Suddenly, the idea that financial sophistication leads to inclusive growth seems to have caught on (well, except with the Ministry of Finance, which is actually in a position to do something about it). First there was my Pragati piece. Yesterday, Nivirkar Singh’s column in Mint also touched on this:
Petia Topalova of the International Monetary Fund has recently examined the links between policy and inclusiveness of growth. In particular, she uses variation across states as well as three time periods, spanning 1983 to 2005, to examine these links. Inclusiveness is defined as the difference between the consumption growth rate of the poorest and richest 30% Indians.
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First, higher financial development, measured either by real credit per capita or by a larger initial share of agricultural labourers with loans from formal financial institutions, is significantly associated with more inclusive growth.
OK, this is interesting. One of the points the Raghuram Rajan report raises is that access to credit is actually only one leg of financial inclusion, and is the most overused one. The other two legs – access to savings instruments and access to risk management instruments like insurance – have traditionally been missing. So there are two ways to read this:
The correlation between credit and inclusive growth doesn’t mean anything. It’s just a coincidence that this turned up, and might be caused by something else – more urbanisation, say, or might even run in the opposite direction – financial inclusion leads to more demand for credit (though I personally think it’s a positive feedback loop – they cause each other)
The research is right. Credit might be only one leg, but it still has an impact. And we haven’t even seen what would happen once savings and insurance also get taken up. In that case, the gap could close in a stunning way.
Moving on. After Nivirkar Singh’s column, there’s also the cover story in today’s Business Standard the Strategist. It’s about FabIndia, and how they’re encouraging artisan communities to set up private limited companies where the shareholding is split between the artisans themselves, their employees, FabIndia, and outside private investors.
The concept, now a Harvard Business School case study, is simple. A fully-owned subsidiary of FabIndia, Artisans Micro Finance, a venture fund, facilitates the setting up of these companies, which are owned 49 per cent by the fund, 26 per cent by the artisans, 15 per cent by private investors and 10 per cent by the employees of the community-owned company.
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The artisans gain in many ways. The value of their shares goes up. They earn dividends when the company is in a position to declare them.
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The shares offer the artisans a divisible asset class (land can be divided but its divisions are often disputed and jewellery is largely indivisible) and community-owned companies help convert FabIndia’s artisan base into an asset.
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“If he wants to get his daughter married and needs money, he can sell his shares and realise the appreciation. He can also take a loan by offering his shares as collateral,” says Bissell.
The article is worth reading even if you aren’t interested in finance, and you’re more interested in social entrepreneurship or marketing or traditional handicrafts. Axshully it is worth reading even if you are a metrosexual and only buy organic muesli as you will get to know about new and exciting opportunities to buy it as FabIndia expands.
By the way, William Bissel mentions in the article that the co-operative system imposes too many restrictions on the artisan and the private limited company makes more sense. This is a massive understatement. The legal and accounting procedures for co-operatives in India are so totally broken that co-ops inevitably end up in the hands of regional politicians. That, however, is the subject of another post, and by someone else.
The article had a checkered history. I had almost finished researching it when I suddenly had to dash to Delhi. When I returned to Bangalore I fell sick and told Ravikiran and Nitin I wouldn’t be able to write it after all. The fact that I had no furniture in this point and writing would have to be done propped up against a wall may have contributed. Then I came to Bombay where I had a guesthouse with a dsek, and called up and offered to write it after all.
By this time I was five days over deadline and had to write it in a mad rush between ten and two in the morning at my guesthouse. The next day I had to check out of the guesthouse and didn’t have a new one to shift to, so I finished the article between noon and three in the afternoon while squatting in an unoccupied cabin next to an FX dealing room. Sadly, I had finished the bit about currency markets and was writing about financial inclusion and regulation by then.
Anyway, the result of all this was that I wrote the article in practically stream-of-consciousness style. As a result, not only was it a week over deadline, it was 1200 words over the word limit. It is a tribute to Ravikiran’s mad editing skillz that the article is now within the limit and still readable.
The leading merchants realized that such practices were damaging the reputation of their most valuable product. One of the leading New York City houses grew concerned that Chesapeake oysters were being sold to England as Bluepoints. An agent for the house intercepted a shipment of Bluepoints, opened the barrels as they were being loaded, and found that they were mostly “Virginias.” It was a new age of communications and the agents was able to telegraph Liverpool so that British authorities were waiting for the shipment when it landed. The oysters were confiscated, though it is not clear what happens to a healthy confiscated oyster. The American shipper was charged with mislabeling, which carried considerable fines. The New Yorkers were not accustomed to such stringent consumer protection and the American agent argued that the oysters had spent a little time in Great South Bay and they had thought that this was all that was required to label them Bluepoints. That the Americans don’t know any better is always an argument of some currency in England, and the charges were dropped.
Since I’ve already expressed dismay and bad language about the debt waiver, let me expand a little.
(Writing this in a rush, so it won’t be entirely accessible to lay readers. Sorry about that. If you’re interested but confused, ask, and I’ll try to explain in the comments.)
For now, let’s ignore the fact that this rewards farmers who took bad decisions and punishes the farmers who’ve actually been diligent about repaying their loans, and so it’s set up all sorts of moral hazard. Let’s accept that indebtedness is making the poor suffer, that ending suffering is of prime importance, and that the ends justify the means.
Over and above that, Business Standard had a report (not linking it, because it’ll disappear in a few weeks anyway) on how this doesn’t help the most heavily indebted farmers, because their landholdings are so small they can’t get bank loans, and have to rely on moneylenders. This whole waiver is only going to end up benefiting large landholding farmers – not very well off, but certainly not the poorest of the poor, and the ones who’re suffering the most.
(Of course, all this assumes that the money allocated will actually go completely towards writeoffs. I’m not even sure where the 60,000 crore rupee figure came from.)
The second shady thing about the waiver is that there are no details on how the mechanics of it are going to work out. I think O P Bhat or someone has said that the loans are going to be swapped with government securities.
If this is true, it presumably means that a 60,000 crore rupee provision for credit losses spread across the banking system is magically going to turn into 60,000 crore rupees of capital. In effect, SBI and other PSU banks (or as Percy Mistry calls them, SOBs) are having their balance sheets recapitalised. And this is not being done through the capital markets, but by soaking the taxpayers. Nice.
I’ve just talked to Skimpy about this, and he’s pointed out that there are flaws in the details:
Chidambaram might not give 60,000 crore rupees of G-secs for 60,000 crore rupees of bad debts. So the net worth could still fall.
Against 60,000 crore rupees of bad loans, the actual provisioning might not actually be 60,000 crore rupees. I’m not sure about the current RBI rules for provisioning. I am tempted to leave this as ‘an exercise for the reader’, since I’m still too busy at work for the next month or so to devote time to finding out how much you have to provision, and what various swap ratios would be like. On the other hand, if the loan waiver is against provisions and not actual bad loans, then my point still holds.
Chidambaram has apparently said that the waiver will be carried out over the next three years. So there may not be a waiver after all.
Fine. Readers, I leave it as an exercise to you, since I will be busy with mobile handset distributors and telecom switch importers and generic drug manufacturers over the next month.
But if my fundaes are correct, the loan waiver is stunning. If the government divests its stake in SOBs after doing this, it’s basically going to get a better valuation, which the taxpayers have funded. So the public at large will pay to get a better performing bank, when the risk should really have been taken up by people like ARCIL. Very, very shady.
Then I started hunting through the budget papers looking for a bulky entry of Rs.60,000 crore for the debt waiver. This is 1.1% of GDP. It isn’t there. So there’s another 1.1% of GDP that’s off balance sheet. Why isn’t it there? I suspect it was a last minute addition to the budget speech.
We’re then in the worst of all worlds. If these calculations are correct, we’re down to a central gross fiscal deficit of 4.6%. In other words, we failed to harness the great business cycle upturn of the recent years to do the fiscal consolidation in these good times. And, we did this in the worst possible way: by setting up a new level of mistrust of Indian public finance data.
Chinese banks are not particularly customer focused, and are reluctant to give car loans to anybody whose income level is not high enough to make a midsize car affordable. Chinese banks would have little or no experience with consumer finance, and without competition from foreign banks, they would have no incentive to create consumer finance products either. That makes life difficult for anybody who wants to upgrade from a motorcycle to a small car.
The problem of financial underdevelopment isn’t restricted to home loans. Since credit checks are perfunctory, cards come with low spending limits and have lukewarm acceptance. Auto finance is still in its infancy. A survey conducted in April last year by consulting firm KPMG LLP and Taylor Nelson Sofres Plc, a market researcher, showed that while 25 percent of car buyers in China had access to finance, few actually opted for it.
A warm fuzzy feeling pervades. This still doesn’t prove that the lack of small cars in Qingdao is because there are no auto finance companies there, but it strengthens my hypothesis. Such joy. Such joy.
Ramesh Ramanathan is fuming about Bangalore’s new airport being underdesigned and underconnected (via Ajay Shah’s excellent roundup on infrastructure). As is happening far too often these days, Skimpy beat me to blogging about the main topic. However, that just gives me more stuff to discuss. In fact, I’ll make the whole post an outsider-layperson-dummy’s guide to the Bangalore airport, infrastructure design, infrastructure financing, and maybe even special check-in counters. So. Yeah. Let’s do this shit. In Q&A.
While this will be the first time Tata Teleservices will be partnering with a brand such as Virgin, Branson has already formed two similar alliances globally.
(emphasis mine)
So, it’s not Virgin’s first time, but it is Tata Teleservices’? I’m confused.
Which leads us to the question: Why is it legitimate to acquire land for industrial use, but prohibit farmers from consolidating and expanding their landholding to improve agriculture? Why shouldn’t a farmer be able to legitimately acquire a thousand acres?
Indian industry can raise capital from the global market on the basis of a prospectus, which promises performance in the future. But Indian farmers can’t raise adequate capital on the basis of the land asset which they already possess.
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However, it is critical that the value of the land of farmers, often their only asset, is maximized, and it is made simple to capitalize. The problem facing the poor is not their poverty, but inability to capitalize their assets. Typically, agricultural land hardly fetches Rs2-3 lakh per acre. Agriculture income, even if the land is cropped twice a year, can hardly be more than Rs30,000 per acre, at current productivity levels.
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The industry could also offer shares or bonds in lieu of land. Or even provide alternative land if the farmer decides to continue with his vocation. In an open land market, with protected property rights and security of contract, there would be a wide range of choices to meet almost every requirement.
Allowing the free and easy conversion of agricultural land for residential, commercial, or industrial purposes creates a liquid market for agricultural land.
The liquid market for agricultural land makes it more acceptable as collateral for lending.
The existence of the liquid market also makes agricultural land more valuable.
Point 2 and Point 3 combine to drive down interest rates and increase the loan amount a farmer can get against his land.
This means that being indebted is not such a problem for farmers.
I now worry that I gave the impression back in October that allowing the sale and conversion of agricultural land was a magic bullet, and that once this happened we would enter a happy agricultural paradise. It isn’t. It’s necessary, but not sufficient. You need other things too. The three most important ones I can think of are:
Farmers actually knowing that they can sell and mortgage their property legally, and knowing what the market rate is. Currently, anybody who wants to buy agricultural land to put up flats or a factory bribes the collector to change the land usage, buys it at a bargain basement rate from the farmer, and then goes ahead and develops it. If land sale is legalised, but the farmer doesn’t know about how much more valuable this makes the land, all that changes is that the developer no longer has to pay a bribe (or as much of one). As I mentioned in the October post, auction sales are a good mechanism to prevent this happening.
Competition in the market for lending. Which means multiple banks lending to rural areas. As things currently stand, I think each Regional Rural Bank has a geographical monopoly on rural banking in its particular region. Discussing how to create viable and competitive rural banking is a blogpost in itself – many blogposts axshully. Maybe later.
The agricultural land needs to be well-connected enough to urban centres that there’s demand for it. Which in turn means rural roads. Rural roads also have the advantage that they make it easier for banks to reach farmers (fulfilling Point 2), and make it easier for multiple land developers to court farmers for their land (fulfilling Point 1).
For every million rupees spent, roads raised 335 people above the poverty line, and R&D 323. Every million rupees spent on education reduced poverty by 109 people, and on irrigation by 67 people. The lowest returns came from subsidies that are the most popular with politicians – subsidies on credit (42 people), power (27 people) and fertilisers (24 people).
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For decades, rural roads in India were neglected by most states. Besides, rural employment schemes, starting with Maharashtra’s Employment Guarantee Scheme in the 1970s, created the illusion that durable rural roads could be built with labour-intensive techniques. In practice labour-intensive roads proved not durable at all, and those built in the dry season vanished in the monsoons.
The posts on rural banking and agricultural finance will happen sometime in the future. Work is horrible this month.
Posted by Aadisht