But speculators are having a great time
With the benefit of hindsight, a lot of...
The market regulator, which was mindlessly forwarding suggestions from EAS Sarma, a highly respected former bureaucrat, to the SEBI Complaint Redress System or SCORES, has finally replied after over six months
After keeping mum for over six months, market regulator Securities & Exchange Board of India (SEBI) has finally replied to the letters sent by EAS Sarma, former secretary to the Government of India (GoI) on the menace of money circulation schemes. Although, SEBI took over six months to reply, it admitted that these money raising schemes run by multi-level marketing (MLM) operators, take advantage of regulatory gaps and overlaps.
“The main difficulties with unauthorised or unregulated money raising schemes are that they are often successful in taking advantage of regulator gaps as well as overlaps,” SEBI said in its reply.
On 19 December 2012, Mr Sarma wrote to the prime minister about the scourge of MLM companies that have been taking “full advantage of the soft regulatory structure to swindle unwary and financially illiterate Indians on a mind boggling scale.”
The letter was copied to UK Sinha, chairman of SEBI, as well. The reaction from the SEBI chairman was, however, shocking. The letter was automatically diverted to SEBI Complaints Redress System or SCORES, SEBI’s web-based system. An automated reply directed Mr Sarma to lodge a complaint on SCORES, with a long explanation of the process. This was repeated, when the former secretary send a suggestion to ministry of corporate affairs (MCA) on the increasing menace of shell companies with a suggestion to tighten the procedure of registration of companies to pre-empt unethical persons indulging in money laundering. A copy of this letter was marked to the SEBI chairman. And SEBI again send its ‘standard’ automated reply to Mr Sarma.
Irritated at this “automatic reply route” from SEBI on his suggestions, Mr Sarma, the former secretary wrote to Arvind Mayaram, secretary, Department of Economic Affairs (DEA) in the finance ministry (who deals with these regulatory institutions). “Apparently, SEBI had no clear understanding about the difference between a ‘grievance’ from an individual and a ‘suggestion’ from the public! If at all there is any grievance, it is the grievance of the public about the indifferent manner in which SEBI has been dealing with suggestions from the public,” he said in his letter.
After finally receiving a reply from SEBI, Mr Sarma said, “I hope that, from the point of view of good governance, SEBI will institute a system in which letters from the public are treated with respect and replied promptly. After all, it is the tax payers’ money that is invested on your computers and internet connectivity and I do not see any reason why SEBI should conduct itself so insensitively, when even PMO sends acknowledgements promptly.”
The former secretary also asked the concerned official, who sent the reply, to place his letter before the chairman and members of SEBI for their information and to let them know how rest of the people in the country feel about the role of SEBI.
In 1999, both the SEBI Act and the Securities Contracts (Regulation) Act were amended to declare collective investment schemes (CIS) as ‘security’ risk and to provide jurisdiction to SEBI to regulate CIS. “However,” SEBI in its reply says, “four specific tests have to be applied to hold that a particular money raising scheme is a CIS or not. Besides, there are specific exemptions from CIS for activities like Non-bank financial companies (NBFCs), Nidhi, Chit fund, deposits raised by companies under the Companies Act and insurance. These activities are regulated by agencies like Reserve Bank of India (RBI), state governments, MCA and Insurance Regulatory and Development Authority (IRDA).”
While the RBI has maintained that the deposit-taking companies does not fall under its jurisdiction, market regulator SEBI tried to rein in such companies in the past under its CIS regulations. However, these companies managed to subvert the SEBI orders and continued to flourish with political patronage.
In its reply to Mr Sarma, the market regulator said, “MLM schemes in the nature of money circulation schemes are banned under the central legislation titled Prize Chits and Money Circulation Schemes (Banning) Act 1978 (PCMCS Act) and as such these do not fall within the purview of SEBI”.
The PCMCS Act defines money circulation scheme as under:
(c) “money circulation scheme” means any scheme, by whatever name called, for the making of quick or easy money, or for the receipt of any money or valuable thing as the consideration for a promise to pay money, on any event or contingency relative or applicable to the enrolment of members into the scheme, whether or not such money or thing is derived from the entrance money of the members of such scheme or periodical subscriptions;
Even Section 3 of the PCMCS Act, prohibits any entity from promoting, conducting any prize chit or money circulation scheme, enrolling any member of any such chit or scheme, or participating in it otherwise, or from receiving or remitting any money in pursuance of such chit or scheme.
However, though PCMCS is a central Act, Section 13 empowers the concerned state government to make rules, in consultation with the RBI for carrying out the provision of this Act.
SEBI said, “It would be pertinent to mention here that MLM schemes have been declared as prohibited money circulation schemes under the PCMCS Act by various high courts and Supreme Court in following cases:
1. Amway v/s Union of India and others, 2007(4) ALT808 Andhra Pradesh
2. Apple FMCG v/s Union of India and others, 2005 Writ LT115 Madras
3. CIT v/s Amarjeet Kaur, (2006) 283 ITR71 (KAR) Karnataka
4. Kuriachan Chako and Others v/s State of Kerala, (2008)8SCC708 Supreme Court
SEBI said, at the time of notification of CIS Regulations in 1999, it had information about 664 entities operating CIS without obtaining registration from the market regulator. As of March 2013, SEBI said in 138 cases accused have been convicted.
However, the market regulator also admitted several deficiencies and procedural delays while prosecuting such CIS operators. SEBI said, since none of these companies are registered with the regulator as CIS, it has to first issue a show cause notice, hear them, establish that the test for CIS as prescribed under SEBI Act are fulfilled and then pass orders. All this takes time. In addition, any order passed by SEBI is appealable before the Securities Appellate Tribunal (SAT).
Even, other courts, which have no jurisdiction under the SEBI Act, grant injunction orders on the SEBI directions. In one case, district courts from West Bengal passed 11 injunction orders one after another and the market regulator had to name these courts and get these orders vacated by the high court.
SEBI said it has passed orders banning 11 companies and asking them to refund the money collected over the past three years. Some of the companies against which the orders were passed include Rose Valley Real Estate & Construction, Sun-Plant Agro, NGHI Developers India, MPS Greenery Developers, Nicer Green Forests, Maitreya Services Pvt, Sumangal Industries, Osian's Connoisseurs of Art Pvt Ltd, Saradha Realty, Ken Infratech and Alchemist Infra Realty.
Given the chance, consumers around the world act more or less the same. Credit card abuse is a universal past-time. But this time the credit bubble is no longer in the US
Spend, spend, spend! It seems that is all Americans consumers do. They happily buy the latest appliances, second or even third cars and every electronic device known to man. In fact they spent so much they eventually caused a global meltdown. Before the crash they leveraged up their spending using overvalued real estate as collateral and created a huge credit bubble. When the housing market started going down instead of perpetually going up, they found that the household debts they had created could not be paid back.
In contrast, there are all of those thrifty people in emerging markets. They save vast amounts of money that can be used for investments in growing economies. With strong family traditions, they eschew debt in any form. Or do they? Actually they don’t. Given the chance, consumers around the world act more or less the same. Credit card abuse is a universal past-time. But this time the credit bubble is no longer in the US.
Consumer debt meltdowns are not exceptional in Asia. Before the American crisis, there were three. Over the past 15 years Hong Kong, South Korea, and Taiwan have all experienced excessive household debt which threatened the stability of their financial systems. But these countries and their issues were relatively small and localized.
The combination of rapid economic growth in emerging markets, combined with trillions in stimulus money and the search for yield has provided borrowing opportunities never before available to millions. The result is that non-mortgage consumer credit in Asia outside Japan rose 67% in the past five years. It now amounts to over $1.66 trillion. Car, motorcycle, appliance and electronic loans all more than doubled while credit card loans grew 90%. These issues are no longer small or local.
But is this a problem? Overall, consumer debt in Asia is far lower than in many more developed countries. The difference is income. As a percentage of income, debt burdens in Asia are up to 30% higher than in the US. Overall, debt burden relative to GDP is higher in India, Indonesia, Thailand, South Korea, China and Malaysia. It is only less in than the US in Taiwan and Hong Kong, two of the countries that have experienced consumer credit problems.
One of the most vulnerable economies is Malaysia. Unusually, strong economic growth has led to an explosion of consumer credit. Consumer debt is approaching developed world levels. Malaysian household debt has risen to 76.6% of GDP from 65.9% five years ago. It is the highest in the region. Malaysian consumer boom has followed the country’s economic expansion. A lot of this expansion has been due to commodity producer exports to China.
Much of the credit has been due to the inflow of money from developed countries specifically the QE program of the US Federal Reserve. With China slowing and the QE program ending, consumers specifically and the Malaysia economy as a whole may be vulnerable. But they aren’t the only ones.
Indonesia has also benefitted enormously from the export of its mineral wealth to China. Indonesian non-mortgage consumer credit nearly tripled in the last five years. Domestic consumption has become the other main driver of Indonesian economic growth and has been driven by easy access to credit cards. The central bank has belatedly realized the danger and is trying to rein in credit by imposing minimum down payments for car and motorcycle loans. But unlike some of the other South Asian countries, Indonesia manufactures essentially nothing. That makes it particularly vulnerable when the two main sources of economic stimulus, commodities demand and cheap money, dry up.
It is not just its trading partners that are at risk as China slows. The main beneficiaries of China’s financial systems have been local governments and unprofitable state owned industries. Still consumption and consumer credit have also grown at a spectacular rate. Credit cards were first introduced into China in 1985. There are now 320 million credit cards in circulation. Like other Asian countries this number has exploded recently. Since 2006 the number of credit cards has quintupled. Growth is projected to increase by another 31% in the next five years. The number of credit card purchases represents almost 40% of all purchases. In 2011 the number of purchases was $1.2 trillion a 48% increase over the prior year.
The potential catastrophe from credit card defaults is huge, but it is exacerbated by a particularly the Chinese issue, the control of information. Credit agencies in most emerging markets are still in their infancy which makes consumer lending riskier than in developed countries. This is especially a problem for China where the only source of credit information is the Credit Reference Service of the central bank—the People’s Bank of China. Private commercial credit agencies are allowed to operate, but they are not allowed access to bank and public sector information. As someone familiar with mistakes on my own credit reports, which are different for each of the three credit agencies operating in the US, I can only imagine the vast errors inherent in the Chinese data.
The dangers of consumer debt in emerging economies are particularly well illustrated by South Korea and Brazil. Korea has already suffered from one consumer credit meltdown, but is now at risk of another. It has problems that are in a way similar to the US. Since the crash US consumers have been deleveraging. US share of debt payments to disposable personal income has fallen to 10.38%, the lowest level since 1980. The one exception is student loans. The amount of outstanding student loans is now more than $1 trillion, making them the largest category of consumer debt in the US aside from home mortgages. Worse, 11% of these loans about $110 billion are now seriously delinquent, meaning at least 90 days past due. In 20003 the number of delinquencies was only 6 %.
In Korea families also borrow heavily to send their children to university. Total household debt is now 959.4 trillion won ($844 billion). In 2011 it reached 164% of disposable income compared with 138% for Americans before the recession. It is now the biggest risk to the Korean financial system.
Like Indonesia, Brazil is also experiencing a credit boom. The country has developed a culture of instalment payments or parcelas. Almost anything from shampoo to plastic surgery is available on instalments. The result is that the average family spends 20% of its monthly income paying off debt, handily beating American consumers who reached a record of 13.5% in 2007 and twice the present rate. The Brazilian economy is slowing and the defaults are, not surprisingly, rising. Overall loan defaults rose to a record 5.9% at mid-year 2012. Due to tighter lending they improved a bit by last December, but only slightly, to 5.8%. At the end of 2011, they were 5.5%. Like China, to stimulate the economy, the state-owned banks have been ordered to increase lending. Their market share increased from 47.6%, up from 43.5% in 2011. No doubt their share of defaults will increase as well. Like Indonesia and Malaysia, Brazil is heavily dependent on Chinese demand for commodities. China edged out the US as Brazil’s main trading partner. So a Chinese slowdown will hurt Brazil and its over leveraged consumers as much if not more than countries in Asia.
Unlike developed countries emerging markets have been growing rapidly since 2008. While Europe is in recession and the US is barely able to grow at 2%, emerging markets have been racking up 5% and more growth rates a year. It is part of the emerging market investment ‘story’ that these growth rates are based on demographics, exports, high savings and investment rates. People in emerging markets were supposed to be far more frugal and avoid debt. So both household and national debt levels were much lower. All of this was supposed to add up to rapid recession free sustainable growth.
But as it turns out, many of these countries and their citizens were just like their more developed counterparts. When introduced to cheap credit, thanks in part to central banks, they happily took advantage of it, to their and their countries’ financial systems’ detriment. Growth rates in emerging markets have been falling since 2010. The slowing of the world economy, especially in China, and the end of free money will no doubt increase the trend. At the end of the day emerging markets will be found to be just as susceptible to credit crisis and business cycles as everyone else, perhaps even to a higher degree.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)