Stock Market

Lower interest rates a red flag, says banking veteran KV Kamath

Speaking to CNBC-TV18 veteran banking expert KV Kamath said that he is watchful than worried about recent market developments. The market is skittish and liquidity is at an unprecedented level, he maintained. “There will be a flight for quality, he said, adding that the interest rates couldn’t be lower.

However, the fact that interest rates are lower is a red flag, according to Kamath. “How do you correct it to a level when things even out. At these rates, pension funds are underfunded,” he said and that makes me him nervous.

A variety of things could rattle markets, he said. Fed rate hike, oil market are all causes for worry, he said.

Growth in India could be driven by a lot of factors. The passage of the Goods and Services Tax is a boon to India. A decent monsoon is another plus, he mentioned. The tightening the government seems to have done to ensure distrubtion of essential commodities will put a lid on distortions that were happening. The push of technology is another element that will drive Indian growth, he said.

Below is the transcript of KV Kamath’s interview to Latha Venkatesh on CNBC-TV18.

Q: First up, because you sit at a vantage point and the world is looking so skittish, let me start with the global markets itself before I come to the Brazil, Russia, India, China and South Africa (BRICS) Summit and the New Development Bank that you head. Like we were discussing, equity valuations are at near all-time highs and bond prices are at all-time highs. Even corporate bond yields have fallen so much. This is a contradiction. Are you worried something will give?

A: I would use the word watchful rather than worried because from where I sit and maybe what we set out to do, we look at other things that are critical in this skittish market and what are those? Liquidity. Liquidity is at a level where it is unprecedented you could say. There will be a flight for quality and at the same time, for a good borrower, the interest rates could not be lower. So, clearly, we are sitting at a good time to borrow and to lend to our constituents. So in all this skittishness, I look at these as signs of comfort, as it were. But there are very interesting challenges apart from the market.

Q: In January it was this sudden Chinese devaluation which ultimately turned out to be not so bad at all. What might be the next red flag?

A: Some of the red flags, I have already see. The interest rate which I have mentioned which is low is to me also a red flag because how do you correct it to a level where things even out. For example, at these rates, of interest, no treasury makes money. At these rates of interest, pension funds are underfunded to a very large extent and in some cases, the topping up that you need to do even exceeds the wage bill. These sort of situations are arising. That makes me nervous. But at the same time, low interest rates and ample liquidity would mean that global business should be going on fine. And of course, the question is who is driving this business.

Q: Let me come to India itself. Last time, when the taper tantrum noise grew louder, we suffered badly. Now, there could be another Fed hike or there could be a banking problem in Europe. We do not know. Would you say that we are better prepared?

A: Let me look at it dispassionately. Whatever happens there, to what extent should it really impact us? It will impact us certainly to the extent of flows coming into the capital market. We have factored that in. Does it distort our ability to do business as a nation? I do not think it impacts it at all. What impacts us, things within our hands and those clearly in terms of priority where I would think the GST which the bill has been passed. So, that is a big plus. Immediate thing that comes into mind in India is the monsoon which was good. So, second thing has happened. I would think that a large consuming market which is now a two trillion plus and I would think growing at a fairly rapid rate by looking around the last two days in Mumbai, is a big plus. Industry is coming back. There is unutilised capacity which will be utilised. Low interest rates are going to be here to stay and I was again told in the last 1-1.5 days trying to talk to people that the tightening that this government has done to ensure that distribution of essential commodities and food grains and other things clearly will put a lid on distortions that were happening. We will not go into why they were happening, but clearly will put a curb on that.

Seventh, is the declaration scheme which was a great success. Eight, and I will stop there, is the whole push of technology in which I would say the tax machinery could be tightened and so many other positive things can be done in the context of distribution to people who are needy and so on avoiding losses. We are not factoring this when we talk of India. To me, these eight things really drive Indian growth going forward.

Q: Do you think NPAs are out of the way?

A: If I look at the NPA problem there are three ways in which you need to look at it. the first is the problem itself. Second is the recognition of the problem. I think we have gotten to that stage of recognition of the problem. Third is resolution of the problem. Resolution of the problem also can be broken into 2 or 3  buckets. One, finding capital for the provisions that you make and making sure that your health remains what it ought to be.

Second is getting the asset cleaned up and working again because we cannot as a country afford not to put these assets back to productive use. That action I find is probably now the pending work.

I saw a statement by Vinod Rai today saying that, that is what is required and I can’t agree with him more. In think in the context owners of the bank which in this case is largely the government needs to work on these two things, one is how do you find the capital for clean that has been done and second, now talk in terms of resolution. How do you get the banks to sit together and resolve. Unfortunately it is no longer an individual bank which can resolve. A consortium of banks have to come together and resolve. I would think time bound action plans, holding people accountable for resolution I think is the way forward. If you are going to leave it to the banks and banks believe that they have done their jobs by recognition, I think that is just the first step, the second step.

Third step I think which is recapitalisation. We have somehow reached a sweet spot that is what I believe. The sweet spot because I clearly see an interest rate cycle which is reversing. In that the mark to market gains, I did a rough estimate today, I understand about Rs 100000 crore of mark to market gains have already accrued. If I would say that in the next one year, again I have never tried to tell anybody what to do with interest rates, that is entirely monetary policy matter, I will just use a hypothetical number, if interest rates come down by 1 percent, we are looking at another roughly Rs 150000 crore of mark to market gains. You put these two numbers together, you get Rs 250000 crore. Now what does the owner have to do or the banks have to do? Make sure banks recognise this. Do not lose this opportunity, recognise these gains, shore up your capital, so that part is done. So, your recognition is done, your shoring up of assets is done, now all you need to do is still resolve. So, bring them to a table, I don’t want to use anything stronger than that and get them to resolve.

Again I am reminded of 2002, when we were recalcitrant or some of us were recalcitrant in wanting to resolve, we were called collectively to Delhi on the steel industry I remember and we in a space of one hour we resolved about a dozen steel industry cases and that stood and that industry came back on its feet. I think some such strong action is required to get the banks together. This is not calling the clients, this getting the banks together to address this problem and go ahead.

To answer your question, I would think the problem is addressable now but there is no time to lose. We should address it now.

Q: At the BRICS summit not just the New Development Bank, but the larger summit that is on, is there a contradiction that can be resolved a large part of the steel problem is because cheap steel is getting dumped by other countries. Should not the BRICS summit be used exactly for this to enable that countries don’t grab each other’s growth.

A: Well, I think the problem is not just in steel as far as India is concerned, the problem is excess capacity, capacity in the industrial context across all industries and resolution that is needed by banks across all industries, but this question raises a very interesting question for planners not just the BRICS countries are going into the future.

If we clearly identify surplus capacities in certain countries and those surplus capacities are efficient and produce goods at a significant lower cost and other. I am not talking of dumping at this stage, I am talking of sheer efficiency built by skill, leaders probably will start to think how can we utilise these capacities effectively, which may be located elsewhere but we could then benefit from it.

I think dumping will be addressed in its own way, but there is a large opportunity to share facilities which are very efficient and productive and share knowledge around these amongst member countries. I would think discussions will go on these directions in the coming years.

Q: You intent to raise all the money for the New Development Bank only through local currencies, you already done an RMB bond, but that will be the way forward as well?

A: Large part of the way forward will be that, but I must explain this in 30 seconds what, so year back when I expose this, I don’t think there was too much excitement around the concept of local currency financing. China was good enough to say that yes you can raise the Renminbi in the market, we raise the Renminbi, we had a 10 billion Renminbi approval we raise one-third of this amount in the marketplace. What interesting is that Renminbi swaps into US dollar when you first look their rate it swapped well below 100 basis points below LIBOR and even when we did the raising and swapped it, it is significantly below LIBOR.

You are getting an advantage even if you want to use Renminbi as a hard currency, but China was willing to take Renminbi as funding for projects, so we will use our Renminbi balances to fund China. Now if I were to do an offshore bond in India, a masala bond in India I would believe that we should be able to raise money at a rate attractive enough for the government to borrow and now the government is willing to engage with us.

Now what does this do similar story in Russia, similar story in South Africa come raise money in our market and lent to us at attractive prices. Suddenly people have realised that some of their currencies have been hit very hard and there is a readiness now to look at alternatives, which will alleviate this pain.

If you look at India itself our effective cost of borrowing though it may look like we are getting the dollar loan at 1.5 today, the effective cost of it over its life allowing for exchange is probably in the teens. We are talking of 13-14 percent, whereas if you can get rupee at 7-8 percent you certainly are better off. As long as this rupee that you are raising is not crowding out somebody else and for that you use offshore market.

Today there are so many tools available to look at markets and also I would think that raising part of the currency yourself is making a statement by countries of the south that we are now capable of standing on our own feet or capable of wanting to stand on our own feet and to me that is an important statement that we will make.

Q: You see New Development Bank being as large as the ADB very soon, as large as the IMF. Do you see a big vision for it?

A: I would think that IMF is not in our context, but if you look at other multilateral banks, if you are running a bank there is always a question of how fast you can scale up a bank, so we cannot cut too many corners, so it is going to take time to get the foundation really sturdy and build the super structure. I don’t think that we will be competitors to any of these players in the immediate context, but we certainly will be complimentary player to these established institutions.

My thought is that the bigger role that we can play is to be innovative player as I said earlier we look at local currency, mobilise local currency, then look at the way you do in terms of responsiveness to client need, the speed of that. The ability to listen and I would think these are three. Other very interesting thing I also see is, if I were to wear a banker’s hat in the seat which I am. I see that the way we are looked at by the rating agencies are in a different class. I don’t see any difference between a bank and this. So Development Bank and MDB leverage itself 3 times. When a bank on a tier 1 basis even if you assume 11 percent tier 1 is leveraging itself 9 times I am looking at risk rating and doing it.

Here the risk rating is all sovereign or at least 70 percent sovereign because only 30 percent is private sector, so I find that development banks are significantly underleveraged and probably overcautious in what they do. It is a very interesting question should we not align the way development banks are look at as is a commercial as strictly and then I think you will get more leeway to play and we believe that we pushed this thought in the system we will get traction as we go along.

Q: There are lot of question marks in the world about China’s actual rate of growth, that 6.5-7 percent is not believed. How would you rate China’s growth story?

A: I would think that growth is happening near about the numbers that they are saying, what I think the world is not factoring in is the consumption opportunity in China. The world and external observers are probably relying more on stated numbers in terms of capacity utilisation in various sectors and things like that, but there is a whole lot of change that is happening in the consumer market and consumption.

My belief is somewhere growth is now being driven largely by consumption than it was in the past where clearly it was infrastructure and that infrastructure is visible and is already being done and that’s why you are probably seeing capacity utilisation of certain industries going down, but that is being corrected by further export drives and by building infrastructure in third countries, but primarily by driving internal growth.

Q: What about NPAs, there is a lot of worry that there are shadow banks with NPAs, that their problem is even probably bigger than India?

A: I would look at this way, even in the past I have seen the Chinese system very pragmatic about what the problem is and how to resolve it. You go back to 2001-2002 to just put the extent of the problem in context NPAs were around USD 500-600 billion on an economy which was just USD 1.2 trillion, so today we are putting things in context today it is a USD 10 trillion economy, but 17 years back it was USD 1.2 trillion economy and non-performing assets were half the economy. We are nowhere there even today and they resolved it, so I am sure that whatever is the challenge today, the same degree of resoluteness will be shown in addressing it.

Q: In the last 5 year what is the big story that you see in India, what is the best change that you have noticed?

A: Actually the change you want to put in context you have to really look at 2000 onwards. 2000-2004 we went to a country with per capita income of 500, within the next 5 years we went to 1,000 and then for a variety of reasons which I won’t go into we stalled, but I think just now we have created the momentum to get to probably near USD 2,000 per capita or slightly below that number.

To me this is a dramatic change in 15 years if I have to look at and the last two and a half years they have been preparatory to big things because there are whole lot of things that are to be done and again if I won’t repeat it, the 8 things that I said in the beginning lay down the foundation for growth in the future. I would thing we are now rebuilt a foundation for growth which should take us fairly easily to a 10 percent double digit growth and that is what I will watch very carefully and with great interest and great enthusiasm as we achieved that target.