100 Days of #Demonetization. Citizens’ Protest on 19th February 2017.

demonetization-poster

The highs of demonetization when the Government can’t be LYING low.

Countering the Economic Emergency imposed ON the people. 
The Government has redefined Democracy, A form of Government BY the people, FOR the people, OF the people and crucially, ON the people. Rather than democracy, Demonetization has shown what DEMONcracy is all about. Please join in huge numbers on the 19th February 2017 for a Citizens’ Protest and shout out to the Government that Enough is Enough. 

#Demonetization #100DaysofDemonetization #CitizensProtest #JantarMantar

 नोटबंदी के 100 दिन 

धरना और रैली

19 फरवरी, 2017, रविवार , 12 बजे से 

मंडी  हाउस  से जंतर मंतर तक 

जंतर मंतर पर जनसभा और सांस्कृतिक कार्यक्रम

इसमें कोई गुंजाईश नहीं कि पिछले 100 दिनों में भारतीय जनता आर्थिक आपदा से जूझ रही है. 8 नवंबर 2016 की रात को प्रधानमंत्री ने 500 और 1000 के नोटों का विमुद्रीकरण कर इनके चलन को अवैध घोषित कर दिया और दावा किया कि इससे कालाधन पर रोक लगेगा, कर चोरी रुकेगी, आतंकवादी गतिविधियों के फंडिंग पर रोक लगेगी और जाली नोटों पर लगाम लगेगा. जिनके पास ये नोट थे, उन्हें जमा करने के लिए करीब 2 महीनों की मुहलत दी गयी और निकासी के लिए  भारतीय रिजर्व बैंक ने कई स्तर की सीमाबद्धता निर्धारित कर दी. भारतीय अर्थव्यवस्था जो मुख्य रूप से नकदी पर आधारित है और इसमें भी एक बड़ी तादाद ऐसे लोगों का है जिसे इस पूरे आर्थिक तंत्र से बाहर कर दिया गया है, वह केवल और केवल नकदी मुद्रा पर निर्भर है. यह गुहार किया गया कि “फौरी तौर पर थोड़ी तकलीफ सह लें” क्योंकि यह देश की सेहत के लिए बहुत जरूरी है. प्रधान मंत्री का यह आह्वान था कि इस “तात्कालिक मुसीबत” को झेल लेने से भारतीय अर्थ व्यवस्था की सारी बीमारियाँ ठीक हो जायेंगी.

लेकिन हुआ क्या? पूरे देश की जनता अपने बचत को जमा करने और नोट बदलवाने के लिए बदहवास बैंकों की कतारों में लगने को मज़बूर हुई. नए नोटों के लिए लम्बी और अंतहीन कतारों में लोग लगे रहे. इन कतारों में कई लोगों की जानें चली गयीं, बीमारों का समय पर इलाज़ नहीं हो पाया, सामाजिक कार्यक्रम जैसे शादी और मैयत के लिए लोगों को दर-दर की ठोकरें खानी पड़ी और ताने ये दिया जा रहा था यह कि देश की सरहद पर हमारे सैनिक अपना खून देकर आपकी रक्षा कर रहे हैं, और आप थोड़ी तकलीफ नहीं झेल सकते? पर उनका क्या जिनका किसी बैंक में खाता तक नहीं है. या उनका क्या जो बैंक या एटीएम से काफी दूरी पर हैं,वो अपना  नोट कैसे बदलवायें? उन लोगों का क्या जो अपनी छोटी-छोटी बचत को जमा करने के लिए अपनी दिहाड़ी छोड़ कर दिन भर कतारों में लगे रहे? उन महिलाओं का क्या जो बड़ी मेहनत और जतन से किसी विपदा के लिए वर्षों से कुछ बचा कर रखीं थीं? उन करोड़ों रुपयों का क्या जो कोआपरेटिव बैंकिंग सिस्टम में बचत कर के रखा गया था, जो अभी भी मुख्यधारा के बैंकिंग तंत्र से कोसों दूर हैं, लेकिन ये कई राज्यों में  करोड़ों लोगों के पैसे को हिफाज़त से रखते हैं? जो लोग इस मुसीबत को झेल रहे थे, मालूम हैं उनके लिए पी.एम. मोदी का समाधान क्या था? 9 नवंबर को लगभग तमाम अखबारों में विज्ञापन दिखा “अभी एटीएम नहीं पेटीएमकरो”

ऐसी क्या मज़बूरी थी कि सरकार यह नहीं बताना चाह रही थी कि अस्थाई मुसीबतें कैसे हमारे जीवन को, आजीविका को और अनौपचारिक क्षेत्र की अर्थव्यवस्था को स्थाई रूप से तबाह कर देगी . सरकार को पता होना चाहिए था  थ कि इस कदम के लिए न तो आरबीआई और ना ही बैंक पूरी तरह से तैयार थे, और यह कदम उल्टा पड़ सकता था. प्रधानमंत्री को यह निश्चित तौर पर मालूम था कि इससे कालाधन पर रोक नहीं लगेगा. अमेरिका-मेरिल लिंच बैंक के एक अध्ययन के मुताबिक अनुमान है कि सकल घरेलू उत्पाद में 25 % धन काली अर्थव्यस्था का है और इसमें महज 10 प्रतिशत हिस्सा ही नकद रूप में है. यानी कि 90 फ़ीसदी कालेधन का कभी भी नकदी के रूप में प्रयोग  नहीं रहा.  यह सच्चाई श्रीमान मोदी, श्रीमान जेटली और श्रीमान शाह अच्छी तरह जानते थे. आखिर क्या वजह है कि सरकार उसी जनता से लगातार झूठ बोल रही है, जिसके वोट से ये सत्ता में आये हुए हैं. आखिर किसके हितों को इस नोटबंदी के जरिये साधा गया.

जहाँ तक जाली नोटों का सवाल है, RBI का आंकड़ा दिखाता  है कि करीब 90.26 अरब भारतीय मुद्रा के नोट 2015-16 में चलन में थे, इसमें से मात्र 0.0007% ही जाली नोट थे. 2015-16 में इन नोटों का कुल मूल्य मात्र 29.64 करोड़ रुपये था जो कुल चलन में 16.41 लाख करोड़ रुपये का महज .000018 फ़ीसदी ही है. नोटबंदी का वास्तविक असर जैसा कि ढिंढोरा पीटा जा रहा था, बहुत ही आंशिक रहा . पुरानी कहावत  है कि “एक चूहे को पकड़ने के लिए पूरे घर को जला दिया गया”. इस नोटबंदी के पीछे यह भी तर्क दिया गया कि इससे देशद्रोही गतिविधियों के लिए फंडिंग रुकेगी. लेकिन क्या आज तक एक भी उदहारण देखने को  मिला जिससे कि आतंकवादी गतिविधियों में कोई रुकावट आयी हो? यदि कुछ प्रभाव पड़ा भी तो महज क्षणिक ही प्रभाव रहा जबतक कि नए नोट बदल नहीं लिए गए. नए  2000 और 500 के नोट पुराने 1000 और 500 के  नोट से कहीं ज्यादा देशद्रोही गतिविधियों के लिए माकूल हैं. तमाम गतिविधियों में नकदी का चलन बहुत छोटा हिस्सा है, यह ना तो आतंक का प्रेरणा स्रोत है और ना ही आतंकवादी गतिविधियों का मूल कारण. केवल एक ही दहशतगर्दी दिखी, वह थी सरकार द्वारा देश की जनता पर चलाई गई आर्थिक दहशतगर्दी.

आखिर यह पूरी कवायद क्या थी. हम भारत के लोग, पूरी शिद्दत के साथ अपनी आवाज बुलंद करते हैं कि हमें किसी अतिमानव (सुपर हीरो) की जरूरत नहीं जो अलोकतांत्रिक ढंग से काम करता हो और हमें सपने दिखाता  हो, और सपने बेच कर हमें उल्लू बनाता हो. हमें जनपक्षीय सरकार की जरूरत है ना कि कॉर्पोरेटपरस्त आर्थिक आपदा की. हम इस प्रकार के किसी भी आर्थिक और राजनीतिक  विमुद्रिकरण को अस्वीकार करते हैं, और पूरी शिद्दत के साथ मांग करते हैं कि हमें पारदर्शी और जवाबदेह सरकार चाहिए जो वर्त्तमान सरकार के कुतर्क तर्क और झूठे दावे “हमें मालूम है लोगों को क्या चाहिए” को पलट दे. हम आधार स्कीम के तहत सरकार के तानाशाही और दमघोंटू मुहिम का पुरजोर विरोध करते हैं और मांग करते हैं कि इस मुहिम पर तत्काल प्रभाव से राजनीतिक और न्यायिक दखल कर रोक लगाई जाय. हम मांग करते हैं कि सरकार नोटबंदी पर श्वेतपत्र जारी करे कि लोगों की जिंदगी और उनके आजीविका पर कितना प्रभाव पड़ा है और इसका तुरंत हर्जाना दे. हम मांग करते हैं कि कॉर्पोरेट द्वारा “कैशलेस” मुहिम को तत्काल वापस लिया जाय.

Indian people have undergone nothing less than an Economic Emergency for the last 100 days. On the midnight of 8/11/16, in a single pronouncement, the Prime Minister of India made higher denominations of Rs. 500 and Rs. 1000 illegal tender under the pretense of curbing black money, arresting tax evasion, stopping funding of terrorist activities and counterfeiting of currency. Those who had these notes were given a time frame of less than 2 months to deposit them and withdraw new denominations in different slabs of limits set by the RBI. The Indian economy, which is predominantly cash based and the Indian people, a great section of who are financially excluded, existing solely on hard currency, would somehow have to manage through this ‘temporary crisis’ for the greater good of the nation. This was the call of the Prime Minister to undergo ‘temporary hardships’ to root out the ills of the Indian Economy.

And so what happened? The country panicked and people rushed to banks to deposit their cash savings, exchange high denominations and lines formed. Long lines, winding unending lines full of people waiting to deposit and get new notes. People died in those lines, many patients could not get timely medical help, many social functions – marriages and burials got drowned in questions of “why cant you suffer a little for the country, when soldiers are giving their blood in the borders to protect you”. But what about people who never had a bank account? Or those too far away from a branch or ATM to withdraw or exchange? Or those whose earnings were so marginal that they could not spare losing a day’s work waiting in lines? Or women who had painstakingly collected money for emergency over many years? What about those crores of rupees that was saved through co-operative banking system, still far away from the mainstream banking operations – but was safeguarding the money of crores of people in many states? Modi’s solution for those suffering was clearly evident on the morning of the 9th, plastered on almost every major newspaper “abhi ATM nahin, Paytm Karo.”

What the government did not tell us was that these temporary hardships would leave a permanent damage on lives, livelihoods and disturb a major chunk of the informal economy. The Government should have known that with underprepared RBI and unprepared banks, the move was bound to backfire. In retrospect, the Prime minister surely knew that demonetization wasn’t about black money; it wasn’t about funding the terrorists; and it certainly wasn’t about counterfeit currency.  A study done by Bank of America-Merill Lynch estimates black economy at 25% of GDP and quantifies the cash component at 10% of the above. Hence, 90% of black wealth was never in cash. A fact that was well known to Mr. Modi, Mr. Jaitley and Mr. Shah. Why did the Government then lie to the citizens of India who voted them to power? Whose interest are being pushed through demonetization?

As for counterfeiting, RBI data shows that, of the 90.26 billion Indian currency notes in circulation in 2015-16, only 0.0007%, were detected as fake. The value of these fake notes in 2015-16 was Rs 29.64 crore, which is 0.0018 per cent of the Rs 16.41 lakh crore currency in circulation. The actual impact of demonetization is then so marginal that the ideology behind its application can best be captured by the old saying, “burning down the house to catch a mouse.” Seditious funding was also given as a reason for demonetization, but did we ever hear of any examples of how terrorism was halted by this move? Even if there was any impact, it can only have been temporary, until new cash replaced the old! The new Rs.2000 and Rs.500 note is as seditious as the old Rs.1000 and Rs.500 note then! Cash is merely one of many conduits; it is neither the source, the motivation nor the act of terrorism. The only act of terrorism seems to be by the government in economically terrorizing the entire population of the country.

So, what exactly was the drive for? We, the people of India, affirm that we do not need a superhero, who does not act democratically and instead is all about weaving and selling dreams. We need people oriented governance and not corporate driven economic emergency. We reject the economic and political premises of demonetization and affirm that a transparent and accountable government is required to replace the current logic of ‘we know what is good for the people’. We reject in totality the authoritarian drive to push the UID/Aadhar scheme down people’s throats and demand political and judicial intervention to stop the drive immediately. We demand that the government produce a white paper on the impacts of demonetization on people’s lives and livelihoods and compensate for the lives and livelihoods. We demand that the corporate driven ‘cashless’ economy plan be immediately withdrawn.

Helicopter Money Drop, or QE for the People or some other Unconventional Macroeconomic Tool…? Hoping the Government of India isn’t Looking to Buy into and Sell this Rhetoric in Defense of Demonetisation.

Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated.

This famous quote from Milton Friedman’s “The Optimum Quantity of Money” is the underlying principle behind what is termed Helicopter Money, where the basic tenet is if the Central Bank wants to raise inflation and output in the economy, that is below par, potential, the most effective tool would be simply to give everyone direct money transfers. In theory, people would see this as a permanent one-off expansion of the amount of money in circulation and would then start to spend more freely, increasing broader economic activity and pushing inflation back up to the central bank’s target. The notion was taken to a different level thanks to Ben Bernanke, former Chairman of FED, when he said,

A broad-based tax cut, for example, accommodated by a programme of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead rebalanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman’s famous ‘helicopter drop’ of money.

The last sentence of the quote obviously draws out the resemblances between the positions held by MF and BB, or helicopter money and quantitative easing, respectively. But, there is a difference that majorly lies in asset swaps for the latter, where the government bond gets exchanged for bank reserves. But, what about QE for the People, a dish dished out by two major ingredients in the form of financial excesses and communist manifesto!!! Thats a nice ring to it, and as Bloomberg talked of it almost a couple of years back, if the central bank were to start sending cheques to each and every household (read citizen), then most of this money would be spent, boosting demand and thus echoing MF. But, the downside would be central banks creating liabilities without corresponding assets thus depleting equity. Well, thats for QE for the People, the mix of financial excesses and communist manifesto. This differentiates with QE, as in the process of QE, no doubt liabilities are created but central banks get assets in the form of securities it buys in return. While this alleviates reserve constraints in the banking sector (one possible reason for them to cut back lending) and lowers government borrowing costs, its transmission to the real economy could at best be indirect and underwhelming. As such, it does not provide much bang for your buck. Direct transfers into people’s accounts, or monetary-financed tax breaks or government spending, would offer one way to increase the effectiveness of the policy by directly influencing aggregate demand rather than hoping for a trickle-down effect from financial markets.

geoq416_special-focus_fig1

Assuming Helicopter Money is getting materialized in India. What this in effect brings to the core is a mix of confusion fusion between who enacts the fiscal and who the monetary policies. If the Government of India sends Rs. 15 lac to households, it is termed fiscal policy and of the RBI does the same, then it is termed monetary policy and the macroeconomic mix confusions galore from here on. But, is this QE for the People or Helicopter drop really part of the fiscal policy? It can’t be, unless it starts to be taken notice of the fact that RBI starts carrying out reverse repurchase operations (reverse repo), and plans to expand its multiple fold when it raises its interest rate target in order to put a floor on how far the funds rate could fall. And thats precisely what the RBI undertook in the wake, or rather during the peak of demonetisation. So, here the difference between such drops/QE for the People and QE becomes all the more stark, for if the RBI were to undertake such drops or QE for the People, then it would end up selling securities thus self-driving the rates down, or even reach where it has yet to, ZIRP. Thus, what would happen if the Government does the drops? It’d appear they spend money and sell securities, too. But in that case, people would say the security sales are financing the spending. And in their minds this is the fiscal policy, while the RBI’s helicopter money is monetary policy. If the confusions are still murky, the result is probably due to the fact that it is hybrid in nature, or taxonomically deviant.

It seems much clearer to simply say that (a) the act of creating a deficit—raising the net financial wealth of the non-government sector is fiscal policy, and (b) the act of announcing and then supporting an interest rate target with security sales (or purchases, or interest on reserves), which has no effect on the net financial wealth of the non-government sector is monetary policy. In the case of (a), whether the RBI cuts the cheques, it’s fiscal policy, and with (b), whether the RBI sells securities, it’s monetary policy. In other words, fiscal policy is about managing the net financial assets of the non-government sector relative to the state of the economy, and monetary policy is about managing interest rates (and through it, to the best of its abilities, bank lending and deposit creation) relative to the state of the economy.

So, how does this helicopter drop pan with India’s DBT, Direct Benefit Transfers or getting back the back money to be put into accounts of every Indian? What rhetoric to begin and end with? Let us go back to the words of Raghuram Rajan, when he was the Governor of the RBI. “It is not absolutely clear that throwing the money out of the window, or targeted cheques to beneficiaries… will be politically feasible in many countries, or produce economically the desired effect,” he said because the fiscal spending hasn’t achieved much elevated growth. So, bury the hatchet here, or the government might get this, import this rhetoric to defend its botched-up move on demonetisation. Gear up, figure out.

A Rejoinder to Public Sector Banks Lending, Demonetisation and RBI Norms: an adumbration

The country’s central bank said 405,000 counterfeit 500- and 1,000-rupee notes were found in the banking system in the year that ended in March, representing around $4 million. But researchers at the Indian Statistical Institute estimated this year that the total value of fake bills in circulation, including those that go undetected by banks, may be as high as $60 million. Now, this is a major discrepancy considering the fact that ISI is invested with data collection, and if one were to go extrapolating this discrepancy, the breach is already broken even without the government stepping in to play its complicit part. 

India is a cash-rich economy, in that most of the transactions are effected in hard cash. This predominance leads to huge stacks in store leading to culmination of corrupt-practices that multiply. One way to emaciate the flow is through narrowing the spigot, which is precisely what is expected out of this exercise, though a caveat of it leading a full circle to corruption cannot be belittled as you have wonderfully explained. But, this spigot narrowing could at least streamline the cash flows of abundance in terms of higher-denomination for the time being. But, how would this cause any lowering in corrupt practices? Probably, it might only for the time being with increased liquidity in banks seize up economy by making it difficult for large volumes of transactions, especially in sectors allied with infrastructure. 

How is the gold sector impacted? Negatively to begin with as no one is investing in gold bullion but rather placing orders to capitalise once the system smoothens. The RBI might go slow on open market operations (OMOs) till there is clarity on how much money will flow into bank deposits by December 30. Moreover, this adverse wealth impact will likely hurt higher-end discretionary demand temporarily. At the same time, lower rates should provide a buffer. A combination of two would result in RBI recouping forex reserves if the adverse wealth effect cuts down gold import demand, a teleological consequence.

rbis-open-market-operations-key-to-recovery

Would Large Exposure Framework, LEF effectively nip the NPAs/NPLs in the bud?

The narrative that non-state actors contribute to stressed assets (NPAs/NPLs :: English / Hindi) via their infrastructural forays and are as complicit in debilitating the banking health in the country as their public counterparts (excuse me for the liberty of giving budgetary allocations the same stature) is slightly misplaced on one important count: accessibility to market mechanisms. The former are adventurous with their instrumentals (yes, more often than not resulting in ignominy, but ingenuous in escaping for a better invention of monetary and fiscal instruments), while the latter are hand-held devices suffocated by Governmental interference and constrictions. The key point lies in the fact that former and not the latter enjoy as well as enjoin connectography, the key pillar to globalised financial in- and out-flows. Turning on to LEF, which I personally feel has enough teeth to sink into narrowing the risk exposure, but, sharpness of the teeth is still speculatively housed in the orbit.

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Although regulatory mechanisms are on an uptick, these efforts are not yielding results to be optimistic about, and even if they are, they are only peripheral at best. Deterrents to prevent large exposure of banks’ bad accounts are marred by lenient approach towards: inadequate tangible collaterals during credit exposure enhancements; promoter-equity contribution financed out of debt borrowed by another bank, leading to significant stress of debt servicing; and short-term borrowings made by corporations to meet working capital and current debt servicing obligations exerting severe liquidity pressures on account of stress build-up in their portfolios. These are cursory introductions to the necessity of Large Exposure Framework (LEF) by the Reserve Bank of India (RBI). This framework confines banking sector’s exposure to highly leveraged corporates by recommending an overarching ceiling on total bank borrowing by the corporates. The idea is to secure other external sources of funding for corporates other than banks by introducing a cap on bank borrowings. With the introduction of this cap, corporates would have to fend for their working capital by tapping market sources. How well this augurs for mitigating NPAs is yet to be scrutinised as the framework will take effect from next financial year. But, the framework has scope for recognising risks, whereby banks would be able to draft additional standard asset provisioning and higher risk weights for a specific borrower no matter how leveraged the borrower is. The issue of concentrated sectoral-risk would get highlighted, even if the single and group borrower exposure for each bank remains within prescribed limits. The framework thus limits relentless lending to a borrower reducing risks of snowballing NPAs by throwing open avenues of market capitalisation on one hand and more discernment regarding sectors vulnerable to fluctuating performances. The efficacy will only have to stand the test of time.

Demonetisation, Cashless Economy and PayTM

Disclaimer: This was written with specifically activists, grassroots movements in mind and is all set to be translated into Hindi after undergoing editions.

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Almost everyone remembers Narendra Modi’s full-page cover ad in leading newspapers, where PayTM congratulated him on the boldest ever financial decision made in Independent India. And almost everyone was stunned by the fact that the Prime Minister could actually endorse a private entity. Rewinding back, the date was 9th of November, an evening after Modi took the decision to demonetise Rs. 500 and Rs. 1000, stripping these bills of their legal tender pushing millions of Indians in a state of chaos with serpentine lines almost in every nook and corner of the country outside of banks and post offices either to exchange old denominations with new ones or deposit currencies in old denominations. With numerous fatalities resulting from this move, the Government is bent on marketing the rhetoric of cashless economy and has even announced a spate of tax exemptions and rewards for those going on to digital transactions. Recently, Chandra Babu Naidu, CM of Andhra Pradesh, who is often credited with floating the idea of demonetisation way back in 2013 expressed his utter helplessness in trying to get the situation under control, and the story is afloat across the political spectrum, but for the ruling dispensation, who sees this move as glorious in order to curb black money, counterfeiting, terror funding and tax evasion. But, for the last, the first three are misplaced as eminent economists from left as well as right have called demonetisation as sickly implemented bringing vainglory to the plan and extreme hardships on the common citizenry, which continues unabated even today. The logics have changed from the four parameters that demonetisation was supposed to effectuate towards going cashless, or digital. PayTM is one such intermediary that seems to have captured the imagination of the country. But, would this be the future of cashless economy, or would Indians be able to sink going cashless is too early to state at the moment. Let us turn our attention to what exactly is the scheme all about.

To begin, let us try and understand what is digital money. Ely, B.  in his Electronic Money and Monetary Policy: Separating Fact from Fiction says, “Digital money or electronic money is the money balance recorded electronically on a “stored value” card, often called “smart cards” that have a microprocessor embedded which can be loaded with a monetary value.” But, that is one form of such money, while the other form is network money, where the software allows the transfer of value on computer networks, particularly the Internet. Just like a travellers’ cheque, a digital money balance is a floating claim on a private bank or other financial institution that isn’t linked with any particular account. this money is issued by both public and private institutions and is raising concerns about the futuristic ability of central banks to set monetary supply targets, to which we would turn later. So, how does one envisage cashless economy for India? And before that, what exactly is cashless economy? Cashless Economy is when the flow of cash within an economy is non-existent and all transactions have to be through electronic channels such as direct debit, credit and debit cards, electronic clearing, and payment systems such as Immediate Payment Service (IMPS), National Electronic Funds Transfer (NEFT) and Real Time Gross Settlement (RTGS) in India. Since, India has been a cash-rich economy, post demonetisation, the government has launched itself into the cashless drive. But, before venturing any further, we must have to deal with statistics. In India, cash-to-GDP ratio hovers around 12%, which is enormously high and is attributable to lack of banking access resulting in high cash transactions; almost zero costs incurred in cash transactions; and a large unorganised sector with overwhelming majority of retailers, suppliers and service providers banking on cash rather than going the digital way.

Pros and Cons of cashless economy for India:

The cashless economy has its own advantages. The transaction costs are coming down and will further go down. Once a substantial part of transactions are cashless, it would bring down the cost of printing, managing and moving money around. Further, the cashless economy automatically solves the problems of cash out on long holidays, risk of carrying currency notes etc. Further, the lesser use of cash strangulates the grey economy, prevents money laundering and increase tax compliance. Increased tax base would result in greater revenue for state and greater amount available to fund the welfare programmes. Lastly, Cash being material, can be prevented from circulation but electronic channels alleviate this friction and increase circulation of currency.

But, it also has its series of disadvantages, and for a country like India, these are gargantuan, for the basic prerequisite to going cashless is Internet literacy, and whatever may be ascribed to India being a IT giant, its large swathes of population are still bereft of the basic of network and communication technology. Even if India is touted as the largest growing smart phone market in the world, the permeability isn’t much to hope for as a significant population of the country resides in pockets where networks either are weak or do not have any presence. Apart from this, hacking and cracking pose a serious danger as digital wallets, how much ever secured they are touted to be are vulnerable to security breaches where encryption-decryption keys could be easily manipulated and therefore used for vested and malicious intent. The third important danger to be factored here is biometric usage in accessing cashless-driven economy, where rates of failure are high with concomitant hardships faced by the consumers. These cons counter the pros in making cashless economy a distant dream and there is indeed a long way to venture before the Governmental claims can make this happen and turn this into a reality through a magical wand.

Anyways, moving on, what are the prerequisites of bringing about a cashless economy? Enabling access to banking is a pre requisite to promote cashless economy. A robust payments mechanism to settle a digital transaction is also needed, though the National Electronic Funds Transfer and Real Time Gross Settlement services. The Reserve Bank of India will also have to shed some of its conservatism, part of which is because it has often seen itself as the protector of banking interests rather than overall financial development. This part is definitely undergoing a sea change as the role of RBI seems to have undergone precisely that under the Chairmanship of Urjit Patel. The expansion of telecom and smart phones would provide a digital shift to the economy in near future. The private sector the driver of this change. Government is also mulling to provide incentives for electronic payments for example waiver of tax when electronic settlements are used, which it has already initiated. But moving back the circle, the question remains whether India is ready for this cashless transition? Looking at the reports published by the Economic Times, while the jury is still out whether government’s move at demonetisation to arrest black money would backfire, one thing is certain that it has brought digital in the centre of payments debate, and as banks and vendors are trying to capitalise on the country’s severe cash crunch, the verdict of going cashless would all boil down to the people. As ET asked, will this shove finally make people conscious of the cost of cash?

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Consider this Trilogue,

At a fish vendor, an erudite lady buys fish and wants to transact the purchase with the vendor using her debit card. An esquire is in the queue eavesdropping on the conversation.

Lady: So, do you accept payment through cards?

Vendor: Not by cards, but you could PayTM me. 

Lady: Isn’t it true that while suing PayTM, you are being charged 1.5% as surcharge that goes to the Government? 

Man: No, it isn’t 1.5%, but hovers between 1.5% – 2.5% depending upon the volume of purchases. 

Lady: So, it goes to the Government, right?

Vendor: (exasperatedly) To the Government? No, it goes to the company. 

Lady: But, isn’t PayTM a Government undertaking? 

Vendor: (shockingly) From all that I am aware of, it is not Government-owned or Government-run,  but the money goes to the company. 

Man: PayTM has nothing whatsoever to do with the Government, as it is a purely private company/corporation/institution. 

Lady: (anguished) Then why is it that the Modi Government is advertising for a private corporation? 

The trilogue isn’t fictional, but happened a couple of days back in Delhi’s upmarket INA, and narrated by a colleague of mine, who incidentally happened to be the esquire in the conversation.

But, it needs to be noticed here that Paytm had scrapped the merchant transaction fees for offline transactions (i.e. while using Paytm for payments at physical shops) back in Feb 2016, which means the merchant also need not bear any extra cost while accepting payments through Patym.

Welcome to the world of PayTM.

PayTM, owned by One97 Communications, is a digital payments platform that allows you to transfer cash into the integrated wallet via online banking, debit cards, and credit cards, or even by depositing cash via select banks and partners. Using the money in the PayTM wallet, you can pay for a number of goods without using cash. PayTM Wallet, as mentioned above, is the digital payment instrument where you can transfer money from your bank account or credit card to use for transactions on the platform. You need to set up an account using your mobile phone number and email ID to setup a PayTM account and transfer cash to the wallet. You can add up to Rs. 10,000 in a month in the Wallet; if you want to increase the monthly limit, then you can get the KYC (Know Your Customer) processor done. With this, you can have up to Rs. 1 lakh in the PayTM Wallet at any point of time. No, the obvious question is: is this digital wallet safe and secure? PayTM – which is an RBI-approved wallet – says it keeps the money you put in the Wallet is “protected under Escrow account with a reputed bank.” PayTM uses Verisign-certified 128-bit encryption technology, which means that the secret key used in transactions is a sequence of 128 bits and does not reveal anything about the password length or contents. The platform is PCI DSS 2.0 certified, which means it does not store credit card data in unencrypted form. Technicals aside, PayTM could be used for online as well as offline payments. By online would mean, payment over the internet, and by offline would connote scanning the Quick Response (QR) code/barcode along with an OTP, One Time Password to realise the payments at a vendor’s.

PayTM is an e-commerce fin-tech web portal with services in online shopping based out of NOIDA in the National Capital Territory of Delhi. Owned by One97 Communications, Vijay Shekhar Sharma is the CEO of the firm. In March 2015, Indian industrialist Ratan Tata made personal investment in the firm. The same month, the company received a $575 million investment from Alibaba Group of China, after Ant Financial Services Group, an Alibaba Group affiliate, took 25% stake in One97 as part of a strategic agreement. Paytm borrowed 300cr from ICICI Bank in March 2016 as working capital. These three make up for the chief funding sources of the firm.

Let us focus on how PayTM works and how it earns its share of monies or profits? Once a user registers on PayTM, it creates a escrow account (virtual code) against which a ledger is made with an entry of Rs.10k (Rs. 20k till Dec. 31, 2016). Whenever a buyer adds some money to PayTM wallet, a debit entry is created in the ledger account with the amount entered by the user. Suppose, a buyer enters Rs. 1000 and keeping the maximum limit of wallet to Rs.10k then in the ledger a debit entry will be created with Rs.1000 and the balance will be shown as Rs.9000. Now suppose the user makes a transaction of Rs. 500 from the wallet, then a credit entry is created in the ledger with Rs. 500 and making the balance amount to Rs.9500 and wallet balance to Rs.500. Suppose the user receives a cashback of Rs.50 into his PayTM wallet. In this case again a debit entry of Rs.50 is created on the ledger leaving the balance in the escrow to Rs. 9450 and wallet balance to Rs. 550. PayTM is more about escrow economy. PayTM does recharges and bill payments. While Government entities may not entertain commissions to PayTM they surely hook the customer to PayTM’s wallet for payments because PayTM gives CashBack on all of these in the form of Wallet Cash which can only be redeemed against any payment made via its network and can be withdrawn into one’s bank account. It is important to note here that PayTM negotiates hard on the Settlement time to these vendors i.e. there is a time lag in which you pay PayTM and PayTM pays the Vendor. Assume Your Due date for payment of Light Bill is 1st of the Month – You pay it by that date, PayTM will release the same money to the vendor by say 8th of the Month (Your Electricity will not be disconnected because PayTM has given confirmation to the vendor that the payment has been settled) and thus PayTM in turn will make money out of the interest that it earns out of the lying deposits in the wallet.

How is PayTM any different from normal debit or credit cards? It is not feasible to physically carry point of sale (POS) machine to swipe the card at every location. Thus Payment Gateway comes to the rescue, The payment gateway, or PayTM in this case acts as a virtual POS on the webpage/portal to accept money. Lets assume a customer made a purchase of 1000 INR on the website of the merchant, the merchant did some 9 similar transactions in the week i.e. Total Value of Weekly sale is 10,000 INR, now at the time of settlement from the payment gateway (PG) to the seller the PG will get a discounted amount from the bank, since the PG has a higher bargaining power with the bank on account of its large transaction volume the bank agrees to cut down Transaction Discounting Rate (TDR) from 2% to 1.5% (assume). Thus the PG will receive (10,000 * (1-1.5%*(1+14.5%))) = 9828.25 INR and will further discount it by 1% (assume) to pass it on to the merchant i.e. the merchant will finally get about 9715 INR (9828.25 * (1-1% * (1+14.5%))). Thus in the whole process, the Card Issuer made the same amount of money, the bank made slightly lesser money on account of customer acquisition and the payment gateway made some money. It is not about promoting PayTM at all, it is as I said the escrow economy which economically/financially is better at cost-effectiveness that I (used metaphorically) would be most benefitted by. The larger picture is thus to be considered vis-a-vis debit/credit cards, where banks are charged higher by the issuers, even if these are bank-owned cards. For instance, a MasterCard issued by the SBI would have a charge that the SBI would be mandated to pay the MasterCard, which itself acts as a payment gateway.

To end this, I did mention about how the Central Bank, Reserve Bank of India in our case would be finding it challenging to decide on monetary supply with an economy that is increasingly going cashless. If electronic money is issued through the conversion of banknotes or sight deposits, it does not change the money supply and price stability is not endangered. However, if electronic money is issued as a consequence of credit, private issuers have incentives to supply additional amounts of electronic money as long as the difference between the interest charged on the credit and the one paid on electronic money covers the credit risk premium, the provision of the payment service, and possibly also the cost of refinancing. Given the low marginal cost of producing electronic money, its issuance could in principle proceed until the interest rate charged on the credit extended for the provision of electronic money is equal to the credit risk premium. This, by lowering the level of interest rates, could in turn endanger the maintenance of price stability. The risk of overissue would be limited by two factors which increase the costs of issuing elec- tronic money, thereby limiting its supply: first, in a competitive environment, electronic money balances could be remunerated; second, and more importantly, a redeemability requirement could oblige the issuer to possess central bank money. An even stronger measure, which could be con- sidered in the light of future developments in electronic money, would be to introduce a coverage requirement on electronic money, i.e. to request issuers of electronic money to cover part or all of their liabilities with base money. Another way to limit the risk of overissue would be to require rapid clearing of electronic money balances in central bank money. Thus, it appears that there are several reasons to assume that the risk of overissue of electronic money can be contained. However the issuance of electronic money may have an impact on the conduct of monetary policy, as I have been claiming for quite a time now. Or else, switch to bitcoins!!!

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FINANCING POWER IN INDIA: GENERIC TRENDS

Banks and Infrastructure Finance Companies (IFCs) are the predominant sources of financing of power sector in India. Balance sheet size of many Indian banks and IFCs are small vis-à-vis many global banks. Credit exposure limits of banks and IFCs towards power sector exposure is close to being breached. Any future exposure seems to be severely constrained by balance sheet size, their incremental credit growth and lack of incentives to lend to power sector. The desirability and sustainability of sectoral exposure norms of the banks in the future may be examined in view of the massive exposure of the banks and projected fund requirements for the power sector.

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Further, any downgrade in the credit rating of power sector borrowers would adversely impact the ability of the major NBFCs viz. PFC and REC to raise large quantum of funds at a competitive rate from domestic as well as international capital markets. In such a scenario, the sources of funds available for power sector projects are expected to be further constrained.

Tenor of Funds

The capital intensive nature of power projects requires raising debt for longer tenor (more than 15 years) which can be supported by life of the Power Project (around 25 years). However, there is wide disparity between the maturity profiles of assets and liabilities of banks exposing them to serious Asset Liability Maturity mismatch (ALM). Accordingly, the longest term of debt available from any bank or financial institution is for 15 years (door-to-door) which could create mismatch in cash flow of the Power project and may affect the debt servicing. Options like re-financing are explored to make funds available for the power project for a long tenor.

Though maturity profiles of funds from insurance sector and pension funds are more suited to long gestation power projects, only a minuscule portion is deployed in power sector. Appropriate fiscal incentives need to be explored to channelize savings. New debt instruments and sources of funds viz. Infrastructure Debt Fund, Clean Energy Funds etc. are identified for the purpose of infrastructure financing.

Cost of Funds

Cost of Rupee funding is high as compared to foreign currency funding. In a competitive bidding scenario, higher cost of borrowing could adversely affect the profitability and debt servicing of loan. External Commercial Borrowings (ECBs) for power projects is not well suited due to issues relating to tenor, hedging costs, exposure to foreign exchange risks etc. Project financing by multilateral agencies (World Bank, Asian Development Bank) has been low due to various issues.

While bond offerings are a lower cost option to raise funds vis-à-vis syndicated loans, corporate bond market for project financing is virtually absent in India. The credit rating of the power projects being set up under SPV structure is generally lower than investment criterion of bond investors and there is a need for credit enhancement products.

Specialized Debt Funds for Infrastructure Financing

Creation of specialized long-term debt funds to cater to the needs of the infrastructure sector; a regulatory and tax environment that is suitable for attracting investments is the key for channelizing long-term funds into infrastructure development.

RBI may look into the feasibility of not treating investments by banks in such close-ended debt funds as capital market exposure. IRDA may consider including investment in SEBI registered debt funds as approved investments for insurance companies.

Long tenor debt funds

Insurance Companies, Financial Institutions are encouraged/provided incentives to invest in longer dated securities to evolve an optimal debt structure to minimize the cost of debt servicing. This would ensure lowest tariff structure and maximum financial viability. Option of a moratorium for an initial 2 to 5 years may also reduce tariff structure during the initial years.

Viability Gap Fund

The power projects that are listed under in generation or transmission and distribution schemes in remote areas like North-eastern region, J&K etc and other difficult terrains need financial support in the form of a viability gap for the high initial cost of power which is difficult to be absorbed in the initial period of operation. A scheme may be implemented in the remote areas as a viability gap fund either in the form of subsidy or on the lines of hydro power development fund, a loan which finances the deferred component of the power tariff of the first five years and recovers its money during 11th to 15th year of the operation may be introduced. Any extra financing cost incurred on such viability gap financing should also be permitted as a pass through in the tariff by regulators.

Policy Measures for Take-out financing for ECB Lenders

RBI has stipulated guidelines for Take-out Financing through External Commercial Borrowings (ECB) Policy.

The guidelines stipulate that the corporate developing the infrastructure project including Power project should have a tripartite agreement with domestic banks and overseas recognized lenders for either a conditional or unconditional take-out of the loan within three years of the scheduled Commercial Operation Date (COD). The scheduled date of occurrence of the take-out should be clearly mentioned in the agreement. However, it is felt that the market conditions cannot exactly be anticipated at the time of signing of document and any adverse movement in ECB markets could nullify the interest rate benefit that could have accrued to the project. Hence, it is suggested that tripartite agreement be executed closure to project COD and instead of scheduled date of occurrence of the take-out event, a window of 6 or 12 months could be mentioned within which the take-out event should occur.

Further, the guidelines stipulate that the loan should have a minimum average maturity period of seven years. However, an ECB of average maturity period of seven years would entail a repayment profile involving door-to-door tenors of eight to ten years with back-ended repayments. An analysis of past ECB transactions indicates that ECB with such a repayment profile may not be available in the financial markets. Further, the costs involved in hedging foreign currency risks associated with such a repayment profile could be prohibitively high. Hence it is suggested that the minimum average maturity period stipulated should be aligned to maturity profiles of ECB above USD 20 million and up to USD 500 million i.e. minimum average maturity of five years as stipulated in RBI Master Circular No.9 /2011-12 dated July 01, 2011.

Combined Exposure Ceilings: RBI exposure norms applicable to IFCs allow separate exposure ceilings for lending and investment. Further, there is also a consolidated cap for both lending & investment taken together.

In project funding, the IFCs are mainly funding the debt portion and funding of equity is very nominal. Therefore, the consolidated ceiling as per RBI norms may be allowed as overall exposure limit with a sub-limit for investment instead of having separate sub-limits for lending and investment. This will leverage the utilization of unutilized exposures against investment. It is well justified since lending is less risky as compared to equity investment. This will provide additional lending exposure of 5% of owned funds in case of a single entity and 10% of owned funds in case of single group of companies, as per existing RBI norms.

UMPP: As each UMPP is likely to cost around Rs.20000 crore and would require around Rs.15000 crore as debt component considering D/E ratio of 75:25. Such a huge debt requirement could not be met with present RBI exposure norms of 25% of owned funds in case of single borrower and 40% in case of group of companies.

So, a special dispensation could be considered by commercial banks for UMPPs in respect of exposure limit as at the time of transferring UMPP all clearances are available, escrow account is opened in favour of developers and PPAs are signed. Considering the above, there is a need to allow relaxed exposure ceilings for funding to UMPPs.

Exposure linked to Capital Funds: RBI Exposure ceilings for IFCs are linked to ‘owned funds’ while RBI exposure norms as applicable to Banks & FIs allow exposure linkage with the total regulatory capital i.e. ‘capital funds’ (Tier I & Tier II capital). Exposure ceilings for IFCs may also be linked to capital funds on the lines of RBI norms applicable to Banks. It will enable to use the Tier II capitals like Reserves for bad and doubtful debt created under Income Tax Act, 1961, for exposures.

Provisioning for Government Guaranteed Loans: RBI norms provide for 100% provisioning of unsecured portion in case of loan becoming ‘doubtful’ asset. Sizeable loans of Government IFCs like PFC and REC are guaranteed by State Governments and not by charge on assets. On such loans, 100% provisioning in first year of becoming doubtful would be very harsh and can have serious implication on the credit rating of IFC. Therefore, for the purpose of provisioning, the loans with State/Central Government guarantee or with undertaking from State Government for deduction from Central Plan Allocation or Direct loan to Government Department may be treated as secured.

Loan-wise Provisioning: As per RBI norms, the provisioning for NPAs is required to be made borrower-wise and not loan-wise if there is more than one loan facility to one borrower. Since Government owned IFC’s exposure to a single State sector borrower is quite high, it would not be feasible to provide for NPA on the total loans of the borrowers in case of default in respect of one loan. Further, the State/Central sector borrowers in power sector are limited in numbers and have multi-location and multiple projects. Accordingly, default in any loan in respect of one of its project does not reflect on the repaying capacity of the State/Central sector borrowers. A single loan default may trigger huge provisioning for all other good loans of that borrower. This may distort the profitability position. Therefore, provisioning for NPAs in case of State/Central sector borrowers may be made loan-wise.

In case of consortium financing, if separate asset classification norms are followed by IFCs as compared to other consortium lenders which are generally banking institutions; the asset classification for the same project loan could differ amongst the consortium lenders leading to issues for further disbursement etc.

Capital Adequacy Ratio (CAR): Prudential Norms relating to requirement of capital adequacy are not applicable to Government owned IFCs. However, on the other side, it has been prescribed as an eligibility requirement for an Infrastructure Finance Company (IFC) being 15% (with minimum 10% of Tier I capital). Accordingly, Government owned IFCs are also required to maintain the prescribed CAR. Considering the better comfort available in case of Government owned IFCs, it is felt that RBI may consider stipulating relaxed CAR requirement for Government owned IFCs. It will help such Government owned IFCs in better leveraging.

Risk Weights for CAR: RBI prudential norms applicable to IFCs require 100% risk weight for lending to all types of borrowers. However, it is felt that risk weight should be linked to credit rating of the borrowers. On this premise, a 20% risk weight may be assigned for IFC’s lending to AAA rated companies.

Similarly, in case of loans secured by the Government guarantee and direct lending to Government, the IFCs may also assign risk weight in line with the norms applicable to banks. Accordingly, Central Government and State Government guaranteed claims of the IFC’s may attract ‘zero’ and 20% risk weight respectively. Further their direct loan/credit/overdraft exposure to the State Governments, claims on central government will attract ‘zero’ risk weight. It may be mentioned that RBI vide its letter dated 18.03.2010 advised PFC and REC that State Government guaranteed loans, which have not remained in default for more than 90 days, may be assigned a risk weight of 20%.

ECB: As per extant ECB Policy, the IFCs are permitted to avail of ECBs (including outstanding ECBs) up to 50% of their owned funds under the automatic route, subject to their compliance with prudential guidelines. This limit is subject to other aspects of ECB Policy including USD 500 million limit per company per financial year. These limits/ceilings are presently applicable to all IFCs whether in State/Central or Private Sector.

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Government owned IFCs are mainly catering to the funding needs of a single sector, like in Power sector where the funding requirements for each of the power project is huge. These Government owned IFCs are already within the ambit of various supervisory regulations, statutory audit, CAG audit, etc. It, is, therefore, felt that the ceiling of USD 500 million may be increased to USD 1 billion per company per financial year for Government owned IFCs. Further, the ceiling for eligibility of ECB may also be increased to 100% of owned funds under automatic route for Government owned IFCs to enable them to raise timely funds at competitive rates from foreign markets. Thus, these measures will ensure Government owned NBFC-IFCs to raise timely funds at competitive rates thereby making low cost funds available for development of the infrastructure in India.

Recapitalisation and Demonetisation. Is the link exaggerated?

What has been witnessed in the aftermath of demonetisation is the declining yield on Government securities, and as a consequent of which treasury gains for public sector banks have already surpassed capital infusion. With a sluggish economy, high levels of stressed assets and eroding bottom-lines, banks have been pushed to the corner to regulate lending. The aim of recapitalisation, and/or capital infusion is geared towards shoring up the lending capacities of banks, public sector banks in this case as countenance  against these erosions. To understand what recapitalisation is, let us take a jaunt to Indradhanush 2015, the seven colours or A2G meant for reviving the banking industry in the country. The seven colours talked about are: Appointments, Bank Board Bureau, Capitalisation, De-stressing PSBs, Empowerment, Framework of Accountability, and Governance reforms. The third colour, i.e. capitalisation (Capital Infusion or Recapitalisation) is an exercise to estimate the capital requirements based on credit growth rate of 12% for the current year and 12 to 15% for the next three years depending on the size of the bank and their growth ability. It has been presumed that the emphasis on PSBs financing will reduce over the years by development of vibrant corporate debt market and by greater participation of Private Sector Banks. Based on this exercise, it is estimated that as to how much capital will be required this year and in the next three years till FY 2019, despite the banks being under a lot of stress and still adequately capitalised and meeting all Basel-III and RBI norms. It must be noted that under Basel III, a bank’s tier 1 and tier 2 capital must be at least 8% of its risk-weighted assets. The minimum capital adequacy ratio (including the capital conservation buffer) is 10.5%. The capital conservation buffer recommendation is designed to build up banks’ capital, which they could use in periods of stress; where tier-1 capital is the core capital and includes equity and disclosed reserves, while tier-2 capital are hybrid capital instruments, loan-loss and revaluation reserves as well undisclosed reserves.

After excluding the internal profit generation which is going  to be available to PSBs (based on the estimate of average profit of the last three years), the capital requirement of extra capital for the next four years up to FY 2019 is likely to be about huge amount of Rs.1,80,000 crore.

Out of the total requirement, the Government of India proposes to make available Rs.70,000 crores out of budgetary allocations for four years as per the figures given below:

(i) Financial Year 2015 -16 Rs. 25,000 crore
(ii) Financial Year 2016-17 Rs. 25,000 crore
(iii) Financial Year 2017-18 Rs. 10,000 crore
(iv) Financial Year 2018-19 Rs. 10,000 crore
Total  Rs. 70,000 crore

According to the document itself, PSB’s market valuations will improve significantly due to (i) far-reaching governance reforms; (ii) tight NPA management and risk controls; (iii) significant operating improvements; and (iv) capital allocation from the government. Improved valuations coupled with value unlocking from non-core assets as well as improvements in capital productivity, will enable PSBs to raise the remaining Rs. 1,10,000 crore from the market.  Moreover, the government is committed to making extra budgetary provisions in FY 18 and FY 19, to ensure that PSBs remain adequately capitalized to support economic growth. The banks can raise capital from the capital markets as well be availed of tranche facilities running over three tranches, and nowhere is there any mention of such budgetary allocations meant for capital infusion or recapitalisation on the substitute for the process of demonetisation. Before moving on to demonetisation, it must be remembered that capitalisation, recapitalisation or capital infusion (the first two are generally used interchangeably and depends on who the user is, with the former lying squarely with the banks, while the latter with academics, if that wasn’t too generic a distinction, I be forgiven!) is through budgetary allocations. Let us underline this.

Demonetisation is when the Central Bank, RBI in our case strips the bill of its legal tender. What happened post November 8 was stripping bills of Rs. 500 and Rs. 1000 of their legal tender, thus rendering them invalid.

Almost everyone seems to be collaging demonetisation and black money, terror funding, illicit and counterfeit money flows. Not that there isn’t correlation between these, but the whole of argumentation is getting reducible to these aspects and what seems to be totally sent to oblivion is tax evasion. Though, some talks do touch upon these, many of these commit the folly of citing tax havens like Mauritius and Singapore and black money hoarded and channeled through there. A populist line of thought, without considering the fact that a recently concluded tax treaty between India and Mauritius has choked the tax haven significantly. One with Singapore is in the pipeline, and once that gets concluded, the two tax havens would then need to seep through populist discourse as no longer the culprits before the narrative changes sense. A tall order from a half-baked recipe.

On the other hand, even if terror funding is caused by higher denominations, one shouldn’t belittle other ingenious ways of carrying out the same. Though, flushing the economy of higher denominations could trickle down to curbing such illicit fundings, the government should not be gung-ho over this as the be-all end-all to choke such flows, for such denominational crushes would only exaggerate Kosher funds, funds through oil economics, extortion and crucially politically-motivated funds slipping through religiously-fundamentalist and right-wing techno geeky consortiums.

So, whether the move is short-term distress or long-term satisfactory should not be decided on subjectivities, but rather on economic complexities, the answers to which sadly the Government doesn’t have at the moment and no wonder crying foul over any resistances to its move. The same goes true for even those calling the government to dock, for the problem is economics should not be totally (read: wholly) studied sociologically anymore, but all the more importantly, sociology needs to be studied as a consequence of economics, and once the order goes for a tailspin, its only fertile for such sentimental concerns, not that anythings wrong with such concerns, but for the fact these have tendencies to become authoritarian. By authoritarian, what is meant is surely Prime Minister’s grand designs. Unlikely entities in the form of Ratings Agencies is stifling PM’s grand designs. But, all of that could change. With demonetisation of notes and GST, hopefully not this quarter but over the next six-seven quarters, there will be an improvement in the fiscal debt-to-GDP ratio by virtue of expansion of denomination, and improvement in the fiscal tax-to-GDP ratio by virtue of better tax collection. Meaning, a possible upgrade from Baa2 (Moody’s) and BBB- (S&P), a notch over the junk. Consequentially, it’d mean all the big three seeing this war on people capitalistically profitable. a sort of double bind, ain’t it? And, here I am guilty of parsimonious arguments, for reasons that most of these are in liberal supply on the media. So, the basis is to look out at connectors and/or disconnectors between recapitalisation and demonetisation, which is still within approaching distance from here on.

With demonetisation has come massive exchanging of old currency for new denominations of Rs. 2000 and Rs. 500 on one hand and depositing old currency in accounts till 30th of December 2016. The deposits have spiked and banks are faced with surplus liquidity, which they are finding hard to find avenues to disburse, say in the form of investments. The cause, which has been reactionary has left the effect no less reactionary, and the culpability lies squarely with planning and implementation of the scheme. Well, thats a different matter, and thus at best put aside. But, the fractures within the social fabric caused due to this lack of implementation has had fatalities that have been extremely costly. As the Financial Express was prescient in noting, there was ecstasy with deposits rising just at beginning of the busy season. Consumerism had shown strong signs in the period leading to Diwali and the good times were to come along supported by banks, which were running tight on deposits. In fact, RBI has been supplying funds through OMOs all through, and it is against this background that banks became ecstatic as deposits rolled in. Most households were in a panic mode and were just keen on getting rid of old notes safely and, hence, most of this money went into savings deposits. The consequences were significant. First, banks automatically started lowering the deposits rates as they no longer had to wait for RBI to announce changes in the repo rate. This also meant that the lending rates could be reduced without a prod, which was a win-win situation for the system. The transmission mechanism became smooth under the compulsion of market forces. In fact, some sections of the market believed that RBI need not lower the repo rate in the December policy, as circumstances have already delivered the result unobtrusively. Banks were also pepped up as the G-Sec yields had crashed with the 10-years paper going down to 6.3% with sentiment providing a guidance of sub-6%. This meant there were capital gains to be had, which would prop up income and banks would be better able to manage provisioning for their NPAs. But, the downside is that the banking sector does not have the capacity to absorb so much of liquidity, and with a low demand for credit, the alternative is to approach G-sec (Government Securities) market. Now, the catch. With stringency to the fiscal target, having additional paper in the primary segment would be self-defeating, and thus another turn, which happens to be the secondary segment for banks to target. This has led to the yields coming down sharply. Given that banks have been paying a minimum of 4% interest on deposits, a positive net return is what they would have wanted. The reverse repo window has been used widely to park these funds where the return could go to 6.25%, which would just about cover their operating cost to assets ratio of 2-2.5%.However, RBI has limited G-Secs in its balance sheet, which is around R7.5 lakh crore, and in case deposits do shoot up to R10 lakh crore, it would not be possible to satiate the market. One option is seeking recourse to MSS bonds (market stabilisation bonds), which have been used in the past when money supply increased mainly due to the influx of foreign currency in the system leading to sharp appreciation in currency. But given the quantum involved (between Rs. 5-10 lakh crore ultimately if the target is reached and cannot be used for lending), this would push up government debt substantially. In fact, it will also add directly to the fiscal deficit, which is not acceptable.

So, what has the RBI proposed? Locking in liquidity on an ex-post basis. It has increased Cash Reserve Ratio (CRR) by 100% of net demand and time liabilities (NDTL),  which is the difference between the sum of demand and time liabilities (deposits) of a bank and the deposits in the form of assets held by another bank. Formulaically,

NDTL = demand and time liabilities (deposits) – deposits with other banks.

The amount specified as the CRR is held in cash and cash equivalents, is stored in bank vaults or parked with the Reserve Bank of India. The aim here is to ensure that banks do not run out of cash to meet the payment demands of their depositors. CRR is a crucial monetary policy tool and is used for controlling money supply in an economy. towards the end of November, the RBI hiked the incremental CRR by 100%. The incremental cash reserve ratio (CRR) prescribes the reserve ratio based on the extent of growth in resources (deposits). It im­mobilises the excess liquidity from where it is lodged (the banks which show high growth), unlike the average ratio which impounds from the banks which are slow-growing as well as banks which are fast-growing. It also avoids the jerkiness of the average ratio. This means it has literally mopped the surplus liquidity that has gone into the banks as deposits in the wake of demonetisation. So, banks do not have capital to lend.  There is a formula on how much a bank could lend. It is:

Lending = Deposits – CRR – SLR (statutory liquidity ratio) – provisioning

; SLR is the amount of liquid assets such as precious metals (Gold) or other approved securities, that a financial institution must maintain as reserves other than the cash.
Formulaically,

SLR rate = (liquid assets / (demand + time liabilities)) × 100%

As of now, the CRR and SLR rates are 4% and 23% respectively. Hence, the bank can only use 100-4-23= 73% of its total deposits for the purpose of lending. So, with higher CRR, banks can give less money as loan, since with higher interest rates, it becomes expensive to lend. This can curb inflation (and this is one of the main arguments of pro-demonetisation economists), but may also lead to slowdown in economy, because people wait for the interest rates to go down, before taking loans.

To reiterate: This move by RBI was necessitated by the fact that the central bank at present holds Rs 7.56 lakh crore of rupee securities (G-Secs and T-Bills) and will soon run out of options of going in for reverse repo auctions, where it sells G-Secs in return for cash from banks, which have surplus deposits. These transactions have been reckoned at rates between 6.21%-6.25%. There are expectations that the volume of deposits will increase by up to Rs10 lakh crore by December because of the demonetisation scheme. The present equation of Rs3.24 lakh crore impounded by CRR and Rs7.56 lakh crore to be used as open market option (OMO) or reverse repo auctions broadly covers this amount, leaving no extra margin. There are two implications out of this: One being, as the level of deposits keep increasing, banks may have to park the increments as CRR with RBI which will affect their profit and loss (P&L). The expectation till today morning had been that the RBI would lower the repo rate aggressively in the December policy by 50 basis points (bps), i.e. today, which it did not do. This surely is deferred till stability due to demonetisation is achieved in the system. The other being on interest rate transmission. Banks could have delayed cutting their lending rates given that they had promised at least 3-4% interest rate to savings account depositors, and not be receiving any interest on the deposits impounded for CRR, which they haven’t as on individual levels, they have been cutting lending rates to approach RBI rates. This culminates into liquidity to tighten and send bond yields on a northward blip, and this is where lending would shrink automatically. And, that is the connector spoken about above, where when the lending spigots are tightly controlled due to tightening of liquidity, the logic behind capital infusion, which anyways comes in through budgetary allocations gets defeated. The real constraining factor could arise when Large Exposure Framework (LEF) gets kickstarted next financial year confining banking sector’s exposure to highly leveraged corporates through a cap scanning risk environs along the way. But, these consequences are still in a speculative realm, though definitely geared to life via demonetisation. 

 

Public Sector Banks Lending, Demonetisation and RBI Norms: an adumbration

How far is it true that in the current scheme of things with stressed assets plaguing the Public Sector Banks on one hand and the recent demonetisation rendering bills of Rs. 500 and Rs. 1000 legally invalid has fuelled once again the debate of these public banks with excess deposits or surplus liquidity in their kitty are roaring to go on a relentless lending, thus pressurising the already existing stressed assets into an explosion of unprecedented nature hitherto unseen? Now, that is quite a long question by a long way indeed. Those on the civil sector spectrum and working on financials leave no stone unturned in admitting that such indeed is the case, and they are not to be wholly held culpable for India’s Finance Minister has at least on a couple of times since the decision to demonetise on 8th November aided such a train of thought by calling upon banks to be ready for such lending to projects, which, if I were to speculate would be under project finance and geared towards the crumbling infrastructure of the country. Assuming if such were the case, then, it undoubtedly stamps a political position for these civil actors, but it would hardly be anything other than a cauldron, since economics would fail to feed-forward such claims.

So, what then is the truth behind this? This post is half-cooked, for it is as a result of an e-mail exchange with a colleague of mine. The answer to the long question above in short is ‘NO’. Let us go about proving it. Reserve Bank of India in no different manner has been toying the switch of a flip-flop in policy makeovers in the wake of demonetisation. But, what the Central Bank and the Regulator of India’s monetary policy has done increase Cash Reserve Ratio (CRR) by 100% of net demand and time liabilities (NDTL),  which is the difference between the sum of demand and time liabilities (deposits) of a bank and the deposits in the form of assets held by another bank. Formulaically,

NDTL = demand and time liabilities (deposits) – deposits with other banks.

The amount specified as the CRR is held in cash and cash equivalents, is stored in bank vaults or parked with the Reserve Bank of India. The aim here is to ensure that banks do not run out of cash to meet the payment demands of their depositors. CRR is a crucial monetary policy tool and is used for controlling money supply in an economy. towards the end of November, the RBI hiked the incremental CRR by 100%. The incremental cash reserve ratio (CRR) prescribes the reserve ratio based on the extent of growth in resources (deposits). It im­mobilises the excess liquidity from where it is lodged (the banks which show high growth), unlike the average ratio which impounds from the banks which are slow-growing as well as banks which are fast-growing. It also avoids the jerkiness of the average ratio. This means it has literally mopped the surplus liquidity that has gone into the banks as deposits in the wake of demonetisation. So, banks do not have capital to lend.  There is a formula on how much a bank could lend. It is:

Lending = Deposits – CRR – SLR (statutory liquidity ratio) – provisioning

; SLR is the amount of liquid assets such as precious metals (Gold) or other approved securities, that a financial institution must maintain as reserves other than the cash.
Formulaically,

SLR rate = (liquid assets / (demand + time liabilities)) × 100%

As of now, the CRR and SLR rates are 4% and 23% respectively. Hence, the bank can only use 100-4-23= 73% of its total deposits for the purpose of lending. So, with higher CRR, banks can give less money as loan, since with higher interest rates, it becomes expensive to lend. This can curb inflation (and this is one of the main arguments of pro-demonetisation economists), but may also lead to slowdown in economy, because people wait for the interest rates to go down, before taking loans.

Moving on, what civil actors perceive, and not totally wrongly is that in the wake of demonetisation, deposits going into the banks are some form of recapitalisation, or capital infusion, which is technically and strictly speaking, not the case. For capital infusion in India happens through a budgetary allocation, and not this route. The RBI even came out with reverse repo, so that banks could purchase government securities from the RBI and thus lend money to the regulator. Thereafter, CRR was raised to 100, which, though incremental in nature would be revised 2 days from now, i.e. on the 9th. This incremental CRR is intended to be a temporary measure within RBI’s liquidity management framework to drain excess liquidity in the system. Though, the regular CRR would be 4, this incremental CRR is precisely to lock down lending going out from surplus deposits/liquidity as a result of Demonetisation. This move by the RBI was necessitated by the fact it at present holds Rs. 7.25 lac crore of rupee securities (G-Secs and T-Bills) and will soon run out of options of going in for reverse repo options, where it sells G-Secs in return for cash from banks, which have surplus deposits. These transactions have been reckoned at rates between 6.21% – 6.25%. There are expectations that the volume of deposits will increase by up to Rs. 10 lac crores by December due to demonetisation. The present equation of Rs. 3.24 lac crore impounded due to CRR and Rs. 7.56 lac crore to be used as open market option (OMO) or reverse repo options broadly covers this amount, leaving no extra margin.

There are two implications out of this:

One being, as the level of deposits keep increasing, banks may have to park the increments as CRR with RBI, which will affect their profit and loss (P&L). The expectation till today morning, i.e. the 7th December, 2016 had been that the RBI would lower the repo rate aggressively by 50 basis points (bps), which it did not do. This surely is deferred till stability due to demonetisation is achieved in the system. The other being on interest rate transmission. Banks could have delayed cutting their lending rates given that they had promised at least 3-4% interest rate to savings account depositors, and not be receiving any interest on the deposits impounded for CRR, which they haven’t as on individual levels, they have been cutting lending rates to approach RBI’s. This culminates into liquidity to tighten and send bond yields on a northward blip, and this is where lending would shrink automatically. Hence the banks cannot go after relentless lending, either in the wake or otherwise of demonetisation. QED.