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

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Dynamics of Competition in the Indian Banking Sector

Competition is supposed to make banks more efficient and stimulate financial innovation by opening up of new markets. Given the dynamic changes within the Indian banking system in the last two decades, the effect of the developments in the market on the competitive behaviour of Indian commercial banks is assessed. The empirical analysis suggests monopolistic competition. This feature of the Indian banking market is consistent with other emerging-market economies and developing countries. We also find a decrease in competition across the two time-periods, before and after 2007. This may be attributed to the consolidation of the sector, with major banks acquiring smaller banks to gain economies of scale, market share and transaction volume.

Engineering Banking Sector Recovery and Growth

The idea of “bail-in” in cases of serious banking instability has been widely discussed in India ever since the introduction of the Financial Resolution and Deposit Insurance Bill. Given the large non-performing loans of public sector banks, the Government of India and the Reserve Bank of India as the regulatory authority have to quickly act to ensure that public confidence in the soundness of commercial banks is not breached. In this context, three approaches are explored that could be adopted either individually or in a variety of combinations in different proportions essentially to secure banking stability. The bail-in idea should not be considered except in extreme conditions of large financial stress. The idea could be tried even before the extreme situation arises with provision of incentives.

The Banking Conundrum

Neo-liberal banking reform was launched in the early 1990s to address the low profitability of the public banking system and the large presence of non-performing assets. It set itself the objectives of cleaning out NPAs, recapitalising the banks and modifying banking practices to restore profitability and drastically reduce NPA volumes. This did initially have some effect. However, while the NPA ratio fell between the early 1990s and the mid-2000s, it has risen sharply since then. Moreover, while earlier priority and non-priority loans contributed equally to total NPAs, more recently, large non-priority loans to the corporate sector account for the bulk of NPAs. An analysis of these features reveals that these trends are indicative of the failure of neo-liberal banking reform in India.

Appetite for Official Reserves

There is a strong nexus between the level of reserves, frequency of intervention, and exchange rate variability. Given the current exchange rate arrangements, there is a mandate to accumulate reserves in line with other developments such as import growth, growth in short-term external debt, and so on. The Reserve Bank of India seems to have no option, especially in times of capital flight, than to allow the exchange rate to absorb market pressure if the volume of reserves held is not adequate. This indicates a limited scope for using other instruments. The objective of accumulating additional reserves seems to override the ambition of exchange rate stability when there is a limit on the capacity to intervene imposed by the reserve shortfall. Therefore, reserves matter in times of crisis.

Long-run Determinants of Sovereign Bond Yields

Keynes’s supposition of short-term interest rates as the key driver of long-term government bond yields is investigated for India, after controlling for various key economic factors. It is seen that long-term interest rates of Indian government bonds are positively associated with the short-term interest rates of Treasury Bills. Higher long-term interest rates on IGBs are influenced by higher short-term interest rates, higher rates of inflation, a faster pace of industrial production and higher fiscal deficit (and vice versa). The bond market was disrupted during 2013 when yields rose sharply in India. Incorporating this structural break improved our findings.

Can Central Banks Reduce Inflation?

To explore the empirical validity of the proposition that a rise in the interest rate would necessarily lead to a lower rate of inflation, empirical evidence from 158 countries, during 1981 to 2013, is used to critically evaluate this widely accepted idea. Based on the findings, it is argued that from a policy perspective, the so-called “inflation targeting” should be revisited.

The Story of Currency in Circulation

The impact of demonetisation on the movement of currency in circulation in India over time is examined. Four different models of currency in circulation are used to estimate these models using weekly data from April 1992 to October 2016. An analysis of out-of-sample forecast performance of these models prior to demonetisation reveals that the series could be forecast well before this event. Out-of-sample forecast errors of these models during the post-demonetisation period are, therefore, interpreted as shocks due to demonetisation. As far as weekly growth rates of the series are concerned, we observe no major change in intra-month seasonality in currency in circulation once the shock due to demonetisation mitigated.

Demand-led Growth Slowdown and Inflation Targeting in India

A variety of indicators are presented to show that demand restricted output during the growth slowdown of 2011–17. The macroeconomic structure of the economy is such that a policy-induced demand contraction affects output more than it affects inflation. In this context it is important to evaluate the application of inflation targeting. Flexible inflation targeting was too narrowly and strictly implemented initially, although there are signs of moderation in 2018. Since inflation forecasts were biased upwards, the more effective expectations anchoring channel of inflation targeting was underutilised. The output sacrifice imposed was higher than necessary. Finally, possible mechanisms to ensure inflation targeting is implemented flexibly as required in the Indian context are discussed.

Foreign Finance, Real Exchange Rate, and Macroeconomic Performance in India

The paper examines whether financial inflows cause economic contraction in India through appreciation of the rupee. To this end, it formulates a structuralist macroeconomic model and calibrates it to India’s national income accounts. It then simulates and analyses an alternative scenario involving greater inflow of foreign finance. It is seen that real exchange rate appreciation, despite its negative effect on trade surplus, stimulates real wages and consumption demand. The paper does not endorse complete capital account convertibility but warns against a blanket approach towards different forms of foreign finance.

Mortgage Loans, Risky Lending, and Crisis

The link between the loan market and the housing market that works through mortgage loans is critically examined. Repayment of such mortgage loans depends on the future earning potential of the borrowers, which in turn depends on the overall state of the macroeconomy. Under buoyant macroeconomic conditions, all borrowers pay back their loans and both the loan market and the housing market function well. However, a temporary income shock in the economy, which undermines the repayment ability of the borrowers, may result in imprudent lending by banks thereby leading to a crisis. This calls for strict monitoring of mortgage loans by regulatory authorities.

Plurality in Teaching Macroeconomics

For economists, the Great Recession—the worst crisis the world has seen since the Great Depression of the 1930s—has highlighted the need for plurality in macroeconomics education. Ironically, however, there is a move towards greater insularity from alternative or contrasting points of view. Whereas, what is required for vibrant policymaking is an open-minded academic engagement between contesting viewpoints. In fact, there does not even exist a textbook that contrasts these contesting ideas in a tractable manner. This pedagogical paper is an attempt to plug that gap by presenting a comparative study across different traditions in macroeconomics in a unified framework, which can be developed into a semester-long intermediate-level course.

Monetary Economics of Fascism and a Working-class Alternative

Fascism is the usurpation of the economic process by the elite and the related decimation of the working class and the poor. This process is represented by the shrinkage of fiat money backing the production of goods and services and its substitution by financial instruments. This domestic coup is accomplished by the spread of what is generally referred to as “false consciousness.” The tools of basic economics can be fashioned to introduce students to these concepts. Mainstream economists continue to demonstrate the different ways utility functions can be manipulated.

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