Archive for the ‘Indian Economy/Financial Markets’ Category

History of India’s NBFCs: 70 Years Of Potholes And Repair Work

May 20, 2019

New piece in Bloomberg Quint.

I explore how NBFCs and its regulation have evolved over the years in India.

It is useful to get opportunities with BQ to write on various aspects of Indian financial history. One learns a lot writing these pieces.

The pieces written so far:

Earlier pieces for Mint on Sunday (which was suddenly stopped):

Hope many more to come…


Why the World needs National Development Banks? (though India did away with NDBs…)

May 16, 2019

I don’t know but quite a few ideas which were rejected by Indian policymakers are making a comeback in global policy.

I blogged about how BIS is advising EME central banks to engage in forex markets. Now Stephany Griffith-Jones and and Jose Antonio Ocampo in this piece advocate national development banks, again an idea which took shape in India. Post-independence, we had development banks such as IFCI in 1949, ICICI in 1955 and IDBI in 1964. This was followed by NABARD in 1982, IDFC in 1997 and so on. In India, we called them Development Financial Institutions or DFIs.

Griffith-Jones and Ocampo say NDB’s offer following advantages:


Bank Deposits in India: Underlying Dynamics

May 15, 2019

Harendra Behera and Dirghau K. Raut and Arti Sinha of RBI in the monthly bulletin for May-2019 research analyse the recent trends in bank deposits:

Bank deposits remain an important part of the financial savings of households and key to the financing of bank lending.

Deposit growth is picking up in recent months in a cyclical upturn since December 2018, which is overwhelming a trend lowdown that has been underway since October 2009. The latter warrants policy consideration since deposit mobilisation is fundamental to India’s bankbased system of financial intermediation.

Empirical evidence puts forward several interesting facts about the behaviour of bank deposits.

First, it underscores the income as its most important determinant, both in the short-and in the long-run.

Second, interest rate matters for deposit mobilisation but only at the margin.

Third, financial inclusion has a boosting effect on deposit mobilisation over the long-run suggesting expansion of bank branches in unbanked areas.

Fourth, substitution effects associated with Sensex returns for deposit growth are limited to the short-run, warranting a careful appraisal of regulatory reforms and tax arbitrage, even as efforts need to be intensified to make both more market determined.

Finally, similar to Sensex return, small savings substitute bank deposits in the short-run but supplement deposits in the long-run, reflecting that limits on income tax exemption eventually evens out substitution effects and allow income to be the key determinant of both in the long-run.

In the final analysis, therefore, accelerating the rate of growth of the economy and disposable incomes holds the key to higher deposit mobilisation by the banking system.


Undermining Central Bank independence, the Cyprus way (reads much like India’s story!)

May 13, 2019

It has been 5 months since RBI Governor resigned from the central bank. A lot was written exploring several reasons which led to his sudden exit from the central bank. But much of it is still speculation and truth is known to either Governor or someone close to the scenes in the Government. However, there is one book which reads much like what could have happened between the RBI and the Government.

The concerned book is written by Dr. Panicos Demetriades, former Governor of Cyprus (May-2012 to Apr-2014) and is titled as ‘A Diary of the Euro Crisis in Cyprus’. It is highly surprising that such an account by a central banker has not got due attention. The book was written in 2017 and should be on top of the charts. There are other central bankers who have written their accounts recently. But neither had they faced experiences as telling as those faced by Demetriades nor wrote as frankly as Demetriades.  One reason for ignorance is Cyprus being a tiny economy. Even then the book is a must read for those interested in political economy of central banking.

I came to know of this book by reading a recent speech by Lesetja Kganyago, Governor of the South African Reserve Bank. Kganyago speaks on how central bank independence is under attack including South Africa (which requires a separate article of its own) and picks insights from this book to reflect on Cyprus experiences. The events which happened in Cyprus during those 2 years read as the events in India during 2016-18. The resemblance is so striking, that it leaves you in splits.

What happened in Cyprus which is so telling?

First some basics. Before 2008, Cypriot banking sector grew enormously to touch 10 times the size of its GDP. The banks had invested heavily in Greek government bonds as they gave higher yields. Further, Cyprus banks not just offered higher deposit rates but also lend aggressively towards real estate sector. One of the real estate developers even became chairman of one of the Bank Boards. The financial transactions were not limited locally but funds flowed from and to Russia, Ukraine and Romania, becoming a deadly cocktail at the end. The banks were also the main advertisers in the media leading to no one really raising fingers.

Though, this was hardly unique to Cypriot banks as we saw banks in Iceland, Ireland, and US etc. following similar strategies only to end up in crises. In Cyprus too, the Greece crisis and European financial crisis engulfed banking system of Cyprus which was anyways built on shaky foundations. What is unique though is what transpired later.

Enter Panicos Demetriades who was appointed Governor of Cyprus Central Bank in May-2012. He had taken over from Athanasios Orphanides, who in in his send-off remarked that though banking system was quite stable under his tenure but wasn’t sure what would happen next.

Talk about prophecy as what followed was complete meltdown of the Cypriot banking system. The blame lies on Orphinades as well, as the fragile banking system took shape under his tenure. Demetriades knew he was sitting on a time bomb and tried to figure a solution but could not succeed. The troika of IMF, ECB and European Commission wanted to implement stricter norms for recapitalization which were not agreeable to politicians. The banks remained highly undercapitalized, politicians continued to underestimate the scale of problem also on account of high cronyism. Gradually losses mounted and the share of non-performing loans as a percentage of total loans in Cyprus was next only to Greece. Even today the share of NPLs are as high as 20% of total assets.

As banking problems worsened, a scape goat had to be identified and who better than a central banker! The media anyways disliked Demetriades right at his appointment as he was seen as an outsider. Soon, the political parties joined this chorus. The politicians wanted Demetriades to be ousted but as Cyprus was part of Eurosystem and under this system the central bank governor could not be fired. The only way was to pressurize the central banker and push him towards resignation.

The Government did two major things (apart from humiliation) in mid-2013 which pushed Demetriades towards his resignation – firing the Deputy Governor who backed the Governor and pushing the governance powers from Governor to the Central Bank Board!  Under the new legislation, the Government expanded the Central Bank Board membership from 5 to 7 with the two new members becoming Executive Directors. Further, the decisions related to licencing of new and old banks were to be made by the Board and not the Governor. The ECB protested against this legislation but to no avail.

The new Board stopped backing the Governor and even the loyal staff started complaining of harassment. Demetriades began to tire eventually and health started to suffer. The personal attacks mounted even bringing his family into picture. In March-2014, he submitted his resignation citing “personal reasons and difficulties working with the Board as the reason for resignation. This way the government won not just the battle but also the war against its own appointed Governor.

The events in Cyprus showed how governments can undermine central bank independence in interesting ways. The rules prevented the Governor from being fired but one could still build the pressure through the Board and firing the Deputy Governor.

Given this brief, there is a reason why I mention that Cyprus case reads much like India’s case. The RBI Governor was under pressure for rising NPAs, low credit growth and maintaining high reserves, leading to discontent with the Government. There was news on how the powers of governing RBI had shifted from the Governor to the Board members. There were also reports on how Governor Patel was tired fighting these battles and his health was suffering. In the end, these multiple events forced him to resign, also serving for two years just like his Cypriot counterpart. The resignation letter of the Governor also mentions personal reasons but not saying anything else.

The German classical archaeologist Gustav Hirschfeld once said ‘He who would become and remain a great power in the East must hold Cyprus in his hand.’  Paraphrasing the quote, those who believe in great power of central bank independence, should hold and read this account of Cyprus central bank Governor in their hands! Hope Dr Urjit Patel writes his own account as well.

How much equity capital should a central bank hold? Case of RBI

May 13, 2019

New paper by Ila Patnaik and Radhika Pandey of NIPFP:

The mechanism to calculate how much reserves the RBI transfers to the Central Government has been at the forefront of debate amongst experts and policy makers. The present legal framework allows the RBI to choose what proportion of reserves it transfers to the Government. As a consequence, it has built up reserves that are higher than most other central banks hold. This paper presents the logic for why central banks might hold reserves. Drawing on cross country practices, it presents a discussion of the possible arrangements for transfer of reserves to the Government. Any institutional arrangement to determine a framework for reserves transfer must consider these options.

One expects Bimal Jalan Committee to submit its report after election results. One expects the committee to advocate some rules for capital and reserve management of RBI..

NSE Case: The Indian financial sector story is unravelling

May 10, 2019

My new piece in moneycontrol on the NSE case.

Kerala launched offshore chit fund for NRIs…

May 9, 2019

This is just a fascinating news in Mint (which I missed). Kerala has a long history of chit funds. Despite several misses and crises in chit funds industry, it continues to be an important source of financial intermediation in Kerala.

Now they are launching chit funds for NRIs. A pilot was launched last year in Gulf:


Cross-border Trade Credit: A Post-Crisis Empirical Analysis for India

May 9, 2019

New WP by RBI economists: Rajeev Jain, Dhirendra Gajbhiye and Soumasree Tewar:

The paper profiles trade credit extended by domestic and foreign banks to Indian importers, focusing on its size, composition and cost pattern. Using a
panel data of 55 banks for 2007-08:Q1 to 2016-17:Q4, the paper finds that both demand and supply-side factors influence the flow of trade credit.

The paper suggests that higher imports – whether due to high prices or volumes – lead to an increase in trade credit. From the supply-side perspective, financial health of banks, cost of trade credit and size of their overseas network seem to influence their trade credit business.

In light of the empirical findings, banks need to expand their global banking relationship and shift towards the use of globally accepted trade finance instruments instead of indigenous instruments (i.e., LoUs /LoCs) which, however, may push up the cost.

LoU was in controversy in the recent PNB crisis…

State Finance Commissions: How successful have they been in Empowering Local Governments?

May 6, 2019

Interesting paper on one of the least known aspect of Indian fiscal federalism: Working of State Finance Commissions.

It is written by Manish Gupta and Pinaki Chakraborty of NIPFP:

While the Constitution provides for setting up of SFCs at regular intervals, this has not been adhered to by the states. The paper reviews the reports of the latest SFCs of 25 states in India. This involves examining the status of constitution of SFCs, their functioning and the approach adopted by them in carrying out their task and the principles adopted by them in allocating resources to local governments both vertically and horizontally. It also quantifies the devolution recommended by the SFCs in order to get a comparative picture of funds devolved by them across states. It is observed that there is huge variation
in the recommended per capita devolution across States.

We do not find any relation between the recommended per capita devolution and per capita income of States, but per capita devolution is in general very low across states in India. Is it that the state governments arbitrarily reject the recommendations or are the SFCs themselves to be blamed for non-acceptance of their recommendations? The paper also examines the quality of SFC reports from the point of view of their implementability and finds that at times state governments are constrained to implement these recommendations on the grounds of poor quality of SFC report.

Karnataka has consistently devolved the highest…

Lots of other interesting points in the paper.

The persistence of caste in Indian business

May 1, 2019

Mint edit points how caste continues to matter in Indian business, The edit is based on this paper by team of 4 economists.

A research paper titled Firms Of A Feather Merge Together: Cultural Proximity And Firms Outcome by scholars of Indian Institute of Management Bangalore and Pomona College, Claremont, California, has revealed that a disproportionate number of mergers and acquisitions (M&A) occur between businesses whose directors belong to the same caste group. The report, which took up 1,200 M&A deals in the country for analysis, also delves into the mechanism that makes endogamous deals more likely. Not only is information shared more smoothly between caste-proximate firms, their directors tend to place a higher value on the outcome of such a merger. To those who see business as a caste-neutral meritocracy, this is an eye-opener.

A crucial point made by the study is that caste-proximate deals see a significant reduction in value compared to caste-distant ones. In other words, businesses are harmed by in-group mergers. That a policy of caste diversity is always better for profits, however, cannot quite be inferred from this. It could well be the case that identity blindness, which ought to bring about diversity, holds the key. Several observers had expected the forces of private enterprise and free market competition unleashed by liberalization to loosen the hold of caste on commerce. Indeed, millions of Indians found work beyond the traditional occupations ordained by their lineage, but even a cursory look at any list of India’s business elite since 1991 shows the sustained dominance of a caste group that has been in this profession down the ages. This is so even of new-age markets to an extent. The role of nature versus nurture in this remains contested, though the latter seems far better backed by academic research.

What’s woefully underexplored by economists is what the prevalence of caste implies to the Indian economy. A basic premise of the free market model is the absence of entry barriers—not just for firms keen to enter markets for goods and services, but also for people pursuing career options. In theory, companies that are under the pressure of competition to perform would want to hire workers in a way that maximizes the productivity of their workforce; a caste bias would probably stymie the cause of corporate efficiency. None of it may be overtly or even consciously done, but the effects of such a tendency could add up. Caste, thus, would result in an inefficient allocation of human resources across the economy. On this reading, the expectation that a shift towards capitalism would dissolve the unofficial rigidities of our labour market may have been wildly optimistic. For India to achieve its economic potential, the identity of individuals needs to matter less and less.



Estimating forecasting errors in Kerala budgets

May 1, 2019

Research by Ruzel Shrestha and Lekha Chakraborty of NIPFP:

Our paper analyses the subnational public finance practices in one of the States in India –Kerala- and estimate the fiscal marksmanship. Fiscal marksmanship is the analysis of fiscal forecasting errors. Kerala, though well known for its achievements in human development outcomes, is facing fiscal stress within the rule-based fiscal framework and innovating policy tools to achieve a revenue-led fiscal consolidation.

We have examined the Budget Estimates, Revised Estimates and Actuals for the macro-fiscal variables from Kerala State Budgets, for the period from 2011-12 to 2016-17 to analyse deviations between the projections and actual realizations. We found that the magnitude of forecasting errors
was significant in case of tax revenue.

While partitioning the sources of errors in the budgetary forecasting in Kerala, we observed that the random components of the error were larger than the systematic components for all the macro-fiscal variables, except for grants, own revenue and capital expenditure. This has three macro policy implications.

One, the volatility in intergovernmental fiscal transfers can affect the stability of finances at subnational level. Two, the State needs to identify innovative policy tools for Additional Resource Mobilisation (ARM) to maintain the human development achievements.

Three, within the rule-based fiscal framework, State has to innovate financing strategies for strengthening growth-inducing capital infrastructure formation.


History of the Swadesi soaps: Godrej No.1, No. 2 and Vatani…

April 30, 2019

Interesting piece by Himani Chanda in The Print.

She tells us how Godrej entered the field of soap making and used the swadesi appeal to sell their products:


When RBI Played Angel Investor To India’s Early Financial Institutions

April 29, 2019

Last week, RBI transferred its stake in NABARD and NHB to the Government. Now RBI just has three subsidiaries on its balance sheet.

However, there is a long history of how RBI played the role of VC in developing India’s Financial Institutions of different kinds. Perhaps RBI is of the few central banks which are unique in this aspect.

My BQ piece (behind paywall) tracks this interesting journey, which is one of several in RBI’s history.

Public sector banks (PSBs) are more efficient than private sector peers in labour cost efficiency

April 24, 2019

K. M. Neelima, Radheshyam Verma and Preeti Asthana (research intern) of RBI in this paper (in Apr-19 Bulletin), estimate the labour cost efficiency of Indian banks:

The shift in emphasis from brick-and-mortar operations to digital modes, coupled with increasing per employee output, suggests an improvement in the labour cost efficiency (LCE) of Indian banks.

Using Data Envelopment Analysis (DEA) for the period 2005-2018, the results presented in this article show that LCE has not improved. Public sector banks (PSBs) turn out to be more efficient than private sector peers, reflecting deceleration in employment growth as also cost cutting through innovative techniques. Furthermore, large banks are found to be more efficient than small banks as they can reap economies of scale.

This finding provides an additional rationale for recent mergers of banks, both amongst PSBs and PVBs and suggests that further avenues of consolidation in the banking sphere may be explored.

Quite surprising to read that PSBs have done better than private counterparts on labor costs.


Tracking churning in Indian capitalism via the history of BSE Sensex

April 23, 2019

Another nice piece by Niranjan (Cafe Economics):

The Indian equity market was in the midst of turmoil a hundred years ago, as the speculative boom after the end of World War 1 ended. The colonial government set up a committee in 1923 to take a closer look at the operations of the Native Share and Stock Brokers’ Association of Bombay, aka the Bombay Stock Exchange. The report of the committee has data on perhaps the first index of tradable securities — dominated by textile companies — with July 1914 prices as the base. “Considerable difficulty was experienced from the absence of daily official lists … It is desirable that the Bombay Stock Exchange should publish daily official lists on the lines of the London Stock Exchanges and similar exchanges. Where considerable fluctuations take place it is desirable that the opening, closing, highest and lowest prices should be known,” the committee members complained in their report.

Such a lack of basic price information is worth recalling at a time when a lot of attention has been focused in recent days on the fortieth anniversary of the benchmark BSE Sensitive Index (Sensex). As Narendra Nathan pointed out in the Economic Times, the Sensex was set up only in 1986, though its base is 1979. The Reserve Bank of India constructed an index of traded securities in 1949, but Indian investors had to wait till 1986 for a credible daily gauge of market movements.

The list of 30 companies that make up the Sensex have changed since 1986. The changing composition of the benchmark index offers interesting clues about the changing nature of the Indian corporate sector.

The first iteration of the Sensex was dominated by the Tata Group. There were as many as six Tata companies in the index — ACC, Tata Power, Tata Steel, Tata Motors, Voltas and Indian Hotels. The extended Birla Group had another five — Century Textiles, Grasim, Indian Rayon, Hindalco and Hindustan Motors. The Sensex now is less dominated by a few groups although there are still three Tata companies in the list.

There has been a lot of churn in the Sensex over the decades. Corporate power in India seems to be more fragile than usually understood. Only a handful of companies such as Tata Motors, Hindustan Unilever, Mahindra & Mahindra, ITC, and Larsen & Toubro have managed to hold their place in the index. Many of the older industrial houses such as the Thapar group, the Walchand group and the Kirloskar group have slipped out of the benchmark index. Even the real estate and infrastructure giants who had a strong presence in the Sensex a decade ago — Jaiprakash Associates, Reliance Infrastructure and DLF, for example — are no longer in the index.


The changing composition of the Sensex tells us two big stories — of the rise of a new generation of Indian firms as well as the shift from manufacturing towards services.

Lots of business and economic history in the piece….Read the whole thing…

What explains India’s farm distress? Demand or Supply?

April 19, 2019

Hrish Damodaran had earlier written a piece on how India was suffering from an oversupply in case of food supplies leading to decline in prices. This was used to explain the current distress in farm not just by Harish but several others.

Rosan Kishore in HT provides a rebuttal to the narrative. He says it is not a case of oversupply but of decline in demand. This is just like Keynes arguing his case for Great Depression as well!:

In an article published in The Indian Express on 18 April, Harish Damodaran has argued that “production glut, not dearth of cold storage and processing infrastructure, is the real cause of farm distress (in India) today”. The argument, if true, has serious ramifications for Indian agriculture. This is because it suggests that the only way to deal with farm distress is to reduce agricultural production in the country.

This is an interesting argument, but does it have a macroeconomic justification? The article cites problems of potato and sugar cane farmers in some districts of Uttar Pradesh, but such anecdotal evidence may not warrant the radical inference. Indeed, such an argument focuses almost entirely on supply side factors without looking at demand side issues. And two, it does not recognise the fundamental asymmetry which characterizes global agricultural markets.

Whether or not a particular commodity is in excess supply in a market also depends on the level of demand for it, which is a function of many things including purchasing power and preferences. For example, if all billionaires were to vanish from the world tomorrow, we would suddenly have a glut of private jets. Similarly, if the number of billionaires suddenly doubled in six months, there would be a severe scarcity for these jets. Both of these situations can arise without any change in the supply of private jets in the world.

What many commentators do not realise is that demand for food also varies drastically among countries. This becomes clear by a comparison using the data published by the Food and Agricultural Organisation (FAO). The relevant category to look at in the FAO database is per capita supply of food items.

India is nowhere close to reaching peak food consumption levels in the world. This (price crash for food items) could have happened if mass purchasing powers have come under squeeze in the recent period. Unfortunately, there is no consumption expenditure data to accept or reject this claim. The recently leaked findings of the National Sample Survey Office (NSSO) employment survey did suggest that the Indian economy has fared badly on the employment front. If these findings are true, there is bound to have been a negative impact on mass purchasing powers. To be sure, farm incomes have also suffered in India due to the adverse turn in international food prices, which have brought down export opportunities and earnings and also created problems for crops such as sugar cane.

Also, agrarian distress is not something which has suddenly appeared in India in the past couple of years. Viability of the average Indian farmer has been in crisis for a long time now. What many people do not realise is that this is not a problem which is unique to India. Even in a country like the US, where farming is extremely mechanised and practiced on very large farms, prices cannot cover the cost of production for important crops such as wheat and cotton. Statistics from the United States Department of Agriculture show that the difference between value of output and total costs has been continuously negative in the US.


RBI’s MPC member also supports rate changes other than in multiples of 25 bps..

April 19, 2019

RBI Governor Shaktikanta Das created interest and debates over why central banks need to change policy rates in multiples of 25 bps.

SK Ghosh of SBI pointed to evidence from China where rates were changed in non-multiples of 25 bps.

Further, in RBI MPC minutes of meeting held on 7-Apr-2019 were released yday. One of the members, Prof Ravindra Dholakia said:

As per the mandate given to the MPC, under such circumstances, we need to give a sustained boost to the economy. I, therefore, vote for a change of stance from neutral to accommodative with a 25 bps cut in the policy repo rate, though I would have preferred to cut it by 35-40 bps this time.

The discussions seem to have started in the MPC itself…

Prof Dholakia also calls core inflation as ‘so-called’:

I have been consistently arguing that unless the real growth exceeds 8-8.5 percent per annum, the output gap reflecting the unemployment gap in the economy is not likely to close. Till that point, there would be downward pressure on the labour market and market determined wages and thereby on the so-called ‘core’ inflation.



Will Vijaya Bank merger sway electoral results in Dakshin Kannada?

April 18, 2019

The Central government ignored the protests of people of Dakshin Kannada over merger of “their Vijaya Bank” with Bank of Baroda.

Vikram Gopal reports that the ruling party will face ire of the Bunt community of the region, which formed Vijaya Bank :

In the village of Machina, about 50km from the city, a fresh coat of plaster on the board outside a Vijaya Bank branch announces that it will henceforth be called Bank of Baroda. Resident H Subbayya Shetty says it is hard to digest the fact that the bank he worked in for 34 years is losing its identity. Shetty began his career as a clerk and retired as the managing director of the bank’s housing finance department. He was also leader of Vijaya Bank employees’ union.

Over its 88-year history, the bank came to symbolise the pride of the Bunt community, starting from the pre-Independence days. In the 1970s, when the community’s lands were redistributed to tillers as part of land reforms, the bank helped the Bunts transition out of the agrarian economy.

The government mandated a merger of the public sector Vijaya Bank and Dena Bank with Bank of Baroda on April 1, to create a more competitive financial institution. It has now turned into an emotive community pride issue in coastal Karnataka — where five of India’s prominent banks were founded in the first half of the 20th century, a fact acknowledged by Prime Minister Narendra Modi at a recent rally here.

Protests were held in the region condemning the merger. The Congress is trying to cash in on the issue in Dakshina Kannada, a seat that has been the stronghold of the Bharatiya Janata Party since 1991 and which will go to the polls on Thursday, along with 13 other Lok Sabha constituencies in the state. Congress candidate, Mithun Rai, is a member of the Bunt community as is the sitting BJP MP Nalin Kumar Kateel.

Rai says the issue is important because the community feels a sense of loss. Kateel, in turn, argues that the merger was initiated by the previous United Progressive Alliance (UPA) government led by the Congress.

A major chunk of the community has supported the BJP over the past three decades, said Vijay Prasad Alva, secretary of the Federation of Bunts Associations. However, this time around there was disenchantment against two-time winner Kateel, because of his failure on this front. “Kateel should have tried to put forward the community’s concerns on the matter,” Alva said. This though would not automatically translate into support for the Congress, Alva said, because the disenchantment was against the political class as a whole.


The merger has been challenged legally with petitions pending before the Supreme Court. Dinesh Hegde Ulepady, a lawyer involved in the case, said the merger felt cruel “because the Bank of Baroda and Dena Bank were making losses and Vijaya Bank was turning in a profit”.

However, the real letdown, according to Ulepady, was the apathetic attitude of the major political parties. “It is not enough to hold symbolic protests,” he said, adding that there are two petitions before the SC, one challenging the failure to nominate bank employees on the board, which predated the merger. “The other is a petition challenging the merger itself,” he said.

This is Dakshin Kannada region for you. As the late Dr Thingalaya explained to me, there is enormous pride in the region over their banks. There is a reason why people are so effected by this merger and loss of identity as the region’s 5 banks are their identity.

It will be interesting to see the election results in this region. After all it is perhaps a unique moment in banking history that it could influence election results too…


A debate on the regulatory ambit of a central bank: RBI is not alone in the battle

April 17, 2019

My new piece in Mint newspaper.

The Supreme Court recently called RBI’s circular on banking regulation as “ultra vires”. In the article, I bring insights from a recent speech by Ignazio Angeloni, Member of the Supervisory Board of the ECB. Mr Angeloni mentions that one of ECB’s proposals to increase bank capital was also questioned by European Parliament! Thus, there are parallels with Indian case. Mr Angeloni raises the debate further arguing for Supervisory independence much like monetary policy independence.

Monetary Policy Transmission in Financial Markets: Evidence from India

April 16, 2019

Edwin Prabu (of RBI) and Prof Partha Ray  in this EPW paper:

In the Indian context, a key question is addressed: What has been the influence of monetary policy on different segments of the financial markets? Constructing a structural vector autoregressive model with the monetary policy rate, the pattern of monetary transmission to financial markets is examined over three distinct periods of regime changes in the Indian monetary policy and liquidity management framework. The empirical evidence indicates that there is sufficient period-specific transmission of monetary policy across the different segments of the financial markets. While the transmission of monetary policy to the money and bond markets is found to be fast and efficient, the impact of the policy rates on the forex and stock markets is limited.

Policy implications:

Monetary transmission is often implicitly seen to be a two-stage process whereby in the first stage monetary policy affects the different segments of the financial markets, and in the second stage, the impact of the financial markets gets transmitted to the real sector of the economy. The present paper looks into the first stage of this process.

Our results indicate that the impact not only varies across different segments of the financial markets, but it is also sensitive to the operating procedure of the monetary policy. Expectedly, our results find the primacy of the call rate in the money markets and are in consonance with the official RBI stance of treating the weighted average of overnight call money rate as the operating target of monetary policy. In particular, there is differentiation in the monetary policy transmission to the financial markets in India, being faster and persistent for the call and bond markets, to the least impactful for the forex and stock markets.

As far as the periodicity the transmission is concerned, in the first period (April 2005 to April 2011), the positive shock to the repo rate did not have any impact on the call money, while in both the second (May 2011 to June 2016, when the liquidity framework was fine-tuned with a clear operating target and introduction of term repo) and the third (July 2016 to December 2018, following the introduction of flexible inflation targeting) periods it was found to be quite high.

As already indicated, these impacts are the first stage impacts of monetary policy on financial markets. As is well known, monetary policy works through the Wall Street but wants to influence the Main Street ultimately. How can we link this story of financial markets to the real sector? This question remains unanswered in this paper and constitutes the agenda for further research.


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