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Sebi’s proposal on concentrated holdings could disrupt the balance between the supervisory and business roles of stock exchanges.

On January 6 the Securities and Exchange Board of India (Sebi) released a discussion paper on the review of the current ownership and governance norms regulating stock exchanges and depositories. Market infrastructure institutions (MIIs) such as exchanges clearing corporations and depositories occupy an unusual place in the market economy. While there is a great game afoot of trading on financial markets the MIIs are the entities which build and run the playing field. Their smooth and harmonious functioning is a pre-requisite for achieving a capable financial system. Indeed a great deal of the achievements of Indian finance from 1991 onwards came through the remarkable work that was done in building the current landscape of MIIs.

Can we view MIIs as just a business? In what ways are MIIs special? There is a small problem and there is a big problem. The small problem is that exchanges tend to be a natural monopoly. In most countries the bulk of activity has coalesced into one main exchange. Orders tend to go where orders are and it is hard to have multiple competing exchanges that compete for orders. The big problem is that an MII is the front line of regulation. It is itself akin to a regulator with rule-making functions enforcement of the rules that it makes and some enforcement of the rules that the securities regulator makes. The MII is the front line of supervision; it plays a major role in market integrity.

For the shareholders of an MII revenues are proportional to trading volume. There are unfortunately many ways in which managers of MIIs can cater to the objective of higher turnover by cutting corners on market integrity. Consider a situation where something is wrong with a given security e.g. some fake news or a cartel that is trying to corner the stock or execute some manipulative scheme on it. From a market integrity viewpoint managers need to intervene but from the viewpoint of increasing turnover these problems are fine. Managers can go lax on how rules are created or enforced thus helping a greater buoyancy of trading. The top 20 securities firms tend to account for a large proportion of the turnover; managers could choose to be lax in enforcement against them in return for more turnover.

In the 1990s we saw a class of problems at the BSE which illustrates these issues. At the time the BSE was controlled by stock brokers who derived revenues from trading and from activities on the exchange. These same firms had management control at the BSE. Their incentives were to obtain higher turnover even if this involved sacrificing market integrity. This gave poor and sometimes dangerous outcomes. Alternatively consider a focused shareholder one who stands to gain profit or market capitalisation when the turnover of an exchange goes up. If this shareholder has a substantial say in the management of the exchange we run into the problem of “high powered incentives”. Large sums of money are involved in the profits or the market capitalisation of an exchange. When the manager-cum-shareholder has high powered incentives this tends to generate a bias in favour of turnover and against market integrity.

In order to address these problems the financial economic policy community evolved the concepts of enshrining “low powered incentives”. The essence was to have no focused shareholder avoiding managers who are shareholders (or stock brokers) and avoiding share ownership or stock options for managers. The extant framework caps the ownership of Indian MIIs at a shareholding limit (not more than 5 per cent) for individuals (domestic or foreign) and institutions (domestic or foreign) in general and permits up to 15 per cent ownership by a select category of institutions (domestic or foreign). This has been done so that ownership is not concentrated in the hands of a few.

These ideas laid the foundations of the shareholding structure of the National Stock Exchange and BSE. Subsequent events in the world of commodities served as important validation of this approach.

It is in this context that we should see the recent Sebi discussion paper on the review of ownership and governance norms regulating stock exchanges and depositories. The purpose of the move is to facilitate entry of more entities and thereby increase competition in this space. To enable this the regulatory framework for these MIIs is proposed to be changed to allow:

1. A higher ownership for resident and foreign promoters at the initial stage with a gradual dilution in shareholding over time and
   
2. resident and foreign individuals/entities to merge with and acquire existing MIIs subject to approval by Sebi.

Changes to governance norms to ensure further diversification of statutory committees at MIIs are also mooted.

At present there are concerns about monopolistic pricing by MIIs. These concerns are important and need to be addressed. However the prices charged by MIIs are tiny values compared with the activities of their customers and even if the mark up is excessive the damage caused to the economy is small. In contrast the big scandals of the markets have rocked the economy and are worth avoiding. There are regulatory mechanisms through which excessive prices by MIIs can be reined in most notably by going closer to a cooperative model where the bulk of the shareholding of MIIs is with the biggest users of the exchange i.e. the institutional investors. These organisations stand to gain more from inexpensive transactions with market integrity when compared with the small flow of dividends from the MIIs.

Dispersed shareholding and low powered incentives for managers in MIIs is based on a cautious approach where we balance the large impact upon the economy of a stock market scandal against the potential gains from concentrated ownership. The question that we have to ask ourselves is: Do we have high confidence in the enforcement of the regulations so that citizens and markets are convinced that the regulator will be able to overcome the conflicts of interest that arise when the managers of an MII have high powered incentives?

The writer retired as a secretary to GoI and is now a professor at the National Council of Applied Economic Research

India can fix its public-sector lenders by letting them raise enough equity capital to significantly reduce government control.

As with the whole economy the covid pandemic dealt a severe blow to India’s banking sector which was already reeling under a huge burden of non-performing assets (NPAs). Stress tests reported in the Financial Stability Report (FSR) indicate that the low ratio of capital to risk-adjusted-assets (CRAR) is likely to decline further. To revive the economy and resume sustained high growth bold structural reforms will have to be combined with strong fiscal and monetary measures.

Here the big challenge for the latter is the low and declining growth of credit. A credit-to-gross domestic product ratio of around 51% is not too low compared to other countries at comparable levels of per capita income. However the worry is that credit growth is declining rapidly. It fell from around 13% year-on-year in April 2019 to 6% in November 2020. This is not attributable to the lockdown because credit growth was already down to 6% in March 2020 when the lockdown had just begun. It is mainly attributable to rising risk aversion among lenders reflecting the high and rising level of NPAs. Risk aversion spiked during the economic contraction. But the underlying level of banking sector stress has been masked by the regulatory forbearance that the Reserve Bank of India (RBI) mandated subsequently extended by the Supreme Court to provide temporary relief for borrowers during the economic contraction. The FSR stress tests now indicate that the gross NPA ratio is likely to go up to as much as 13.5% by September 2021 in the report’s baseline case and 14.8% in the ‘severe stress’ case.

Within the banking sector conditions are much worse in public sector banks (PSBs) compared to private banks (PBs) or foreign banks (FBs). The gross NPA figure is forecast to rise to 16.2% for PSBs as compared to 7.9% and 5.4% for PBs and FBs in the baseline case. In the severe-stress case gross NPAs could rise to 17.6% 8.8% and 6.5% for PSBs PBs and FBs respectively. Clearly high NPAs are primarily a problem for PSBs which still account for 60% of India’s total bank credit.

Given this background how can we rapidly expand the banking sector and restore a high level of credit growth to support a strong sustainable economic recovery?

One approach is to bypass PSBs and give a big push to private banking by issuing new bank licences. The recent report on Ownership and Corporate Structure for Indian Private Sector Banks submitted by an RBI internal working group (IWG) espouses this approach. Apart from many recommendations on better prudential regulation strengthening the supervision capacity of RBI etc the IWG’s main and most controversial recommendation is to enable large corporations and industrial houses to acquire banking licences.

The proposal has been strongly opposed by former governors and deputy governors of RBI several former chief economic advisers a former finance secretary and most significantly all save one of the many experts the IWG consulted. The key issues which have been intensively discussed especially in Rakesh Mohan’s three part article (‘Ownership and Governance in Private Sector Banks’ Business Standard 14 15 and 16 December) are briefly as follows:

One with an industry CRAR of only 12% the proposed raising of the promoter share cap to 26% could potentially leverage the promoter’s investment by 32 times. The very high risk appetite generated by such leveraging would subject depositors (i.e. individuals small companies large corporations and even governments) to a high level of systemic risk given the limited deposit insurance provided in India.

Two excessive risk appetite would lead to imprudent lending especially connected lending to group companies. Conglomerates always find ways around regulatory restrictions against such connected lending.

Three a conglomerate’s bank would have access to insider information on borrower companies that compete with its group companies.

Four conglomerate banks would lead to massive concentration of economic power and political influence against not just competing companies but even the regulator.

A safer and cleaner option would be to help the country’s banking sector grow through simultaneous privatization and recapitalization of PSBs. In the last three years apart from merging some weak and strong PSBs the government has spent some ₹2.5 trillion on recapitalizing PSBs. This has been financed partly by taxpayer money and partly recapitalization bonds including the recently- introduced discounted zero-coupon bonds sold to PSBs that are to be recapitalized. However these options do not change the ownership and governance structure of PSBs which is what primarily is to blame for their poor performance.

A better option is for PSBs to recapitalize themselves by raising fresh equity. But there will be no appetite for this unless: (a) the banks’ balance sheets are first cleaned up; and (b) it is announced that the volume of fresh equity being raised is more than the government’s holding (which would reduce the government’s ownership to a stake of less than 50%).

Such a bold reform would mobilize substantial resources from a buoyant capital market. It would recapitalize the banks empowering them to resume lending and simultaneously privatize their ownership structure which would lead to improved performance.

It would be more prudent financially and also more acceptable politically to test this approach with one or two small PSBs. But first the Indian government has to bite the bullet. 

Sudipto Mundle is a distinguished fellow at the National Council of Applied Economic Research. Views are personal.

The COVID pandemic has understandably grabbed most of the Government’s attention becoming the single largest health focus in the country currently but as India moves ahead to deal with this challenge it would do well to simultaneously focus on the health of its most precious human resource its children.

The year 2020 has become synonymous with COVID the world over but for India it signifies another health risk calling out for attention. The State and district level findings of the fifth round of the National Family Health Survey (NFHS-5) conducted in 2019-20 and released recently raise serious concern about the status of childhood nutrition in the country. The NFHS a large-scale survey conducted throughout India in four earlier rounds in 1992–93 1998–99 2005–06 and 2015–16 provides State and national level information on various health indicators including fertility nutrition infant and child mortality reproductive health prevalence of anaemia and utilisation and quality of family planning services. NFHS-5 covered 6.1 lakh sample households to provide estimates for 707 districts with data for its first phase encompassing 22 States and Union Territories.   

One of the most promising results in NFHS-5 is the successful use of contraception to control the Total Fertility Rate (TFR) which has declined to touch the replacement rate in almost all States and UTs. The survey however red flags the issue of child malnutrition with the Government hard put to explain the worsening nutrition status among the country’s children vis-à-vis the previous NFHS. This is especially worrisome as most other indicators of child health like optimal vaccination rates reduction in under-5 and infant mortality and rise in institutional deliveries exhibit promising trends. 

Deterioration in Childhood Health Parameters

Another piece of data that stands out like a sore thumb in NFHS-5 is that the prevalence of anaemia has multiplied in nearly 70 per cent of the States across different age groups. The survey indicates that in 18 States at least one in every three pregnant women is anaemic despite a substantial increase in the consumption of iron and folic acid tablets. Most global studies demonstrate that maternal anaemia is one of the key causes of foetal as well as childhood malnutrition. It is also well known that the failure to initiate timely breastfeeding after delivery and to sustain it through the first six months of an infant’s life subsequently leads to undernutrition. NFHS-5 found that only ten of the surveyed States showed an improvement in the rates of early initiation of breastfeeding and even more alarmingly only one-fourth of the infants in all States were reportedly receiving adequate nutrition through breastfeeding. 

So how can a nation that aspires to become a $5 trillion economy within the next few years ensure that its children are healthy and well-fed? The answer lies in tackling three indicators of undernutrition among a nation’s child population—stunting (low height for age); wasting (low weight for height); and being underweight (low weight for age). Children with these anthropometric failures are also more likely to suffer from severe diarrhoea and acute respiratory infection than their healthier counterparts. While addressing these three parameters is imperative for ensuring adequate child nutrition some of the NFHS-5 results are counter-intuitive and necessitate out-of-the-box thinking to find viable solutions. For instance Goa the State with the highest per capita income in the country reported an increase in stunting to 25.8 per cent in the current survey from 20.1 per cent in NFHS-4. And Kerala the most literate State which also enjoys the tag of being a welfare State showed a rise in stunting from 19.7 per cent to 23.4 per cent during the corresponding period. Other developed States like Gujarat and Maharashtra also recorded similar trends. In sharp contrast Bihar widely believed to be less advanced than its peers has proved to be an outlier with an impressive performance in bringing down the incidence of stunting from 48.3 per cent in NFHS-4 to 42.9 per cent in the current NFHS. Albeit NFHS-4 had recorded 62 million stunted children in India accounting for 40 per cent of the global share of stunting. But there was still room for some satisfaction as between the two previous NFHS rounds in 2005-06 and 2015-16 the country had managed to lower its share of stunted children by nearly 10 percentage points. These gains have apparently been frittered away in the last five years with current figures clearly showing that children born between 2014 and 2019 are more malnourished than the previous generation. These findings call for a deeper dive into the reasons for the widespread and rising prevalence of malnutrition across the country.        

Key IHDS Findings

The NFHS figures are largely corroborated by data from the India Human Development Survey (IHDS) carried out by the National Council of Applied Economic Research (NCAER) in collaboration with the University of Maryland USA in two phases in 2004-05 and 2011-12 respectively. The IHDS is a nationally representative multi-topic survey administered to over 41000 households in 1503 villages and 971 urban neighbourhoods across the country in the first wave with a re-contact rate of 82 per cent in the second wave. The IHDS dataset is not only the largest source of panel data for children in India but also the only single source for anthropometric data dietary intake and household income and expenditure. 

A comprehensive analysis of IHDS data in conjunction with the successive NFHS findings suggests that poor nutrition adversely affects the physical and cognitive development of children and consequently their productivity and progress in later life. It is also worth exploring whether apart from anthropometric factors other causalities like maternal autonomy female literacy financial status and social background play a role in mitigating or aggravating child undernutrition in households. For instance a well-educated mother who enjoys some autonomy in her home would ensure better care and nutrition for her children whereas a Below the Poverty Line (BPL) household is unlikely to generate sufficient resources for providing a healthy diet to its children.   

The IHDS also offers evidence that open defecation and poor hand hygiene are two of the leading factors responsible for stunting among children. An assessment of IHDS data shows that the incidence of children being underweight and stunted in households with acceptable hygiene levels even if they were in the low income category were much lower at 25.3 per cent and 35.2 per cent respectively as compared to the much higher corresponding figures of 29.2 per cent and 38.8 per cent respectively in households with similar income levels but poorer hygiene standards. Further IHDS-II found that 26 per cent of the married women surveyed were living in families wherein men ate first clearly indicating that women are more likely to be under-nourished than their male counterparts. This also makes them susceptible to nutritional deficiencies like anaemia which have a cascading effect on the health of the children they nurture especially during pregnancy and lactation. 

Half-hearted Solutions

With the persistence of the problem several solutions have been explored and proposed at the policy levels but how far have they worked? Two of the most prominent measures for facilitating better nutrition and health for households included the passage of the historic National Food Security Act (NFSA) by the Government in 2013 and strengthening of the Integrated Child Development Services (ICDS). The NFSA believed to be one of the largest safety net programmes in the world legislated the availability of 5 kg of cereals per person per month at prices ranging from Re 1 to Rs 3 per kg to about 67 per cent of India’s population. The ICDS is a Centrally-sponsored scheme aiming at holistic development of children below 6 years of age pregnant women and lactating mothers by providing them a consolidated package of health and education services. A sub-programme the Supplementary Nutrition Programme (SNP) is also administered under the ICDS. What then accounts for worsening child health in the country despite the implementation of these measures? One explanation is that economic challenges caused by mounting unemployment and rising food inflation during the period 2014–19 have led to declining household incomes compromised dietary intakes and consequently deteriorating child health outcomes. It is also posited that notwithstanding the policy announcement of ramping up the ICDS in reality it suffers from many gaps such as degenerating infrastructure insufficient human resources including ASHA and Anganwadi workers and declining budgetary allocations—one study by the Accountability Initiative has claimed that the SNP component of the ICDS received only 44 per cent of the requisite funds in 2019-20. All these factors have ostensibly aggravated food insecurity among indigent households with child nutrition becoming the biggest casualty in this situation. 

The COVID pandemic has understandably grabbed most of the Government’s attention becoming the single largest health focus in the country currently but as India moves ahead to deal with this challenge it would do well to simultaneously focus on the health of its most precious human resource its children. 

Anupma Mehta is Editor at the National Council of Applied Economic Research.Views expressed in this article are personal.