'RBI move short-term; only structural steps can close CAD'

RBI's recent measures will at best provide short-term relief, says Shailendra Bhandari, MD & CEO ING Vysya. But long term, there will be no benefit because if the idea was to provide cheaper credit then that’s unlikely to happen, he says.

Also Read: No, this isn't rupee's bottom, more fall likely: Macquarie

Banks will find it extremely difficult to reduce base rates, he says. Only PSU banks with large mark-to-market losses are likely to benefit, he adds.

Jahangir Aziz, Chief Economist, JPMorgan, says there are solutions around the current account deficit problem, despite all emerging markets with Current Account Deficit (CAD) starting from Brazil, Indonesia, South Africa, taking a beating in the last 4-5 days. "The government actually has to take structural decisions now to get back structural portfolio flows, both on the debt and the equity side. In the absence of doing that, one-off measures cannot work," he says.

Below is the verbatim transcript of Shailendra Bhandari and Jahangir Aziz's interview on CNBC-TV18

Q: The Reserve Bank of India (RBI) has come out with latest measures for the banking sector. Whether there is any long-lasting impact that you expect either in the money market or for banks?

Bhandari: The beneficial impact is frankly on those banks, mainly the public sector banks that had large mark-to-market (MTM) losses. The longer term answer is that it actually does not change anything, because if the idea is to provide more credit at cheaper rates to the economy that is still affected by the fact that market stabilisation rate remains at 10.25 percent. That is the operating rate in the market, which means that increasingly deposits in the short and medium-term will fluctuate around that and it would be extremely hard for banks to reduce base rates.

So in the long run this does not provide any immediate sucker, but in the short run there is a relief rally which happened yesterday and that was justified.

Q: To belabour that point a bit, 8.52 percent on the 10-year today is better than the 9.47 percent that we saw day before yesterday, but it is per se high yields. Certificate of Deposits (CD) are still going above 11 percent. Cost of money has not come down for banks in any significant measure. Maybe in 48 hours they looked a little better, but they are still much worse than what you were prepared for maybe even a month ago. Are you hiking base rates?

Bhandari: In terms of base rates we have already hiked our base rate. We hiked it two weeks ago. We hiked it by 20 bps.

Q: But since then costs have gone up even further.

Bhandari: If you look at us, the normal perception is that medium-sized banks do not have large retail deposits or a Current Account Savings Account (CASA), but in the case of ING Vysya among all south-based banks whether public sector or private sector we have the largest CASA. Among medium-sized banks we have the largest CASA around 30-32 percent. So we are not necessarily that exposed to market forces.

Having said that, you are right that there is still an expectation in the minds of the market as well as our Asset-Liability Committee (ALCO) that by the time of the next monetary policy which is mid-September some of these measures will be eased and if they do not we will relook at it.

Q: Because of this rise lending rates go up down the line. Are you getting a sense that more of your Small and Medium Enterprise (SME) borrowers or for that matter even in the economy there are going to be more Non-Performing Loans (NPL) than you earlier budgeted for, because no one budgeted for rate hikes?

Bhandari: You are absolutely right. The pressures anyway were extremely high. The pressures which had flowed through which most people had seen were to some extent just a beginning of a cycle. What we have been seeing and I have been saying this on your show for sometime is that the macro headwinds remain quite large. There was a recent report by one of the broking houses that most of the large groups have increased their debt leverage by 15-20 percent. This has not helped. This will worsen circumstances. I think those of us in the private sector banking space may not be affected as badly, but it would be incorrect to say that there will be no impact.

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Q: The big talking point has been the rupee and how both the government and the RBI just have no control on the situation at this point. In your mind what could be the single solution to the currency crisis? Is it Non-Resident Indian (NRI) bond issuance? Is it the diesel price hike? How long do you think we will have to deal with such depressed levels?

Aziz: The global environment is not really very conducive. All other emerging markets (EM) with Current Account Deficit (CAD) starting from Brazil, Indonesia, South Africa, everybody has taken a beating in the last 4-5 days. So one has to take into account what is happening globally. John Lennon long time back said: "There are no problems, only solutions."

I think India has solutions. The entire idea that there are no options is not true. They have to bring those options into play and I do not really see the exchange rate dropping Rs 1.50 a day as entirely a bad thing. This is when you do get a sense that finally Delhi and Bombay is taking the situation as a full blown crisis and my guess is that given the team and the character of this team in a crisis they actually do react well.

I am not all that unhappy that we are seeing the rupee drop like this. What was happening previously was that we were bleeding about rupee a week and no one really was paying attention to it and we were getting inured to it. Now I think Delhi and Bombay are no longer inured to it and cannot avoid the situation. So they have to react.

Q: What can Delhi do? What do you expect? Are you expecting a Rs 10 diesel price hike? In your mind how much is needed to stem the rot? What will be a genuine salve for investors that the CAD will not be USD 70 billion, but perhaps even USD 60 billion? That is the assurance they are looking for, aren't they?

Aziz: I think the time for doing these ad-hoc one-off measures etc. are off the table. They are not going to change people's mind. We saw what happened to the reaction, to the policy measures that were taken two nights back on bank MTM. They have to get over this thing that half measures can solve the problem. NRI bonds, sovereign bonds issuance of USD 3-4 billion, none of that is going to work.

They actually have to take structural decisions now to get back structural portfolio flows, both on the debt side and on the equity side. In the absence of doing that, I really do not think one-off measures can work. I am sure that everybody is talking about Rs 2-3 increase in diesel price, that can help, but I do not think that changes sentiment.

What will change sentiment is if India can establish in very short-term that they are able to dip into a new pool of global liquidity that they have not tapped into before which will provide them with that funding for the current account.

Q: The problem is CAD, why talk about flows? Why would you think that a Rs 10 diesel price hike or at least very close to market rates is not the solution?

Aziz: You need to look at the numbers, the market isn’t looking at numbers. All those measures that have been taken on gold, all those measures that have been taken on curbing imports are all egregious, they are retrograde, they are pushing back the economy but they are having an effect on CAD. If you look at any estimate of what the monthly current account run rate is, it is about USD 3.5-4 billion right now which gives you an annualized run rate of USD 40-50 billion. I am not saying that CAD for the rest of the year will remain at USD 40 billion but what we have done is we have used these extreme measures to bring down the CAD. CAD isn’t the problem, the problem is we have converted a CAD problem into a capital account problem which is far more serious.

Q: What is your sense, is the market looking at some kind of a bottom for the rupee at this point in time? Does 65 look a level where exports will come in?

Aziz: We started off not too long back when rupee was 45, we thought 50 was a line on the sand, then it became 55 then 60 and now it is 65. There are no lines on the sand. The lines on the sand will come only if the RBI and the government draws a line on the sand. The RBI and the government has not drawn a line on the sand, the market cannot draw a line on the sand. It has been run on expectations, your and my expectations are driving the rupee and has been driving the rupee for the last one and half two months. So unless the RBI and the government draws a line, there are no lines on the sand. So I don't think that 65 is the limit.

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The only positive spin I can provide over here is that having worked on several crisis countries you really do not want to take a bet against the government when they are pushed against the wall because then they are capable of doing the unthinkable. I have seen that happen in the Asian crisis, I have seen that happen in Mexico, in the Russian crisis, Brazil crisis. People usually start acting once they are pushed to the wall. The question is does Delhi feel that they are actually pushed to the wall at this point in time.

Q: So you think that extreme action is a sovereign bond?

Aziz: No I think the extreme action is that the government goes and gets rid of all the FII limits, everything else and tries to get into a global bond index. That gives you a pool of liquidity which is several times larger than the pool of liquidity that equity funds come in. We are talking about all these passive pension fund money, this is structural money, it is sticky money. India grows from 0 to 10 percent in a global bond index even if you are underweight on India because you are afraid of the macro economics etc, you still get substantial amount of flows coming in.

But they have to do it now, they cannot wait for things to turn around to do it. That is the pool of liquidity we haven't touched, that is the pool of liquidity that Brazil has, Indonesia has, Turkey has, South Africa has but we don't have.

Q: What liquidity are we talking about at a time when Fed is going to be tapering its bond buying programme, where EM love has being at the lowest it has been for many years, why would I put my money in a market like India which has problems which are worse than many of the other EMs across the globe? Are we heading for a sovereign rating downgrade because not only are our problems bad but now we have a situation where the government is living in denial and is not coming out with any of these structural reforms like you pointed out?

Aziz: That is the reason this rupee dropping is actually very good, it actually forces the government to rethink its reform plans and get into action. I am not saying that in the absence of structural reforms you cannot get anything done but the structural reforms also need to be in the sources of financing. The structural reforms just cannot be on the real economy.

Right now if you are going to fund a funding gap of about USD 15-20 billion on the external side, you actually need to find a USD 15-20 billion and you have to find it in a permanent manner. If you don't find it in a permanent manner this market is going to look at it and say it is a one day solution, I am going to walk away. So structural reforms need to be done on both sides, it cannot be done only on one side, we have gone beyond that point.

Q: The other macro economic issue that I want to ask you is - what is your estimate of the extent to which bad loans can increase in the system. We were standing at close to 3.5 percent as of FY13, a little less than 3.4. Where do you think we might end the year for the system as well what is loan growth this time, 10 percent in the current year or will it be more because other sources are closed?

Bhandari: Before getting on to that, I want to say something to what Jehangir was saying. I am not in any great disagreement with him because I do feel that there is some merit in what he says because if you look at the issues that we have, we have an issue in the sense as you said there is a current account deficit, there is also the concern that we need to get capital inflows; forget about outflows and he is right that a lot of what we have seen is tinkering, for example raising duties on gold was good, it was harsh, it was good. Raising the duty on television sets is rubbish.

But how do you get the current account deficit under control. So, one is increase exports, so the good news is that the rupee has depreciated. The other is decreased imports; you have done something on gold. So, the question is what the next easy one is and that is oil. Is Rs 5 enough on oil; maybe not. So, then the question comes that how much you need to raise. You need to raise diesel to Rs 70-80-90; those are the numbers we should be talking about.

The next question comes that if you do a number like that, what does it do to economy and how do you get capital coming back in. The only answer I can say is that you do need to get liquidity back. I think the government waiting has said that he is willing to relook at some of the measures, which have been taken. I think that needs to be unwound. If you are going to get market bullish again because we are not going to get foreign direct investments (FDI) coming in, in a hurry prior to the elections but you could get portfolio flows, you need to get the feeling of bullishness both in the bond markets and in the equity markets and the only way out is probably the reverse of what we are seeing, we need to see interest rates go down but you need to see that happening along with a very significant action on controlling the deficit which means raising diesel and petrol a lot more than we are talking about.

The reason I didn’t answer your question because we are in a state of flux and as I referred to, there was a recent report which came out by, I think it was Credit Suisse, which said that ten largest borrowers in India have worsen their positions - the groups they were talking about - by over 15-20 percent and that is what we are seeing right now. Some of these groups, in fact most of them have already started to talk to banks about restructuring, some of them will go to NPAs.

The NPAs that we have seen happening so fast have tended to be either in agriculture or in the case of public sector banks and SME or in terms of projects which have been stuck. But we haven’t seen the large groups bite the bullet so far and I am hoping that we do not see that. But there is a risk that if we do not see liquidity come back, if we do not see interest rates come down, we do not see investments takeoff. You could see things get worse before we take the action I am talking about.