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Singapore: India’s economic growth slumped to 5% in the fiscal year ended 31 March, the slowest pace in a decade, as high borrowing costs in the face of persistent inflation deterred corporate investment and consumer spending. U.K. Sinha, chairman of the Securities and Exchange Board of India, or Sebi, India’s capital market regulator; K.V. Kamath, former managing director and chief executive of ICICI Bank Ltd and until recently non-executive chairman of Infosys Ltd; and Diwakar Gupta, chief financial officer, State Bank of India, discuss whether the worst is behind the economy in conversations with Tamal Bandhyopadhyay, deputy managing editor of MintAsia, at an event in Singapore on 28 May. Edited excerpts:

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Sebi chairman U.K. Sinha.

U.K. Sinha

One year ago, at an event in Delhi, you said the government is doing nothing to push reforms. Has this scenario changed?

I think people took my matter rather seriously. I would like to take the credit. Because, after that, we had a new finance minister (P. Chidambaram). A number of things have happened in the country, which, may be a month ago prior to his coming, were looking extremely difficult. I am, for example, talking about the deregulation of petroleum prices. Everybody thought if that happens government will collapse. That happened. The government has come with very clear-cut performance on reducing the fiscal deficit. Nobody believed that fiscal deficit will come to the level that it finally (did). And in areas like retail, for a country like India, imagine the government puts its entire existence on the block to see the thing passed in Parliament. I don’t think the enormity of this decision has been understood by the people in India or outside India. For an item like how much should be the foreign direct investment (FDI) in retail business, a government was prepared to sacrifice its existence. I see a lot of positives in the last six to eight months. Of course, there are things remaining which should have been done or which are in the pipeline, but I would like to make a point that things are looking up.

The government—both the Prime Minister and the finance minister—has praised Sebi in the recent past. Are you now giving back the compliments?

You yourself gave the answer. It’s not only the finance minister but also the Prime Minister who said India’s markets are very well regulated. If you look at it seriously, I have to repeat what I said earlier: about a year ago nobody believed that the government will be able to take some of the harsh measures which it was finally able to take. In areas like FDI, no government in India thought it to be so important that they will prepare to sacrifice themselves. You know with what difficulty they got the votes through. This shows the government now realizes if it comes to the fundamentals, if it comes to the policy issues, they would rather like economic issues also to be brought in the front.

But many think there are more talks rather than action as some of the critical reforms are yet to be implemented. What are the few critical reforms you would like to see to bring back investor confidence?

Two important things. One is that the government set up a commission called FSLRC (Financial Sector Legislative Reforms Commission). They have highlighted a very important point that today in India there is multiplicity of regulators and it leads to both regulatory overlaps and regulatory gaps, and that is creating a situation where some people can get away by doing things which were not strictly as per the rules and requirements. So FSLRC has recommended a (twin peak) sort of regulatory regime. Finance minister has also expressed his desire towards this. Second important thing is in the Sebi Act, after experience of so many years, we require certain strengthening and amendments. Both the Prime Minister and the finance minister are looking at it very seriously. I’m aware that some very serious work is going into that area. What we are talking there is, for example, if somebody tries to get away with insider trading, how to strengthen the tools that are available with Sebi.

I’m told Sebi has written to the finance ministry expressing its willingness to regulate the unregulated entities that are raising public deposits

In any part of the world it is not the practice of the securities market regulator or the banking regulator alone taking up the responsibility of deposit-taking activity. There are local agencies who supervise most of the small ticket investments that has been made. (What the) government is working on is if any of the companies reach (a) particular size, one of the regulators, most likely Sebi, will take over the responsibility. Also, powers to supervise and take corrective measures or remedial action also will be spelt out.

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Former MD &CEO of ICICI Bank

K.V. Kamath

We’ll start with the obvious: investments.Projects totalling 10.5 trillion are stuck. Banks have given money of about 56,000 crore, and they are stuck, too. So what’s going wrong?

We have about 25,000 megawatts (MW) power projects ready to be commissioned, 20,000MW in coal and 5,000MW in oil and gas. They have not been commissioned. We have a range of problems and we need to look at what is the cause of these problems. A large number of projects are stuck because banks, if they have lent, now find that halfway down the course, suddenly the core conditions have changed. You have now environment issues popping up, access issues popping up, land issues popping up, or M&A (merger and acquisition) rights issue popping up. One of these four issues, for sure, is there to block a project.

You are not as optimistic as you were. How do we bring back investor confidence?

Investor confidence is not that shattered as we put it. Today where the stock market is, that doesn’t show that investors are not confident. Maybe the Indian investors are wary, maybe they have reasons to be wary. But what has really shattered is the confidence of the entrepreneurs. Reasons primarily are that entrepreneurs have ended up getting over leverage on personal account. An entrepreneur has leveraged his hard-earned equity created through various projects to raise more money to put up newer projects that have stalled. Till he sees resolution, his mindset is not going to change.

How do you bring back an entrepreneur’s confidence? You are among those in the close circles of government.

I think that’s simple. The root causes are known, and I think the finance minister understands that. He wants to address it; there is a group of ministers who are working with the finance minister. For example, the power minister is taking steps to ensure that a path forward is found. The cabinet committee on investments is taking positive actions. I don’t think any of these four issues are a serious roadblock. There are issues that need to be clarified, bias for action needs to be shown, and the action has to be taken, rather than wait for regulatory reform. In terms of the momentum going, you need to have various things. You need to have to be able to meet the aspirations of the consumers. Aspirations are alive and well, it is the ability to fulfil those aspirations which have been stuck. Interest rates are at a level where aspirations cannot be met. Because the EMI (equated monthly instalment) burden today has reached such a level than an individual borrower cannot take on any more debt. Interest rates need to drop for things to get affordable. I think we are just reaching about half way in terms of getting the interest rate right. Investment-led growth is possible when there is ability to absorb consumption that you want, that is I would say affordable interest rate. These things need to have happened if we want to go back to higher growth rate.

Another school of thought is that interest rates are just a small part of the whole story.

On the project front, we have lived with an interest rate which is higher than this. And we have safely navigated through that at a time when we were significantly over-leveraged. But I think interest rates do matter, and matter hugely at the consumption level. And if you don’t get your consumption equation right, you are not going anywhere with your investment exercise. Today if you see, most corporates are cash flow surplus. By and large, the manufacturing side can fund themselves through marginal borrowing and marginal access to the capital market. But to me, if we have to go back to the 9% growth level, the consumption has to be revived again.

What’s the ideal interest rate to kick-start the consumption story?

Go back 10 years. There was virtually stagnant market for every single consumer item, home loans were virtually at 15%, car loans were 18% and motorcycle was 24%. That was the market. If I remember right, Dr. Vijay Kelkar was the finance secretary. He said we cannot afford to have government bonds at 11%, he took steps to bring down the bond rates (to) around 6-6.5%; within the period of 12 months to 18 months, home loans were available at 7.5-8%. That started the consumer revolution. You already have benchmarks available. Home loans have to go down 2 percentage points from where they are and so do all other loans. And you will see the consumer coming back in a big way. And that will provide the momentum to the rest of the economy. All these things should not happen in sequence but all should happen in sync.

When it comes to investment scene, there is an interesting contrast. We find that our home-grown companies don’t have much confidence in the economy, but transnationals are investing in India. I am talking about real investment.

You need to lift the veil a little bit. Indian companies are investing enough to allow their growth to continue and to protect their market share. The growth is not visible because it is being done through cash accruals and internal generations.... Whereas a global investor looks at the space which is available and looks at India of tomorrow, assuming growth to return to 9-10% and aspiring to be a part of that market. I think these things will co-exist. If you see in the last few years when Indian entrepreneurs have gone out, they have gone out to acquire distressed assets. Now that has slowed. We could see some revival there. So all these things will co-exist.

What are the macroeconomic concerns that bother you?

I would think a year back fiscal deficit certainly was a big worry. I think it’s on its way to getting fixed. And clearly, we now know that there are solutions out there that really don’t cause too much havoc in the system. For example, the diesel price hike to bring down the deficit. Last few quarters, current account deficit has become concern No.1. As the fiscal deficit gets addressed and some of the structural issues get addressed, this will also come under control...

What’s your take on India’s economic growth in fiscal 2014? And what’s your outlook on interest rates?

If you look at what the chief economic adviser has articulated, that he sees a growth rate of 6-6.5%, I think given the actual situation on the ground, that’s going to be a little tough. Unless we see infrastructure coming back, we will probably barely get there. Because if we were growing at 9% and now it has fallen, that is because 2% of that accounted for infrastructure, that is not happening now. Act of investing in infrastructure or the act of not investing in infrastructure, I think has taken off the topline in growth. And the rest another 1% has gone off because people are hurt as a consequence of this investment not happening. So till that infrastructure investment kick-starts, we will find the slope steep to go from 5-5.5% to 6-6.5%. I would think we are six months to a year away from infrastructure investment picking up pace. My hope on interest rate is that whatever it went up by, we have a correction on that. I think we need bold steps in reviving the consumer demand.

Majority votes for this question: apart from policy paralysis, what do you think is hindering India’s growth? Infrastructure you have already mentioned. Anything else?

I think it is mindset. We have a serious mindset issue that needs to be addressed.

Can India maintain its lead in information technology (IT), given the rising cost of labour, poor infrastructure and competition? Don’t you think it’s necessary (for the IT industry) to reinvent itself?

The answer to that question, whether India is losing its competitiveness, is a loud “no". I think India remains competitive and will remain competitive in a cost-comparative (way) for a long period of time. I don’t believe there is problem related to infrastructure in technology space. If at all, the challenge for the technology industry is to adapt to another big change in technologies that are in use. The paradigm of technology has changed and we need to quickly adapt to that and be on top of it.

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State Bank of India chief financial officer Diwakar Gupta.

Diwakar Gupta

How hard is this hard time? Will it get harder?

For some time now we were in the consensus that we were on the verge of take-off. Somehow that doesn’t seem to have happened with the expedition and intensity that we would have liked to. But I sincerely do feel that the worst is behind us. There’s a lot that the government has to show, by way of not just intention, but also substantive movement. But, given the current state of fragmentation in the Indian political set-up, it takes a little time. But I am very hopeful that this year is going to be better. Rates are coming down, some kind of a pick-up is being seen. In general inflation and some other parameters, indicate recovery is round the corner, sooner than later..

Tell us what the government should do to improve the situation.

CCI (cabinet committee on investment) is a great thing. Governance is centre stage, there’s no doubt about it. And speed of decision-making is what will make all the difference. You have large corporates who are bleeding because there are stuck payments, not getting environment clearances, you have corporates who have been given the clearances but withdrawn... Again in roads there are situations where 2km out of 200km have not been acquired and the project is not allowed to go (on). But all these are getting de-bottlenecked, there’s definitely movement on these. But speed is the key. Sooner it happens, sooner we are back on the rope.

You have 4.75% gross NPAs (non-performing assets as a proportion of total loans). At least eight banks have more than your NPAs as a percentage.

Fact is that asset quality has deteriorated. Gross NPAs have grown and net NPAs have grown, restructured assets have grown. But if you look at the top 40 banks, you have three banks which have a market capitalization of more than 1 trillion, two of them are private sector. Then you have 10 banks which are between 10,000 crore and a lakh crore ( 1 trillion). Six of them are public sector and four are from the private sector. And you have many other banks, smallest of them have barely 400 crore of market cap. So it is very hard to generalize across the spectrum.

But one thing which is very clear is that the new generation private sector banks have done remarkably well on NPAs. On the other hand, the public sector banks, (for them) all ratios have gone up. Gross NPAs have gone up by an average of 1% to 3.17-3.2%, likewise restructured assets have gone from 5% to 7%. Now, there’s the question, why this divergence in an economy where everyone is operating. I think there are issues of structural, decision-making, control and legacy. I talk for public sector banks that control 70% of the banking industry. Decision-making is what suffers there. When we talk about a formal hierarchical system, what we call bureaucracy…a bureaucracy is known for three things: A., the process itself becomes an end, rather than remaining a means; B., there is no accountability for saying or not saying anything; and C., usually, it’s very hard to admit a mistake.

Now, let me also say that this is not something which is rocket science and we can fix in a day. I am a firm believer that if things are happening for 40 years, they are happening for a certain reason. I think public scrutiny, that, too, way after an official demits office, makes him averse to decision-making. That is a very large part of what can be controlled on bad assets. And, of course, there is another aspect that cannot be controlled, which is environment. There I think banks need to step forward and actually fund these units and hand-hold them because we know they are otherwise viable. Giving money to (cover) an NPA is not an easy thing. Again, that’s where the private sector banks and public sector banks are very different.

Is the worst over as far as bad assets are concerned?

I think the short answer is, it is over. I certainly expect that during this year, there will be much-improved performance. The environment is getting better, rates are coming down, some kind of sentiment is returning. We need capital expenditure and that depends entirely on sentiments. You had to recruit a 100,000 IT professionals before the first rupee of revenue came in. It depends upon how well the industry feels it can go in, the uncertainty has to be curbed. I think it will happen this year.

I am glad you brought the topic that private sector banks are doing better than you. You are working in the same economic environment, with high inflation, high interest rates, everything is same. Are you inefficient or is the government forcing you to pay borrowers and go soft on recovery?

There is no issue with underwriting. All these banks have been around for half a century...I can assure you that there is no interference from the government in day-to-day functioning. There are government schemes—40% of lending for priority sector, out of that 18% for agriculture. Every bank has to do that. Then there are legacy issues and obviously, we are not as good in productivity. There is a large workforce, there are other issues like currency chests. For a 17% market share, State Bank of India has 54% currency chests; 2,200 currency chests and 16,000 guards. I am not wishing them away but those are the structural issues that are (a) little harder to correct. And productivity gains to be made, there’s no doubt about it. Still, I think public sector banks can deliver 20-30% growth in net profits year-on-year.

You said interest rates are going down, but interest rates are going down in RBI (Reserve Bank of India) policy documents and newspaper reports. When we come to banks, you are not bringing down your rates at all. Each time RBI raises rates, you are pretty quick in raising rates, but not while cutting. Sometimes we feel like we are in Japan, when you talk about a 5 basis points cut.

Ours is the one bank which has at least made a cut. But that’s not the point. Your question is a classic example of how perception can differ from reality. RBI raised rates 13 times between April 2010 and October 2011, by 3.5%; most of the banking industry raised rates by only 2.25-2.5%, not jumping to raise rates with every policy rate hike by RBI. Now, a 25 basis points CRR (cash reserve ratio) cut gave SBI 280 crore of benefit. We passed on 300 crore. You have to compare apples to apples. If prices of apple drop by 20%, a Maruti car won’t drop by 20%. And we are committed to a rate cut. In fact, we are getting a badgering in stock market only because we have cut rates even where there is no margin to do it.

There are 3 trillion as certificate of deposits. It is a euphemism for short-term, high-cost, volatile deposits. That is a structural issue. The government needs to address this because this is all in public sector space. Bank after bank has gone for topline growth, borrowed at 9% and lent at 9.1%. Now you are locked in, you are riding a tiger. You have to keep rolling and if you keep rolling at high rates, you can’t cut down deposit rates.

If 10 out of 26 public sector banks, which are also sovereign risks, don’t cut rates, there is no way others can. We actually did it. Our rates even today are 50-75 bps (basis points; one bps is 0.01%) cheaper than the average for the public sector space. We had liquidity and we could do it. Those who don’t have enough liquidity cannot cut down on deposit rates. Until deposits rates come down there is no way you can sustain a rate cut. Today we don’t have a problem with liquidity because credit off-take is not robust. When that happens, then we will have another problem.

Coming to credit off-take, what is your outlook for SBI and the industry?

I don’t think really that there is a great pick-up. State Bank’s numbers are larger because it’s a zero-sum game. We had a lot of liquidity and we cut down rates at the top end for our clients. And we got some incremental business. I don’t think as yet if there is optimism that has translated into demand. And that needs to happen sooner than later. The best years of the economy, the early 2000s, were years when the productive capacity of the economy was coming back into the economy. You had stable prices, you had a low interest rate regime, you had a stable rupee; until you get that, your equation will continue to go out of hand. When you have suppressed inflation coming out into the open, that argument can be used to say inflation is still high. So somewhere you need to have that leap of faith but capex has to be brought back.

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