Due to continued weakness in domestic demand and moderate core inflation Nomura expects a 25 basis points cut at the next RBI policy meeting on 18 June 2012
Brokerage and research firm Nomura has said that there will be an additional 50 basis points cut in repo rate in 2012 (25 basis points cut previously) due to continued weakness in domestic demand and moderate core inflation, with a 25 basis points cut at the next RBI policy meeting on 18 June 2012. The cash reserve ratio (CRR) is not expected to be cut on 18 June, as liquidity is closer to the RBI’s comfort zone and open market operations can be used to address the liquidity mismatch, predicts Nomura.
The interest rate cuts are only a quick fix to growth. Without concomitant fiscal tightening, loose monetary policy will likely fan inflation and lead to greater macroeconomic instability down the road.
The research firm is changing its policy rate call. It expects 50 basis points of additional repo rate cuts in 2012 (terminal repo rate of 7.50%), compared with its earlier forecast of 25 basis points, due to a continued weakness in domestic demand and rising downside risks to the global growth outlook. The reasons for the expected 25 basis points repo rate cut on 18 June 2012 include: (a) weaker-than-expected real GDP growth of 5.3% y-o-y in Q1 2012, belying Nomura’s and the RBI’s view that growth had bottomed in Q4 2012; (b) despite rising headline WPI inflation, core WPI (non-food manufactured) inflation has continued to moderate, which suggests that pricing power has declined (A further moderation in core inflation in May, data due on 14 June 2012, is expected); and (c) Brent oil prices have fallen to around US $100/barrel, more than offsetting the drag from the rupee depreciation.
Nomura has assigned a 20% probability to a 50 basis point rate cut at the RBI’s June 2012 meeting. While sluggish growth, low core inflation and weak policy rate transmission argue for a more aggressive 50 basis points rate cut, The brokerage expects a 25 basis point rate cut due to elevated headline inflation (primarily due to persistently high food inflation).
The CRR at 4.75% is close to the all-time low of 4.50% and needs to be kept ready as an emergency buffer to inject liquidity if conditions worsen, says Nomura. Upside risks in headline inflation are expected in the coming months. However, continued moderation in core inflation will likely prompt the RBI to accord a higher priority to growth. As such, following the expected 25 basis points repo rate cut at the June 2012 meeting, Nomura anticipates another 25 basis points cut in the second half of the year.
The current slowdown in growth is largely a payback from continued fiscal excesses and reflects slow government decision-making over the past year. Real effective exchange rate depreciation has already started to ease monetary conditions. As such, the current Indian stagflationary environment needs tight fiscal policy to create a more stable macro backdrop.
Nomura reasons that there are two issues with cutting interest rates: First, in the current tight liquidity environment, the transmission of policy rate cuts may be delayed and sub-optimal. Second, and more importantly, when inflationary expectations are in double-digits and potential growth is at risk of falling below 7%, it will not take much for inflationary pressure to rear its head. Without concomitant fiscal tightening, loose monetary policy will likely fan inflation and lead to greater macroeconomic instability down the road.
Thus, Nomura predicts a gloomy picture ahead for the banks and bond market—not to speak of instability in the equities and forex market—in India, in the absence of firm measures from the government.
Banks needs to avoid appointing all and sundry as their business correspondents, just to meet internal or policy targets
The government in India has adopted a very important strategy to try and achieve financial inclusion, using business correspondents (BC) to serve and service excluded segments of the population, especially those living in rural areas. However, while this is yet to take off in any serious manner, of late we have witnessed greater activity in this area during the BC model being pushed as an alternative route to financial inclusion (vis-à-vis MFIs—microfinance institutions).
While the idea of using BCs is perhaps appealing because of various benefits BCs may seem to provide, there are huge risks as well. This is especially true in the present environment in India, where there are many controversies with regard to financial services provided to low-income and excluded people, service delivery methods used, prices charged, etc, by the outsourced entities (such as BCs). As seen during 2010 and 2011, the new breed of micro-finance agents in India, who functioned almost like BCs, certainly created havoc in the lives of low-income people.
Therefore, it is imperative for regulators and supervisors to ensure that banks have an appropriate due diligence process in selecting their BCs. They must likewise ensure that banks avoid appointing all and sundry as their BCs, just to meet any (internal or policy targets) that may be imposed on them from time to time.
Specifically, the regulators and supervisors must encourage banks to develop a solid criteria that enable them to assess, prior to selection, a business correspondent’s capacity and ability to perform the various required activities effectively, reliably and most importantly, to a high standard, together with any potential risk factors associated with using a particular BC. Cost alone cannot be the deciding factor!
More importantly, the key emphasis must be on ensuring that the BC is indeed sensitive to the needs and situations of low-income clients and/or excluded segments of the population. Regulators and supervisors must also ensure that banks put in adequate client protection measures in the entire scheme of ‘outsourcing’ to BCs, and their on-site examination must verify the implementation of these in real time.
Among other things, such due diligence should include assessments with regard to the following (not exhaustive by any means):
a. Whether the business correspondent is really qualified and interested in performing the specified tasks?
b. Whether the business correspondent understands and can meet the objectives of the bank(s) in performing the specified activities?
c. Whether the business correspondent has the financial soundness, managerial capacity and all other resources in adequate measure to fulfill the obligations and successfully perform the various (outsourced) roles and activities?
d. Whether the business correspondent has the reach, resources and capacity to meet any special needs of the envisaged clients and/or the bank(s)?
e. Whether the business correspondent has proposed a viable operational model to fulfill its obligations and specified tasks?
And given the above background, I was rather surprised to see that Vakrangee Finserve won “the SBI RFP to become the common Banking Correspondent company for all public sector banks operating in Maharashtra. … Vakrangee won the five-year contract, which can be extended by another two years, with a price of 0.48%. The company will now have to appoint BC agents in 4,200 locations in Maharashtra. … If things go as the finance ministry wants them to, welfare payments to the rural/poor population will be routed through Vakrangee now. …The low value of the final bid took some of the other bidders by surprise.” (The Economic Times, 25 May 2012 - Vakrangee wins Maharashtra RFP, becomes common BC for public sector banks in the state
Having spent over two decades in working with rural and urban poor, I must say that such a low value of the final bid is beyond any reasonable comprehension. If there is one thing that I have learnt through my work in over 540 districts in India and elsewhere globally, it is that servicing the rural poor is rather costly and it certainly has minimum costs associated with it. That said, I am really baffled as to how the bidder (Vakrangee Finserve) expects to provide the required quality of service at the (extremely low) bid cost?
What then are the implications based on lessons from past experiences in India and abroad of similar services being outsourced? There are four distinct aspects that need to be looked at with regard to such low cost bids of government/public services. And the RBI and other regulators shaping the financial inclusion agenda certainly have a responsibility to do so:
a) How does the bidder gain cost advantages? Are these cost savings real or illusory? What is the real motivation of the bidder to bid for delivering the services in the first place?
For example, in other instances in India and abroad, companies have bid for large public contracts at extremely low (bid) prices Just to boost their credentials in the stock market—they have either abandoned the service and/or compromised severely on the quality of service provided after the stock manipulation objective has been achieved. Others have got a foot in the door (by winning the bid and extending the various services) and thereafter, have gone back for a revision of the contractual terms (including price) citing various reasons and loop holes. These are aspects that must be guarded against at all times by the RBI and other regulators concerned!
b) What about the quality of service? How is that (to be) maintained at minimum stipulated (quality) levels at all places? How can that be effectively monitored and ensured at all times during the service contract, especially given the remoteness of the rural locations?
For example, please see the proceedings of the meeting held under the chairmanship of the Haryana chief minister on 7th December, 2011 to review the implementation of Electronic Benefit Transfer Scheme and its convergence with Financial Inclusion Plan in Haryana. I quote from this report:
“The implementation at the ground level by the Business Correspondent appointed by the banks is not satisfactory. Non-availability of the BC agents at the field level tantamount to denial of banking service to senior citizens, destitute and disabled beneficiaries and their right to enjoy the benefit timely remittance into their bank accounts by the state government. The Director General, Social Justice & Empowerment informed that since the commencement of implementation from the month of April 2011, a total of Rs54 crore were disbursed manually using physical payee receipts through banks along with simultaneous enrolment for opening of bank accounts and another Rs504 crore was transferred into the bank accounts electronically up to 30 November 2011. In fact, as reported by the banks, an amount of Rs96 crore is still lying undisbursed as on 30 November 2011, though 80% of the total amount was released up to 12 August 2011. This shows that the infrastructure deployed by the business correspondent of the banks is grossly inadequate to provide a satisfactory level of banking service to the 2 million banking customers. Due to the uncertain and rare visit of the BC agent in the local area, there is no perception of banking service amongst the beneficiaries. The schedule of visits of the BC agent is uncertain causing inconvenience to the account holders. The average frequency of visit of the BC agent in the village has been once every 90 days and in some villages, there has been no visit at all in the last six months. An analysis of the transaction data supplied for a period of one month by the TSP indicates that the average transaction value is very high at Rs1,200 against the average monthly benefit of Rs615.
Other major problems encountered are non-operation of accounts; making manual payments using the department's E pay-order to banks, multiple accounts to the same person, not carrying out biometrics based de-duplication, Non establishment of customer complaint centers and non supply of transaction data for monitoring by the department.” (http://socialjusticehry.nic.in/proceedings.pdf)
All of these and similar issues need the attention of the Reserve Bank of India (RBI) and other regulators, especially when the bid is extremely low cost!
c) Is there cause to believe that the bid is a front for some other (corrupt or illegal) activity?
In other countries, especially in Africa, such bid-based public services have served as the platform for carrying on other (illegal) activities. That again needs to be focused on by the RBI and other regulators.
d) Will the low cost nature of the bid result in the poor and disadvantaged being further isolated?
This is a very serious question that the RBI and other regulators need to be clear about upfront as if that is the case, or else the whole objective of financial inclusion would really be lost
Therefore, while the desire to enhance and speed up financial inclusion is much appreciated, such a drive should also have appropriate risk mitigation mechanisms and safeguards so that things do not go wrong during implementation. The lessons from the 2010 micro-finance crisis are still fresh in memory indeed. And as far as the present situation is concerned, while I am not pre-judging Vakrangee Finserve in any manner what-so-ever, we will have to wait and see what they actually do on the ground in terms of their BC operations and the quality of BC services offered there in. That said, the RBI and other regulators who are actively pushing the BC model, will certainly have to look into the critical issues highlighted above if indeed they are really serious about financially including much (if not all) of India’s rural poor…
(Ramesh Arunachalam has over two decades of strong grass-roots and institutional experience in rural finance, MSME development, agriculture and rural livelihood systems, rural and urban development and urban poverty alleviation across Asia, Africa, North America and Europe. He has worked with national and state governments and multilateral agencies. His book—Indian Microfinance, The Way Forward, is the first authentic compendium on the history of microfinance in India and its possible future.)
According to the RBI deputy governor, rising food inflation and depreciating rupee are the conflicting factors the central bank would consider while deciding on policy rates on 18 June
Mumbai: With the economic growth slipping to nine-year low levels, Reserve Bank of India (RBI) deputy governor, Subir Gokarn on Monday said below trend growth and falling crude oil prices offer the central bank a window to ease policy stance, reports PTI.
"(For one,) the growth is somewhat lower than expectations and that may have positive, moderating impact on core inflation. Two, oil prices have come off somewhat more than expected. Those are the two factors that suggest more room (for monetary policy)," Gokarn told reporters on the sidelines of an event.
The economic growth for the three months to March stood at 5.3%, its lowest in nine years, leading to calls for some urgent measures to get it back to track and achieve the targeted 7.3%.
For the financial year 2011-12, GDP growth came down to 6.5%, lower than the 6.7% recorded during the peak of the post-Lehman credit crisis and 8.4% in FY11.
One of factors being blamed for the dip in growth is the Reserve Bank's rate stance, which resulted in elevated interest rates for nearly 20 months as headline inflation continued to remain uncomfortable.
Preliminary indicators on the growth front, coupled with a fall in inflation, led the RBI to announce a surprising 0.50% cut in its key rates in its annual policy announcement in April.
In the announcement, RBI had made it clear that its room for further cuts was very limited given the high current account and fiscal deficits. The mid-quarter policy announcement is scheduled for 18th June.
Gokarn, however, pointed out that rising food inflation and depreciating rupee are the conflicting factors the RBI would consider while deciding on policy rates.
"... some factors suggest room, some factors suggest that inflationary pressure may still remain. I think we'll have to take a balanced view of these factors," he said.
Gokarn also said there has been a slight fall in the rupee price of crude, which came down to below $100 a barrel for the first time in eight months, as the rate of its fall is more than the depreciation of the rupee.
The rupee has lost over 20% in the past 12 months due to factors like widening current account deficit and concerns over the rising fiscal deficit, which have led to a fall in fund flows into the country.
On liquidity, Gokarn said the situation is "comfortable" right now going by the bank borrowings. "If we do see stress re-emerging, particularly with persistence, we clearly have the option of doing more open market operations (OMOs)," Gokarn said.
The liquidity deficit has been above the RBI's comfort mark for the past many months, forcing the central bank to infuse money into the system through bond buybacks also called as open market operations. It has infused over Rs1.25 lakh crore into the system since last November through OMOs.