THE WAY
FORWARD
An institutional framework
is needed to deal with
bankruptcy of financial
services companies.T
he growing financial
services industry in
India, with large play-
ers that include insurers,
pension providers and
mutual funds,
needs a bank-
ruptcy code. The
Financial Resolu-
tion and Deposit Insurance
(FRDI) Bill was earlier
junked because depositors
raised a concern, but the
recent debacle of IL&FS
and Dewan Housing Fi-
nance makes a strong case
to revisit the code, which
lays down the framework
for taking financial services
firms to liquidation.
Second, the regulators
should identify the too-
big-to-fail institutions insub-sectors like insurance,
mutual funds, capital mar-
kets, HFCs, micro-finance
institutions (MFIs), etc,
because the interconnect-
edness between financial
institutions has increased
manifold. Remember the
US had to bail out insurer
AIG with tax payers’ money
after the 2008 crisis. Many
suggest that the RBI should
encourage large NBFCs
to convert into banks. In
her Budget speech, the
Finance Minister referred
to revisiting the Develop-
ment Finance Institution
model of financing long-
gestation projects. This
could partly solve the asset
liability issue but building a
strong bond market is yetanother critical element.
“The RBI or some other
institution should become
a market maker for build-
ing the bonds market,”
says Niranjan Hiranandani,
Co-founder and MD of
Hiranandani Group.
The NBFCs should also
follow prudent business
practices. HDFC Ltd, for
example, has achieved
growth, profitability,
balanced asset liability
management and a strong
balance sheet. “Perhaps, a
combination of experience
and adhering to our risk
appetite held us in good
stead,” writes Deepak
Parekh, Chairman of the
NBFC, in a letter to share-
holders.COVER STORY> LIQUIDITYrowing to bridge fiscal deficit, private investment was
suffering. But the government’s proposed 60,000- 70,000 crore sovereign global bond issuance to partly finance its7 lakh crore borrowing would certainly pro-
vide some relief to the domestic market. Experts suggest
that the pressure on interest rates would ease, there will
be better transmission of policy rates and also leave do-
mestic savings for the private sector.
SYSTEM LIQUIDITY DEFICIT
A broken credit system, decline in deposit growth, and
a falling domestic savings rate all reflect in the liquidity
crunch. The liquidity in the system was in a deficit mode
since July last year, peaking at `1 lakh crore in Decem-
ber last year. This showed that banks were not getting
adequate liquidity from the RBI window for their daily
mismatches (see graph: Currency: Inadequate Cur-
rency in Circulation), which affected money flowing
from banks to NBFCs and to other key sectors of the
economy. The other two factors that also contributed to
liquidity deficit are currency in circulation post-demon-
etisation and the intervention by the RBI in the foreign
exchange market to protect the rupee’s value against
the US dollar. For instance, currency in circulation in-
creased from `13.35 lakh crore during the demonetisa-
tion year 2016/17 to `21.36 lakh crore in 2018/19. The
currency with public, which used to be around `1 lakh
crore for each of the five years before demonetisation,
has jumped to `4.95 lakh crore in 2017/18 and `2.92
lakh crore in 2018/19. Chari of Quantum says that the
currency in circulation has followed a seasonal pattern
for decades, but not so last year.
Outflow of dollars and the consequent pressure on
rupee value against the US dollar has been another part
of the puzzle. “The RBI had to intervene with over $30
billion to protect the rupee’s value at a particular level,”
says a forex dealer. This intervention actually meant
selling dollars and absorbing the rupee liquidity from
the market.
In addition, the general elections, too, absorbed
some liquidity, while government balances with the RBI
increased because of a slowdown in its expenditure as
the Model Code of Conduct kicked in.
Some question whether the economy was fed with
less cash post demonetisation to meet digitisation ob-
jectives? One view is that the currency in circulation
has always been 12 per cent of the nominal GDP. If
one takes the nominal GDP of `190.10 lakh crore in
2018/19, the currency in circulation should be `22.8138 IBUSINESS TODAYIAugust 11 I 2019“There is also a sentiment play
to liquidity. There have been
surprises (defaults) and more
surprises in quick succession”JASPAL BINDRA
Executive Chairman, Centrum Group