Policy Fallacy in Indian Microfinance

A snippet on State Intervention and the resultant Mockery

Financial inclusion and access to finance has been one of the large failure stories of the Indian state intervention. India’s policy thrust for financial inclusion has always been well intentioned with the apex bank pushing for easy capital availability through a slew of policy initiatives; however capital delivery has consistently evaded the target segments. While the Regional Rural Banks have failed to grow without sponsorship of large state owned banks, priority sector lending initiatives have largely been conducted as a top down policy-fulfillment objective rather than a need based bottom up approach. This effectively fuelled the rise of informal sources of finance at costs that have had the exactly opposite effect of achieving financial security, low cost of credit and inclusion.

The Indian private sector after a much wait and watch approach and buoyed by the global success of micro credit loans in the rest of the world stepped in to full fill the role of financial inclusion at an institutional level. Today, India has around 200 million bank account holders and far fewer numbers who access other formal financial services like credit and insurance. A study conducted by the Centre for Microfinance in Andhra Pradesh in 2009-2010 revealed that 93% of the surveyed households were indebted. 75 % of these households were indebted to moneylenders and other informal sources of finance in-spite of fairly high penetration of banking among these households. Micro finance Institutions accounted for 11% of the indebtedness. (Source: Access to Finance in AP, Doug Johnson, Sushmita Meka)

The Indian Microfinance industry (MFI) represented the middle ground between formal financial services provided by banks and informal financial services provided by moneylenders. The industry grew rapidly in the period 2004-2009, with an average increase in number of clients year-on-year being 91%, while the size of micro credit outstanding grew by almost 100% Y-o-Y indicating the massive levels of under penetration to a large part of the Indian population (source: ‘Inverting the Pyramid’, Third Edition, Intellecap Publication). The business models of microfinance also evolved in this period to become businesses which seek capital from the formal sources and lend to the poor at a margin as opposed to the non-profit model earlier.

This period of high growth was accompanied by a barrage of private equity investments chasing established as well as start up microfinance operations. One of the pit falls of the break neck speed at which micro credit grew, was an inherent oversight in capping credit to customer who have borrowed credit from multiple sources. This resulted in multiple refinancing to the same customer resulting in repayment stress and leading to a few cases of personal extremities; an apt calling card for political intervention. Accompanying these events was a two pronged media coverage highlighting (a) the new and seemingly limitless investment & profit opportunity keeping in perspective India’s unbanked population and (b) the anti-thesis to such investments – financial strangulation of the poor. While both arguments had its merits, the second parameter was again an opportune moment for a bit of political mediation. Only, it did not remain confined to a bit.

This period of high growth came to a halt in Oct 2010 with the passing of the Andhra Pradesh Microfinance regulation act. Spurred on by allegations of unfair lending practices and exploitative debt recovery, the AP government, without adherence to what may have been sporadic cases of poor lending, clamped down on the entire microfinance industry in the State. Borrowers across the State sensing social and political sympathy sensed an opportune moment to default thus throwing the entire industry in a tizzy – among others, micro credit leaders SKS Microfinance and Spandana saw serious depletion of their networth and ability to continue. This opened the floodgates of regulation – the Microfinance Institutions (Development and Regulation) Bill 2011 - which was provisionally approved by the cabinet. The bill seeks to handle regulation of MFI's to the RBI and address multiple issues like prudential regulation and registration of MFI's . As per the draft, it would be mandatory for micro finance institutions (MFI) to be registered with the Reserve Bank and have a minimum net-owned funds of Rs 5 lakh. In addition, a Micro-Finance Development Council will be set up to advice the government on formulation of policies, schemes and other measures required in the interest of orderly growth and development of the sector with a view to promote financial inclusion. 

The bill is a classic example of "well intentioned" government intervention in a sector where a market failure has not been conclusively demonstrated. While it provides for certain broad controls and regulation, it fails to answer the question that led to the industry in the first place: what is the policy stance on ensuring credit delivery to the rural and urban poor?

Vinod Kothari, a micro credit securitization expert writes: The word “micro credit” itself is not defined. First of all, there is no monetary limit to the definition of micro credit provided in the law – that is, loans of what amount are “micro credit”, and beyond what amount they cease to be micro credit. Neither is there a definition by reference to who the borrower is - that is, whether loans to rural or urban or both borrowers would be micro credit. It is a surprise how the regulator skipped defining a parameter as rudimentary as this. The cause effect of this will now be regulatory stringency in determining who is a Microfinance NBFC and who is not a Microfinance NBFC – creating another set of regulatory confusion without addressing the core question of how do we deliver cheap credit to the poor.

On another note, the applicability of prudential norms to micro finance institutions also gives away the poor understanding law makers have of MFI's as a business. MFI's unlike thrifts or banks do not incur asset liability mismatches which are very large. The institutions they borrow from are already prudentially regulated and by increasing level of prudential regulation of MFI's the government is increasing the cost of MFI business adversely impacting their capacity to raise credit.

The MFI industry has shown a 20% decline since the AP ordinance. The impact on large MFI's is much more as they have not been able to access credit and they have shrunk in size. As a result, the broader policy questions remain to be asked: What has the regulator done to reign in larger unorganized money lending industry targeting the rural and urban?

While the Central Government’s Credit Guarantee Fund Trust for Micro and Small enterprises (they essentially provide collateral free lending for small sums of money – from zero to Rs.10 Lakhs) is a strong initiative in enabling formal credit to small and tiny enterprises, the Government needs to replicate a similar initiative one step below the tiny enterprises to ensure delivery of affordable credit to the unbanked population – a crucial step in ensuring the delivery of the great Indian demographic dividend.

Bibliography:

(Funding to the microfinance sector: Review of options Guest Article by : Jayshree Venkatesan, CEO, IFMR Mezzanine and Vineet Sukumar, Head, Treasury and Origination, IFMR Capital)

http://articles.economictimes.indiatimes.com/2011-08-13/news/29884306_1_mfis-microfinance-institutions-rbi-deputy-governor 
http://www.moneylife.in/article/experts-concerned-over-new-draft-law-on-microfinance-sector/17968.html
http://www.firstpost.com/business/microfinance-bill-will-do-little-to-help-sks-heres-why-306038.html
http://www.indianexpress.com/news/micromismatch/814369/
http://microfinanceafrica.net/microfinance-around-the-world/india-microfinance-sector-may-decline-20-40-this-year/
http://ajayshahblog.blogspot.in/2011/10/policy-and-legal-review-of-micro.html
http://www.centre-for-microfinance.com/wp-content/uploads/attachments/csy/1602/IIM%20Regulation%20V11.pdf
http://www.microfinancefocus.com/microfinance-institutions-bill-%E2%80%93-bunch-conceptual-and-drafting-problems

Mid-Term Outlook for Metals

Contributed by: Sathyamurthy U, Unifi Research

Global political and economic events such as the sovereign debt crisis and the slowdown in recovery from the last crisis in economically sound countries have rendered the industrial metal prices directionless.   However, copper and aluminium prices have increased by 5.7% and 4.7%  since the beginning of the year.

China, the world’s second largest economy consumes significant share of primary raw materials such as iron ore -60% (of global iron ore trade) , copper – 41 percent, aluminium – 40 percent. Demand outlook for these industrial metals can be explained by import, export and value creation activity in China.

Copper

The metal is currently on an uptrend due to strong fundamentals – supply disruptions due to labor issues in some of the world’s largest copper mines, depleting stocks in LME warehouses, and potential demand supply mismatch.  The following chart shows the monthly import growth of China and Copper prices. (superimposed over one another with same time base). Copper prices have corrected along with the decline in import growth in China. 

Aluminium

A similar trend is seen in aluminium prices during the same time period.  

The impact of slowing imports on GDP is shown in the following chart. The current level of import growth and the corresponding GDP growth are exhibiting similarities to the crisis 2008-09.

The Chinese economy is buffeted by two forces - slow global growth is hurting exports to European union, which is the primary destination for Chinese  exports.  China’s exports have slowed down recently. The domestic consumption due to rise in wages in China might not be enough to make up for the shortfall in foreign orders. (Source – WSJ)

Another problem is the housing prices in China. Government is trying to control prices by making it difficult to finance development of luxury apartments and requiring 60% down payment from buyers.  The low cost housing is not progressing as planned.  These problems will likely have an impact on the GDP growth in China which has already slowed from 10.4% in 2010 to 9.2% in 2011.

Further slowdown in consumption of industrial metals (lower imports) either through slower growth in EU or domestic weakening in the Chinese economy appears likely and will have an impact on metal prices especially copper and aluminium.

Hence my outlook for copper and aluminium is negative.  

Steel

Steel consumption in India has slowed considerably from 14.5% to 2.9% in 1H12, with project offtake slowing down and other macroeconomic challenges cropping up. According to ICRA, 25 MT of new capacity are coming up in the next 18-24 months (30% of current production capacity) and keep the realizations under check despite the weakening currency scenario.

The higher interest payments arising out of the capacity expansions will also decrease margins for steel makers and raise working capital requirements, thereby affecting the liquidity profile of steel companies.  Companies with better capital structures such as Tata Steel  will be able to withstand the competitive pressures.

The major steel consuming sectors in India – construction (65%), capital goods (15%) and automobiles (8%) are witnessing slowdown.  Project offtakes  are affected by land acquisition issues and interest rate scenario.  The near term outlook for steel is weak.  India’s GDP growth rate for Q1 and Q2 FY12 was 7.7% and 6.9% while steel consumption growth for the same period was 2.9%. (Typically steel growth rate is 1.2-1.5 x GDP growth). According to GoI projections of 7.5% growth rate for India in FY12, this will be ahead of steel consumption growth.

Hence the mid-term outlook for steel sector is negative.

Views expressed are personal and do not constitute to the market outlook towards commodities at Unifi. 
Email: sathya@unificap.com

Direct access for foreigners to the Indian stock market - Is the excitement for real??

Glenn Roger Carr, Vice President, Unifi Capital

The Indian Government has made a strong bid to strengthen the domestic markets by proposing to allow Qualified Foreign Investors (“QFIs”) to invest directly into the Indian equity market vide press release dated January 1, 2012 issued by the Ministry of Finance. The proposed new investment route is aimed at providing the much needed stimulus and to improve the sentiment of our markets

Currently, investing through the FII route directly or by going through a sub account of an FII are the only means for foreign individuals or institutions to invest into India.  In August 2011, the Securities and Exchange Board of India (SEBI) had permitted QFIs to invest into mutual fund schemes, thereby providing an indirect way of making foreign investments into Indian equity markets, and that was the starting point of the current policy which we shall carefully analyse

Key Highlights of the Proposed New Regime as provided under the Press Release

1.    RBI to grant general permission (i.e. under the automatic route) to QFIs for investment under PIS route similar to FIIs.

2.    The investment by QFIs would be subject to an individual investment limit of 5% of the paid up capital of the Indian company and an aggregate investment limit of 10% of the paid up capital of the company. These limits are over and above the limits applicable in case of investment by FIIs or NRIs under PIS route.

3.    QFIs would be allowed to invest only through a SEBI registered qualified depository participant (“DP”) and all the transactions would have to be made through this DP only.

4.    DPs would be the ones who would be required to ensure that the QFIs comply with the KYC norms and the stipulated regulatory requirements.

Pros and Cons of the policy

1.      Under the current SEBI (Foreign Institutional Investors) Regulations, 1995 there are stringent conditions imposed on the registration of FIIs and sub-accounts such as if an asset management company or an investment advisor has to be registered as an FII, it has to indicate that it is proposing to make investments on behalf of broad based funds. Further, funds can be registered as sub-accounts only if they fulfill the broad based criteria. Similarly, if an individual wants to register as a sub-account, then inter alia he has to fulfill minimum net worth criteria of USD 50 million. With these conditions not being imposed on a QFI it makes it easy and gives the investor the incentive to register and invest directly as a QFI.

This would allow a large group of foreign investor’s direct access to the Indian equity market instead of investing through FIIs/sub-accounts and at the same time will provide wider opportunity to the Indian companies to raise funds.

2.    If we look carefully at the regulations, it states that the individual limit of 5% and the combined QFI limit of 10% of paid up capital per stock is over and above the FII and the NRI limits that are already in force. This could mean that QFI’s could now buy into stocks that were earlier blocked due to the FII or NRI limit being breached. I would actually think that some of these stocks would see substantial fresh investment into them thus pushing their prices up.

3.   There are questions about whether NRI would be classified as QFI’s? Even though there is no direct mention to the contrary, it is quite clear that the QFI   limits are over and above NRI limits, which could lead us to conclude that NRI’s do not qualify under the new QFI regulations.

4.  The tax treatment for the QFI investment will ultimately decide the success or otherwise of this regulation. While it is quite clear that these investors will not benefit from a zero tax regime( which the bigger players who invested through the FII sub-account route benefitted for many years and continue to do so)it remains to be seen what kind of  tax structure and the method of taxation that would apply to the QFI’s. I do believe that the larger investors would any day prefer their tax benefit to the ease of investing option.

It would only be the smaller foreign investor who invested through the non discretionary route of a sub-account (which is a complicated and costly route to take) who would probably consider this trade off worth taking. In that sense one may not see a rush of fresh investments coming in through the scheme but it could definitely bring in a new breed of investors and widen the base of the current investor profile.

5.    When a guru of the stock market was asked about this new regulation he said that opening just one market does not excite him too much, he went on to say that if one opens the stock market they should open up the commodity and currency market also then only will the big boys be interested to invest large amounts into India. This then clearly is another affirmation that the BIG investments may not line up under the QFI route.

6.    The pessimist may ask why an individual foreign investor should choose India, wont he put his money where his mouth is? And even if we assume that he is a diehard Indian market optimist one would think that he would prefer the easy route of an India ETF which is now available in choice especially in the American markets.  This argument I must confess does hold a lot of weight.

7.   SEBI has stated that one of the objectives of this regulation is to broad base investor bases, improve inflows and make the market less volatile. While the first two objectives are definitely achievable to some degree it is difficult to understand as to how QFI investments will reduce volatility. QFI’s are not lateral thinkers they will think and act like all investors who are driven by greed and fear and in market swings these investors will act like any other thus probably adding to the volatility and not reducing the same. Statistics from the American and British markets also tell us that 90% of the investors are day traders and if they now choose to invest into India there is no reason for these individuals to suddenly turn into long term players.

8.  It would be appropriate to conclude the analysis by looking at one big benefit that the QFI will finally have and that is true beneficial ownership. As a client who invested through the FII or through a sub account the client were merely holders of buy positions in a company and never enjoyed  voting rights and other benefits which they will now be able to exercise as “real shareholders”

It would also be very interesting to study the operative guidelines that SEBI is going to put in place. The qualified DP’s/ brokers  who believe that the QFI segment is a one worth servicing would have to ensure new systems and process( the kyc part of it would be a big challenge-unless simplified), beef up research by a huge margin and also gear up to build their brand, and after doing all this there is no assurance of success.

The QFI has thrown up a lot of debate and discussion and the proof of the pudding will be in its eating, so as we wait and watch for the happenings in the next few weeks like all investors I hope that more than anything this would improve the market sentiment more than anything else.

The author is Vice President at Unifi Capital. Views expressed are personal.

glenn@unificap.com

2012 - Transformational Year? - Focus to shift from Inflation to Growth

Contributed By: M. Ravvichandran, Vice President - Investment Strategy

The previous year turned out to be a nightmare with multiple domestic issues combined with slowing global environment.  What is worrying is the fact that the growth deceleration could spill over into 2012 and perhaps beyond.  As per reports, global growth is expected to slow from 4.2% in 2010 to 3% in 2011 and to 2.5% in 2012.  Considering the false start of FDI in retail and populist measures like Food Security Bill, the domestic policy prospects for 2012 don’t appear good.  Last year, we were discussing about double dip in US economy and possibility of India’s growth overtaking China.  Ironically, today the U.S. is doing satisfactorily and the hot topics are ‘Fiscal Integration in Europe’ and who will slow down more, between India and China!

Although USA may not recover significantly, the recession talk has vanished. European banks will continue to take a hit on their balance sheet owing to their exposure to sovereign debt.  Whether it is a ‘default’ or a ‘managed default’, credit shortage could become a handicap for growth in EU region.  In India, the government has to battle on many fronts.  The first half of 2012 will see concerns about a slowdown gaining prominence over peaking-off inflation.  Most of the leading economists have already revised down the GDP forecast for India to 6.7% for FY12 and 6.6% FY13, well below the government guidance of 7.25%.  This reflects the impact of higher interest rates resulting in slowing investment demand and global uncertainties affecting export demand.  I expect the growth rates to bottom out in middle 2012 on account of rate cuts and base effect.  I also expect the RBI to cut rates by around 200bps in Q2-Q3CY12. At this juncture, inflation is likely to peak off in early 2012.  However, with five states going in for elections in March ’12, I will not be surprised to see price hike in Kerosene, diesel and LPG post-elections.  Further, possible price increase in coal and power tariff cannot also be ruled out. These measures will once again stoke the inflation up, testing RBI’s policy stance. 

Any adverse global economic developments are obviously not in our control. What’s more deplorable is the fact that Indian government has severely fallen short of expectations on the reforms agenda. The problems are well-documented starting from coal shortage to policy paralysis, fiscal slippages and multiple scams.  The market participants don’t have any big hope on the reforms front as any related impact on the economy comes only with a lag.  However, one can hope that the government would be able to manage the fiscal issues without disturbing the rates as slowing economy will pull down the loan demand. Prudent fiscal management coupled with some determined policy decision-making from the political class could help the economy bounce back with a growth rate of around 8% in  FY2014.

What lies ahead?

Cyclical deceleration in growth and policy inertia are the key drivers for the current slow-down in India.  Unlike 2008, the problems now are home grown.  Trading volumes in equity market is at five year low and still declining.  The current bear market has sustained long enough and we have to look out for reasons that can cause a turnaround.  As explained earlier, consensus is also concerned about macro signs with fiscal, current account and rupee spiraling out of control.  Most of the domestic funds and insurance companies are a tired lot with no fresh inflow of funds. 

Though Indian markets look attractive based on P/E multiple, considering the amount of earnings downgrades the PEs may be higher than our current belief.  While markets could rally on rate cuts, the sustainability would depend on investment spending and policy reforms from capital.  As we go in 2012, though the macro picture looks weak, we will probably see raw material prices moderating on the back of a slow-down in China which in turn would help India Inc to improve their gross margins.  Interest cost will peak in next couple of quarters that would help driving below-the-line profits.  In other words, considering the below-expectation profits for December and March quarter, the base effect will provide some sense of optimism that earnings can surprise on the upside during the later part of 2012. Right now, “it’s so bad, it’s almost good”.

As we are in a transformational phase, it is easy to be bearish on India and equally easy to construct a bullish scenario from here-on. Most of the negatives are now well-documented and debated and hence are already reflecting in the price. Given the macro economic scenario, the beaten down stocks and sectors will continue to under-perform at least for next couple of quarters.  A further correction is likely to be in terms of time rather than value and a good entry point is likely to emerge soon. 

The author is Vice President at Unifi Capital, Chennai.  Views expressed are personal. Email: ravvichandran@unificap.com