Is the RBI making a big mistake this time? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Is the RBI making a big mistake this time? 

A  A  A
In this issue:
» Equities is still the favoured asset class
» Who will decide the price of gas?
» Rupee is at a six month low
» Do central banks really have solutions?
» ...and more!

Never before has banking and the role it plays in the prospects of an economy been more apparent than now. What is more, the spotlight on this sector has only heightened in recent times as unscrupulous practices by banks and financial institutions spawned the biggest ever global crisis since the Great Depression. In the developed world at least, governments are increasingly calling for more regulation so that there is no repeat of a crisis of this scale again.

Indian banks emerged relatively unscathed from all of this. A lot of credit for this goes to the Reserve Bank of India (RBI) and the independence it has maintained in overseeing the industry. But a thorny issue has emerged which is likely to test the mettle of the central bank going forward. And this is with respect to banking licenses being issued to corporate houses and conglomerates.

An article in the Economist has questioned this move. RBI so far had been wary of doling out licenses to conglomerates. The reason for this was that such a move would lead to increased crony capitalism. So its decision to reverse its age old policy could be attributed to political pressure. Further, the problem of letting corporate houses put a foot through the door of the banking industry could lead to too much power being transferred to them. What is the guarantee that lending would be done to industries and sectors that really need them and not mostly to their own companies and empires? And then there is of course the question of the vested interests of politicians and rampant corruption.

Given the current environment in India, we believe that this move does look quite dicey. The scams and scandals which have rocked the government and corporates only reinforce the concerns with respect to giving out banking licenses to the latter. The recent chit fund scam is a classic case in point of what happens on account of corruption and cheating people of their life savings. The RBI, of course, would be aware of this and has probably worked out safeguards that it needs to install when these licenses are issued. But it goes without saying that the central bank will have to be on its toes and also adopt a stricter stance when regulating activities of these new banks.

Do you think that RBI's move to issue bank licenses to conglomerates and corporate houses is a good move? Please share your comments or post them on our Facebook page / Google+ page

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01:26  Chart of the day
Stock markets have had quite a volatile run in the past few years. The global crisis in 2008 had an impact on Indian markets as the indices tumbled before bouncing back spectacularly thereafter. Since then the economic slowdown once again weighed heavy on the indices. And weak fundamentals in the US and Europe have not helped matters either. Quantitative easing programs announced by governments across the world have only heightened volatility as liquidity has surged. In such a scenario, we asked those participating in Equitymaster Investor Survey 2013 that if they had investible surplus, which is the one asset class, they would definitely want to invest in? Around 41% of the respondents were keen to stay invested in stocks and equity funds. Indeed, we believe that near term headwinds notwithstanding, equities have the potential to deliver healthy returns to shareholders in the longer term. Provided they focus on quality companies with good business models, sound managements and available at reasonable prices.

Data source: Equitymaster Investor Survey 2013

Firstpost calls it the battle royale and it certainly has all the attributes of one. Given the importance that it carries, there's hardly any doubt that the issue of gas pricing has become a political hot potato. On one side are the producers of gas who argue that they need to be paid close to the market price for their produce. And then on the other, there are the users like power and fertiliser industries who complain about how high gas prices could wreak havoc on their balance sheets. Not to forget the various ministries who've jumped onto the bandwagon taking one side or the other.

It isn't that the Government isn't trying to come out with solutions. But almost all of them have met with stiff opposition. Set too high a price and they end up disappointing the user industries. Set it low and the producers get irked. Given this scenario, it's become really challenging to settle on a price agreeable to both parties.

We believe that a solution needs to be arrived at by taking the big picture into account. And our topmost priority should be nothing but energy security. Thus, the pricing needs to be such that the producers get to enjoy a reasonable return on their capital. It should be noted that it is in the nature of these industries that they tend to create monopolies. Thus, the Government has to ensure that gas producers do not misuse their position and indulge in predatory pricing. However, a reasonable return on capital should be built into the pricing so that long term investments take place in the sector.

The Japanese economy has witnessed two long decades of stagnation. In a bid to revive economic growth, the Japanese Prime Minister has taken some extreme and highly risk steps. As we have said earlier, the Bank of Japan has pledged to double its monetary base .

Ever since the announcement, the financial markets have gone topsy-turvy. Excessive money supply tends to inflate asset prices. As a result, the Japanese stock markets have gone rallying. On the other hand, the Japanese yen has fallen sharply against the US dollar.

Will these measures lift Japan's economy? For one, theoretical expectations do not often translate to real outcomes. Moreover, such high-risk gambles as Japan's monetary stimulus come at a huge price. And they could have unintended far-reaching repercussions.

Some signs are already there. Interest rates on 10-year government bonds have gone over 1% for the first time in a year. Ideally, money printing should result in suppression of yields. But some recent comments by the US central banker raised hopes of retiring the QE3 program. This severely impacted Japanese markets.

The Japanese government is overburdened with debt. As such, a sustained increase in interest rates would severely jeopardise its finances. Any major financial shock arising out of such a situation would ruin the Japanese economy.

"Can the central bank governor please come clean?" Probably this is the million dollar question that investors, depositors and policy makers world over should be asking. But unfortunately no one has put forth this categorically enough to the chiefs of the US Fed and ECB. For that matter, we would not mind even Alan Greenspan answering the question despite that the fact that he has vacated the chair long back! After all, these are the gentlemen who have led the world to take a serious misconception to heart. That printing currencies is the solution to all economic problems.

Finally there is a gentleman who goes by the name of Christopher Whalen who is asking this question. As per Moneynews, Mr Whalen is the executive vice president and managing director of Carrington Investment Services. And his criticism is not limited to the Federal Reserve. He believes central banks around the world are trying to lead people to believe that they have solutions in their toolbox. None of the central bankers have succeeded in any way in proving the merits of quantitative easing. However, no one is willing to accept the wrong doing. It is time that Mr Whalen's voice finds more supporters so that the culprits are brought to book.

While the markets are touching levels they haven't touched in months, a fall seems to be happening elsewhere. In the currency markets that is. As per reports, the rupee is now at a six month low on the back of strength in the US dollar. This is not all. The continued political uncertainty in the country and intervention by RBI as reported by Firstpost is also leading to the weakness in rupee. However, where do we go from here? Is there going to be further weakness or the continued capital inflows into the country could put some floor under the exchange rate? Well, our guess is as good as yours. Longer term however, if we set our house in order and if the US continues down the path of dollar devaluation, then there's every possibility that the rupee starts appreciating yet again. And this is what we should aim for as a strong currency mostly indicates a strong economy we believe.

This week was a volatile one for the global stock markets. For starters, weak manufacturing data released in China did not help matters. But what spooked markets is US Fed Chairman Ben Bernanke's statement that it would be easing out its bond purchases program going forward. Given that a significant chunk of the recent rally in global stock markets has been a result of too much quantitative easing, such a statement sent shivers down the investors' spine. Japan was the worst hit as it lost 3.5% during the week. Indian stock markets were the second biggest loser as the BSE Sensex ended the week in the red piling up losses of around 3%. While global cues played a significant role in adversely impacting the indices, certain negative developments with respect to corporate governance in the pharmaceutical sector also took their toll.

Data source: Yahoo finance

04:50  Weekend investing mantra
"If you're an investor, you're looking at what the asset - in our case, businesses - will do. If you're a speculator, you're primarily forecasting on what the price will do independent of the business. " - Warren Buffett

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    20 Responses to "Is the RBI making a big mistake this time?"

    Anand Nambiar

    May 29, 2013

    People will start choosing a bank the same way they would do with a stock.Banks of trustworthy and ethical managements only will get bonafide deposits.Playing unethically with OPM(other people`s money)can happen only if people can part with their money on trust. Most will not survive the test of time as people are well informed and knowledgeable about business houses and their ways now when compared with one or 2 decades ago...thanks to the all pervasive media...

    Like (1)


    May 29, 2013

    it is a good thing as the PSU banks are already ruining the backbone of the banking industry
    an eg - i asked for a credit card to sbi - answer - i am only a sb acc holder so it is not possibl for me to get it without putting some deposit against which it can be given, INSTEAD IF I WAS A LOAN ACCOUNT HOLDER I CAN GET IT IMMEDIATELY - MEANING - if u have loan u can have more loan - so as per the RBI rules it seems that it wants the banking system to lend loan to already those who have loans ( so if they default not only the previous but the new loan also vanishes ) and not to those who are good in cash as they feel this is risky - wealthier get loan restructured and the poor or small customers never, instead they get the recovrey agent at their doorsteps at odd hours and odd timings ( and RBI allows it without taking any action ), so if the RBI itself wants the banking system to break, it would be better to hand it over to the corporates who are managing their companies better ( we have democracy in INDIA - so everybody should get the same fair chance to ruin the system )

    Like (1)

    Amit Sengupta

    May 28, 2013

    Yes- RBI is making a big big mistake, probably under pressure from the political class, who are trying to clip the wigs of RBI itself. RBI must be able to stand up to such pressures and wait till the time this country achieves a reasonable rate of literacy as well as financial stablity for the larger masses. Otherwise, this move is likely to brew another source of rampant corruption.

    Like (1)

    D.Ganesh Raja

    May 27, 2013

    I am surprised that when the writing is on the wall why people look the other way. That is because they choose to look the other way. This move will be like shooting in their own leg. What is required is more systems in place so that credit flows to deserving sectors after careful risk management. The unbiased approach can only be practiced by a non corporate & business houses.

    Like (1)


    May 27, 2013

    Allowing corporates and business houses to own banks should not be allowed as they would always put their business interests first--their banks would end up serving the corporate's primary business, it would be easy money for ambitious and maybe disastrous acquisitions of the corporate bosses. regds

    Like (1)

    c v krishnakumar

    May 27, 2013

    We had corporate groups owning banks prior to 1969. Government nationalized banks only when they would not put national priorities first. Social Control was tried but failed. Now the Government in its wisdom wants to turn the clock back and that is an ill-advised move. It can only bring in crony capitalism and encourage pillage of public funds through the banking system! An irresponsible move indeed!

    Like (1)


    May 26, 2013

    A perception is gaining that the RBI (like the CBI) is on the way to becoming a handmaid of the Finance Ministry. It seems to be under pressure to issue banking license to industrial houses, while the need of the hour is to facilitate consolidation of PSU banks (and SBI) through mergers & amalgamations. Moreover, the RBI has to ensure that the banks move quickly to unbanked areas in towns & villages, particularly with the govt's proposed Direct Cash Transfer scheme coming into operation. It is unlikely that new banks (leave aside the existing private banks) will meet this objective. The latest sting operation by Cobra post against select, reputed private banks in money laundering allegation only calls for more tightening of banking norms & close monitoring. Besides, it is also time to have a re-look on the working of the co-operative banks and bring it under the sole supervision of RBI. With elections round the corner, it will be better for the RBI to review/rethink it's policy on issuing new banking licenses after a new govt. is installed.

    Like (1)

    parimal shah

    May 26, 2013

    Not at all.
    The Government grabs all the power but does not (or pretends it can not) fix the accountability and the responsibility -(probably because people in very high places are involved).
    This is a "government of the corrupt, by the corrupt, for the corrupt" - and has the arrogance of touting so called success(sic) of 9 years!
    Shameless and disgusting.
    And now wants to make the country more corrupt by banking licences to corporate - shall we say, this a huge retrograde back door entry of license raj - again - for corruption on a larger and glorified scale with a finesse.
    I wish they would use such strategies for our foreign policies and be more concerned about the aam admi then corrupt corporates.

    Like (1)

    Gandhi Pankaj H

    May 26, 2013

    P S U Banks efficiency to improve but not allow more than
    3/4 players in a banking lic.

    Like (1)

    Nandkishor Desai

    May 25, 2013

    RBI is 102% wrong in not granting licence to coglomorate 7 Indutrial Houses.

    Like (1)
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