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Chidambaram is right and wrong
August, 29th 2006
The Finance Minister's letter asking banks to consider keeping any hike in PLR in abeyance may have created much consternation, but he did this in a transparent fashion, which deserves credit. But his utterances on bank mergers may be a different kettle of fish. The Finance Minister, Mr P Chidambaram, said in the Lok Sabha recently that he does not micro-manage interest rates. It would be unfair to disbelieve him. His letter to banks asking them to consider keeping any hike in the PLR (prime lending rate) in abeyance till such time their boards have had time to reflect on raising rates, has created much consternation in the banking industry. Had Mr Chidambaram issued telephonic instructions to bank chiefs, there would have been none of this brouhaha and the Finance Minister would have achieved his objective too. Mr Chidambaram appears have preferred transparency, and ought to be given credit for that. Constituting interference? The next question is whether or not Mr Chidambaram's advice to banks constitutes `interference'. In practical terms, in the corporate world, the board of directors is never independent of the influence of the principal shareholders. A good example is that of Escorts Ltd, which did not transfer the shares bought by Swaraj Paul to his name. If Mr Chidambaram's letter constituted `interference', so are the guidelines issued by the Reserve Bank of India. If it is logical that the RBI, in its capacity as the regulator, steers the conduct of banks' business in a manner that is appropriate for the country's good, the same logic should hold for the government, which is the principal owner of the public sector banks. PSBs happy As a veteran banker pointed out, the PSBs are happy with the RBI regulating the savings bank interest rate, while having deregulated all other rates. This `regulatory interference' is a positive, and, therefore, the banks are happy. Also one has to look at the context in which Mr Chidambaram made his suggestion. The RBI raised interest rates to temper inflation. This itself is of doubtful logic. Interest rates rise for a number of reasons such as shortage of supply of commodities or in sympathy with overseas commodity prices. The interest rate-sensitivity of inflation in this country is yet to be established. One is not going to stop buying a house just because the EMI (equated monthly instalment) on the loan has gone up by, say, Rs 200. On the other hand, any rise in interest rates would hurt the poor more. An extra burden of Rs 200 to a city-dweller may not be huge but a Rs 20 increase in the monthly budget would hit hard a farm labourer in a village. No politician can afford to ignore these realities. Thus, such statements as `making a mockery of Monetary Policy' just do not wash. Another part of the Finance Minister's Lok Sabha statement was that the Government was not forcing a consolidation in the banking industry. Here Mr Chidambaram's stance appears less defensible. Bank mergers The call for banks merging to become more competitive has not emanated from the market. It has come from a politician. (This point is countered with, "wait a minute, didn't the Narasimham Committee recommend consolidation ?". What the Committee recommended was only for a few banks to merge to become large, not a series of mergers and acquisitions resulting in just a few large banks in the country.) Mr Chidambaram may say that he is merely suggesting or advising consolidation and not forcing the idea on banks. But the fact that he repeats the idea makes his `advice' quite strong. In today's banking milieu, a number of small banks are performing extremely well even in a highly competitive environment. For instance, Karur Vysya Bank, City Union Bank and South Indian Bank. These banks do not seem to have any problem in maintaining capital adequacy, keeping the spreads, raising advances or bringing in technology. Consolidation alone not enough On the other hand, as trade unions have repeatedly pointed out, consolidation among banks, no matter how big, cannot create outfits that match the global biggies in size, competitiveness in technology or product sophistication. The apprehension that post-2009, foreign banks will come in and drive Indian outfits out of business parallels a similar fear proved unfounded by subsequent events that the likes of ABB and Siemens would shut down BHEL. People may have different views on whether or not banks can survive global competition in the long run. The principal objection to Mr Chidambaram's suggestion for consolidation is that the call for it has not come from the market. A politician cannot be obviously pushy on these issues. M. Ramesh
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