Sucheta Dalal :Crisis & Solutions
Sucheta Dalal

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Crisis & Solutions  

December 3, 2008

Crosshairs (MoneyLIFE Issue, 18th Dec 08)

Someone closely connected with managing the impact of the global financial crisis tells us that the government in election mode is unwilling to take any drastic action to finance cash-strapped industries which had over-ambitiously extended themselves during the bull run. The strategy, it would seem, is to do as little as possible, make optimistic statements about India’s growth, blame the US for the mess, give a patient hearing to complaints about banks’ refusal to lend and to float trial balloons in the media about government-financed funding plans to pump-prime the economy.
Meanwhile, corporate India is clamouring for lower interest rates and easy bank funding. Banks point out that they cannot be the only source of funds when all other avenues, such as the primary equity market, external commercial borrowing (ECBs), mutual fund lending as well as suppliers’ credit (mainly arranged by foreign banks) have completely dried up. The pressure on liquidity and foreign reserves seems set to continue with forex reserves getting depleted at approximately US$5 billion a month.
Foreign institutional investors (FIIs) are continuing to pull out portfolio funds while ECBs are falling due at a steady rate of around US$40 billion every six months. At this rate, say top bankers, the comfort of India’s fat forex reserves of US$250 billion would vanish in 12 to 15 months. What should India do to replenish its reserves and strengthen the weak rupee when the prospects of attracting foreign direct investment (FDI) look dim? With industrialists clamouring for interest reductions and mutual funds themselves strapped for cash, it was left to bankers to come up with sensible suggestions. Here are some of them:
NRE Accounts: Bankers have suggested offering a return of 200 to 300 basis points above LIBOR on Non Resident External (NRE) accounts. This would attract a relatively cheaper and steady pool of funds that would help strengthen the rupee, fund imports and meet external payment obligations.
Infrastructure Funding: Substitute lending to agriculture under the head of 40% mandatory priority sector advances with infrastructure funding. The idea is not to squeeze funding to agriculture, but to modify it in line with its share of GDP, which has dropped over the past decade from 50% to 20%. Most banks fail to meet the 10% quota for lending to agriculture. If the RBI permits such a substitution, it would enable infrastructure projects to get funds at 7%. More importantly, it will obviate the need for unworkable alternatives such as Rs50,000 crore infrastructure fund as suggested by the Planning Commission. Bankers point out that an infrastructure project takes a minimum of two-three years to obtain all local, central and environmental clearances and achieve financial closure. It is far better to facilitate cheaper funds from banks after following established project evaluation and due diligence processes. Creating alternative channels will only lead to delays when construction needs to get a kick-start in the coming few months.
Substituting agriculture with infrastructure will also end other foolish ideas such as extending a sovereign guarantee to private sector borrowings for large-scale infrastructure projects. This suggestion apparently emanated at a ‘working dinner’ that Indian bureaucrats had with Henry Paulson, the US Treasury Secretary. And Planning Commission chairman Montek Singh Ahluwalia thought this was an excellent way to bring down the cost of funds. Incidentally, Ahluwalia as the finance secretary, GOI, had pushed through the controversial sovereign guarantee for Enron’s Dabhol Power Company. The project remains unviable to this date, despite innumerable rescue efforts and has caused great embarrassment to India. Some things apparently never change.
Reduce CRR and Change Capital Adequacy Framework: Another suggestion is to reduce the cash reserve ratio by another two percentage points so that liquidity is no longer an issue and it leads to a reduction in deposit rates and, consequently, lending rates. So far, deposit rates remain at a high 10.5% to 11% with some banks offering even higher. Bankers also say that there is a case for Indian banks to claim higher capital adequacy standards because of the stricter provisioning norms mandated by the Reserve Bank. Adjusting this will allow Indian banks to show higher capital adequacy (at 9.5%).
Silver Lining?  
The Union finance minister loses no opportunity to claim that India will escape a global recession. If we do, which is doubtful, much of the credit should go to the Reserve Bank of India, which strongly discouraged the creation of toxic debt, or structured financial products, despite active lobbying by the more aggressive banks, Indian and foreign. Another reason is that financial penetration remains abysmal, despite an unprecedented five-year economic boom and a monster bull market. According to Indicus Analytics, “On an average, only 16% of Indian households took loans from institutional sources while 22% took loans from non-institutional sources. This suggests that the bulk of Indians are, financially ineligible and need to meet their borrowing requirements from informal sources. If the impact of the stock market crash is hardly visible, it is because only 5% of Indians invest in capital market instruments. The disproportionately intense media attention to the capital market obfuscates this important fact. The south Indian states of Kerala (by far the leader), Maharashtra, Karnataka and Tamil Nadu have several districts where the ‘penetration of institutional loans’ is a high 37% to 68% and, unsurprisingly, states with the lowest financial penetration are the north-eastern states of Arunachal Pradesh, Manipur and Mehghalaya and J&K.
Realty, Get Real
A Goldman Sachs’s report predicting that India’s property market is “poised for a deep correction” has finally shaken up realty czars. Goldman says that it expects a drop of 30% from current levels, while many banks and lending institutions believe that prices need to drop a minimum of 50% or more. In fact, some numbers quoted by bankers suggest that Goldman is being optimistic. The developers, who had watched with glee as property prices soared over 200% in the past five years, have mixed views. Several companies such as DLF, Purvankara, Sobha and Hiranandani still refuse to recognise that the market for super-expensive properties has vanished. On the other hand, those under pressure to meet payment obligations, such as Unitech and Orbit, are acting quickly and slashing prices to negotiate deals before things worsen. Unitech is selling assets to reduce outstanding debt estimated at Rs8,200 crore. Orbit, which made news with its plan to price its flats at a tony Malabar Hill project at a phenomenal Rs100,000 per sq ft, has dropped its prices to Rs35,000, but buyers are still haggling for a further cut and are willing to pay only on project completion, says a top banker. He also says that newly constructed malls in Mumbai’s suburbs are finding no takers even after a 30% price cut. The worst hit, apparently, are those who borrowed heavily to create fresh land banks at peak prices. These properties will neither find buyers nor see any development when on-going construction even on mega projects has come to a dead halt.
Goldman’s research makes two significant points in connection with the previous realty slump that began in 1996 after yet another bubble. It points out that prices dropped 40% over three years – developers who believe that bad times will end in 12 to 15 months need to take note. It also points out that prices did not recover to their previous peaks for the next decade. This time, however, Goldman believes that the ongoing infrastructure demand and favourable demographics may lead to a faster turnaround. That remains to be seen.

-Sucheta Dalal


-- Sucheta Dalal