Much ado about fiscal deficit

A Budget that spurs demand is the need of the hour. The view that fiscal stimulus crowds out private spending is questionable

Whatever may be the actual recommendations of the NK Singh panel tasked to review the fiscal consolidation roadmap, it has been widely agreed, by now, that the upcoming Budget should focus on stimulus measures in order to boost domestic demand, improve investments and pave the way for job-filled growth.

Demonetisation is behind us and the withdrawal of cash has led to temporary problems of demand compression with consequential impact on growth. But, if there is something akin to the balance sheet of the economy, it can be seen that this is indeed the moment for a path-breaking Budget that can induce a sharp recovery.

The balance sheet

Budgets refer to income and expenditure statements. But there is very little discussion around the major elements of what could be construed to constitute the country’s balance sheet. The UN has been bringing out the Inclusive Wealth Report (an exercise which broadly looks at “manufactured capital, human capital, natural capital and social capital” as a country’s assets and internal and external debt of the government and private entities as liabilities) which had attempted to marry essentially an accountant’s perspective with that of an economist.

If one were to take just the liabilities from this ‘balance sheet’, it would emerge that the country is perhaps at an economic sweet-spot from where a jumpstart is possible. Let us take external debt first. According to the latest report of the Ministry of Finance, India’s external debt stock stood at $485.6 billion at end-March 2016 as against $475.0 billion at end-March 2015. While external debt has increased over 2015-16 by a small 2.2 per cent, important debt indicators such as external debt-GDP ratio and debt service ratio remain comfortable.

Our external debt continues to be dominated by long-term borrowings. The external debt policy pursued by the Government has kept external debt within manageable limits. India continues to be among the less vulnerable countries with its external debt indicators comparing well with other indebted developing countries, as the survey states. Of this debt, what is significant is that government debt is only $93 billion in India’s case.

Further, the ratio of short-term debt on the external front is a modest 18.5 per cent which means that there is no reason for any anxiety on the debt-servicing front, at least for the next year. Just for comparison purposes, it may be noted that China’s share of short-term debt is 71.2 per cent though that is mitigated by its very high reserves position.

Government debt

As for short-term government debt, it stands at a measly $108 million, indicating that concern on the external debt front, as of now at least, is unwarranted. Our foreign exchange reserves are at $359 billion.

When it comes to total government debt, the figure is ₹60, 33,464 crore including external debt. To give an idea of the indebtedness of the country, it would be useful to compare this with the total credit/ loans taken by all domestic entities inside India from the banking system — it stands at about ₹76,00,000 crore. And one major difference has been that whereas the Government has been borrowing at fixed rates, all others are borrowing at floating rates.

So, in a falling interest rate regime, the Government has been effectively paying higher interest!

Our share of government debt to GDP is at about 70 per cent and there are countries in the Euro Zone which have these ratios closer to about 90 per cent. Of course, the percentages in the case of Japan, the UK and the US are much higher.

The obsession with fiscal deficit is premised on two grounds, mainly. One, that budget surpluses are a form of national saving, and two, that higher fiscal deficits would crowd out private investments because of the pressure it would put on interest rates.

There have been studies and reports which have negated both theses empirically. One of them, based on RBI data, conclusively stated that there is no significant relationship between high fiscal deficits and high interest rates.

Anecdotal evidence is also now on hand; banks have invested more in government debt than the SLR requirement and still have liquid surplus to lend, which has forced them to drop rates. At present, a 10-year government security has a yield of 6.7 per cent, much lower than a one-year bank deposit rate.

Much of what can be called “fiscal deficit fundamentalism” can be attributed to neo-classical views which would fit western liberal economies. Thanks to our inclination to save (net savings rate is about 31 per cent of GDP), government borrowing, per se, need not be seen as a matter of concern.

Fiscal fundamentalism

Of course, like any other economic entity, our government also cannot perennially borrow and live beyond its means. But to cling to numeric targets even when the crying need of the hour is to boost demand and public investments (so that it will crowd in private sector investments) would be detrimental to the growth trajectory that we need to have to generate enough jobs.

Also, when monetary policy is seemingly constrained by exchange rate considerations, fiscal fundamentalism may have to be abandoned.

Putting money in the hands of the poor and the middle classes, making life easier for the distressed farm sector and making for vibrancy in the small and medium businesses is vital.

The country’s economic balance sheet seems strong and resilient enough to afford the Government ‘space’ to be accommodative enough to spur growth impulses, without going overboard on fiscal loosening.

The writer is with the State Bank group. The views are personal

India plan: Hitachi Data bets on digitisation, smart city projects

Russell Skingsley, Chief Technology Officer, Asia Pacific, Hitachi Data Systems

“A country with a billion people, a large democracy, a desire to transform, modernise and standardise, it will be crazy not to have India on high priority,” said Russell Skingsley, Chief Technology Officer (Asia Pacific), Hitachi Data Systems (HDS). HDS is a wholly-owned subsidiary of $90-billion Hitachi of Japan. It has been in India for the last 15 years and has over 600 customers.

Digitisation, focus on investments in manufacturing, smart cities and skilling, the four major programmes of the government will drive a huge demand for cloud, analytics and Internet of Things, he told Business Line. Last year, HDS India, which works with system integrators such as Infosys, Wipro, Tata Consultancy Services, Cognizant and Tech Mahindra, witnessed a 39 per cent revenue growth, said its Managing Director Vivekanand Venugopal, without giving any number.

“India is getting better to do business. This is going to be India’s advantage. But, of course, there will be always location-based challenges, and that where we rely on local partners who understand the environment,” said Skingsley.

With over 100 smart cites to be implemented in India, HDS will play a significant part in this. The company has already won a couple of projects, he said.

An area of expertise that HDS has is in video analytics.

Normally, people will monitor from a room full of screens. However, in video analytics, machines understand behaviour from video feeds and provide alerts. For instance, detecting people dumping something in an area where it he should be not be done.

Blend of IoT and operational technology is another opportunity for HDS which along with Hitachi won a project from British Rail Network to provide high speed train replacement. Hitachi will be paid on punctuality of train service. To achieve high level of efficiency and punctuality, IoT was built into the system with every single rail path having around 25,000 sensors. The sensors aggregate data and sendit in real time to a centre to analyse various aspects of the rail network, he said.

Such IoT projects will be done in future where IT, data analysis and connectivity will be built in large scale infrastructure projects. India is really a fertile kind of environment for such projects, Skingsley said.

Centre puts ‘green bank’ listing on hold as winds deemed unfavourable

The government intention to list India's green bank – the Indian Renewable Energy Development Agency (IREDA) – is not likely to happen for at least a year as the public sector undertaking faces rough weather both at home and abroad.

Company officials say they want to wait for the market to stabilise before approaching the bourses, to ensure better valuation for the company.

Challenges

The falling interest rates and the rise of competing clean energy financing by banks are threatening returns of the PSU back home. Besides, US President Donald Trump’s policies have raised the cost of hedging for IREDA.

Officials say the burden of Trump’s policy of closing down the American economy to encourage domestic manufacturing has been reflecting on the rupee. According to December 2016 rating of Moody's Investors Service, multilateral agencies accounted for around 55 per cent of IREDA's total borrowings as of March 31, 2016.

Rupee depreciation

The rupee has depreciated 1.8 per cent over the past three months (since October 30, 2016), putting additional strain on IREDA, when it will have to repay the foreign sourced fund.

Currently, IREDA raises funds from international development agencies such as the German government-owned KfW and Asian Development Bank. IREDA also builds its corpus by issuing bonds for clean energy development projects. It hedges its borrowing in foreign currency denominated financial instruments.

As the Indian currency depreciates, IREDA will have to shell out more for hedging or have to pay back a much higher amount to its borrowers. But, this is just the tip of the iceberg for IREDA. Company officials told BusinessLine that Indian banks are eyeing to take over the loans disbursed by IREDA. Clean energy projects have assured offtake over a period of 25 years and banks are looking to take over these committed loan accounts.

A senior official said, “The banks are attempting to poach loan accounts buoyed by the prospects of assured returns. Banks are offering customers a lower interest rate from IREDA’s rate.”

Assets valuation

The company reported consolidated assets of ₹13,200 crore (around $2.0 billion) in June last year. The takeover will allow faster repayment of debt, boosting IREDA’s immediate cash profile. This will, however, result in a loss of earning from interest that IREDA had estimated while disbursing the loans.

IREDA will thus earn less from the loans it disbursed and will have to pay back more to the international development financing institutions it borrowed from.

Hybrid annuity road projects face financial closure hurdles

Out of the 26 hybrid annuity model projects awarded this fiscal, about four-five may get scrapped due to inability of the developer to invest equity or bring in debt

Some of the road projects under the new hybrid annuity model (HAM) that attracted aggressive bidding this fiscal year are struggling to achieve financial closure as banks remain cautious, developers and analysts said.

Under HAM, the government commits up to 40% of the project cost over a period and hands the project to the developer. The developer has to fund the balance with debt and equity, and is paid annuity income in instalments. The model was designed to make it safe for banks and investors.

Satish Parakh, managing director at roads developer Ashoka Buildcon Ltd, said some lenders are “not happy” with the hybrid annuity model. “Some of the banks are refusing to finance on the basis of those documents, and only a few banks are coming forward for the hybrid annuity model. They have some reservations which they are discussing with the NHAI. The other part is that some companies are finding it difficult to put equity,” said Parakh said. He added the company had achieved financial closure of its HAM project.

Like all public-private-partnership (PPP) projects, HAM projects too are facing issues with financial closure, said K. Ramchand, managing director, IL&FS Transportation Networks Ltd (ITNL). ITNL, which has the largest portfolio of build, operate and transfer (BOT) road projects, has bid for HAM projects in various states but not announced a win so far.

Out of the 26 HAM projects awarded this fiscal, about four-five could get scrapped due to inability of the developer to invest equity or bring in debt, said an analyst, asking not to be named as he is not authorized to speak to reporters. Large banks such as State Bank of India (SBI) and Axis Bank are selectively funding HAM projects even as many companies continue to bid for and win such projects, according to this analyst. SBI and Axis Bank did not respond to email queries sent on Thursday.

“Earlier, banks were slightly reluctant with funding hybrid annuity projects, especially for developers with weak balance sheets and lack of construction experience. They (banks) were taking longer time than usual to assess HAM projects as they wanted to understand the new business model. However, in the recent weeks, a lot of companies including Welspun, MEP Infra and Sadbhav have been able to achieve financial closure for their hybrid annuity projects,” said IIFL Wealth analyst Alok Deora.

On 2 December, Deora had said in a report that certain small developers had failed to receive financial closure for their HAM projects, which were consequently cancelled.

The government’s push for new low-risk HAM awards to kick-start private sector investments has led to the emergence of a number of smaller, regional companies that have added to the sector’s competitive intensity, according to road developers and analysts. The increase in awards of projects under the government-funded engineering, procurement, and construction (EPC) model too has driven up bidding aggression.

Companies including Sadbhav Infrastructure Projects Ltd, Welspun Enterprises Ltd, and Ashoka Buildcon have been able to tie up loans and submit their financial closure details to NHAI. MEP Infrastructure Developers Ltd has been able to achieve financial closure for two of its projects with two others yet to be closed, while PNC Infratech Ltd and Dilip Buildcon Ltd are expecting to achieve financial closure by March. Some other companies such as MBL Infrastructures Ltd, APCO Infratech Pvt. Ltd, Oriental Structural Engineers Pvt. Ltd and GR Infraprojects Ltd, are yet to achieve financial closure of their won projects, according to channel checks of the firms.

“A concern in the roads sector today is that there is huge aggression even though the number of players is less. The job being bid out are quite large, but theirs is no comfortable participation and instead, there is a lot of aggression. And that will lead to execution challenges,” Ashoka Buildcon’s Parakh said.

Road projects in India have always been awarded in one of the three formats—BOT annuity, BOT toll and EPC. In BOT annuity, a developer builds a highway, operates it for a specified duration and transfers it to the government, which pays the developer annuity over the concession period. Under BOT toll, a concessionaire generates revenue from the toll levied on vehicles using a road. In EPC, the developer builds with government money.

India has set a target to award 25,000km of road projects in FY17 under the ministry of road transport and highways and National Highway Authority of India (NHAI), compared to 10,000km achieved in FY16.

RBI's Overseeing Committee approves 1st ever S4A scheme to HCC Ltd

The Overseeing Committee of the Reserve Bank of India (RBI) has given its approval for the Scheme for Sustainable Structuring of Stressed Assets (S4A) for Hindustan Construction Company, the latter said in a notification to the BSE on Sunday.

The move has made HCC the first company to get an approval by the RBI's Overseeing Committee, it said.

HCC has a total funded debt of Rs 5,107 crore, which has been considered under the S4A scheme. The debt will be divided into two -- sustainable and unsustainable debt.

The Part A or the sustainable debt, according to the company, will be of Rs 2,681 or 52.50% of the total debt.

The Part B or the unsustainable debt, will be Rs 2,426 crore or 47.50% of the total debt.

According to the notification, "the lenders will subscribe to 24.44% fresh equity (Rs 1,008 crore assuming Rs 40 rate) which will bring down the promoter holding from 36.07% to 27.44% The share price will be determined as per Sebi guidelines and accordingly, the debt will go down to the extent of the conversaion amount.

"The balance portion of Part B, will be converted into Optionally Convertible Debentures for ten years with coupon @0.01%, 11.5% YTM," it said.

Commenting on the development, HCC Group CEO Praveen Sood, said, "The S4A scheme will help the company bridge the gap of 'Cashflow Timing Mismatch' between claims realisation (including its interest) and debt servicing.

"The move comes at an opportune time as HCC is already on recovery path with order book growth of over 30% in last one year. We feel that it's a positive move for HCC and will bring sustained long term solution for the company."

HCC's shares will be in focus today on the bourses. On Friday, the company's shares had closed at Rs 34.45. In pre-open hours,

Business Standard Banking Round Table, 2016

Business Standard Banking Round Table, 2016, started on Thursday.Here are the highlights of what the top banking honchos said:

1) The one thing striking about the banking side in concentration of assets and liabilities, said IDFC Bank MD & CEO Rajiv Lall

2) IDFC Bank's Rajiv Lall said that 45 per cent of all outstanding advances were made to only 300 corporates.

3) Rajiv Lall pointed out that 60 per cent of India's household savings were still outside the financial system.

4) Union Bank of India CMD Arun Tiwari said that there is a perception advantage in terms of which bank is a retail bank and which is involved in corporate lending.

5) Axis Bank MD & CEO Shikha Sharma said that credit growth to the corporate sector was relatively weak and that working capital demand has also been depressed.

6) Shikha Sharma added that there have been no new projects in the last 18 months and working capital demand has also been depressed.

7) Axis Bank's Sharma pointed out that the retail and small and medium-sized enterprises sectors were showing demand. However, she cautioned that there was worry over whether that is the next bubble.

8 )Chandra Kochchar, the head of ICICI Bank highlighted that it's imperative for banks to become agile and active to keep evolving their business models. A cause of concern is that loan against property and unsecured loans appears to be growing at a fast pace, she added. Kocchar also said the next round of credit growth will come from the secondary impact of all the government spends.

9) Aditya Puri of HDFC Bank pointed out that the government, banks and the Reserve Bank of India are very clear that they're not in the business of charity. If money has been borrowed, it must be given back, he said.

10) Pramit Jhaveri of Citibank thinks technology  is going to be the biggest driver for banking."India is among most attractive destinative as far as financial services industry is concerned," said Jhaveri.

11) Chanda Kocchar of ICICI Bank said infra projects will be funded partly by banks and partly by other means such as bonds. This means that project finance will get more structured before money is committed towards a particular project.

12) She also said robotics have reduced  the bank's error rates and response time to consumers

India’s elusive bond market

The expectation that financial liberalisation would lead to a proliferation of non-bank financial companies and an expansion of the bond market in India has been belied

 Jayati Ghosh                  C.P Chandrashekhar

In recent times, much concern has been expressed about the poorly developed corporate bond market in India, which is seen as hampering the financing of long term investment. There is much evidence to suggest this is indeed true.

As Chart 1 shows, in 2014, the ratio of loan liabilities (largely to the banking system) in the total of loan, note and bond liabilities was way higher in India than in its Asian counterparts and relative to its partners in the BRICS grouping.

What is more, the increase in bond financing relative to the expansion in bank credit in the period between 2009 and 2014 (or after the global financial crisis) was much lower in India than in most other emerging markets of relevance, excluding Indonesia (Chart 2).

An era has ended

This lethargy in India’s bond market is not because of the absence of any effort on the part of the government to promote that market. In fact, the government has also held the view that a vibrant bond market is a prerequisite for the financing of long-term investment in the post-liberalisation period.

In the past a large part of such financing was supported with allocations from the budget in the case of public sector projects or with credit from the development finance institutions (DFIs) for private projects. The DFIs themselves were supported with concessional funds from the RBI and the government, especially the former, which had a separate window for the purpose. That era has, however, ended.

The government’s failure to mobilise adequate resources through taxation and its post-reform emphasis on fiscal consolidation, which limits its borrowing, has reduced its capital spending.

This requires the private sector to play a greater role in capital intensive industries and infrastructure. On the other hand, a consequence of Indian-style financial liberalisation has been the conversion through reverse merger of the DFIs into regular commercial banks.

ICICI Bank and IDBI Bank are all that is left of the erstwhile all-India development financing infrastructure. This has meant that the burden of financing private investment in capital intensive areas including infrastructure has fallen on the commercial banks, especially the public sector banks.

However, the maturity and liquidity mismatches between the funds sourced by the commercial banks and investments in large industrial and infrastructural projects has resulted over time in rising non-performing assets in the books of these banks. So they too are retreating from financing of investment in these areas.

Hence, besides foreign borrowing, a liquid bond market has become the only possible alternative to clear this financing bottleneck and support such investment.

To realise that alternative, investors looking for long term investment opportunities and offered the expected yield and the required liquidity as insurance have to be brought to market in adequate numbers.

Unfortunately, the penetration of the corporate bond market is almost marginal in the Indian financial sector. In 2014, while the ratio of bank deposits to GDP stood at 64 per cent, and that of domestic credit to the private sector at 52 per cent, the ratio of outstanding corporate bonds to GDP was only 14 per cent.

By the end of 2015 while corporate bond penetration in India was at around 17 per cent of GDP, the figure was close to 45 per cent in Malaysia and 75 per cent in South Korea.

Moreover, at the end of 2015, government securities (G-Secs, State Development Loans and Treasury Bills) accounted for 72 per cent of value of outstanding bonds, with corporate paper (bonds, commercial paper and certificates of deposit) contributing the balance 28 per cent.

Liberalisation fallout

The weakness of the bond market is partly the result of a larger failure of the financial liberalisation agenda. This was the failure to ensure the transition away from a bank dominated system, through a proliferation of non-bank financial institutions (NBFIs) that may have turned to the bond market for investment opportunities. As Chart 3 shows, when compared with South Africa, Brazil and Korea, the relative importance in terms of asset shares of NBFIs such as insurance companies, pension funds and other financial institutions was much lower in India.

This has been a bottleneck to the entry of saving households into the bond market (and more so the retail market for equity). The global evidence is quite clear that small investors are exposed to the debt market through institutions like mutual funds, insurance companies and pension funds. So the government’s effort seems to be to use the latter as means to bring a larger share of household savings into the corporate bond market.

It has done this in the past by persuading public sector insurance companies and pension funds to allocate a larger share of their investments to the market for corporate bonds. In addition, under the new pension scheme of the government, subscribers are required to choose some level of risk exposure as part of a move from defined benefit to defined contribution schemes. But, given the fiduciary obligations of investment managers in these funds, they tend to be cautious when following government advice.

Further, the relative importance of these institutions is far less than in many other countries. That does not help strengthen the corporate bond “market”.

Bank dependence

The Reserve Bank of India has in recent times attempted to respond to this through a host of measures. But the most important of those strengthens the problem of “bank dependence”. Banks are being roped in to render bonds less risky by extending the already existing partial credit enhancement (PCE) scheme. In September 2015, the RBI introduced a scheme under which banks were allowed to provide partial credit enhancement to bonds issued by corporate entities and special purpose vehicles.

This involves providing a non-funded but irrevocable line of credit linked to a bond issue, which companies can access to meet commitments in case they find themselves unable to meet interest or amortisation payments on the bonds. There were conditions set on this facility including the requirement that the rating of the bond issue must be “BBB minus“ or better before the credit enhancement and that the aggregate PCE provided by all banks to any bond issue cannot exceed 20 per cent of the bond issue size.

The essential aim of the PCE scheme is to reduce the risk associated with a bond and enhance its rating. With the banks taking over part of the risk, the bonds can be upgraded to investment grade, making them eligible for purchase by insurance and pension funds.

The new measure implemented also increases the aggregate PCE exposure of the financial system to any bond issue to 50 per cent (from 20 per cent) of the size of the issue, with a ceiling of 20 per cent on the exposure of any single bank. Measures such as this, it is hoped, will help resolve a problem, which has been created by the government’s own policies, of an unavoidable dependence for finances on a market that is still to mature. But in the process it is exposing banks, insurance companies, pension funds, and those who place their savings in these institutions to increased risk.

Banks dominate in India

Tepid market for bonds

The NBFC boom hasn't happened