The Indian Rupee Crunch..........(2)

Until 1997, Asia attracted almost half of the total capital inflow into developing countries. The southeast Asian economies were characterized by high interest rates (attractive to foreign investors) and  experiencing "Asian economic miracle" with growth rates of 8–12%. Some economist had attacked "Asian economic miracle" saying growth had historically been the result of increasing capital investment.

In July 1997 the Asian financial crisis  started in Thailand with the financial collapse of the Thai baht after Thai government was forced to float the baht (due to lack of foreign currency to support its fixed exchange rate), cutting its peg to the US dollar. Also, foreign debt had made Thailand effectively bankrupt even before the collapse of Thai baht. The crisis spread to most of Southeast Asia and Japan with slumping currencies, devalued stock markets and other asset prices, and a rise in private debt.

The causes of the Asian financial crisis are many and disputed, such as bubble fueled by "hot money"; growing exports of China; currency manipulation; "crony capitalism", excessively dependent upon exports; credit withdrawal causing credit crunch, policies that distorted incentives within the lender–borrower relationship resulting large quantities of credit that became available generating a highly leveraged economic climate and pushed up asset prices to an unsustainable level etc.  The asset prices eventually began to collapse, causing individuals and companies to default on debt obligations.

The size and situation of the Bhutanese economy are totally different. Well, nothing new! But are the  economic fundamentals also different to ignore lessons of past? And are we going to ever wait for capital to resolve the problem the way the Ministry of Finance is saying? And, most importantly where are we heading with the actions taken so far? 

Take a look at the chronology of events unfolded so far:

1 March 12	The Royal Monetary Authority stopped Indian rupee replenishment to the commercial banks.
8 March 12	The Royal Monetary Authority's Circular on foreign currency issued, which included: treating  INR as foreign currency; limiting INR cash or credit card access to  Bhutanese nationals by banks to INR 10,000/day with a maximum of INR 50,000/person/month; not allowing banks to keep deposit accounts by non-resident foreigners  from 9th March 2012, and closing existing deposit accounts by 15th March 2012; allowing resident foreigners (RFs) with valid Bhutanese business licenses and work permits to hold BTN accounts in banks; allowing RFs with valid Bhutanese work permits but without  bank accounts  to remit/pay INR upon employers’ validation; allowing INR transactions (subject to submission of documentary evidence including but not limited to proforma invoice/invoice/tax receipts etc.), until further notice, for: (i) government and public sector corporation payments ; (ii) import of capital goods, spares, raw materials and other inputs for industries (manufacturing and services);  (iii) import of oil and fuel products; (iv) medical supplies and equipment; (v) import of construction materials for approved housing constructions as on 8th March 2012; (vi) import of goods excluding transport/vehicle goods (except for public transport buses) by individuals/business entities; and (vii) education/training and medical treatment expenses in India; and carrying out export related transaction through the banking channel with 91 days from the date of export.
14 March 12	Banks take following actions: Bank of Bhutan – not suspended loans but goes strictly as per directives of RMA. Bhutan National Bank – suspended all loans. Druk Punjab Bank – raised interest rates on housing loan by 1%. T-bank – suspended housing and vehicle loans.
15 March 12	Indian traders close more than 3,500 accounts withdrawing BTN 3.5 billion, of which about BTN 2 billion comprises fixed deposit accounts.  (As per RMA directive if the fixed deposits were withdrawn at maturity,  they were to be paid in INR otherwise to be paid in BTN.  It is not sure if it would have made more sense if the deadline was 31 March 12, the day Indian financial year closes.)
15 March 12	Copper & Software Export: A convoluted business model that profited largely from tax differentials has lost its legitimacy. http://www.kuenselonline.com/2011/?p=28682 The trade department issues notification to its regional offices not to issue  certificate of origin for software “export” to third countries.
20 March 12	Bhutan National Bank (BNB) increases interest rates for corporate fixed deposits. (BNB looks vulnerable.)
20 March 12	Department of Trade issue notice suspending  issuance of Import License for import of non-essential goods from 23 March 2012, except for import of following essential goods: 1.      Food items including cereals, diary product, sugar, edible oils, prepared meat & fish products. 2.      Pharmaceutical products (medicines) and medical equipment/instruments. 3.      Clothing accessories and footwear, excluding luxury & expensive textile fabrics. 4.      Basic household articles of iron or steel, excluding furniture. 5.      Household electrical items such as cookers, oven, toaster, telephone, etc. 6.      Approved industrial raw materials. 7.      Construction materials for approved construction projects. 8.      Educational stationery. 9.      Essential capital equipment for industries, replacement and spare parts. 10.  Public transport vehicle (only) and spare parts for all other types of vehicle.
22 March 12	RMA gives one day to Indian traders to deposit BTN back to Bhutanese Banks.
22 March 12	Bank of Bhutan temporarily stops receiving loan applications (except consumer loans) till 31 March 12.
22 March 12	Indian income tax (IT) raid in Jaigaon, reportedly not “arranged” IT raid this time. (The IT raid resulted in clashes and arrest of three persons. The raid was presumably by the central IT authorities.)
23 March 12	Informal exchange rate in Jaigaon: INR 100 = BTN 130
24 March 12	Reportedly Indian traders deposit BTN 311 million in Bhutanese banks (Bank of Bhutan: BTN 140 million, Druk Punjab Bank: BTN 83 million . Bhutan National Bank: BTN 50 million; and T-Bank: BTN 38 million) (It is difficult to imagine Indian traders depositing BTN and getting INR in the form of bank draft and real time gross settlement system (RTGS) when their earning do not match with the bank deposits.)

The government measures including increasing standby credit line with India from INR 3 billion to INR 6 billion; stage releasing INR 100 billion development grant aid by the Government of India; and undertaking “swap” with Reserve Bank of India under SAARC Finance framework will support BTN near term. Let us hope that these are not an exhaustive effort to support BTN in the face of a financial overextension that is driven in part by real estate. If it is, BTN will not be able to sustain at its pegged value. The resulting depreciation of BTN will mean that foreign currency-denominated liabilities will grow substantially in BTN terms, causing serious economic problems. The decision of the Ministry of Economic Affairs to suspend import of non-essential items from third countries for now may not be popular with the people but will help ease the rupee crunch to an extent through  hard currency savings.

The RMA measures, item 3 in particular, look hazy.  If it was not, why would RMA invite Indian businessmen to deposit back BTN in Bhutanese bank? It shows that RMA did not take into account the repercussion of closure of more than 3,500 accounts withdrawing capital, both in INR and BTN, amounting to BTN 3.5 billion (175% of the authorized capital of RMA). There is no denying that clean and green economy  is good in longer-term. The fact is developing remarkable entrepreneurs who create value from the present entrepreneurial culture is a gigantic task. But it is not impossible, and easier if there is strong commitment flowing top-down.

In golf, you take a shot with right-shoulder-lower-than-left for "fade/cut". The “fade/cut” curves the ball to the right to land it on fairway, if fairway is dog-leg right (turning right). For "draw" (ball to left) a swing with right-shoulder-higher-than-left curves the ball left for dog-leg left (left-turned) fairway. And, leveled shoulders will hit straight shots.  In other words, you choose the type of shot looking at the targets. Same principle applies to brains in the left and right.  Let us wish that RMA has properly seen the “financial fairways” and taken the shot balancing both left and right brains to fulfill, as per  Royal Monetary Authority Act of Bhutan 2010, the following:

“The primary objective of the Authority shall be to formulate and implement monetary policy with a  view to achieving and maintaining price stability.

Without prejudice to the primary objective, the secondary objectives of the Authority shall be to –

(a)	formulate and apply financial regulations and prudential guidelines to ensure the stability and integrity of the financial system, as empowered by this Act or by any other Act;
(b)	promote an efficient financial system comparable to international best practices;
(c)	promote, supervise and, if necessary, operate national and international payment and settlement system including electronic transfer of funds by financial institutions, other entities and individuals;
(d)	promote sound practices and good governance in the financial services industry to protect it against systemic risk; and
(e)	Subject to the above, promote macro-economic stability e) and economic growth in Bhutan.”

If not, the shot is bound land in rough. In this case it is not golf ball at stake, but the risk of country’s economy rolling over the top!

continuation under April.....................The Indian Rupee Crunch..........(3)

The Indian Rupee Crunch in Macro Perspective

The macroeconomic fundamentals including GDP growth, trade balance (surplus/deficits), interest rates and inflation levels determine the value of country’s currency. The Bhutanese Ngultrum (BTN) pegged to Indian Rupee (INR) has been serving us well even though it forced local interest rates and inflation to follow those in India. This will happen even if the local economy is completely out of sync with the Indian. For times to come it is beyond my intellect to envision Bhutanese economy being out of sync. So the scope and effectiveness of monetary policy to achieve macroeconomic stability has very little space. That leaves GDP and trade growth to improve INR liquidity, leave aside strengthening BTN. The best (longer-term) option for improving INR reserve is export-led GDP and trade growth with proper fiscal and monetary instruments in place. The near-term measures could be spending cut on uneconomical/unaffordable programs/activities/items both in public and private sectors, and the last and somewhat easier than above two is to increase standby credit, development grant,  “swap” arrangement, increase taxes (doubtful), plug loopholes etc. The last two have immediate implications on both public and private sector expenditures that eventually reflect in GDP.

The import-driven internal consumption-based growth model tends to dance at the dangerous economic threshold, the current INR crunch shows. This is not conducive to leading the country towards the national philosophy of Gross National Happiness (GNH). China is aggressively shifting its economy from production-based export model (presumably considered not very sustainable longer-term in changing geopolitical environment) to internal consumption with priority on indigenous innovation (reverse engineering as part of the process has being having its controversies) while India emphasizes on internal consumption with inclusive innovation for its economic growth. Economists know better! So, economic growth model determine the investment/expenditure pattern. The sound strategy for us should be to strongly support production base for export of goods and services, and improve balance of payment – a slow shift towards export-led growth model (from current import driven economy, characterized by high credit growth and internal and external imbalances) focusing more on agriculture and manufacturing sectors than services sensing wind of  opportunities.

Crystallizing the above, my main concern is in soundness of our investments/expenditures. On 13 Feb 2012, Reuters correspondent asked Premier Win Jiabao, during his final National People's Congress (NPC) news conference, how China will deal with local government’s massive debt accumulation on account of central government credit, and capital raised through bond and stock markets. The Premier replied that China was closely monitoring the local government debt and confident that the debt will not destabilize Chinese economy mainly because local government investments were more on revenue generating areas and less on government asset formation. In line with Chinese strategy to shift growth model mentioned above, the operative words are “monitoring”, “local government”. “revenue generating areas” and “government asset formation”. Banking skeptics may argue government asset generates economic return. But the fact is financial return on investment (ROI) is required to service commercial debt (short-term). Asset formation is good provided it is related to affordability entrenched in sound socioeconomic development framework. The soundness of an investment rests on channeling appropriately commercial vis-à-vis development finance (longer-term, 25 years and above). Generally former triggers the crisis!

The commercial lending for asset formation (capital investment) with little/no ability to service debt with ROI may be categorized as sub-prime lending, meaning making loans to people who may have difficulty maintaining the repayment schedule. One does not need to dig deep to classify the following loan portfolios of commercial banks in FY2010-11 into prime/sub-prime category:

	Sector	Amount (BTN billion)	Percent
(a)	Building & Construction	8.4	24%
(b)	Personal & Other Loans	6.7	19%
(c)	Manufacturing	6.7	19%
(d)	Trade and Commerce	5.3	15%
(e)	Service & Tourism	4.6	13%
(f)	Transport	2.8	8%
(g)	Agriculture	0.7	2%
	Total	35.1	100%

Source: Royal Monetary Authority of Bhutan, Annual Report 2010/11, January 2012

The commercial bank lending in FY2010-11 increased  by BTN  9.0 billion (34.5%) to BTN 35.1 billion accounting 98% of banking sector credit to private sector.  The robust commercial lending -- a sign of  high liquidity  due to all kinds of bank deposits known to monetary and banking authorities -- seems to have been driven by banks' short-term profit motive while the borrowers seem to have devised credit risk protection presumably through over-valued mortgaging and construction quality/cost undercutting to leave cushion for crisis – a dangerous trend for high credit  and internal/external imbalance environment.  “Ordinary entrepreneurs chase profit. Remarkable Entrepreneurs create value (and profit is the inevitable result),” says Robin Sharma. Even Alan Greenspan conceded failure in allowing the self-regulation of commercial banks  in sub-prime lending in the US. Therefore, bank deposits and sub-prime lending principles emanating through strong fiscal/monetary measures combined with  commercial bank’s self-regulatory discipline and private sector education/awareness may be best option to streamline commercial banking and nurture “remarkable”  entrepreneurs.

In the above context, it would be pertinent to see the Government measures undertaken/proposed so far to ease INR crunch, which include:

       

1. increasing standby credit line with India from INR 3 billion to INR 6 billion from April 2012;
2. stage releasing INR 100 billion development grant aid by the Government of India;
3. undertaking “swap” with Reserve Bank of India under SAARC Finance framework from April 2012;
4. treating  INR as foreign currency;
5. limiting INR cash or credit card access to  Bhutanese nationals by banks to INR 10,000/day with a maximum of INR 50,000/person/month;
6. not allowing banks to keep deposit accounts by non-resident foreigners  from 9th March 2012, and closing existing deposit accounts by 15th March 2012;
7. allowing resident foreigners (RFs) with valid Bhutanese business licenses and work permits to hold BTN accounts in banks;
8. allowing RFs with valid Bhutanese work permits but without  bank accounts  to remit/pay INR upon employers’ validation;
9. allowing INR transactions (subject to submission of documentary evidence including but not limited to proforma invoice/invoice/tax receipts etc.), until further notice, for: (i) government and public sector corporation payments ; (ii) import of capital goods, spares, raw materials and other inputs for industries (manufacturing and services);  (iii) import of oil and fuel products; (iv) medical supplies and equipment; (v) import of construction materials for approved housing constructions as on 8th March 2012; (vi) import of goods excluding transport/vehicle goods (except for public transport buses) by individuals/business entities; and (vii) education/training and medical treatment expenses in India; and
10. carrying out export related transaction through the banking channel with 91 days from the date of export.

The fiscal and monetary measures look uncoordinated, disorderly and bit of macro/micro hotchpotch with somewhat little consideration to immediate impact on business, and in streamlining policies, regulations and procedures to improve medium- to longer-term socioeconomic performance. The comments in press following government’s fiscal/monetary measures to deal with INR crunch are equally fragmented, at times misleading  and often lacking in substance. In view of the above and your own analysis, you may see for yourself where we stand in terms of resolving INR crunch notwithstanding immediate unfavorable bearing on business, in managing bank reserves, on commercial lending and in streamlining investment/expenditure pattern.

My experience in China says that when it says local government credit is safe means it is more than safe reflecting its strong ability to deliver, major difference between China and most countries. Can we repeat Premier Jiabao’s words for our BTN 35 billion lending last year? We cannot escape from the reality that our ability to manage finance,  among others, is directly related to our capacity to produce and deliver goods and services that reflects in performance figures annually. Every country has potential to do well. The potential is lost if its citizens’ days are spread thin. The country’s ability to deliver requires core structural strength including institutional and individual capability to perform, more specifically, in this digital age, ability to perform with creativity and innovation. This cannot happen if the able professionals are under ignorant elites (exploiting linkages for their hierarchical legitimacy) and/or bean counters in government/corporate chain of command. It has never happened anywhere and will never happen. We need, in my view, not only rational reform but paradigm shift as well!


continuation  .......   The Indian Rupee Crunch........(2)