India is the second largest market for the Russian defense industry. In 2017, approximately 68% of the Indian Military’s hardware import came from Russia, making Russia the chief supplier of defense equipment. Russia has stated publicly that it supports India receiving a permanent seat on the United Nations Security Council. In addition, Russia has expressed interest in joining SAARC with observer status in which India is a founding member. Russia with 68%, USA 14% and Israel 7.2% are the major arms suppliers to India (2012-2016), and India and Russia have deepened their Make in India defense manufacturing cooperation by signing agreements for the construction of naval frigates, KA-226T twin-engine utility helicopters (joint venture (JV) to make 60 in Russia and 140 in India), Brahmos cruise missile (JV with 50.5% India and 49.5% Russia) (Dec 2017 update). Under the leadership of India’s Prime Minister Narendra Modi  and President Vladimir Putin, the bilateral relationship has seen further growth and development. An informal meeting between them in 2018 at Sochi helped accelerate the partnership, displaying the role of interaction and cooperation between India and Russia.

Economic Development and Policies

Monetary and Credit policy: Meaning and Importance

Monetary policy of   pertains to controlling and regulating money supply and cost borrowing with twin objectives of price stability and economic growth.  The monetary authority of all modern economies (countries), typically the central bank, targets an inflation rate or interest rate to ensure price stability and general trust in the currency. The other goals of a monetary policy are usually to contribute to the stability of gross domestic product, to achieve and maintain low unemployment, and to maintain predictable exchange rates with other currencies.

Types of Monetary Policy

There are two types of monetary policy:

  1. Expansionary Monetary Policy and 2. Contractionary Monetary policy

Expansionary Monetary Policy

When an economy is undergoing recession, expansionary monetary policy is used to stimulate the economy.  The monetary authority in an expansionary policy maintains short-term interest rates at a lower than usual rate or increases the total supply of money in the economy more rapidly than usual. It is traditionally used to try to combat unemployment in a recession. A lower interest rate leads to increased borrowing (due to low cost of borrowing ) and investment  by  businesses This increases aggregate demand (the overall demand for all goods and services in an economy), which boosts short-term growth as measured by gross domestic product (GDP) growth. Expansionary monetary policy usually leads to depreciation of currency of the country in question . In other words it diminishes the value of the currency relative to other currencies (the exchange rate).

Contractionary Monetary Policy

In  contractionary monetary policy, the monetary authority increases short run interest rates or in other words maintains short-term interest rates higher than usual in order to reduce borrowing (as it becomes costlier) This in turn slows the rate of growth in the money supply or even shrinks it. This slows short-term economic growth and lessens inflation. The contractionary monetary policy is resorted to curb high level of inflationary expectations or “cool down” an “over- heated economy” due to much higher aggregate demand than aggregate supply.However, it can lead to increased unemployment and depressed borrowing and spending by consumers and businesses, which can eventually result in an economic recession if implemented too vigorously.

Credit Policy

Credit is created on the basis of money supply. In a branch banking system operating with provision of a reserve ratio, every bank has to maintain an amount equal to reserve ratio out of its total time and demand deposits and the remaining part is lent out. This is how “reserve money” or “high powered money” creates “credit”. In economics, credit policy is government policy at a particular time on how easy or difficult it should be for people and businesses to borrow money and how much it will cost.

Money Multiplier or Credit Multiplier

Money multiplier or credit multiplier is a model that illustrates how banks can create money. The rate at which credit is created depends on the reserve ratio and the capital ratio for banks. The money multiplier or credit multiplier tells how the maximum amount the money supply could increase based on an increase in reserves within the banking system. Money multiplier closely related ratios of commercial bank money to central bank money (also called the monetary base) under a fractional-reserve banking system. In a fractional-reserve banking system, the total amount of loans that commercial banks are allowed to extend (the commercial bank money that they can legally create) when there are no leakages is equal to a multiple of the amount of reserves. This multiple is the reciprocal of the reserve ratio, and it is an economic multiplier.

In equations, writing M for commercial bank money (loans), R for reserves (central bank money), and RR for the reserve ratio, the reserve ratio requirement is that {\displaystyle R/M\geq RR;} {\displaystyle R/M\geq RR;}

 R/M{\displaystyle R/M\geq RR;} ≥ RR

the fraction of reserves must be at least the reserve ratio.

Taking the reciprocal,

M/R≤1/RR{\displaystyle M/R\leq 1/RR,}

 Which, yields {\displaystyle M\leq R\times (1/RR),}M≤R X (1/RR)

meaning that commercial bank money is at most reserves times (1/RR) which is the multiplier ignoring leakages into currency If banks lend out close to the maximum allowed by their reserves and there are no leakages into currency holdings, then the inequality becomes an approximate equality, and commercial bank money is central bank money times the multiplier. If banks instead lend less than the maximum, accumulating excess reserves, then commercial bank money will be less than central bank money times the theoretical multiplier.

High Powered Money

It is high powered money that creates overall money and credit supply in an economy. High powered money or powerful money refers to that currency that has been issued by the Government and Reserve Bank of India. Some portion of this currency is kept along with the public while rest is kept as funds in Reserve Bank. Base money or high powered money in a country is the total amount of bank notes and coins circulating in the economy. This includes:

  • the total currency circulating in the public,
  • plus the currency that is physically held in the vaults of commercial banks,
  • plus the commercial banks’ reserves held in the central bank .

The monetary base should not be confused with the money supply, which consists of the total currency circulating in the public plus certain types of non-bank deposits with commercial banks.

If a country’s gross domestic product is declining or growing sluggishly, monetary policy can offset this with open market purchases of bonds, which expand the monetary base. This expansion of the base in turn leads to expansion of the money supply and to downward pressure on interest rates, which makes it less expensive for consumers to buy consumer goods and for companies to purchase new physical capital; the increase in these types of expenditure gives an upward push to gross domestic product. On the other hand, if gross domestic product is growing at an unsustainably high rate, threatening to cause an increase in the inflation rate, contractionary open market operations can be used to slow the economy down.

Objectives of Monetary Policy

  • The primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth. Price stability is a necessary precondition to sustainable growth.
  • In May 2016, the Reserve Bank of India (RBI) Act, 1934 was amended to provide a statutory basis for the implementation of the flexible inflation targeting framework.
  • The amended RBI Act also provides for the inflation target to be set by the Government of India, in consultation with the Reserve Bank, once in every five years. Accordingly, the Central Government has notified in the Official Gazette 4 per cent Consumer Price Index (CPI) inflation as the target for the period from August 5, 2016 to March 31, 2021 with the upper tolerance limit of 6 per cent and the lower tolerance limit of 2 per cent.
  • The Central Government notified the following as factors that constitute failure to achieve the inflation target:(a) the average inflation is more than the upper tolerance level of the inflation target for any three consecutive quarters; or (b) the average inflation is less than the lower tolerance level for any three consecutive quarters.
  • Prior to the amendment in the RBI Act in May 2016, the flexible inflation targeting framework was governed by an Agreement on Monetary Policy Framework between the Government and the Reserve Bank of India of February 20, 2015.

Monetary Policy Framework

  • The amended RBI Act explicitly provides the legislative mandate to the Reserve Bank to operate the monetary policy framework of the country.
  • The framework aims at setting the policy (repo) rate based on an assessment of the current and evolving macroeconomic situation; and modulation of liquidity conditions to anchor money market rates at or around the repo rate. Repo rate changes transmit through the money market to the entire the financial system, which, in turn, influences aggregate demand – a key determinant of inflation and growth.
  • Once the repo rate is announced, the operating framework designed by the Reserve Bank envisages liquidity management on a day-to-day basis through appropriate actions, which aim at anchoring the operating target – the weighted average call rate (WACR) – around the repo rate.
  • The operating framework is fine-tuned and revised depending on the evolving financial market and monetary conditions, while ensuring consistency with the monetary policy stance. The liquidity management framework was last revised significantly in April 2016.

Instruments of Monetary Policy

There are several direct and indirect instruments that are used for implementing monetary policy.

  • Repo Rate: The (fixed) interest rate at which the Reserve Bank provides overnight liquidity to banks against the collateral of government and other approved securities under the liquidity adjustment facility (LAF).
  • Reverse Repo Rate: The (fixed) interest rate at which the Reserve Bank absorbs liquidity, on an overnight basis, from banks against the collateral of eligible government securities under the LAF.
  • Liquidity Adjustment Facility (LAF): The LAF consists of overnight as well as term repo auctions. Progressively, the Reserve Bank has increased the proportion of liquidity injected under fine-tuning variable rate repo auctions of range of tenors. The aim of term repo is to help develop the inter-bank term money market, which in turn can set market based benchmarks for pricing of loans and deposits, and hence improve transmission of monetary policy. The Reserve Bank also conducts variable interest rate reverse repo auctions, as necessitated under the market conditions.
  • Marginal Standing Facility (MSF): A facility under which scheduled commercial banks can borrow additional amount of overnight money from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a limit at a penal rate of interest. This provides a safety valve against unanticipated liquidity shocks to the banking system.
  • Corridor: The MSF rate and reverse repo rate determine the corridor for the daily movement in the weighted average call money rate.
  • Bank Rate: It is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers. The Bank Rate is published under Section 49 of the Reserve Bank of India Act, 1934. This rate has been aligned to the MSF rate and, therefore, changes automatically as and when the MSF rate changes alongside policy repo rate changes.
  • Cash Reserve Ratio (CRR): The average daily balance that a bank is required to maintain with the Reserve Bank as a share of such per cent of its Net demand and time liabilities (NDTL) that the Reserve Bank may notify from time to time in the Gazette of India.
  • Statutory Liquidity Ratio (SLR): The share of NDTL that a bank is required to maintain in safe and liquid assets, such as, unencumbered government securities, cash and gold. Changes in SLR often influence the availability of resources in the banking system for lending to the private sector.
  • Open Market Operations (OMOs): These include both, outright purchase and sale of government securities, for injection and absorption of durable liquidity, respectively.
  • Market Stabilisation Scheme (MSS): This instrument for monetary management was introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through sale of short-dated government securities and treasury bills. The cash so mobilised is held in a separate government account with the Reserve Bank.

The Monetary Policy Process

  • Section 45ZB of the amended RBI Act, 1934 also provides for an empowered six-member monetary policy committee (MPC) to be constituted by the Central Government by notification in the Official Gazette. Accordingly, the Central Government in September 2016 constituted the MPC as under:
    1. Governor of the Reserve Bank of India – Chairperson, ex officio;
    2. Deputy Governor of the Reserve Bank of India, in charge of Monetary Policy – Member, ex officio;
    3. One officer of the Reserve Bank of India to be nominated by the Central Board – Member, ex officio;
    4. Shri Chetan Ghate, Professor, Indian Statistical Institute (ISI) – Member;
    5. Professor Pami Dua, Director, Delhi School of Economics – Member; and
    6. Dr. Ravindra H. Dholakia, Professor, Indian Institute of Management, Ahmedabad – Member.(Members referred to at 4 to 6 above, will hold office for a period of four years or until further orders, whichever is earlier.)
  • The MPC determines the policy interest rate required to achieve the inflation target. The first meeting of the MPC was held on October 3 and 4, 2016 in the run up to the Fourth Bi-monthly Monetary Policy Statement, 2016-17.
  • The Reserve Bank’s Monetary Policy Department (MPD) assists the MPC in formulating the monetary policy. Views of key stakeholders in the economy, and analytical work of the Reserve Bank contribute to the process for arriving at the decision on the policy repo rate.
  • The Financial Markets Operations Department (FMOD) operationalises the monetary policy, mainly through day-to-day liquidity management operations. The Financial Markets Committee (FMC) meets daily to review the liquidity conditions so as to ensure that the operating target of the weighted average call money rate (WACR).
  • Before the constitution of the MPC, a Technical Advisory Committee (TAC) on monetary policy with experts from monetary economics, central banking, financial markets and public finance advised the Reserve Bank on the stance of monetary policy. However, its role was only advisory in nature. With the formation of MPC, the TAC on Monetary Policy ceased to exist.
Economic Development and Policies

NBFC crisis: CEA for stricter compliance norms

The Chief Economic Adviser in the finance ministry Krishnamurthy Subramanian said (April 09, 2019) that the Non Bank Financial Companies are facing the problem of adverse asset-liability mismatch of firms and there are genuine fears that more non-banking financial companies (NBFCs) may default like IL&FS due to a growing liquidity crunch. According to him the issue is actually one of solvency and very few of them are solvent. He asserted that  the entire shadow-banking space needs to be “very tightly and carefully monitored” to ensure the crisis doesn’t recur or flare up. He added, “Assets of some NBFCs are long-dated while liabilities are short-term. When the going gets tough, those NBFCs that are not solvent enough find it difficult to roll over (payment obligation). So what is typically a solvency issue appears to have been a liquidity issue.”

He said that the role of credit rating agencies is very important perhaps because they help knowing which the firms in which insolvency problems are brewing. The onus of ensuring the quality of ratings lies solely with the rating agencies; they can’t just crib that companies didn’t provide enough information to them to be able to discharge their duty efficiently. Similarly, auditors, being the first line of information intermediaries, can’t complain they couldn’t detect irregularities early because they went by what the company’s management told them. Also, they must not be self-regulated, so the National Financial Reporting Authority (NFRA) has to be strengthened. Even some of the developed countries like the US were forced to shun self-regulation after the Enron scandal in 2001. The CEO prescribed the option of a seven-day default rule for lenders if the one-day default rule is too difficult to be implemented. However, such strict default-reporting mechanisms are essential, he viewed. Commenting on some of the mutual funds delaying full redemption for investors due to a delay in recovery of their funds lent to NBFCs, the CEA said investors need to be made aware of risks.

What is meant by NBFCs?

Non Bank Financial Companies are kind of nonbank financial institutions. The World Bank Group defines Non Bank Financial Institutions as follows:

“A nonbank financial institution (NBFI) is a financial institution that does not have a full banking license and cannot accept deposits from the public. However, NBFIs do facilitate alternative financial services, such as investment (both collective and individual), risk pooling, financial consulting, brokering, money transmission, and check cashing. NBFIs are a source of consumer credit (along with licensed banks). Examples of nonbank financial institutions include insurance firms, venture capitalists, currency exchanges, some microloan organizations, and pawn shops. These non-bank financial institutions provide services that are not necessarily suited to banks, serve as competition to banks, and specialize in sectors or groups.”

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property. A non-banking institution which is a company and has principal business of receiving deposits under any scheme or arrangement in one lump sum or in installments by way of contributions or in any other manner, is also a non-banking financial company (Residuary non-banking company).

A NBFC’s financial activity is taken as principal business when a company’s financial assets constitute more than 50 per cent of the total assets and income from financial assets constitute more than 50 per cent of the gross income. A company which fulfils both these criteria will be registered as NBFC by RBI. The term ‘principal business’ is not defined by the Reserve Bank of India Act. The Reserve Bank has defined it so as to ensure that only companies predominantly engaged in financial activity get registered with it and are regulated and supervised by it.

Difference between banks & NBFCs

  • NBFC cannot accept demand deposits;
  • NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself;
  • Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.

Types of NBFCs

By the kind of activity they conduct NBFCs may be Asset Finance Company (AFC) , Investment Company (IC), Loan Company (LC), Infrastructure Finance Company (IFC; Which deploys at least 75 per cent of its total assets in infrastructure loans,and minimum net owned fund Rs. 300 crore; a minimum credit rating of ‘A ‘or equivalent  and a CRAR of 15%.), Non-Banking Financial Company  Infrastructure Debt Fund, Mortgage Guarantee Companies (MGC) etc.

Some Examples of NBFI

 Insurance companies underwrite economic risks associated with death, illness, damage to or loss of property, and other risk of loss. Another example is Contractual savings institutions (also called institutional investors) provide the opportunity for individuals to invest in collective investment vehicles in a fiduciary rather than a principle role. Collective investment vehicles invest the pooled resources of the individuals and firms into numerous equity, debt, and derivatives promises. The two two main types of mutual funds are open-end and closed-end funds. Open-end funds generate new investments by allowing the public buy new shares at any time. Shareholders can liquidate their shares by selling them back to the open-end fund at the net asset value. Closed-end funds issue a fixed number of shares in an IPO. The shareholders capitalize on the value of their assets by selling their shares in a stock exchange.

Market makers are broker-dealer institutions that quote both a buy and sell price for an asset held in inventory. Such assets include equities, government and corporate debt, derivatives, and foreign currencies. Once an order is received, the market maker immediately sells from its inventory or makes a purchase to offset the loss in inventory. The difference in the buying and selling quotes, or the bid-offer spread, is how the market-maker makes profit. Market makers improve the liquidity of any asset in their inventory.

Specialized sectoral financiers provide a limited range of financial services to a targeted sector. For example, leasing companies provide financing for equipment, while real estate financiers channel capital to prospective homeowners. Leasing companies generally have two unique advantages over other specialized sectoral financiers. They are somewhat insulated against the risk of default because they own the leased equipment as part of their collateral agreement. Additionally, leasing companies enjoy the preferential tax treatment on equipment investment.

Other financial service providers include brokers (both securities and mortgage), management consultants, and financial advisors. They operate on a fee-for-service basis. For the most part, financial service providers improve informational efficiency for the investor. However, in the case of brokers, they do offer a transactions service by which an investor can liquidate existing assets.

How the problems arose in NBFCs in India: The IL&FS’ Issue

Since August 2018, several NBFCs in India including debt-ridden Infrastructure Leasing and Financial Services (IL&FS), in which various corporates, as well as mutual funds and insurance firms, had invested through short-term instruments like commercial papers and non-convertible debentures (NCDs), has been defaulting on its several debt-obligations. The ongoing liquidity crisis in the NBFC industry is the result of asset-liability mismatch (ALM). Since the NBFCs cannot raise retail deposits from the general public, they depend on wholesale lending for their capital requirements. As a result, the cost of funds for NBFCs is higher than that of banks.

The biggest error that the majority of NBFCs and housing finance companies (HFCs) committed with regards to the real estate sector is that they ventured into long-term lending to builders and also into underwriting loans with very long-term repayment tenures. As a result, the NBFCs short-term borrowing was channelised towards financing long-term loans. They were heavily dependent on banks, mutual funds and private placements to meet their capital requirement as well as for refinancing of loans.

Driven largely by global factors – chiefly rising crude oil prices, rising interest rates in the U.S., and trade tensions – Indian interest rates started to rise. The yield on the benchmark 10-year government bond moved up from around 6.8 percent to over 8 percent in a period of about three months. Fresh inflows into mutual funds, especially into debt funds, slowed, and debt fund managers began to adopt a “wait and watch” policy on deploying fresh funds. Liquidity supply to NBFCs began to dry up rapidly. Fresh bond issuances by NBFCs declined and the costs of borrowing rose. All this preceded the spate of defaults by IL&FS.

Infrastructure Leasing and Financial Services (IL&FS) defaulted on short-term debt obligations.  According to the Ministry of Corporate Affairs (MCA), IL&FS’ borrowings from banks and financial institutions added to nearly Rs 63,000 crore as per the balance sheet of 2017-2018. There were concerns that many NBFCs could have their funds stuck in IL&FS debt instruments. Reportedly, approximately Rs 2 trillion ($27.23 billion) of NBFC and HFC debt was due for redemption by the end of December 2018. Also, funding costs of NBFCs were likely to go up and could lead to a sharp decline in their margins. And then the news of IL&FS defaults broke. It had two immediate implications. First, there was a fear of large scale redemptions in debt mutual funds. So some funds resorted to panic selling of debt securities which sent a negative signal to the entire market. Second, the defaults shattered faith in ratings of debt securities. IL&FS debt had the had the highest rating just a couple of weeks before the default. The rating was revised to the lowest default grade (“D”) after the default occurred. This raised doubts about the quality of other issuers assigned similarly high ratings. The reaction in the market was vicious. Yields on corporate bonds went up and the debt market almost stalled. The RBI acted quickly and took steps to inject liquidity via open market operations. Since then calm has returned to the market for securities of less than one year but the market for medium-term securities remains tight.

Steps taken to resolve NBFCs crisis in India

The central bank has been taking several initiatives, including intermittent open market purchase of government securities, ever since the occurrence of a series of payment defaults by IL&FS and its arms which had culminated in the Centre disbanding the entire board of the infrastructure company and appointing a new one in its place under the leadership of Uday Kotak.

On September 27, the RBI permitted  banks to avail higher liquidity with effect from October 1 as it had enhanced the Facility to Avail Liquidity for Liquidity Coverage Ratio (FALLCR) from the existing 11% to 13% of their deposits. Liquidity coverage ratio refers to highly liquid assets that financial institutions need to hold in order to meet short-term obligations. The Reserve Bank has also permitted banks to use government securities, equal to their incremental outstanding credit to NBFCs, over and above their outstanding credit to them as on October 19,to meet the liquidity coverage ratio requirement. This would be in addition to the existing FALLCR of 13% of NDTL and limited to 0.5% of the bank’s NDTL (net demand and time liability), the RBI said. The additional window will be available up to December 31, 2018, the notification said.

On October RBI The Reserve Bank of India (RBI) decided to increase the single- borrower exposure limit of banks for non-banking finance companies (NBFCs) which do not finance infrastructure, to 15% from the existing 10% of their capital funds. This was to remain effective till December 31. While the Reserve Bank of India (RBI) and the Government have taken steps to ring fence the NBFC crisis and support its financing needs by providing additional liquidity to banks and credit enhancement for refinancing needs.

Business and Economy

Sensex continues to fall, investors lose over Rs 6 lakh crore in 7 days

The seven-day selling spree in the Indian equity market has eroded investors wealth to the tune of Rs 6.2 lakh crore. With Thursday’s fall, the Sensex has lost 1,508.42 points or about 4% in the last seven sessions, marking its longest losing streak in nearly three months.  On Thursday (May09/2019), the Sensex slid another 230.22 points, or 0.61%, to close at 37,558.91 as investors remained cautious ahead of trade talks between the US and China this week. The fall was led by Reliance Industries.


The broader Nifty ended the day lower at 11,301.80 points, down 57.65 points, or 0.51%. Both indices closed at their lowest levels since March 12. The investor sentiment was also dented by the weak results reported by some corporate heavyweights. The Street chose to stay cautious ahead of results from other bluechips given the trend so far has been somewhat mixed.

Motilal Oswal Securities observed in an interim earnings note for Q4FY19 that corporate banks demonstrated a decent improvement in asset quality, while the auto slowdown continues and management commentary from manufacturers of consumer staples was somewhat subdued. “The trend in earnings revision remains in favour of downgrades,” the brokerage said.

Thursday’s fall in the Sensex was largely led by Reliance Industries (RIL) after Morgan Stanley downgraded the country’s most profitable company to equal-weight from overweight. RIL contributed 140.65 points to the Sensex fall of 230.22 points. The stock, which has been on a downward trend in the last four days, has lost 10.8% of its value, translating a market cap erosion of Rs 96,265 crore.

Nevertheless, the benchmark indices are trading in the green so far in 2019 with a gain of about 4%. That is thanks to the gains posted by a handful of stocks, including HDFC Bank, Reliance Industries (RIL), Tata Consultancy Services, Axis Bank and Infosys. These stocks have contributed about 1,730 points to the Sensex rally of 1,490.58 points with the remaining constituents giving either negative or marginal returns.

Business and Economy

How Corporate Sector Fared in Five Years of Modi Sarkar

There are a number of initiatives taken by Modi Government with regard to infrastructure, labour reforms, ease of doing business and implementation of GST besides welfare initiatives such as efforts to make Swachha Bharat a movement for cleanliness and mooting a beautiful programme like Ayushman Bharat, doesn’t matter how difficult it is to implement on ground. However, the performance of the Indian corporate sector during this period gives reasons to be concerned. Some of the areas of concern that come out are as follows:

Falling corporate profits

According to the assessment of CRISIL, corporate profits in the last year of the NDA regime is poised to record 0% or nil growth. The net profits of the sector also fell both in 2014-15 and in 2017-18. The growth of   operating profits remaining at only sub 5% in two of the four years to 2017-18 and sub 10% in the other two is also a matter of concern.

Slowdown in GDP, manufacturing and export Growth

According to this assessment Both manufacturing and exports have fared poorly these past few years and that’s why despite the push to GDP from the re-based data, the economy has been slowing from 8.2% in 2016-17 to 7.2% in 2017-18 and further to an expected 7% in 2018-19.

The problem is demand has flagged following the general slowdown in the economy, the disruption from demonetisation and GST which threw smaller companies off-kilter. Negligible investments by the private sector in the last four years have meant very limited job creation and in some instances job losses.

Economists now expect the economy to grow at sub-7% in 2019-20 — and only 6.2-6.3% in H1. The slowdown in global growth and trade will stymie exports, both merchandise and software.

Insufficient Liquidity hits consumption and capital formation

Insufficient liquidity, worsened by the NBFC crisis, is beginning to hit consumption demand and is starving even mid-sized firms of affordable working capital. And large government borrowings — including those done off the balance sheet — have crowded out the private sector. Real interest rates are at nears
even-year highs. Investors have lost money in the markets. The Sensex may be up but the rise masks a much broader weakness; 70% of the stocks with a market capitalisation of over Rs 1,000 crore have lost value in the last one year.

Tapering Investment

Most critically, India Inc’s credit profile isn’t improving; Crisil’s debt-weighted credit ratio rose to 0.89 in H2FY19, a dip from H1, primarily on account of downgrade of two large telcos. The ratio could worsen with several real estate companies strapped for cash. The short point is most companies don’t have the cash to make fresh investments especially since this time around banks will check the quality of the equity. And that means a revival in private sector capex is many years away.

FDI is on a declining trend probably because of the government’s excessive oversight, especially on tax matters. Had the government eased the FDI norms and thrown open more sectors, global corporations may have invested more.

Manufacturing Sector facing various challenges

While rural distress and stagnant farm incomes are hurting sales of consumer staples and tractors, the moderation in urban demand too is hurting sales of consumer durables and retailers. The auto and  two-wheeler makers are grappling with big inventories and are staring at production cuts and car sales are crawling. Poor regulation and intense competition has left telecom in tatters and highly indebted. Limited private sector greenfield investment has seen order books of most engineering companies dry up.

Insufficient supplies of coal and gas have left power plants running at low load factors. Home sales have moderated substantially in the last five years and the subdued construction and real estate activity — as buyers would have postponed purchases to take advantage of the new GST rates — will have a bearing on sales of a range of goods.

Economic Development and Policies

Urjit Patel resigns as RBI governor

Well known economist and Reserve Bank of India (RBI) Governor Urjit Patel resigned today (December 10, 2018).  He said that he has decided to “step down” from his current position effective immediately “on account of personal reasons”. The governor’s decision to resign came five days after the bi-monthly policy meeting, in which he refused to answer questions on the controversies surrounding the RBI’s autonomy. He also appreciated the support and hard work of RBI staff, officers and management saying that it had been the proximate driver of the Bank’s considerable accomplishments in recent years. He expressed gratitude to his colleagues and Directors of the RBI Central Board, and wished them all the best for the future. All sober officers like Urjit Patel claim personal reasons when they resign, but public and observers do not take such reasoning on its face value. The differences between the RBI and government came loudly in public domain in last few weeks. Resignation of the RBI government is no doubt partly because of irreconcilable difference between the approach of the RBI and government. Media reports were rife with speculation of Urjit Patel’s resignation following the government’s decision to invoke the never-used-before special powers under Section 7 of the RBI Act to initiate consultation on a range of issues such as the Prompt Correct Action (PCA) norms, RBI’s capital reserves, and liquidity problem in NBFCs.

To clear the cloud, few minutes after Urjit Patel announced his resignation, Prime Minister Narendra Modi tweeted praise for him, saying that he is “an economist of a very high calibre with a deep and insightful understanding of macro-economic issues”. The PM added, “He steered the banking system from chaos to order and ensured discipline. Under his leadership, the RBI brought financial stability”.

Former Governor of the RBI, Raghuram Rajan, reacting  on Urjit Patel’s decision to step down, said that the autonomy of the central bank should not be undermined. He said, “Believe resignation of RBI Governor Urjit Patel is a matter of great concern. Resignation by a government servant is a note of protest when faced with circumstances they cannot deal with” .  While refusing to speculate what led to Urjit Patel’s resignation, he advised the government to take “extreme care” in its relationship further with the RBI. “Need to understand what prompted this act by Urjit Patel”.

Urjit Patel was appointed the 24th governor of the RBI on September 2016 for a three-year term. He was heavily criticised for his silence on demonetisation, which was announced just two months after he took the position. Urjit Patel earlier served as a deputy governor of the RBI and was elevated to the governor’s position after Raghuram Rajan’s tenure ended.

Economic Development and Policies Persons in News

Krishnamurthy Subramanian: The New Chief Economic Advisor to Govt. of India

The Appointments Committee of the Cabinet (ACC) has approved for the appointment of Dr Krishnamurthy Subramanian, Associate Prof. and ED (CAF), ISB, Hyderabad, to the post of Chief Economic Adviser,” said a government notification. Subsequently, the government appointed ISB Hyderabad professor Krishnamurthy Subramanian as Chief Economic Adviser for a period of three years on December 7, 2017. The Chief Economic Adviser (CEA) is the economic advisor to the Government of India. The CEA is the ex-officio cadre controlling authority of the Indian Economic Service. The CEA is under the direct charge of the Minister of Finance.

Who is Krishnamurthy Subramanian?

Mr. Subramanian is seen as one of the world’s leading experts in banking, corporate governance and economic policy. Before being appointed to the post, he was an associate professor and executive director (Centre for Analytical Finance) of Indian School of Business (ISB), Hyderabad. He Subramanian is a trained engineer and has a degree in Electrical Engineering from IIT Kanpur. He is also an alumni of IIM Calcutta, where he was named to the famed Honour Roll on account of his stellar academic performance after he had topped his batch. He earned PhD from Chicago-Booth, US  in Financial Economics under the advice of Professor Luigi Zingales and Professor Raghuram Rajan, the former RBI governor. Prior to taking a plunge into the world of academia, Subramanian worked as a consultant with JPMorgan Chase in New York and also served in a management role in the derivatives research group at ICICI Ltd. Besides being on the boards of Bandhan Bank Ltd, the National Institute of Bank Management, and the RBI Academy, Subramanian also serves as a member of SEBI’s standing committees on alternative investment policy, primary markets, secondary markets and research.

Economic Development and Policies

Former CEA Arvind Subramanian speaks on back series GDP data and autonomy of RBI

The former Chief Economic Adviser (CEA) Arvind Subramanian, in an interview with the PTI,  called for an investigation by experts into the back series GDP data of India to clear doubts and build confidence in the country. He opined that the “puzzle” about the data needs to be explained. According to him, the institutions which do not have technical expertise in calculating the GDP data should not be involved in the process, apparently referring to the Niti Aayog. The well known economist also criticised demonetisation in his new book titled ‘Of Counsel: The Challenges of the Modi-Jaitley Economy’. He stressed the need to explain the issues involved in the back series data just to create confidence and eliminate any uncertainty or doubts. He also spoke on the controversy over the Niti Aayog’s presence at the release of the GDP back series data by the Central Statistics Office (CSO) last month. He opined that (only added) experts should have the main job of producing and explaining data.“I think this [calculation of GDP] is a very technical task and technical experts should do the task, institutions that don’t have technical expertise should not be involved in this.” It may be noted that data of past years using 2011-12 as the base year instead of 2004-05, the CSO last month lowered the country’s economic growth rate during the previous Congress-led UPA’s regime.

On the issue of demonitisation and Mr. Subramanian criticism of the policy after he demitted the office of the Chief Economic Adviser to the Government of India, he said that “this is not a Kiss and Tell memoir, that is for gossip columnists.” Referring to criticism that he did not speak on demonetisation when he was working for the government and now he is raising the issue to sell his book, Mr. Subramanian said that whatever people say, it is important to ananlyse why even after 86% reduction in cash [after demonetisation], there little impact on the economy; was it due to current GDP calculation method. It was important according to him to understand is it because “we are not measuring GDP correctly, or is it because our economy is very resilient,” Mr. Subramanian who currently teaches at Harvard Kennedy School remarked.

In the six quarters before demonetisation, growth averaged 8% and in the seven quarters after, it averaged about 6.8% [with a four-quarter window, the relevant numbers are 8.1% before and 6.2% after],” Mr. Subramanian wrote in the chapter “The Two Puzzles of Demonetisation — Political and Economic”.

On the recent spat between the government and the Reserve Bank of India (RBI) over a host of issues, Mr. Subramanian opined that the autonomy of the RBI must be protected because the country will benefit by having strong institutions. He, however added, “But, I think there must also be cooperation, consultation and everything. Both have to happen.”

Business and Economy

Sudipto Mundle committee report: Understanding the back series data on GDP growth

Sudipto Mundle committee report: Understanding the back series data on GDP growth

The NDA government won 2014 elections by highlighting low growth of the Indian economy due to policy paralysis and corruption during UPA regime and by promising the people “Achche Din.” Four years hence, the trust of the people in the NDA government has started dwindling for many reasons including whimsical economic policies, stopping publishing data on unemployment and news of 50 per cent increase in Swiss Bank deposit of Indians, apart from unabated cronyism and flight of money from the financial system further aggravating the NPA problem in the banking sector. The hounding of political opponents, vigilantism and incidents of demeaning intellectuals is too visible to ignore. Under the façade of building the economy or development policies, the thrust of government is on dismantling the old institutions instead of reforming them, take the case of the planning commission, UGC or JNU etc., the underlining objective of seeding one party’s ideology in the system is vulgarly apparent. And now the lies and slanders about the UPA government on the count of economic growth and emptiness of bravado of the claim of ‘4 years of NDA versus 70 years of Congress’ have once again been resoundingly revealed by back series data on the Indian economy, carried out first time after the new GDP measurement methodology was used since 2015.

The back series data released by the Sudipto Mundle-led committee show that GDP growth under the UPA government crossed 10 percent in 2007-08, which was only the second time in history. The back series data is essentially what the GDP growth rate and other macroeconomic indicators would have been, if computed with the present base year as the benchmark.

In addition to changing the base year, the new series adopted the system of measuring the gross value added (GVA) at basic prices in lieu of calculating the GDP at factor cost. The Indian Economic Service reckons that basic prices are less representative of the true cost as they do not take into account, the subsidies and taxes associated with the production process. The resultant numbers, arguably inflated, have often been brandished by the ruling dispensation to demonstrate the economic turnaround initiated under its watch.

What was new in the new method of GDP Measurement?

The base year was changed to 2010-11 instead of 2004-05. The base year is important in GDP calculation as factors such as purchasing power and inflation are taken as the benchmark for subsequent years. The prevalence of anomalous factors in the base year can distort calculations going forward.

Instead of Reserve Bank of India (RBI) data on company finances, the new series incorporates information from the Ministry of Corporate Affairs’ MCA21 database. This implies that corporate data is more accurately depicted in GDP figures. The review of the services sector, which accounts for almost 60 percent of India’s GDP, is also more comprehensive than earlier.

The committee has adjusted the data going as far back as 1994. It found that under the prevailing methodology, the GDP growth rate for each of the years between 1994 and 2014 is higher by at least 0.3 percent to 0.5 percent.

The new estimates released by a government constituted committee suggest that GDP growth in the period 2004-05 to 2011-12 may have been higher than reckoned earlier. According to the report, the growth of the Indian economy is 0.3 to 0.5 percentage points higher for each year. The revised figure for 2006-07 pegs growth in that year at 10.1% against the original 9.6%. The last time the economy grew at over 10% in any fiscal year was in 1988-89, when it registered a 10.2% expansion. Ironically, the perception of a tanking economy was among the causes for the demise of the UPA in 2014.

It proves that the economy under both UPA terms (10-year average: 8.1 percent) outperformed the Modi government (average 7.3 percent). Congress said on its official Twitter handle. According to the new data, the economy grew at an average of 9.42 percentage in the first four years of UPA-I, touching double digits in 2007-08. The impact of the global recession was felt in 2008-09, as GDP plummeted to 4.15 percent. Under the old series, the figure for 2008-09 stood at 6.7 percent, 2.55 percentage points higher than the revised number. However, it is testament to the resilience of the Indian economy that the GDP rebounded to 8.84 in 2009-10, even breaching the 10 percent mark in 2010-11. Recovery took much longer in other emerging markets. Under the old series, GDP grew at 8.4 in each of the years between 2008 and 2010.

The unification of the base year for data since 1994 lends to comparisons between the performances of successive governments. The UPA-I government clocked 8.36 percent growth over a five-year period beset with high crude oil prices and the blowback from the global financial crisis of 2008. If the first four years of UPA-I are considered in isolation, the average GDP growth rate stands at 9.42 percent. In contrast, economic growth during the first four years of the Narendra Modi-led NDA government has been relatively anemic at 7.15 percent.

India overtook China to become the fastest-growing large economy in the world, a fact frequently advertised by the NDA government to highlight its achievements in micromanaging the economy. However, the GDP back series data throws up a slightly different picture.

According to the report, India’s GDP growth rate for 2010-11 was 10.78 percent, 0.17 percentage points more than the 10.61 percent achieved by China in the same year. China’s growth rate has slipped since then. This means that India outdid its neighbour in a year when the latter’s economy was at its highest point in the past eight years. More importantly, this came at a time when global oil prices were high, as was the government’s subsidy bill.

India recently overtook France to become the sixth largest economy in the world, but problems persist. Disruptive measures like the implementation of the goods and services tax (GST) and the demonetisation of high-value currency notes have taken the wind out of the economy’s sails. Recovery has been subdued.

The banking sector, which is saddled with bad debt, is adding to the pressure on the economy. Credit has been drying up. The Insolvency and Bankruptcy Code has just started delivering on resolution of bad loans but lenders will have to take a substantial haircut on large loans even if new promoters are found, or asset reconstruction companies manage to turn around sick ventures.

However, the outlook is not entirely bleak. The International Monetary Fund (IMF) reckons that the adverse effects of demonetisation and the implementation of GST are fading. In its bi-annual World Economic Outlook, IMF said India is projected to grow at 7.4 percent in 2018-19, and 7.8 percent in 2019-20.

Business and Economy

US Federal Reserve raises interest rates 

The Federal Reserve raised interest rates on June 13 indicating a shift from the policies used to battle the 2007-2009 financial crisis and recession. In raising its benchmark overnight lending rate a quarter of a percentage point to a range of between 1.75 percent and 2 percent, the Federal Reserve dropped its pledge to keep rates low enough to stimulate the economy “for some time” and signaled it would tolerate above-target inflation at least through 2020. However, it is not the first time that the US has raised its interest rate in recent times. The Fed has raised rates seven times since late 2015 on the back of the US economy’s continuing expansion and solid job growth, rendering the language of its previous policy statements outdated. One of the reasons of recent hike is that inflation in the US is expected to be higher than projected earlier by the Federal Reserve. According to fresh projections from policymakers, it would run above the central bank’s 2 percent target, hitting 2.1 percent this year and remaining there through 2020.Also the Federal Reserve indicated that the need for near zero interest rate to buoy a crisis hit economy has lessened in view of strengthening labor market and rising economic activities. It also pointed out that household spending in the US has picked up while business fixed investment has continued to grow strongly. Fed Chairman Jerome Powell was latter to do a press conference to announce this policy changes.

The rate increase was in line with investors’ expectations and showed policymakers’ confidence in the economy’s growth prospects, continued low unemployment and steady inflation. The Fed now sees gross domestic product growing 2.8 percent this year, slightly higher than previously forecast, and dipping to 2.4 percent next year, unchanged from policymakers’ March projections. The unemployment rate is seen falling to 3.6 percent in 2018, compared to the 3.8 percent forecast in March.

The Fed’s short-term policy rate, a benchmark for a host of other borrowing costs, is now roughly equal to the rate of inflation, a breakthrough of sorts in the central bank’s battle in recent years to return monetary policy to a normal footing. Though rates are now roughly positive on an inflation-adjusted basis, the Fed still described its monetary policy as “accommodative,” with gradual rate increases likely warranted as a sturdy economy enters a 10th straight year of growth. Estimates of longer-run interest rates were unchanged and seen reaching as high as 3.4 percent in 2020 before dropping to 2.9 percent in the longer run.

 United States of America is the e biggest economy by size (about $18 trillion GDP) and the biggest trading partner and investor for many other economies. It is the best investment destination for many investors. Keeping in view these factors any change in the in the US fiscal and monetary policies has marked effect on the flow of global trade and investment.  The US is returning to normalcy with short-term rates moving up from the near-zero level in the post-2008 period to 1-1.25 per cent and further to 1.75 percent. The interest rate hike in the world’s largest economy has implications for emerging economies like India. The dollar inflows from foreign institutional investors (FIIs) have been robust in the past in India and other emerging economies due to troubles and uncertainties in the US. The focus on a normal monetary policy is now playing out well for the financial markets. There are expectations that a part of the money will flow back to the US as there will be investment safety and also good returns. The rupee value against the US dollar can also come under pressure if dollar funds’ outflow from the Indian markets take place. The rupee, which has strengthened a bit lately, came under pressure post the US Fed rate hike. The gradual hike in Fed rates will also make the international debt more expensive. If there would be narrowing of  the interest rate differential between the US rates and the Indian interest rates it may impact the speculative or short-term money that comes to the domestic financial markets.