ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

T T Ram MohanSubscribe to T T Ram Mohan

From the Subprime to the Ridiculous

It is somewhat misleading to label the present crisis a "subprime crisis". This suggests that when banks make subprime loans, that is, practise financial inclusion, they are apt to get into trouble. Some commentators have even gone so far as to warn against political pressure for financial inclusion in India. It is not exposure to subprime loans that is a problem; it is the loss on subprime related securities that explains the sheer magnitude of the present crisis. The evolution of the crisis shows that the world did not fully absorb all the lessons from the collapse of the hedge fund, Long-Term Capital Management in 1998. When do episodes of financial stress have a measurable impact on the real economy? Over the past 30 years, 60% of the financial stress episodes that led to downturns were banking-related events.

Reforming the Banking Sector

The committee on financial sector reforms highlights several concerns on the Indian banking sector - about financial deepening, inadequate competition, lack of scale, high spreads banking, the low usage of new technologies, the decline in market share of public sector banks, etc. These concerns are either valid only up to a point or are misplaced when viewed against the totality of the Indian banking situation. Concern is also expressed about social obligations, delinking the government from banks and greater freedom to private banks - these too are not valid concerns. Indian banking is in a reasonably healthy state and is evolving in the right direction. It needs incremental, not sweeping, changes.

Is It Time to Open Up to Foreign Banks?

What are the benefits and costs to India of an enlarged foreign bank presence? Going by the three important criteria of access to financial services, efficiency and provision of credit, it is unlikely that foreign banks can do more than what the Indian banking system can provide. Add to that the risks posed by larger operations by foreign banks and there is a case for revisiting the 2005 road map of the Reserve Bank of India which indicated that these banks may be able to expand their presence after 2009.

Sovereign Wealth Funds: Western Fears

Sovereign wealth funds control assets of somewhere between $ 1.9 and $ 2.9 trillion. What are swfs, how are they governed and why are developed countries anxious about such funds being set up by developing countries? And should India consider setting up a swf with a part of its large foreign exchange reserves?

Mumbai as International Financial Centre

Is an international financial centre in Mumbai such a big deal that all policymaking should be oriented towards this objective? This is the fundamental question that needs to be addressed in evaluating the report of the high-powered expert committee on Mumbai as an IFC. By that yardstick, the committee fails to provide a convincing argument that an IFC is necessary to sustain an 8-10 per cent growth rate.

Banking Reforms in India

The public sector banks have shown a remarkable transformation in the post-reform period. Profitability is comparable to international banks, efficiency and stability have improved and there is a convergence between PSBs and private banks. But the PSBs will be severely tested as disintermediation proceeds apace on both the asset and liability sides. Their survival depends on their ability to rise to the challenges ahead. Both unions as well as government in its capacity as owner have an important role to play in ensuring that PSBs are well prepared to meet these challenges.

Stock Market Fall

What caused the sharp fall in the prices of stocks in the month of May? The most plausible explanation is that, after the prolonged rise in prices, foreign investors judged that the market was overvalued and decided to book profits. They might have been pushed towards doing so by the rise in interest rates in industrial economies and the expectation that the rate rise has not run its course. The troubling aspect though is that India's share of portfolio equity flows has been fuelled substantially by participatory notes. Also, the composition of total equity flows of private capital in India is at variance with that of developing countries.

Neither Dread Nor Encourage Them

Foreign institutional investor inflows into the Indian stock market have conferred several benefits - in terms of lower cost of equity, securities market reforms and corporate governance. However, more receipts are unlikely to increase these benefits, while the downside is the potential volatility in exchange rates arising from the fact that participatory notes constitute a large component. We are unsure about the origins of funds that go into participatory notes and we do not know whether they are permanent in nature. It is possible to derive the benefits of FII investment without having to put up with the uncertainties created by PNs. We do not need to dread FII flows, but neither is there any need to be fixated about raising them.

Taking Stock of Foreign Institutional Investors

Institutional investors have grown in importance in the mature economies in recent years and come to supplant banks as the primary custodians of people?s savings. Flows of private capital through FIIs have in recent years augmented forex reserves in emerging markets. In India, over the past decade FIIs have displaced domestic mutual funds in importance in the equity market. Their shareholding in the Sensex companies is large enough for them to be able to move the market. The volatility in portfolio inflows to India has been modest compared to other emerging markets. As domestic funds grow in size and pension funds enter the equity market, that would provide a measure of self-insurance against volatility occasioned by FII flows. The real problem caused by variations in FII inflows from year to year is not stock market volatility but difficulties posed in management of money supply and the exchange rate.

Bank Consolidation

India's public sector banks lack a compelling rationale for consolidation. Contrary to the experience elsewhere, spreads at PSBs have not declined consequent to deregulation and profitability has improved sharply, making the Indian banking system the second most profitable in the world. The performance of PSBs, measured by the appreciation in stock values, has also been very impressive. It is hard to argue, against this background of improving performance, that greater size is the key to further performance improvement. At the very least, such a contention needs to be backed by rigorous research as to what constitutes the optimal size of assets in the Indian context.

Is India's Central Debt Sustainable?

This paper revisits the proposition that India?s debt problem is unsustainable in light of the recently changed outlook for growth and interest rates. Using a decomposition model, it separates out the effects on the fiscal deficit of growth and government behaviour in the past. If recent government behaviour were to continue, the economy would need to grow at 6.1 per cent in the coming years for the centre?s debt to be sustainable, a growth rate that seems eminently achievable. If a real growth rate of 6.2 per cent is posited in the coming years, only a modest degree of fiscal adjustment would be required, or none at all, to reach a tolerable level of the debt to GDP ratio by 2009-10.


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