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‘The funny money is gone and now we are all coming down to earth’

In this Idea Exchange moderated by Subhomoy Bhattacharjee, Deputy Executive Editor, Financial Express, Uday Kotak, a captain of the banking industry and a brilliant financial mind, speaks on the global meltdown, the road ahead for India, precautions that banks in the country should take and the strength of the Indian regulatory system


November 16, 2008 1:07:15 am

Subhomoy Bhattacharjee: We still do not know the extent of the toxic waste in the Indian financial system and unless that comes to light, we would not know whether we are really bottomed out, would we?

Uday Kotak: I agree that global de-leveraging is still on in a big way and when you have such high leverage on the asset side that is 30 to 35 times the debt-equity ratio, it has to be brought down to 10:1. You can do it in two ways. You add some equity or you have to sell some assets. Some of the assets are very poor quality loans. So as you deleverage that you see a global shrinkage of money. In October 2007, India’s total FII equity, at market price, was around $280 billion and total reserves were close to $300 billion. Today that FII has come down to $75 billion. Another 20 per cent has reduced because of rupee depreciation in dollar term, so it’s $140 billion minus that. The amount of money that has gone out is only $15 billion, but this amount going out has brought down the portfolio value from $280 billion to $75 billion. Look at trade from India’s point of view: the reserves that were close to $300 billion are $250 billion. My feel is that because of this toxicity, there is still money going out.

P. Vaidyanathan Iyer: How close were we to a systemic crisis since there was a lot of camaraderie amongst market participants—corporates, banks and government institutions?

As deleveraging started, investors and savers around the world wanted their money back. So, worldwide, the dollar was moving back to the US, which is why you saw a dramatic appreciation in the US currency against all other currencies. Dollar was also going away from India and this led to a tsunami-like situation. There was a mad rush of the dollar going back home. They were sucking liquidity out. Two things were happening. One, the rupee was depreciating because of the dollar outflow. Then, the RBI was supplying dollars to the market, and the moment you do that, you are sucking out rupees. So you had a depreciating rupee and a tightening interest rate situation as massive outflow of dollar was happening.

Saubhik ChakraBarti: Both deposit and lending rates have gone up. If in the next six months, interest rates are to come down, what do you think should happen?

Because of the scare which we saw in the second half of September or early October, where you saw inter-bank rates going up substantially, there was an element of worry—let us take as much money as we can. So, the banking system feared what would happen if the money suddenly evaporates. The psychology of banks is that they should spare some money and keep the deposit rates high. That is the one general situation. Also, once I start taking deposits, I must keep more liquidity with me. And the moment I keep more liquidity on which I am earning low returns, I am carrying negative spreads. So, whatever I lend, I have to lend higher. As an example, look at some of these electricity boards. They are subsidising the consumers. So they keep the industrial rates so high that it becomes very tough for the industry to afford. In a way, if the banks are borrowing at high rates, that is an issue but that is coming out of this shortage worry. One thing is clear: banks did not price risk well.

Saubhik ChakraBarti: What should a single bank look at?

Bankers should move away from the fear that there is a shortage of money. Then, there must be confidence that the economy is not going into a tailspin. And that is the concern today because then the banks start pricing risk higher. Commercial vehicles, autos, real estate and many other sectors are beginning to see dramatic drops in the sales lines, we need to create a certain base level of confidence. Iron ore exports around the world have stopped. China is not honouring its commitments. As a result, there are 12,000 trucks in Karnataka and no goods to move. What happens? If the economy starts feeling the pressure, there is little we can do. I think it is time that the government comes on the front foot. It should spend on infrastructure like never before. You got to hold this economy from falling in terms of GDP, and that is what governments worldwide have done. I am not talking in terms of a bailout. I agree that India is among the few countries who have nothing to do with bailouts. And yet, we need to spend money at a time like this to hold the confidence that the economy is okay. In many ways, the ability of the private sector in a time like this is always limited. Today, take the top 10 market cap companies in India and compare it with last year’s top 10. One year ago, two out of 10 top market-cap companies in the country were from the public sector. Today, it is 6 out of 10. It is very significant development because in a time like this, the government and only government owned-entities have to make things happen. We are fortunate. It is very perverse logic but when rest of the world moves towards getting government into companies, we already have them.

Saubhik ChakraBarti: A rapid cut in CRR and intelligent government spending. Suppose both things happen, how long will it be before lending rates are cut?

I think it could happen in the next few weeks or months. It all depends on how soon the confidence is built. And right now, there is too much talk of bad news. We want to talk about some good news. It is said that recession happens in the minds of people. India today has the safest system because of the sound regulation and monitoring by the government. We don’t need bailouts and therefore, in a way, the system has taken care of all the banks. In India, most of the banks had a capital adequacy ratio of 10 per cent plus. Therefore we have a regulatory system that saved us.

Surabhi: With the financial crisis, do you think it is the right time for India to go in for financial sector reforms in banking and insurance?

Reform is a wonderful generic word. Anything that makes the system efficient while keeping it safe is welcome. Anything that makes us more cowboyish should not be welcomed. What I have seen is that very often, this reform argument is backed by many lobbies, who push it in a particular direction. This may not necessarily be appropriate for the system. A more sensible thing to do, I think, is for the system to surgically analyse the nature of the reform and then make a call. I would say there are two emotions. One is, thank God we were a system the way it was. The other is, just because we were too conservative, we should not use that as an argument to do what is not right in going forward.

Sanjay Singh: You spoke of the liquidity mismatch where funds are made to honour their commitment to customers within a day. So, is there a rethinking within the mutual fund industry?

I believe the regulator is taking it up very actively. I have learnt that there is a move to make new Fixed Maturity Plans (FMPs) locked in till maturity. And the portfolio that the mutual fund invests out of that FMP should be such that the maturity of the asset should not exceed the maturity of the FMP by more than seven days.

Shekhar Gupta: Does RBI need to take more steps?

I think so. I am really hoping that we continuously remain ahead of the curve and these are not normal times. My view is that make sure that you don’t act after the call goes to 20.

Coomi Kapoor: How long will the current economic crisis last?

I wish I really knew the answer. My view is that the global structural problem is 3-5 years fixed. It is in Europe, US, Japan, it is spread to Korea, South Africa…all over. If we take the right set of initiatives, I would still like to believe that India’s GDP for 2008-09, that is the current year, should average around close to 7 or 7.

Sunny Verma: You mentioned an uneasy calm. Can you elaborate?

I think the financial sector is breathing well. The question in our minds is what is happening in the real sector. The job of the financial sector is to serve the real sector. And if the real sector has issues, it comes back to the financial sector. So what we really want to see is what is happening to the auto demand, commercial vehicles, aviation, real estate, and construction. That is where the action is.

Sunny verma: The origin of the problem seems to be over-leveraging. Is there a particular level of leveraging you think ideal?

Globally, this excessive leveraging was creating some kind of funny money. So the entire world was seeing this funny money coming into its system and India got its share of funny money. This money was there in our system for the last five years and this started becoming the steroid. We got hooked to exuberance, high stock market, asset values, real estate, spending, and high salaries. And you saw this kind of drug the world got addicted to. Most of us were walking two feet above the ground. Now the funny money is going and gone and we all are coming to earth.

Subhomoy Bhattacharjee: Talking of the safety of the Indian financial system, the day after Lehman Brothers collapsed, there was a spike in RBI repo rate with Rs 90,000 crore being taken out. But other parts of the economy were as badly hit as in any other part of the world. So what really helped us?

There was so much of global steroid and the Indian real sector started believing that all the money that it was getting from banks abroad was real money. It was basically that 34th leverage point and that was the money that was funding, say for example, India. That was for me was unsustainable. No financing system in the world could support that level of funny money.

Shekhar Gupta: Did you have this feeling before the crisis came? Did you warn anybody?

I was in New York before the sub-prime crisis started in August 2007 and many people I met said there was too much leverage in the system. We are all getting very uncomfortable and knew this was not going to sustain. Few people whom I know in New York said, just raise equity while you can. And thank God we and many other institutions in India did that. So we did benefit from this funny money, but it’s gone. But new capital is not going to come and you need to use this capital well because it was artificial, like maya. You know, when you start leveraging at 33 times, you create money, it is like drug. The world looked great with money pouring in, but it was not real. It is gone and gone forever.

Praveen Singh: Are banks reluctant to lend?

Banks are not reluctant to lend, but are wanting to be a little more careful about the credit worthiness of the borrowers. So today, a massive dose of government spending is the only answer. India has a very big advantage unlike the rest of the world. The rest of the world is now reaching a situation where if interest rates go to zero, what more can you do? The interest rate in the US is 1 per cent, after zero what? You can’t tell the depositor, we will charge you interest for putting money with the bank.

Gayatri Verma: When the markets were healthy, banks offered different kinds of loans: home, car, personal. Now they advertise and selling insurance, which is beginning to feel like trying to instill fear in customers.

I personally feel India will be okay with all lending which is backed by security. The problem in India will be unsecured credit cards and unsecured loans. The reason I feel India is safer than other countries is that finally you have a depreciating rupee and reasonable inflation. Therefore the underlying assets will not depreciate as much as in the rest of the world. I am a believer that as long as you are lending for car, home against the security at a right margin to value, it is fine. The problem arises when it is unsecured. People are used to so many credit cards and borrowing from one credit card to another that suddenly if that money is withdrawn, it creates a significant withdrawal syndrome.

Vikas Dhoot: As a banker as well as an investment banker, do you see Indian corporates going back to the basics?

I don’t think there is an alternative. They better get back to the basics. That is the only route. In many ways this was similar to the internet bubble. This was the leverage bubble. So you had seen the internet bubble in 1999, you have seen the leverage bubble between 2003-2007, that bubble is gone.

Vikas Dhoot: So this is a calming cycle?

Absolutely. At some point of time, when we get out of this, we will see a counter high inflation cycle around the world. But that is down the road. Right now, back to basics. What is not in common sense, don’t do it. If something is too good to be true, it is too good to be true.

Smita Agarwal: In the current situation, which are the sectors you would be comfortable lending to?

We would be comfortable with sectors where the primary aspect is domestic consumption. I am a deep believer in the Indian consumer story. I think the capital spending side will take a little longer and that is where the government has to come in much more. But on the domestic consumption side, we will be fine. We will touch anything as long as we have enough margin of security and clear visibility of cash flow.

Poorna Bhattacharjee: Do you think the Indian job market is witnessing a downturn and will the situation get worse?

The times are definitely tougher than ever before. And therefore, the ride is not going to be easy. Businesses have built a lot of their models on exuberance. So to that extent, the exuberance is going out because the steroids are going out of the system. I am pretty confident that if India manages itself well, we can land at 6 per cent growth, stabilise for a while and then start moving up. India has a very big advantage therefore of minimising job losses compared to the rest of the world. There would be some pain, it won’t be zero but we can certainly minimise that. We got to make sure there is no panic, but we should have a great sense of alertness and responsiveness to be ahead of the curve. And if we do that I think India has a phenomenal, once in a lifetime opportunity of differentiating itself in an extremely turbulent world.

Shekhar Gupta: During the financial crisis, did you lose sleep?

I always had a problem after watching CNBC at night. Honestly, I feel there were two parts of the emotion. I felt that the world was crumbling much more than what we had ever seen in our lives. And having said that, you start being more and more alert vis-à-vis your system when you see what is happening outside. Therefore you are far more alert to make sure that you are okay and deep down, India’s conservatism and stability are something that let you sleep well at night.

Transcribed by Praveen Singh

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