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India: Mis-governance at its best!

Aug 8, 2006

Addressing the 35th convocation of IIT Bombay in August 1997, the legendary jurist Nani Palkhivala started with a note of warning, that "Never had India in its entire history ever reached a lower level of degradation than it had reached now. The only achievement of the Indian democracy had been that it had survived unfractured for fifty years. We started our republic with three inestimable advantages. First five thousand years of civilization behind us, second a political entity united under the British rule and third an excellent constitution. But subsequent years saw in the country too much government and too little administration, too many laws and too little justice; too many public servants and too little public service; too many controls and too little welfare." Since this address, while certain things have changed in the country for the better (due to the reforms process, though slow and unsteady), we still see 'too much government and too little administration; too many laws and too little justice; too many public servants and too little public service; too many controls and too little welfare.'

One example vindicating this thought is the latest war of words taking place between the Indian Ministry of Finance (MoF) and public sector banks, as the former has directed a missive at the latter to 'roll-back' their latest interest rate hikes. The MoF has, instead, instructed the PSU banks to take the board's (a majority of which is made up of 'un-economical' government representatives) approval prior to any rate hike. Ironically, this directive from the government comes at a time when it has been demanding these PSU banks to match the performance and services of their private counterparts. Regulations, regulations, and more regulations!

The storyline flows something like this. On August 1, some of the leading public sector banks like the State Bank of India (SBI), Punjab National Bank and Bank of Baroda hiked their prime lending rates, or PLRs*, by 25 basis points (0.25%), for the second time during this year. The bankers explained that the decision to raise rates was taken by their asset liability committees (that are authorised by the banking boards to make interest rate adjustments).

Now, the differences between the MoF and PSU banks came to light post this rate hike on August 1. As per the MoF, the banks had ignored an earlier letter dated July 28 asking them to consider in their respective board meetings, all aspects of any changes in the interest rate structure. And, as such, the banks' move of raising rates without discussing these with their boards raised the alarm for the MoF, which then forwarded a second letter on Thursday (August 3) to the bank chiefs, directing them to keep their rate hike decisions on hold till they get their respective boards to discuss all relevant issues.

In the meanwhile, however, the finance minister has indicated that, "It is for the respective boards of the banks to take a decision. But the government has a view on interest rates and the government nominees on the bank board will represent that view." Regulations in disguise, this time!

The PSU banking community is already under tremendous pressure to match competencies with its private sector counterparts, who, despite a lesser reach geographically, have the advantage of nimbler decision making processes, and better technological and manpower advantages. Also, in these times of rising interest rates, the latter (private sector banks) have been able to raise their lending rates faster, in line with the rise in cost of deposits. On the contrary, PSU banks, which rely on a lot of low cost public deposits (due to their spread across the population), and which are bound by the government to a large extent with respect to lending rate increases, have faced pressure on their net interest margins (NIMs).

All in all, we believe that the malaise of 'too much' government regulations will continue to be the dampener to the overall reform process in the country. It has been the energy sector that has borne the brunt of 'babu-dom' in the recent past. Now it is for the PSU banks to slip to the government's diktat. You, as an investor in the India growth story have a tough task on hand - to protect yourself from slipping, all the time in the next three years, till we have another (or the same) set of mis-governing politicians at the helm. Is there a way out?

* As defined by Barron's, PLR is the interest rate banks charge to their most creditworthy customers. The PLR is determined by the market forces affecting a bank's cost of funds and the rates that borrowers will accept. Banks may offer major customers discounts on the prime rate.

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