Vision 2030: Unfinished Agenda that is fair, just and egalitarian

The 71st Republic Day makes me reflect on the unfinished agenda for growth before the nation and a vision for the next decade. It is one thing to set a quantitative goal post and quite another to move higher on a qualitative agenda.

 

Such a qualitative goal requires more inclusivity and higher sensitisation than what we have at present. 

 

As a citizen, I would like to dream of an India, where peace and tranquility prevail; where transparency in governance exists in all fields; where there would be 100% food security and 100% self-sufficiency for food; where market forces do not devour the poor and the weak in society. 

 

India should be a country where better water and farm management would lead to better employment and least migration to urban and metropolitan areas from the rural areas; where population growth would not stand as an impediment for further growth of the economy; where all the employables get fully employed and the less employables would be endowed with appropriate skills and knowledge for full employment; where there is free entry and exit for firms in the economy with no parasites. 

 

Also it should be a country where women can walk freely even at midnight anywhere in the country; where values of life fall in tune with the culture and ethos of the nation and where the digital divide between the rural and urban vanish; where information asymmetry and moral hazard do not exist and where all the sectors of the economy realize their mutual dependence to their mutual benefit and the growth rate of the economy would move to a double digit figure as a matter of practice. 

 

I recall what Swami Ranganadhananda said once: “I look forward to the day when rural people stop easing themselves in public and start eating in public.” 

 

The statement is profound and carries with it an agenda for action: provision of good sanitation, safe drinking water, crossing the caste and other societal barriers and food within the reach of all. 

 

Fortunately, during the last few years, the Swachh Bharat mission has taken the open-defecation-free (ODF) areas close to 80-90% in several cities, although a lot remains to be done in many rural areas. 

 

Aspirational Districts program would similarly make several lagging districts to come to the forefront. Still, a lot needs to be done for an ODF India and safe drinking water being universally available. This calls for a synthesis between social and economic budgeting.

 

The barriers to realising such a vision would be:

• Fragmented political will;

• High population growth;

• Poverty and low level of literacy;

• Inadequate resources;

• Weak financial sector mired in unrecovered corporate debts and frauds;

• Poor governance;

• Improper structural plans;

•  Institutionalization and harmonization of legal aspects to set up monitoring systems.

• Deficiencies in implementation.

 

Some of our strengths recognized worldwide are:

 

• A middle class estimated at 350 million out of a total population of over 1.2 billion providing a stable market;

• The second largest English-speaking scientific, technical and executive manpower in the world;

• An abundant supply of raw materials;

• An extensive rail and road network;

• A stable political system based on parliamentary democracy;

• A common legal system with English as the court language;

• India is emerging as a major market and investment destination;

• The dramatic economic reforms initiated in 1991 have left a wide canvas of positive thinking and affirmative action.

• India is one of the top five in the world’s growing economies even after this temporary slowdown (5% of gross domestic product (GDP) at the end of FY2020).

• The sweeping change from unorganized to organized ways of doing businesses with the introduction of the goods and services tax (GST), Real Estate Regulatory Authority (RERA) and the Insolvency and Bankruptcy Code (IBC).

• An ardent desire to pursue financial inclusion agenda and 

 

Another major strength is India’s ability to respond to crises:

 

When there was a crisis in meeting the food requirements against the backdrop of colonial misrule, with severe famine and large patches of drought, we fought it out valiantly through the green revolution and made India self-reliant in food; we are now on the threshold of food exports. When we had a crisis in foreign exchange, we ably steered through. 

 

Most of the natural calamities – recurring floods in several States or hard-hitting recurring cyclones in Andhra Pradesh (AP), Assam, West Bengal, Bihar, Tamil Nadu, earthquakes of Latur in Maharashtra or Bhuj in Gujarat; the Tsunami of 2004 in Tamil Nadu -- have been ably handled with domestic resources.

 

Gross inadequacies are noticed in terms of value addition due to inadequate attention to crop specific infrastructure and post-harvest technologies like pre-cooling, cold storages with assured power at uniform voltage, price hedging operations, and market reforms in the farm sector. 

 

Some States have initiated special studies in this regard to prioritize their investments in these areas and deploy the needed resources. The impacts of these initiatives would be felt in due course. However, there is a regulatory overhang in India with more than twelve Union ministries, corresponding state ministries, laws framed by the Union government with rules framed by the state governments for implementing them. 

 

Still, due to the several food control orders governing the production and trade of those commodities and crops into which the farmers would like to diversify, the farmer, rural industry and farm trade are virtually strangulated. While there is an awakening in respect of these areas, the speed of reforms and actions in these areas deserve urgent attention.

 

Farmers benefit from more accurate weighing, faster processing time, and prompt payment, and from access to a wide range of information, including accurate market price knowledge, and market trends, which help them decide when, where, and at what price to sell. E-NAM has not fully absorbed the e-Choupal model.

 

Farmers selling directly to ITC Ltd through an e-Choupal typically receive a higher price for their crops than they would receive through the mandi system, on an average about 2.5% higher. The total benefit to farmers includes lower prices for inputs and other goods, higher yields, and a sense of empowerment. The e-Choupal system has had a measurable impact on what farmers chose to do. The system also provides direct access to the farmer to information about conditions on the ground, improving planning and building relationships that increase its security of supply. Farmers Producers Organizations (FPO) are gaining ground, albeit slowly. FPOs need clusterisation to derive greater advantage. 

 

Every Law should stand the test of the Constitution and stakeholder consultation a priori and should be subject to regulatory impact assessment at the beginning of the first Parliament session of the year.

 

Increased urbanisation during the last five decades has not diminished the rural space significantly. Comprehensive connectivity of village complexes providing economic opportunities to all segments of people remains unfulfilled. 

 

The integrated method that will bring prosperity to rural areas envisages four types of connectivity: physical connectivity through quality roads and transport; electronic connectivity through telecom with high bandwidth fibre optic cables; knowledge connectivity through education, skill training for farmers, artisans and craftsmen and entrepreneurship programmes, where the future roadmap of economic growth lies. 

 

It is not so much globalisation that is important as global competitiveness that is the need and healthy growth of manufacturing micro, small and medium enterprises (MSMEs), empowering women and reordering the subsidy regime in all the fields. We have no room for complacence. 

https://www.moneylife.in/article/vision-2030-unfinished-agenda-for-an-india-that-is-fair-just-and-egalitarian/59226.html

 

Banking reforms the Budget should not miss

Banking Reforms the Budget should not miss

Former President of India, Pratibha Patil, in her address to the Lok Sabha on 4^th June 2009 said: “Our immediate priorities and programmes must be to focus on the management of the economy that will counter the effect of global (domestic) slowdown by a combination of sectoral and macrolevel policies.” She laid emphasis on accelerating growth that is ‘socially and regionally more inclusive’. 

The objective of overall policy in India is accelerated inclusive growth with macroeconomic stability. This approach is likely to reverberate in the ensuing Budget Session.

FM needs to give a measured response to the imperative outlined. In order to take the States on board, she may announce clearance of all the dues on GST to the States once the present audit of GST concludes. She may also like to give a new financial sector reform agenda to resolve the existing imbroglio. A few of the available options will be the focus of this article.

FM is at crosshairs between fiscal austerity and enhancing public spending to stimulate growth. Discomfort lies in the worst performance of Public Sector Banks (PSBs) and failure of NBFCs. While the RBI is balancing inflation and growth objectives, the recently released Financial Stability Report re-emphasis on the need for ‘good governance across board’, improving the performance of PSBs and the necessity to build buffers against their disproportionate operational risk losses.

None of the recent bank mergers added to her comfort. Hence there is need to look at the unfinished earlier reform agenda suggested by various Committees since 1991 and announce either a Reform Agenda or appointment of a High-Level Committee with a specific timeframe for actionable agenda that could stonewall criticism against the PSB failures, bank frauds and twin balance sheet problems. 

The issues surrounding banking are not peripheral.

The moral hazard consequence of banks receiving bailout is worrisome now and therefore, she may refrain from any further bailout announcement. Stress in the NBFCs and Cooperative banking seemed to have forced re-look at the Financial Resolution and Deposit Insurance Bill, 2017. While the Bill proposes to establish a Resolution Corporation to monitor the health of the financial providers on an ongoing basis, the bail-in by depositors and stakeholders is worrisome.

Increasing stress in various buckets of assets stands unabated and calls for a surgical strike. Banks’ credit origination risks need urgent evaluation. It is important to relook at the universal banking model the country adopted aping the west. Customer preferences and customer rights have taken a back seat.

Market-led reforms of the past have replaced social banking with profit-banking objective. 2025 $5trn GDP target should look at more efficient performance of banking as key to its achievement. There is a need for reconciling satisfactorily the dilemma of policies appropriate for short term with those suitable for the long term.

Governor, RBI in a recent address indicated that he would like to look at the priority sector categorization afresh to ensure that it delivers the intended. This assumes greater importance in financial inclusion agenda as efforts hitherto like Jandhan, Mudra etc could make only numerical and not qualitative advances. Provision of adequate and timely credit to the rural areas in general and agriculture, micro and small enterprises and weaker and vulnerable sectors, remained a major challenge for Indian banks for decades.

Direct credit programmes in Korea, Japan in 1950s and 1980s revealed the need for narrowly focused and nuanced programmes with sunset clauses delivered the results. The problem with directed credit is essentially three-fold: First, pricing at its true market level, second, avoidance of the persons who are not credit-constrained, and third, selection of focused areas and regions without political interference in undefined democracy.

Credit discipline and equity, the twin principles of credit dispensation suffered a systemic failure with politically motivated loan write-offs in several States. Both farm and micro and small enterprises require credit with extension, handholding, monitoring and supervision as key deliverable. This calls for out-of-the-box thinking.

While there has been broad recognition that increasing supply to cope with the rising demand through diversified lending institutions like small finance banks, and NBFCs of various hues, ever-increasing demand to cope with new technologies, low labour productivity, and absence of aggregators structurally to resolve the pricing of produce at the farmer’s doorstep, are all issues that require comprehensive solutions. Resources should not fall short of the requirement for such effort. Budget 2020-21 should make a bold and strategic announcement regarding the direction of investments in farm sector supportive for responsible credit flow. FM would do well to avoid announcing any crop loan targets and leave it to the RBI’s priority sector reformulation.

Supply-side issues cannot be adequately and appropriately addressed without institutional reforms focusing restructuring NABARD and giving a new mandate consistent with the future goals of the economy. SIDBI the second surviving DFI is living on interest arbitrage and enjoying the munificence of the Finance Ministry to the detriment of the sector it was intended to protect and promote. This also begs either closure or restructuring.

As regards governance of banks, the unattended reforms of Narasimham Committee -II deserve attention: Removing 10% voting rights; reducing the legally required public shareholding in PSBs from 51 to 33 percent; improving the Boards qualitatively with well-defined independent and functional directors’ roles.

Since the FM already announced that she is exploring the amendment to the Cooperative Act to skip the duality of regulation of cooperative banks by both the Registrar of Cooperative Societies and RBI, she would be going one step further in eliminating similar duality between her Department of Banking and RBI in so far as the PSBs are concerned, particularly because the RBI created separate Departments of Supervision and Regulation and College of Supervisors to improve the supervisory skills of RBI personnel.

the Hindu Business Line, 16.1.2020 https://t.co/eNEANVcaW8?amp=1

Uion Budget 2020 worrisome

Hardly the time for a tight fisted Budget 2020-21

FM in her second year of budget presentation has very unenviable task in performing a balancing act. GST revenues are looking southwards and the input tax credit, the key for success of GST is mired in data upload controversy and hostile inverted duty structure. Markets do not seem to worry about this going by the forward movement of indices, blowing against the wind.

PSBs absorbed all the capital that the government buffeted and yet did not perform. On top, some banks have acquired the notoriety in manipulating balance sheets. Frauds have surfaced like never before to Rs.71,543cr – a rise of 74% over the previous year in the financial sector. NBFCs too joined the cry for capital or regulatory relaxations.

Through legal process – IBC, SARFAESI Act, DRT and Lok Adalats, 14.9% in 2017-18 and 15.5% in 2018-19 is the amount recovered out of the claims lodged. Recovery through IBC at 42.5% is the highest, while it is 3.5% through DRTs, the lowest, according to RBI -M&M Economic Research.

No economic recovery will be possible with a crippling banking sector like the one we have today. Some Banks having Insurance and Mutual Funds are still entrusting targets under these subsidiaries to the regular banking staff taking away their productive time for selling banking products like deposits, credit and digital services.

Creating demand in rural, semi-urban, and urban areas would occur when the people have enough money in their hands. Credit has not moved in tandem with the demand from farmers and MSMEs in manufacturing. RBI doing its job by reduction of 135 basis points in the base rate has no spread effect in retail lending market as there is no risk appetite among banks.

Knowledge in banking products and services has come down significantly among line staff and this is the reason for credit origination risk escalating to failure in repayments. Capital infusion without rectification of the basic malaise and governance, will not address the problems.

Why worry about fiscal deficit when the denominator GDP has many undisclosed data escaping entries? Several economists make mountain of mole hill while speaking about fiscal deficit. Right from the Union Finance Ministry to the regulators, all converge on the fact that the slowdown of the economy is real and need demand boosters. There were occasions when we reached around 6-6.5 percent (2008-11) of GDP and the economy registered growth thereafter.

The worry on employment growth is real. Unemployed youth hitting the streets would exacerbate the security risks. Industry, despite the skill development initiatives, bemoans that they do not find the right persons for the right job.

Sector-wise, agriculture grew 2 percent while manufacture showed less than 1%. Make in India, the flagship manufacturing initiative has not shown uptick during the last four years in continuum. Services sector too is showing decline.

Priced education and health have made increasing demands on the government. Several States and Union Government have schemes like Arogya Sri, Kutumba Sri, Ayushman Bharati etc., and yet their reach to the intended is still facing issues in payment for the services to the hospitals. Affordability is still an issue.

What should be the measures in the budget to boost employment? Which sectors need focused attention from such perspective by way of fiscal incentives? How can the States be brought on the same page as the Union Government?

The slowdown is both cyclical and structural. There should be consensus between the States and Union Government on the way forward. Union Government should release post-haste all the payments for the pending works under MNREGS.

Several States and Union Government have huge arrears to suppliers, contractors and sub-contractors for several project works that has choked the bank working capital releases and all these payments should be released to the last pie.

The paltry pension to farmers at Rs.6000 per annum should be altered to Rs.12000 per cultivator whereby even the tenant farmers would be eligible for pension payment after 60 years. Since the scheme envisages payment by the farmer between 40 and 60 years of age his/her contribution, several farmers who are of 60 and above right now, would not be benefitting from the scheme. The scheme should benefit those who are above 60 now. Adequate budgetary provision is necessary.

Budget allocation for health sector should significantly go up to a minimum of 6% of the total outlay from both the States and Union. Health infrastructure is pretty poor and needs improvement.

Education budget should target universal education up to Class 12 and this happens when teacher pupil ratio significantly improves, and school infrastructure also improves. National Education Policy shall indicate the prospect of resource allocation as well.

Ensuing Budget should convert intent into actionable allocations in the critical sectors and lay a path firmly for cleaning up the banking sector. Frustration should not be at the breaking point.

Published in the Hindu Business Line, 3.1.2020

www.thehindubusinessline.com

Enhancing Competitiveness of MSMEs in Slowdown

Strategies for enhancing Competitiveness of Manufacturing MSMEs:

Muted manufacturing with PMI just around 51, a fall from about 54 almost couple of years back, increasing protectionism of the US, UK with the BREXIT winning a thumping majority for Boric Johnson and global trade winds heading to recession have taken the toll of India’s growth story. Industry would face more challenging times than before due not merely to adverse headwinds on external trade but the turbulence in the domestic economy. Enhancing competitiveness for manufacturing firms in the small sector has several challenges and these can turn into opportunities for growth.

Inefficiency, increasing fraud rates and faulty Bank Balance sheets of almost all the major Banks in India compounded the woes of domestic debt markets. No surprise that the equity suppliers like the VCs and Angel Funds are distancing themselves. The impact is the most on the vulnerable – MSMEs, particularly in the manufacturing segment. The thriving or successful even in this current environment are those SMEs in the Defense, Aerospace, Gems & Jewelry, pharmaceuticals and a few agro-industries linked to market giants like the ITC.

Nobody can have a guess of how many MSMEs shut their shops due to the Banks’ unwillingness to revive despite the RBI and GoI instructions as no ‘exit’ statistics are captured. The corporate sector exits alone show up in the data because the Ministry of Corporate Sector statutorily demands it and IBC has become a barometer for industry and financial institutions’ health.

Banks never gave data on number of units financed or closed but only number of accounts. Each unit can have number of accounts: term loans for specified purposes; working capital – cash credit, overdraft, SME Plus, etc., and unfunded limits like LCs, Guarantees etc.

Since 98 percent of the MSMEs are either partnerships or proprietary and are linked to onetime registration on Udyog Aadhar, there is no way the closed shutters get into the data. Even the industry and trade associations do not get a wind of the closures as several so-called members are irregular in the payment of membership subscription annually.

This scenario leaves the policy maker to public noise and a wild hunch. Every State is concerned about improving the ecosystem for the MSME sector and more in conjunction with the Union Government. States do know that a robust MSME sector is a red carpet for the global investors. However, improving the MSME competitiveness remains the biggest challenge and it requires a more holistic approach than now.

Information asymmetry and adverse selection continue to be the biggest blocks for institutional interventions, both financial and non-financial. Several MSMEs complain of a serious setback due to demonetization and GST. The reasons for such a far cry should be seen in the advantages they got without them: cash sales not routed through the bank accounts and yet several MSEs thrived until their debtors ditched them; inventories over-invoiced could get into the recorded working capital cycle with banks as the banks have been going by what is shown to them instead of what they should see and count for want of field visits; there have been many qualified ‘account experts’ to show the convenient excel spread sheets for securing working capital limits from banks; the small volumes these enterprises produce and the small size of the firms have also distanced them from the reach to markets; and there have been very few mentors and counsellors to advise responsibly either from the financial institutions or others to advise the units right financial discipline would get them all the gains they are looking for as also their entry to new markets.

GoI on its part, unleashed MUDRA, SME99Minute Loans and whipped up the Shamiana Camps that could give the lever to the FM to announce that the Banks sanctioned 8lakh loans amounting to Rs.70000cr in just two months, which they could not do for years!! Future NPAs would show the unknowns and unseen among such crowd. Dy. Governor, RBI recently sounded the alarm on the growing MUDRA account NPAs.

MSMEs on their part should earn their right to grow by following best accounting practices. Working capital management basically rests on four important factors:

•       Predictability of Cycle

•       Material flows

•       Receivable – overdue

•       Independent Credit rating agencies’ assessments.

Some more essentials are set out below:

(i) Realistic Assessment of Morale Building Assurances: MSMEs would be well advised to cautiously assess morale building assurances during the current slowdown of the economy. MSMEs which accepted such assurances in the backdrop of global recession of 2008 and built up capacities and kept up production levels, resulting in very high inventories, were devastated. Furthermore, when demand for a product falls, there could be pressures on small enterprises not to cut output as this would eventually result in labour lay- offs. Units that accepted such suasion faced disastrous outcomes.

(ii) Capacity Expansion: Quite often, MSMEs come to the erroneous conclusion that their product would experience an unrealistically high increase in demand. Units which build up capacities on tenuous information invariably end up with serious problems. In a savagely competitive environment, it is these small units that end up in ‘fire sales’ which are available to buyers at attractive prices. There is merit in building up financial resources to avail of such opportunities rather than increasing the capacity of their existing units. It is time to realize that coopetition would bring better synergies among similar producers to meet up with temporary surge in demand.

(iii) Interest Rate Cycles and Excessive Dependence on Bank Credit: During the expansionary phase of the credit cycle, banks are only too willing to lend but during the downturn small borrowers are invariably the first casualties in being denied additional credit. As an abundantly prudent measure, MSMEs are well advised to seek bank credit essentially for inventory financing but be very cautious when using bank finance for capital expenditure. Excessive borrowing for capital expenditure generally puts MSMEs in to distress during cyclical movements in the economy. It is good to learn to build equity gradually from out of the revenues and avoid excess leverage. They should learn to conform to financial discipline when alone they will win the trust of investors. Strategic partnerships are best bet in times of stress and not overindulging in debt. It is good news for the MSMEs that Government of India has extended the Interest Subvention Scheme up to March 2021.

(iv) Importance of an Appropriate Exchange Rate: MSMEs account for about 40 per cent of exports. It is unfortunate that there is a widely held perception that a strong rupee exchange rate reflects good macroeconomic management. This is clearly erroneous. Large industry is generally import intensive while small industry is export intensive. Hence a strong exchange rate of the rupee (i.e. an overvalued rupee) helps large industry and hurts MSMEs. It is not as if the exchange rate should be excessively undervalued. As a rule of thumb, over the medium/long-term, the nominal exchange rate of the rupee vis-à-vis the major industrial country currencies, should be adjusted downward based on the inflation rate differentials between India and the major industrial countries. An overvalued exchange rate makes MSMEs uncompetitive in international markets. MSMEs should not attempt to be forex traders; they should concentrate on their own line of production.

As a staunch optimist and believer in the excellent capabilities of MSMEs in innovation, incubation and future growth, least expensive handholding, mentoring and counselling as process consulting tools have immense scope to become highly competitive both domestically and globally if certain synergies are built into the system. Telangana Industrial Health Clinic Ltd has adequate capabilities in this exclusive portfolio of handholding, mentoring and counseling as a preventive and stress relieving measure.

Supply Chain to Value Chain:

There is need for building ‘pools’ or aggregators to gain both cost advantage and brand image through co-branding of products.

India Mart are trying to do supply chain aggregation. MSME online Bangalore is also trying to evolve an ecosystem where a lot of questions of MSME are getting answered by about 50 consultants and they have started CEO Club for taking MSME entrepreneurs to next level by having a monthly meeting. Jeevan is trying to develop a 360' view for developing the ecosystem in Hyderabad on Hub and Scope model. These are welcome initiatives, no doubt. They need traction.

Many of the user population should not merely know such initiatives but should also know how best to access them. Second, by aggregators, I mean those that are fully capable of building a common brand for a set of products from the micro and small manufacturing enterprises through building also their capacities and capabilities to rise above their existing levels, introduce those practices and technologies that make them closer to the global standards even if sold in domestic markets and secure price at their doorstep within the promised wait-in period. These would mean investment on the part of aggregator and a price that the aggregator should legitimately get for such services without losing the competitiveness in the market. Ipso facto, it would mean that at the firm level, cost reduction should take place at each link in the value chain. There are different ways of doing it.

The Industry Associations can develop a Marketing Arm and establish net linkages with e-commerce players; 2. they can help the industry avail the host of incentives waiting to be used from the GoI-MSME schemes; 3. they can establish linkage with NSIC, MSME-DI and such other institutions. 

MSMEs should earn their right to grow. This happens only when they are quality conscious where precision, functionality and producing premium products will be their driving forces. Their passion and pride rest on satisfied customer. Intellectual property rights, improved technology processes and getting equity to fund such technologies are all their sustainable future. Employee retention strategies depend not just on higher remuneration but on building trust and social cohesion as also gender equity.

MSMEs should also realize that death is a process of development. They must know when to exit from the enterprise and how. Strategies to clear sovereign dues and realization of overdue creditors on a mission mode pre-exit have a clear role. Ignoring them will be suicidal.

*Author of ‘The Story of Indian MSMEs: Despair to Dawn of Hope’ (2019) is an economist and Adviser, Government of Telangana, Telangana Industrial Health Clinic Ltd., Hyderabad (www.yerramraju1.com)

https://www.moneylife.in/article/enhancing-competitiveness-of-manufacturing-msmes-i/58932.html 18.12.2019 and 19.12.2019

What went wrong with Mudra Loans?

Speed Thrills but Kills Too – A Story of Mudra Loans

B. Yerram Raju* & J. Sitapati Sarma**

The concerns on rising NPAs in Mudra Loans are red flagged by the Regulator starting from Shri Raghuram Rajan, followed by current Governor Shri Shaktikant Das and Dy Governor of RBI.   This only manifests the seriousness of the issue. 

The NPAs in Mudra saw a steep jump of 126% in one year – increased from Rs. 7227crore in FY 18 to Rs. 16481 crore in FY 19 with number of infected accounts totaling to 30.57 lakh. India Ratings and ICRA estimated NPAs under MUDRA between 10-15% as compared to 5.39% in March 2018.  Since the Mallya debacle, surging corporate NPAs are now in the company of their less endowed MUDRA borrowers pepped up by the Government.  Economy slowdown should have nothing to contribute to this sordid story.

What went wrong with Mudra Loans? 

Ever since the scheme has been flagged off in April 2015, the targets were not only set but closely driven breathing over the necks of the banks by the Ministry of Finance, to impress the importance attached to the scheme.  Bankers have exhibited more than required enthusiasm and competed with one another  to  achieve  targets to dwarf the peers before the Delhi bosses. 

While massive numbers are to be achieved within set deadlines, it appears that the appraisal was given a go by as hinted by the Deputy Governor urging banks to monitor repayment capacity of borrowers before disbursement.  All the targets – increased year after year - were achieved by not only PSBs but other participants too. 

The total sanctions till March 2019 since inception stood at Rs. 8.92 lakh crores.   The speed at which these loans are sanctioned can be noticed from the fact that Rs.18000 crore worth sanctions were pushed during the last 8 days of FY19 to achieve the target.  During FY19 an amount of Rs.970 crore was sanctioned per day by all Mudra Lending Institutions together. 

Coverage of these loans under Credit Guarantee Fund for Micro Units (CGFMU) up to Rs.10 lakh could be another reason for sloppy appraisal It is amply clear that these are push loans without proper appraisal and due diligence of the borrower.  Informed sources say that bankers chose this route to ‘evergreen’ their small ticket loans!  

The numbers reveal some different facts.  Of the total sanctions, the new loan sanctions hovered around 26% barring the first year of introduction where it stood at 36%.  Can we draw a conclusion that the renewals/existing loans accounted for larger share probably owing to evergreening process of existing loans with increased limits?  More than 70% of the loans are sanctioned under “shishu’ (Not exceeding Rs.50000), considered least risky in the portfolio. 

While Banks can finance up to Rs.10 lacs under the scheme, they preferred to keep the average ticket size to less than Rs. 1 lac.  To be more precise, the average ticket size of mudra loan increased from Rs.39405 in FY16 to Rs.52739 in FY18.  Statewise disbursals also indicate unequal distribution that also needs correction.

One way it is blessing in disguise; otherwise, the slippages and NPA accretion could have been higher.  But the only issue that remains in such small ticket loans is the adequacy of finance and resultant viability.   

During the current fiscal 29 million loans were disbursed amounting to Rs. 1.41 trillion, showing slight slowing down, against Rs. 3 trillion in the previous fiscal. Not even 2% has been sanctioned to the manufacturing enterprises because that involves onsite verification and follow up.  

The positive part of the story is employment creation.   As per an unpublished survey a total of 11.2 million new jobs were created in 2015-18, of which 5.1 million were new entrepreneurs.   If government were not to push for targets, Banks would not have touched these clienteles with a barge pole. It is however doubtful whether banks given a free hand would improve the quality of portfolio as everywhere else they had the free hand too, NPAs are surging ahead. Banks’ eye on quality has much to do with their knowledge, skills and attitude. All the three seem to be at low ebb.

Jandhan accompanied by savings and insurance and MUDRA led by credit with refinance and guarantee are two schemes of the most acclaimed inclusive agenda of NDA government. MFIs, Small Finance Banks also lent heavily along with PSBs in MUDRA realized that they did not have much to loose as the money to lend came from refinance window while post disbursement losses are guaranteed. Since the funds to MUDRA are from the Union Budget, the losses arising from the scheme devolve on the taxpayer.

RBI would do well to commission a detailed study of the portfolio and take corrective measures to ensure that the inclusive agenda of the government would not get undermined and the taxpayer is saved of the undue burden of the scheme.

Yerram Raju is an economist and risk management specialist and Sitapati Sarma is retired General Manager of SBI and present Chief Operating Officer of Telangana Industrial Health Clinic Ltd. The views are personal.

Published in Money Life on 2,12,2019 www.moneylife.in

Rating the Ratings is imperative

CREDIT RATING – YET AGAIN ON THE BENDING MAT

It is three decades since CIBIL rating has commenced its operations and a decade since Brickworks has started. We also see the frequent sovereign ratings of Standard and Poor, Ind-Ra (Fisch) and Moody’s. Very recently, Nirmala Sitaraman, in the wake of serial failure of well rated corporates – eg., DHFL, IL&FS, and several other PSUs as well as Private Companies, mentioned her serious concern. Sovereign ratings are also not infallible. This article would like to see the present status and suggest the modifications.

Credit rating agencies (CRAs) are expected to play an important role in mapping the risks in the financial system. They facilitate investment decisions and can help investors in achieving a balance in the risk return profile. They assist firms in accessing capital at low cost. Allocative efficiency of capital across the sectors, and appropriate risk pricing would be the gain to the economy. Information asymmetry to an extent is resolved.

“A credit rating is technically an opinion on the relative degree of risk associated with timely payment of interest and principal on a debt instrument. It is an informed indication of the likelihood of default of an issuer on a debt instrument, relative to the respective likelihoods of default of other issuers in the market. It is therefore an independent, easy-to-use measure of relative credit risk.”[i]

If a bank chooses to keep some of its loans unrated, it may have to provide, as per extant RBI instructions, a risk weight of 100 per cent for credit risk on such loans. Basel regulations provide for supervisors increasing the standard risk weight for unrated claims where a higher risk weight is warranted by the overall default experience in their jurisdiction. Further, as part of the supervisory review process, the supervisor may also consider whether the credit quality of corporate claims held by individual banks should warrant a standard risk weight higher than 100%.

The working of the entire rating system was questioned after the sub-prime crisis resulted in collapse of not just Fennie May and Freddie Mac but even UBS Credit Suisse, Citi group, Deutsche Bank etc. This led the US Fed and the Wall Street to revamp the entire rating mechanism after a careful study of the processes they followed and the measurement they gave to different parameters. But such changes are not followed uniformly across nations.

Theoretically, internal credit scoring models are effective instruments for the banks in loan origination, loan pricing and loan monitoring.  But the banks’ rating architecture is different from the rating agencies and this is one of the reasons for the regulator to insist on a rating review mechanism to be part of the Banks’ Credit Risk Management Committee. 

The rating process involves assessment of Business Risk arising from interplay of five factors: industry risk; market position, operating efficiency, financial risk and management risk. While industry risk and market position can be assessed from the macro level data, operating efficiency and management risk can be captured by observation, frequent interaction and experience. Unless cross functional, sectoral, trade data from all sources is available on digital platform and that too verifiable easily, the rating agencies are bound to err.

As per Basel II (2000): “An Internal Rating refers to a summary indicator of risk inherent in an individual credit. Ratings typically embody an assessment of the risk of loss due to failure by given borrower to pay as promised, based on consideration of relevant counter party and facility characteristics.  A rating system includes the conceptual methodology, management processes and systems that play a role in the assignment of a rating.”  Understandably, there was a collapse of the rating instrumentality looking at the collapse of the corporate credit and investments almost without notice. 

One of the common failings noticed by informed circles, for example, has been, a firm that owes to MSMEs beyond Rs.2lakhs should have been rated lower than those that would have paid promptly. Most corporates both PSUs and Private Companies were chronic defaulters and this came to surface more prominently in all the NCLT-dealt with cases. Second, poor governance should have got bad rating. Including Banks, PSUs and Private Companies fare badly and yet got good ratings!!

Ever since the Rating is mandated by the RBI while extending credit, we have seen phenomenal failures in the well-rated corporates both in the private and public sectors, e.g., DHFL, IL&FS. SMEs have no option but to get the rating of one or the other agency and yet, the Bank concerned would have its own rating that would decide the quantum of credit.

Measuring policy risks, sovereign risks and governance risks is the major challenge and this challenge has become visible in the recent corporate rating failures. Banks severely compromised by pitching high on CIBIL ratings and particularly, the individuals and Directors of the Companies. The thirty-year old CIBIL needs to amend its ways if the ratings book should be cleaned.

Technology disruption, easy regulations governing payment platforms, data on merchant performance, changes in consumption patterns, differential product regulations across the nations for similarly placed products and increasing protectionism are all the new risk areas for capture by the CRAs.

In so far as Indian financial sector is concerned, consolidation following the merger of PSBs, failure of NBFCs, Urban Cooperative Banks, and the lackluster performance of the MFIs, metrocentric banking are all new challenges to the CRAs. Telecom regulations and their interface with the payment and settlement systems, Internet of Things, Blockchain technologies are the new disruptors and even moderate margin of error can impact heavily and the rating can collapse. Further, product regulations have also become dynamic. In a way, all these aspects seem to have their shadow cast on the rating instrumentality as a risk mitigant.

There is therefore an imminent need for a High Level Committee of the SEBI, RBI, PFRDA, IRDA, and Telecom Regulatory Authority to examine the methodologies of CRAs for a more reliable rating process and pricing of rating agencies.

*Dr. B. Yerram Raju is an economist and risk management specialist and can be reached at yerramr@gmail.com Also see my blog on the subject June 11, 2011

Published in the Money Life on 28.11.19

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[i] Report of the Committee on Comprehensive Regulation for Credit Rating Agencies, Ministry of Finance, Corporate Affairs Division, December 2009

Negotiating a Loan during Slowdown

Ten-Point Recipe for Loan Negotiation with a Bank in Slowdown

Most first generation entrepreneurs, CFOs and CEOs of mid-corporates find it tough to negotiate a business deal with a bank. Banks usually are tight-fisted in times of recession to grant enhanced limits. They also claim full information of the enterprise, ecosystem in which it operates and the depth of the export markets. They also have a track record and credit record of the enterprise seeking to expand its operations. Economy in slowdown is tough time both for Banks and Enterprises. One has to run twice the speed in slowdown to remain where they are like Alice in the Wonderland.

Exacerbated NPAs despite the IBC have made Banks risk averse. Increase in frauds further accentuated risk aversion. The enterprises requiring higher working capital and those in export markets requiring packing credit facilities are facing formidable challenges. However, Banks may not like to lose good clients. Further, particularly those in PSBs, are also under pressure from the government to expand the portfolio in farm and MSME sectors.

Banks also actively work on the recoveries, write-offs of NPAs and topping up their Balance sheets. They are under pressure on the Asset side of the Balance sheet and therefore, look for clients who, despite slowdown, come up with a good proposal. And a good proposal in their parlance means that they would have little to exercise their thinking. Their time is under pressure most times in video conferences, meetings, Seminars, publicity and several internal committees.

Look at Mr. Raman who understands the predicament of the current banker and who is a CFO of a mid-sized corporate entrusted with the task of increasing domestic market by 100% and overseas market of the Company’s innovated tablets and injections duly approved by the US Food and Drug Administration. He is sure that the Banks would not like to lose a good client for another bank. Since his Company has proven track record, he was hopeful of the deal for higher limits on both working capital and export packing credit.

He took an appointment with the GM (mid-corporates) of the Bank one fine morning. He did his homework well. He gathered full data of the enterprise; environment in which the entire industry has been working; economics of his proposal; the area into which the Company would like to expand; the types of clients the company are targeting; the distribution system of the new markets; the incentives Company has on table; the drug controls of both India and the Asian economies in which the Company is going to operate; the disease patterns there; government health care and insurance mechanisms; the IPR and above all the financials. He also worked on the stress testing of his projections.

He presumed that in the first instance the Bank would know of the enterprise and ecosystem equally well. He started off with all humility. During the discussions, when he noticed that Bank officials do not have half the information, he had either on the product or competitiveness but are looking at only the financials and spreadsheets and not the rationale behind them, he pitched his fork high. He left some issues deliberately for the bank to come up with subsequently. He did not press for a solution instantaneously. He left a cooling time with the Bank.

After three days, when the call came, he went with his accounting team and with the required project proposal in the bank’s usual format. He took care to ensure that no additional collaterals would be offered. He kept under his armpit the directors’ individual guarantee to offer when necessary. Finally, when asked, he just mentioned that it was the company’s intention to go for public issue at a propitious moment and raise equity to meet future needs and therefore, it would be difficult to offer the same at the moment. The deal got through.

The recipe is simple:

1. Do your homework well: know your own enterprise, its SWOT.

a. Brainstorm possible implications of the proposal with the Board and internal management.

b. Cushion the proposal with adequate collaterals and guarantees but keep it undisclosed.

c. Go as a team for presentation with your confident technical and financial team for discussion.

2. Do not thrust yourself at inconvenient times for the banker.

3. Be transparent during negotiations.

4. Be humble; but do not compromise on limits sought as it might affect profitability.

5. ERP will help keeping the data required by the Bank and tax authorities transparent and timely.

6. Go with a vision, objectives and goals for the future.

7. Keep also the succession plan ready.

8. Give reasonable time to the Bank to think and come back with their offer,  but indicate your expectation for the result and also indicate that a Bank and a leading NBFC have also indicated their willingness to look at the proposal to attract competitive pricing of the loan.

9. Post sanction and post disbursal, keep compliance of terms and conditions tidy.

10. Make sure of half-yearly review of the limits by the Bank by feeding the required data online.

The above principles work equally well for the MSMEs. Since the MSMEs lack the attributes of a CFO and accounting team, they need to look for committed process consultancy firms like the Telangana Industrial Health Clinic Ltd (TIHCL) who handhold them and help scaling up with strategic interventions at the right time.

Published in Telangana Today 

Pre-Budget Blues for the Union Budget 20-21

Suggestions for the Union Budget 2020-21

Focus on Manufacturing MSMEs;

Industries should bloom like flowers 

We have the potential to overtake China if we trust our MSME sector more than now and provide long-lasting solutions.

Manufacturing Micro enterprises with specific focus on agro based industries and rural enterprises, which are unique and provide maximum employment need to be separated from Small and Medium enterprises and the existing MSME Act needs to be amended accordingly. All micro enterprises in future may be encouraged to be set up in clusters only with suitable infrastructure and marketing facilities. They should be enabled for scaling up and the required support system should come from the Entrepreneur Development Centres (EDCs), proposed to be co-located at the DICs. The DIC officials’ performance should be evaluated basing on the number of micro enterprises scaling up to small enterprises. Although this comes under the State domain, the Amended MSMED Act should provide for this appropriately.

The SMEs may be defined based on sales turnover and employment to incentivise them to join the formal sector and achieve GST compliance.

2. All the incentives from the government and other agencies to the MSMEs need to be linked to the employment they provide to people directly. 

3. All the subsidies and other payments by the governments and their bodies to MSMEs must be paid within 45 days from the due date. Any delay beyond this and up to 90 days should attract penal interest rate at twice the RBI repo rate. Delay beyond 90 days should be treated as criminal violation. Since the purchase and sale is a contract between the buyer and seller, Indian Contract Act should be amended appropriately, simultaneously.

4. An Independent Evaluation Office on the lines of IMF may  be set up as independent agency under Ministry of MSME/Finance/NITI Aayog to evaluate the policies, programmes, implementation and payments to MSMEs and submit a report to the Government for action and placing before the Parliament at the beginning of the Year.

5. SIDBI has had limited impact. The role and responsibilities of SIDBI may be re-examined by a High Level Committee.

Fiscal Incentives:

¡  2% to 5% of Income Tax / GST for up to every 10 in Micro & to every 25 persons employed in small evidenced by self-certified muster roll and corresponding increase in the expenditure on wages and salaries in the annual P&L statement.

¡  Micro: 1. No Cess on GST; 2. First 5 Years waive income tax for manufacturing enterprises

¡  Small: First 3 years for firms graduating from Micro exempt income tax; No corporate tax

¡  Small to Medium Enterprises: First 3 years 2% less than the usual Corporate tax for large enterprises;  

¡  Medium to Large Enterprises: First 2 years < 2% of the usual corporate tax applicable to the Corporates

¡  Technology: Micro to Small: transition with new or imported technologies – Duty to be exempted.

¡  Small to Medium: Duty to be 2% less than for large.

There should be no levy of Cess on export duties to enable the SMEs to be major contributors to export markets.

Banks and NBFCs helping revival of MSMEs:

Income Tax reduction of 1% if the institution revives 100 enterprises in a year – demonstrated by the increase in capacity utilization by 40% in six months from the date of revival for 80 percent of units revived.

Manufacturing Micro and Small Enterprises post revival earnings of up to Rs.5cr should be exempt from income tax.

With inputs from Dr. Subbaiah Singala, General Manager, CAB, Pune whose views are also personal.