ECONOMIC HIGHLIGHTS

New Delhi, 22 December 2005

Banking Sector

Gearing up to Emerge Stronger

By Dhurjati Mukherjee

Indian banks are set to play an even more important role in the country’s economy. At the recent BanCon 2005, the Finance Minister said that banks’ contribution to national income (GDP) would have to increase from 25 per cent to 50 per cent in the coming years. This would only be possible by raising the size of the banks.

Chidambaram was optimistic that the average rate of return on capital has been 32.8 per cent for Indian banks compared to 16 per cent in China and 19.9 per cent in Singapore. He has been urging for quite some time the need for consolidation among banks.  He pointed out that only 22 Indian entities figure in the top 1000 banks of the world. State Bank of India ranks 83^rd; in Asia, however, its position is 11^th among the region’s top 25. The largest bank in China, six times as large as SBI, has grabbed the 11^th spot among the world’s leading banks.

The consolidation of Indian banks has raised a controversy and most unions have not accepted the idea. Gurudas Dasgupta, M.P. and General Secretary of AITUC, has rejected the idea on the ground that monopolistic growth in the banking sector was not needed and thus not welcome.

Meanwhile, McKinsey has drawn up a dream picture of the Indian banking industry in the year 2010. The sector is expected to employ 1.5 million people and the loans to GDP ratio would be more than 100 per cent. It will, however, need investments of around $600 billion as also certain regulatory changes. The market capitalization of the banking industry is expected to grow from Rs.1700 billion at present to Rs.7500 billion by 2010. A growth rate of 20 to 25 per cent has been envisaged which, judging by current trends, may not be too optimistic a projection. But this may require mergers between private sector and public sector banks for greater consolidation, toeing the line of the Finance Minister.

Though consolidation of banks may have its proponents and opponents, it is a fact that the Indian banking sector has a stronger financial profile than Chinese banks or for that matter banks in most Asian countries, according to a study by Standard & Poor’s (S&P) and its subsidiary CRISIL. In its report titled Indian Top 20 Banks, the two agencies have concluded that Indian banks are stronger on key fundamentals, including credit quality, pre-provisioning profitability and capitalization. Yet, the credit ratings on Chinese banks are higher because of the readiness of the Government to provide substantial resources through capital injections and the sale of the banks non-performing assets to Government-owned asset management companies.

Though the two banking systems share certain attributes such as operations in high-growth environment, the Indian system is subjected to relatively tighter restrictions on foreign ownership and other matters. In both these nations, the state-owned banks dominate the sector, accounting for 70-75 per cent of financial assets in India and 55-60 per cent in China.

It is being argued, and quite justifiably, that to meet the large infrastructure projects banks have to grow in size. The financing needs for infrastructure development are high and banks could play a vital role in financing such investments, whether in power, roads or telecom sectors. According to the Finance Minister, Indian banks require $11 to 12 billion of Tier-I capital. Keeping this in mind, the Government has moved to liberalize banking laws and the Reserve Bank of India is framing guidelines that will enable banks to raise capital through hybrid instruments.

Indian banks appetite for capital is expected to drastically increase over the next five years to meet the huge demand for credit. Moreover the implementation of Basel II standards is also expected to exert pressure on capital requirements. It has been estimated by various sources, including the Finance Ministry and also J. P. Morgan that over Rs 55,000 to Rs 60,000 crores might be required by banks over the next five years.

Meanwhile, the Government is serious in implementing banking sector reforms and helping the PSU banks to emerge big and strong. Long back, the Reserve Bank of India had suggested the need to impart flexibility for changes in ownership, help mergers/acquisitions, improve corporate governance and motivate the work force so as to improve the functioning of these banks to international standards.

Amalgamation of two public sector banks even without changing their ownership or character and allowing them a better chance to become an Asian champion should be encouraged. In fact, banks need to incorporate changes in their functioning and adopt themselves to the changing economic environment as also the changing demands and needs of the customer.

Technology is an area where more attention needs to be given in the banking sector and this was emphasized by the chiefs of State Bank of India and HDFC Bank at the recently held Infocom 2005 at Kolkata. In this connection, the SBI chairman announced that it has tied up with the TCS to form a joint venture company, C-Edge Technologies with an authorized capital of Rs 40 crores, to provide technology platform for regional rural banks and co-operative banks in the country.

Indian banking has undergone a paradigm change and, in the coming years, it will have to cope with fresh challenges, especially in increasing efficiency and adoption of modern trends of e-banking, as also in making available more credit to the country’s economy. The diversified requirements of a high-growth economy would have to be kept in mind for which the banking industry has to step in with the required resources, especially at such a juncture when the GDP is poised for an 8 per cent growth. However, repayment would have to be strictly ensured so that profitability of the banks is not hindered.

From current trends, the top 10 banks are poised to grow at a fast rate to cope with the competitive dynamics of the present day market. However, this would not be enough for a country of India’s size and dimension and, as such, amalgamations would be necessary to add strength to middle-level banks. ---INFA

 (Copyright, India News and Feature Alliance)

ECONOMIC HIGHLIGHTS

New Delhi, 15 December 2005

Revenue Shortfall, But……

No More New Taxes,  Plug  Loopholes

By Dr.Vinod Mehta

The economy is buoyant, yet the total revenue collections this financial year again may fall short of the expectations.  This has almost become an annual feature now. The economy keeps growing and so does the deficit, while the revenues do not increase in the same proportion as the economy grows. The shortfall in revenue collection ultimately affects social spending and development of infrastructure. It is being apprehended that the Finance Minister may raise the indirect taxes or may bring in more transactions under the tax net: For instance, it is reported that the Finance Minister is thinking of bringing some more financial services in the ambit of tax. But that will not solve the problem.

There could be a number of reasons for shortfall in revenue collection, which may vary from year to year like recession in the industrial sector or shortfall in agricultural production. But one factor that has been constant for the last five decades is the tax evasion. There are so many loopholes in the tax system that allows people and organizations to evade taxes with impunity.

There are no reliable estimates of the extent of tax evasion in this country.  But available studies on black money show that the size of such money has grown significantly over the past many years.  If this tax evasion were checked, the Finance Minister would never be faced with shortfall in tax collection and would have a very low or zero deficit.  Therefore, the Finance Minister instead of resorting to increase in tax rates, bringing in more transactions under the tax net or coming out with amnesty schemes, should find other means to increase the revenue collection.  One such way is to plug the loopholes, which encourages tax evasion.  The current budgetary exercise may address this question.

Tax evasion is there almost in every country. But the degree varies.  Most of it occurs when transactions are done in cash and never recorded.  This has been the experience of many countries.  So, some of them have come out with measures that discourage cash transactions and encourage recorded transactions.  One such mechanism has been the use of debit and credit cards combined with payment through banking mechanism.  The use of credit and debit cards is increasing in India and needs to be further encouraged.

It has been reported that the Republic of Korea has been using debit cards and credit cards very effectively to curb tax evasion.  The South Korean Government allows 10% rebate in taxes if the payments are made through credit/debit cards.  This is an idea which needs to be adapted to Indian conditions. The Finance Minister should come out with such a provision, which encourages cashless transaction.

As a first measure it may be made mandatory that all salaries above a certain amount, say,  Rs. 10000 per month, both in the public and in the private sectors, be directly credited to individuals’ accounts in their respective banks.  Secondly, payments above a certain amount may also be made mandatory through debit/credit cards and through cheques or bank drafts. It is better than taxing money withdrawals. With electronic banking gaining importance, transfers through banking mechanism will become as easy as receiving or making payments by cash.  In most of the countries the use of debit and credit cards for making and receiving payments has reached a point that for buying even one small ball pen payment is made through credit/debit card.

Similarly, the payment for the sale and purchase of immovable property, various kinds of consumer goods and services beyond a certain stipulated amount should also be made mandatory through banking channels.  While doing so the Finance Minister will not only be plugging one of the biggest loopholes leading to tax evasion but would also reduce the need for ready cash and hence the printing of currency notes on a large scale.

The biggest chunk of black money is invested in real estate and gold. The circulation of black money in the housing sector is beyond someone’s imagination. Since the house tax is based on the current purchase price only one fourth of the money is paid by cheque  and the rest in unaccounted cash. Even the honest buyer of flats/houses is forced to pay in black money to acquire a flat or a house.

Additionally the Finance Minister by encouraging use of plastic money for purchasing foreign currency for making payments abroad would also be curbing hawala racket that has been responsible for all the illegal and terrorist activities in this country.

As the debit and credit cards are now becoming important, the Finance Minister had wisely relaxed last year the rules pertaining to the purchase of foreign exchange by individuals and organizations.  Since the money in foreign exchange can be withdrawn by an individual in any part of the world from its own personal account, or make payment for goods or services purchased abroad against debit/credit card, it will immediately get recorded automatically.  If the money so withdrawn is up to the limit laid down by the RBI no question need be asked.  However, if the money so withdrawn in foreign exchange exceeds the amount laid down by the RBI only then the person may be asked to inform the RBI as to the purpose for which the foreign exchange was used.

The tax amnesty schemes in the past have not been helpful in checking tax evasion and curbing the black money in this country.  It has only punished the honest tax payers. So long as cash transactions continue to be made tax evasion will continue to be there and black money will continue to be generated.  It is high time the Finance Minister starts thinking in terms of developing mechanism to encourage recorded transactions instead of cash transactions. With computers all around, it would be much easier to administer cashless transactions rather than cash transactions and thus check tax evasion to a significant extent.

It appears that the Income Tax Department has already done much of the homework and it is being made mandatory to quote PAN number while making deposits above a certain amount.  But this needs to be followed rigorously. There should not be another tax amnesty scheme. But the Finance Minister’s emphasis should be on checking the growth of black money and penalize the tax evaders.

Also, efforts should be made to do something to reduce stamp duty, property taxes as well as other kinds of taxes to encourage recorded transactions.

 (Copyright, India News and Feature Alliance)

ECONOMIC HIGHLIGHTS

New Delhi, 29 November 2005

Economy on Upswing

Sustaining High Growth Rate

By Dr. Vinod Mehta

India’s economy is enjoying a high rate of growth for the past few years, despite not-so-good performance of the agricultural sector. The current rate of growth is around 7% with the manufacturing sector booming. The agricultural sector is also expected to perform well. The Finance Minister feels that this growth rate can be pushed to 8% provided we increase investment as well as push FDI. The Deputy Chairman of the Planning Commission feels that this growth rate can be pushed to 10% but the coalition politics is coming in the way.

The economy is on the upswing. It is not only the computer software sector but the traditional manufacturing sector like steel, cement etc., which is leading the upswing.  The economists believe that the upswing in the manufacturing sector will continue.  The National Council of Applied Economic Research has already projected the GDP to grow by about 7% during the next three years.  The manufacturing sector is expected to grow by more than 6.21%, infrastructure by 6.54% while mining and construction by 5.89%.  The farm sector which saw a decline of 3.1% in 2003 is expected to grow, which in business terms implies increased demand for manufactured products in the coming years.

Apart from this, the economic reforms of the past one and a half decade have made the Indian industry by and large competitive in the international market.  With foreign exchange regulations being relaxed in a phased manner, the Indian industry is acquiring manufacturing units abroad.  Some have started acquiring new technologies to stay competitive.  For instance, the Indian motor parts manufacturers were initially opposed to the inclusion of motor parts in the FTA (free trade area) between India and Thailand, but now when it has been signed, they are now scouting for new processes and technologies in the South East Asian and other countries.

At the moment, India and China are enjoying relatively high growth rates China around 9% and India 7%.  This has particularly attracted the attention of foreign investors who wish to set up manufacturing bases in India or invest in the service sector.  This is high time that we have a foreign direct investment (FDI) policy which covers all the sectors of the economy, except for those sectors where the state feels that there should be no foreign investment, as in the case of atomic power.

Foreign direct investment in the manufacturing, infrastructure and other sectors of the economy is much better than commercial borrowing or investment in scripts by foreign institutional investors.  The investment by foreign institutional investors (FII) could be considered as hot money which can be withdrawn by them at any time depending upon their judgment of the economic scene.  The FDI in manufacturing, infrastructure etc. leads to the creation of assets which will remain within the territorial boundaries of the country if, the foreign investor wishes to withdraw from the company for some reasons.

At the moment there is no single policy on FDI and there is some kind of ad hocism in it.  It varies from sector to sector.  In insurance business, the FDI cap is 26%; in the banking sector   been set at 74%; in certain cases 100% foreign equity is allowed while there is automatic approval in some cases where foreign equity participation is up to 51%.  There are certain areas like real estate where no FDI is allowed at the moment. 

Moreover, foreign companies are not as yet allowed to take over sick companies.  There are a number of them in the textile sector, bicycle manufacturing sector or there are individual public sector undertakings like pharmaceuticals and photo films which could be allowed to be taken over by foreign companies with salutary effect.  This will not only bring in new technology and new management system but also turn them into profitable units.

In the past the Foreign Investment Promotion Board (FIPB) has been a big failure in attracting  foreign investment.  As early as in 1997, while speaking at the plenary session of the Economic Summit, organized by the CII and World Economic Forum, the then Industry Minister  observed: ”Foreign funds can find their own direction.  It is my personal opinion that the FIPB must go.  There should be no Central interference in matters related to inflow of investment.” Last year  an Investment Commission was set up to advise the Government on FDI, while the role of FIPB was changed. But the observations of the former Industry Ministry on the FDI are still relevant.

Sometime back  the Department of Industrial Policy and Promotion (DIPP) is already reported to have made a proposal  to allow a maximum of 76% stake in the form of FDI across all the sectors, including the real estate.  This is as good as 100% FDI as it will allow full management control to the foreign firm. But at the same time it will also be obliged to disclose its financial results; at the moment 100% owned foreign companies are not expected to make any disclosures.

The other feature of DIPP proposal is that the balance of 24% equity would have to be sold to the Indian public.  It means that the Indian investor will be allowed to share the prosperity of the foreign firm.  But it is much more than that—24% equity to Indian public means that the liquid stock (shares that are regularly bought and sold in the share market) will grow which is not only good for the stock exchanges but also for the widening of the share market.  It may also have positive impact on mutual funds and the proposed pension funds.

If we can have such a policy as proposed by the DIPP with suitable modifications, one can expect a large inflow of FDI into India.  The timing is very important;  and that time is here! The economy has finally come out of the Hindu Growth Rate (about 3%) and FDI can provide the necessary push.

It may be mentioned that not only the developing countries but also the developed countries are looking for opportunities to increase inflow of FDI.  A study prepared by the FICCI three years ago stated that countries like Germany and France still allow investment allowance or accelerated depreciation to foreign direct investors.  China grants 10-year tax incentive to promote firms engaged in infrastructure, energy sector and knowledge industry.  South Korea provides special incentives for capital investments. Countries like the Netherlands, Denmark, Belgium, Spain, Switzerland, Luxembourg provide tax incentives; they follow the concept of group taxation.

If India encourages FDI it will not be doing something unusual or against its own interest.  The FDI in the current context would mean creation of assets, creation of more jobs and competitive economy; it is also likely to contribute significantly to the exchequer in the form of direct and indirect taxes. Therefore, the Left parties as well as opposition parties should have a realistic approach to FDI and should welcome it in almost all the sectors, including real estate and retail except for certain sensitive areas like atomic energy.

(Copyright, India News and Feature Alliance)