Background

The Government of India (GOI) and the Reserve Bank of India (RBI) have released on March 30 2009 a six-volume report of the Committee on Financial Sector Assessment (CFSA), chaired by Dr.Rakesh Mohan, Deputy Governor, RBI and co-chaired by Mr.Ashok Chawla, Finance Secretary, GOI. The purpose of this note is not to cover the content of this report, but to explain first, the objectives and the nature of the FSAP and secondly, the framework and the process followed by the CFSA in undertaking the task of a comprehensive self-assessment of the Indian financial sector, which is unique and not experimented elsewhere. Briefly, it talks about the virtues of the process, and how it addressed the common criticisms associated with any self-assessment.

What is an FSAP

The Financial Sector Assessment Programme (FSAP) was designed jointly by the International Monetary Fund (IMF), and the World Bank after the East Asian crisis of 1997, as a periodic health-check up of the financial sector for member countries. The FSAP evaluates the resilience and soundness of the financial sector and identifies potential areas of vulnerability and recommends corrective steps that may be needed to restore the desired level of systemic health. It aims at identifying both the strengths and vulnerabilities of a country’s financial system; to determine how key sources of risk are being managed; to ascertain the financial sectors’ developmental needs; and to help prioritizing policy responses. These objectives are sought to be achieved through financial system stability assessment (FSSA) by undertaking macroeconomic surveillance and assessment of stability and soundness of financial system in all its facets or the entire gamut of the financial system, viz., institutions, markets and infrastructure.  A detailed assessment of observance of relevant financial standards and codes which gives rise to Reports on Observance of Standards and Codes (ROSCs) as a by-product is an integral part of FSAP – either undertaken as part of FSSA or independently.  Overall, FSAP enhances the scope for strengthening resilience and fostering financial stability within and help promoting smoother integration of economies with the global markets.

The participation in FSAP as also the publication of the FSAP reports is voluntary, but, as of now, more than three fourths of membership have either undertaken or volunteered to undertake an FSAP.  Many of the countries have also agreed to the publication of these reports. However, the membership participation was not uniform.   It is significant to note that among the countries left out figured are advanced countries such as the USA, Australia, Euro area (as a region), Italy and Indonesia, Saudi Arabia, Turkey and China among the G20 Group – though some ROSCs in a sporadic manner have been completed by some of these countries.  As the member countries’ participation in both FSAPs/ROSCs and the publication of related reports are voluntary, their effectiveness hinges upon the ownership and commitment from member country authorities.  The US came in for severe criticism for not having participated thus far in the FSAP and the IMF opined that such participation earlier by the USA would have prevented the current crisis from occurring in the first place, though some may differ with this view. One of the action points of the G-20 Ministerial meeting recently has been that all member countries which have not undertaken an FSAP should take up this exercise on a priority basis and also should publish the reports. Significantly, one of the G-20 Working Groups also has recommended that the national authorities also periodically undertake self-assessment of their regulatory frameworks based on internationally agreed methodologies and tools.

India’s earlier experience with FSAP

Against the above backdrop, it stands to the credit of the Indian authorities that India was one of the earliest member countries subjecting itself voluntarily to the Financial Sector Assessment Programme (FSAP) exercise in 2000-01.  Based on mutual consultations between the GOI and the Reserve Bank of India, an elaborate self-assessment exercise on standards and codes was also conducted in the year 2000-02 by a Standing Committee on International Financial Standards and Codes, headed by Dr.Y.V.Reddy.  In this, India undertook a comprehensive self-assessment of – in all eleven – international financial standards and codes.  These reports served as benchmarks for understanding the status as also for initiating several legal and institutional reforms in the financial sector.  Thereafter, a review of follow-up action taken on recommendations of the eleven Groups, mentioned above, was completed in January 2005.  India has also completed assessments by the Bank-Fund of most of the financial standards by December 2004 excepting that relating to Insurance. The relatively muted impact of the global crises in the 1990s as also the current global economic turmoil on India, can at least partly be explained by the India’s proactive approach to understanding the risks and vulnerabilities and taking up timely corrective steps to overcome the same through prudential macroeconomic and institutional policies.

The CFSA

Building upon the experience thus far, the Government of India, in consultation with the Reserve Bank, decided to undertake a comprehensive self-assessment of the financial sector and for that purpose, constituted the Committee on Financial Sector Assessment (CFSA) in September 2006.  In this context, the publication of a very comprehensive Handbook by the IMF and the World Bank in September 2005, designed for use in financial sector assessments, whether conducted by country authorities themselves or by World Bank and IMF teams, became really handy.  In addition, the assessors have also taken into account the Guidance notes, manuals and questionnaires which have been provided to the CFSA by the international standard-setting bodies. 

A holistic and full-scale assessment

As the standards themselves are evolving and getting modified since the last FSAP and India has also undertaken a series of reforms over this period, the CFSA  undertook a full-scale and a fresh assessment instead of updating earlier assessments.  Also, instead of a selective approach, the CFSA decided to cover assessments of all financial standards and codes, so that a compact roadmap in a medium-term perspective for the entire financial sector could evolve in persevering with convergence towards international best practices.  Also the scope of assessment was more comprehensive. For instance, the Basel Core Principles for financial regulation and supervision which are normally applicable to commercial banks, were also extended to Urban Co-operative banks, and also to Regional Rural Banks and rural co-operative banks. Similarly, the IOSCO principles for assessing securities market regulation, was extended to money, foreign exchange and government securities markets to the extent these principles were relevant and applicable. The current assessment, however, also took into account the earlier FSAP and ROSCs as needed and relevant. The current effort of the CFSA is thus one more step carrying forward the self-assessment approach, further enabling a financial sector stability assessment and stress testing for the first time. 

A constructive and transparent approach

            The CFSA has followed a constructive and transparent approach to self-assessment keeping particularly in view that self-assessments are treated as a weak substitute for external assessments of the IMF/World Bank.  The approach and framework followed by the CFSA would, however, amply demonstrate that it would be possible to achieve the objectivity and credibility through self-assessments, if accompanied by appropriate checks and balances. 

• First, the greatest advantage in self-assessment is that the concerned operating officials know the best about where the shoe pinches and also the best alternative choice for finding solutions. It was, therefore, deemed appropriate and desirable that the basic assessments and technical work should be carried out through Technical Groups comprising officials of the regulators and of the government who actually handle the areas in the course of their regular functioning.  The assessments of the Technical Groups were subjected to a thorough debate and rigorous scrutiny of the Advisory Panels.  These debates ensured that the proper perspectives of various stakeholders were brought to bear on the subjects and a free and fair assessment of the financial sector was conducted in a logical and coherent manner. While the Technical Groups comprised of officials, the Advisory Panels comprised of independent non-officials, some of them were also members of the Percy Mistry and Raghuram Rajan Committees.

• Second, the working of technical groups as also the Advisory Panels with officials directly participating as members or as special invitees, ensured extra-ordinary inter-regulatory co-operation involving SEBI, IRDA, RBI and relevant Government departments besides several agencies such as the ICAI, NABARD, NHB, etc. Such direct official involvement carried with it enormous responsibility, ownership and commitment. 

• Third, it ensured constructive pragmatism while addressing, in particular, contestable issues.  In the current context of several established conventions and practices being re-examined in the light of the subprime crisis, there is a need to approach reforms in the financial sector, particularly from the emerging markets point of view that are more vulnerable than any other, with a sense of humility. The CFSA has thus provided a broad direction to further financial sector development rather than prescribing very specific steps in a rigid time-frame. 

• Fourth, the close involvement of officials and non-official experts in conjunction with external peer reviewers – an entirely a new dimension added for the first time – meant that the process itself proved to be an investment in human resources producing an outcome that sensitized the financial sector agents and the internalized learning is expected to act as a stimulus for spearheading financial sector development and carrying the reform measures forward. No doubt, this has helped in an enhancement of the skill set within the financial sector, leading to significant capacity building.

• Finally, the external peer reviews by international experts added authenticity to the methods and techniques used by the Panels and the Committee.

CFSA’ s Overview Report

The CFSA while finalizing its Main Report, attempted to address issues arising out of the four Advisory Panel reports thematically into a set of key areas.  As the Advisory Panels comprised of independent non-official experts and their reports were peer reviewed by eminent external academics and policy makers and are being transparently made public. While the CFSA mostly endorsed the assessment, findings and recommendations of the Panels, it recognised at the same time that on certain aspects, there were differing perspectives and stance taken by Panels on certain overlapping issues.  Secondly, the CFSA also took duly into account the complexities of the current stage of economic and market development including the Indian democratic polity, and attempted to present a synthesised approach, whenever it viewed that issues were contestable.  The report also has highlighted some dissents among the members of the CFSA itself, the most significant being the dissent of the Chairman himself on the issue of separation debt management function from monetary management. The Chairman viewed that the time is not yet ripe for such a separation, though he supported the creation of middle office in the government for integrated debt management. Another issue, inter alia, was regarding the objectives of monetary policy. While the consensus view was that the present multiple objectives provided flexibility to monetary management, one of the members felt that the objectives of price stability, financial stability and growth should be spelt out clearly. Thirdly, while the membership of the CFSA along with involvement of other regulators provide an enormous comfort of ownership and commitment from authorities, the views of the Committee should for all practical purposes be treated nevertheless as independent.

* This note has been prepared by K.Kanagasabapathy, who was also the Secretary to the Committee on Financial Sector Assessment.

According to the government’s third advance estimate (AE), food grain production in the crop year ending 30 June is expected to be around 229.85 million tonnes, up from 0.9% over an earlier estimate (II AE), largely due to record increase in rice harvest.  Rice production is projected to be at 99.37 million tonnes, up from 98.89 million tonnes pegged in the second advance estimates. However, wheat output in 2008-09 is now expected to be around 77.63 million tonnes, down from the second estimates of 77.78 million tonnes. Pulses production has been revised downward marginally to 14.18 million tonnes from 14.25 million tonnes in the second advance estimates. The production of coarse cereals has been revised upward at 38.67 million tonnes from the earlier estimates of 36.96 million tonnes. Coarse cereals output would be around 40.76 million tonnes. Sugarcane production is estimated to be around 289.23 million tonnes and 23.26 million tonnes of cotton would be produced in 2008-09 season. Jute and mesta production would stand at 9.53 million tonnes and 7.97 lakh tonnes, respectively.

The central government procured 21.75 million metric tonnes of wheat from local farmers since purchases began from 01 April. The quantity accumulated this year by the central agencies is 17% more than the 18.52 million metric tonnes purchased during the same period a year ago. Procurement from Punjab has continued to be the largest contributor to central inventories of 10.52 million metric tonnes, higher by 10% as compared with 9.53 million metric tonnes procured in the previous year. Procurement of wheat has shown an improvement from states like Haryana, Andhra Pradesh, Uttar Pradesh and Rajasthan.   

According to the Solvent Extractors’ Association of India (SEAI) purchases of Vegetable oil in April doubled to 699,396 tonnes from 347,332 tonnes a year earlier. Vegetable oil imports in the six months ended 30 April increased by 64% from a year-ago period to 4.2 million tonnes. It is expected that country would import a record quantity of vegetable oil in the year to 31 October because of higher demand and duty-free purchases amid a decline in local oilseed output. Imports of vegetable oil would increase to 8 million metric tonnes during the oil year, up from an earlier estimates of 7.5 million tonnes. Palm oil imports rose by 68% to 3.37 million tonnes in the six months ended on 30 April 2009 from a year earlier. 

India’s soybean output is expected to drop to 8.2 million tonnes in the year ending September 2009, down from the early estimates, as lower rainfall trimmed yields in producing areas. Most of the farmers are hoarding a good amount of stocks owing to which estimation is difficult. This reduction in output is due to sharp downward revision in production of the crop from Maharashtra. It had been earlier estimated that Maharashtra would produce 3.5 million tonnes, but because of lower rainfall, output in the state would fell by 1.2 million tonnes to 1.3 million tonnes. Lower availability of soybean has cut the country’s soymeal exports, which has reported to be fallen by about 30% to 2.67 million tonnes in seven months to April. 

The central government would allow private traders to import 8, 00,000 tonnes of sugar at zero duty to augment the domestic availability. Earlier, cabinet had allowed STC, PEC, MMTC and agri-cooperative NAFED to import 10 lakh tonnes of sugar at zero duty by August 1. The public sector units (PSUs) have expressed that they would not be able to fulfill the target of importing 10-lakh tonnes by the due date. These PSUs can import a maximum of 2, 00,000 tonnes of refined white sugar, and to balance the quantity of 8, 00,000 tonnes it would be imported through private sector. 

As per the report by Cotton Advisory Board, consumption of cotton would exceed last year’s consumption level by 8.7% to around 25 million bales in the year ending September 30, 2009 as against 23 million bales consumed a year earlier. This increase in consumption is estimated due to rise in demand for yarn from textiles mills resulting into lower availability of cotton for exports i.e. around 3 million bales this year.

Sugar production in Maharashtra has declined by 50% during the current year due to reduction in the area under sugarcane plantation and dry weather. Production of sugar in the state is reported to be around 4.6 million metric tonnes between October 1 and May 11, as compared with 9.1 million tonnes a year ago. Overall sugar output from the country this year is expected to fall for the first time in three years by 44% to 14.7 million tonnes. The central government, in February, had allowed zero-duty imports until September, and last month extended the tax break to white sugar. Four state trading companies have been asked to import up to one million tonnes by August 1.

National Agricultural Cooperative Marketing Federation (Nafed) has started to procure onion from the country’s main trading hub of Nasik so that it would prevent sharp fall in onion prices. It has planned to procure nearly 5,000-10,000 tonnes of onion at market prices and these stocks would be brought into the market during August-October for maintaining stability in the prices. India’s total onion production in the country during the year 2008-09 is estimated to be around 7.6 million tonnes as compared to last year’s production of about 7.4 million tonnes. Onion exports from the country have increased from 8.29 lakh tonnes during 2003-04 to 1.1 million tonnes during 2007-08 and it amounted to Rs 1,285.82 crore. 

Tea exports in the first three months of 2009 tumbled down by 24%, as there has been shortfall in domestic output, firm internal demand and the global economic slowdown. Total exports of tea during the period between January-March 2009 stood at 38.90 million kg, as against 50.94 million kg a year ago, while production during the period fell by 9% to 81.88 million kg. Exports of tea are expected to improve on the back of increased orders from countries like Iran, Iraq and Egypt.

Industry

Infrastructure

Inflation

Capital Markets

Primary Market

The Securities and Exchange Board of India (SEBI) has proposed bringing about uniformity in screening of applications for public issues by registrars, especially in respect of weeding out invalid ones. As per a SEBI discussion paper issued on 19 May noted that the Registrar shall validate PAN, DP ID and Client ID available in the application form with the said data available in the database. If these data do not match, such application shall be rejected and not be considered for allotment. Applications made in public, preferential issue and in Qualified Institutional Placements (QIP) without mentioning PAN or incorrect PAN shall be rejected.

Secondary Market

Among the sectoral indices of BSE, Banking stocks rose 6.13% over the previous week on expectations that lower interest rate will boost growth in advances. Similarly Auto stocks surged on improved sales numbers in April. IT stocks gained on reports that the worst is over for US banks.

Derivatives

Primary Market

Secondary Market

During the second and third week of May one bank, two NBFCs, three corporates and two central PSUs tapped the bond market to mobilize an amount of Rs 5,547 crore.

Currency Derivatives

Banking

Hindustan Unilever Ltd (HUL) has registered a moderate rise of 3.7% in its net profit to Rs 395 crore in the fourth quarter of the financial year 2008-09 as compared to Rs 381 crore in the corresponding quarter in 2007-08. In the last quarter of the financial year 2008-09 profit was Rs 394.99 crore which was Rs 380.95 crore in the fourth quarter of the previous financial year.  HUL’s Q4 net sales increased by 6% to Rs 3,988 crore as against Rs 3,763 crore in the corresponding quarter in 2007-08.

GMR Infrastructure is planning to raise Rs 5,000 crore through private placement of shares. GMR Infrastructure is a flagship company of the GMR Group. The company’s board has given approval for the amount to be raised by way of either a preferential issue, or Qualified Institutional Placement (QIP), or else private placement of shares in the Indian as well as overseas markets.

BHEL has abandoned its plan to manufacturing offshore oilrigs due to huge investments requirement. However, the company is continuing its onshore oil rigs business and is planning to expand it further.

Oil and Natural Gas Corporation (ONGC) following the drop in output from its Mumbai High and other western offshore fields, has decided to invest Rs 6,000 crore in the current fiscal year in new and existing fields to increase output. Currently, the company is developing its eastern offshore Krishna-Godavari basin finds, G1 and GS 15. The two fields, put together, will produce 2 million standard cubic metres per day (mmscmd) of gas.

State owned Indian Oil Corporation (IOC) might cut its stake in the massive gas and oil field in Iran as the company is facing financial pressure on account of continuous losses on fuel sales. IOC holds 40% stake in Farsi gas and oil field. Developing the gas field alone would cost $4 billion and accordingly IOC’s investment would be $1.6 billion (Rs 8,000 crore).  IOC will be unable to make such huge investment as it has to spend more than Rs 20,000 crore for setting up the Paradip refinery in Orissa besides spending another Rs 5,000 – 6,000 crore on fuel upgrade projects. At present, the company is incurring a loss of Rs 1.80 a litre on petrol, Rs 12.27 a litre on kerosene and Rs 91.51 per domestic LPG cylinder.

Reliance Industries Ltd (RIL), Essar Oil and Indian Oil are among the six firms which have expressed interest in taking on lease the LNG terminal adjacent to the Dabhol power plant. Besides, other companies interested in hiring the five- million-ton-a-year capacity liquefied natural gas (LNG) import facility on tolling basis include NTPC and GMR Group. Ratnagiri Gas and Power Pvt Ltd would earn Rs 140 crore annually in the form of tolling fee.

External Sector

Information Technology

Tata Consultancy Services (TCS) has bagged a five-year contract from Volkswagen UK where it would provide transformation an IT support to the automobile major. The company will help consolidate and standardize the IT platform across all brands like Audi, Skoda etc.

Essar group company Aegis has acquired Australian business process outsourcing (BPO) firm UCMS, for around Rs 203 crore. The acquisition will see about 2,000 UCMS employees join Aegis, taking the total strength to 33,000. The fund for the acquisition will be available by the company’s internal accruals.