TABLE OF CONTENTS
A. GS1 Related B. GS2 Related INTERNATIONAL RELATIONS 1. Modi, Pence discuss trade, terrorism in Singapore C. GS3 Related ECONOMY 1. RBI, govt. to bury the hatchet? 2. French govt. didn’t guarantee Rafale deal, Centre tells SC SCIENCE AND TECHNOLOGY 1. GSAT-29 has a perfect launch D. GS4 Related E. Editorials SOCIAL JUSTICE 1. A question of writ ENVIRONMENT AND ECOLOGY 1. Protecting the tiger’s habitat ECONOMY 1. Full disclosure (NBFCs, IL&FS Crisis) F. Tidbits 1. Share trading rings louder on mobiles 2. Free smartphones for women self-help groups 3. No plans to give India MFN status: Pakistan G. Prelims Fact H. UPSC Prelims Practice Questions I. UPSC Mains Practice Questions
A. GS1 Related
Nothing here for today!!!
B. GS2 Related
Category: INTERNATIONAL RELATIONS
1. Modi, Pence discuss trade, terrorism in Singapore
Context:
Prime Minister Narendra Modi is in Singapore for a two-day visit during which he will attend the East Asia Summit, an ASEAN-India informal meet, the Regional Comprehensive Economic Partnership (RCEP) summit and hold a meeting with US vice president Mike Pence.
Details:
- Prime Minister Narendra Modi and U.S. Vice-President Mike Pence held talks on a wide range of bilateral and global issues of mutual interests, including defence and trade cooperation, ways to counter terrorism and the need for maintaining a free and open Indo-Pacific.
- The two leaders had “productive discussion on all aspects of global strategic partnership based on growing convergence of interests on regional and global issues”.
- The shared vision of a free and open Indo-Pacific was also talked about.
- The commitment to strengthen security and counterterrorism cooperation and coordination was reaffirmed.
- Pence’s office said he encouraged “free, fair, and reciprocal trade with India.”
- The terror issue:
- Pence referred to the upcoming 10th anniversary of the deadly Mumbai terror attack on November 26 and hailed cooperation between the two sides on counter-terrorism.
- Modi thanked Mr. Pence and reminded him that in one way or another all the traces and all the leads in the global terror attacks ultimately led to a “single source and single place of origin,” without naming any country or organisation.
- However, Modi did point out that the mainstreaming of people involved in the Mumbai attacks in a political process which has taken place in the recent elections in Pakistan should be a matter of serious concern not just to the two countries — India and the U.S. — but to international community.
- Both countries recognised that terrorism is a challenge that has to be fought together and along with the rest of the international community.
- Discussion on Energy:
- Energy is a new sector in Indo-US relations
- India has started importing oil and gas from US worth about $4 billion this year.
- Issue of H-1B Visa:
- Modi told Pence that Indians when they reached the US brought along with them not only their talents to innovate and excel but also their democratic values.
- The Prime Minister, therefore, expressed the hope that this would be the approach that US might take when it looks at the whole issue of the H-1B visa.
C. GS3 Related
1. RBI, govt. to bury the hatchet?
Context:
- In an indication that he is ready to resolve the recent differences between the government and the central bank, Governor Urjit Patel has called a meeting of the central bank’s board on November 19.
- The stand-off between the government and the RBI started with some non-official directors reportedly pressing for relaxation in the prompt correction action framework for weak banks, increased flow of credit to micro, small and medium enterprise sectors, and a special liquidity window for non-banking finance companies at the RBI’s last board meeting.
- The stand-off between the government and the RBI got exacerbated as there were reports that the former will invoke powers under RBI Act to issue directions to the latter on matters of public interest.
Details:
- The government and the Reserve Bank of India seem to be veering around to reach an agreeable solution, particularly with respect to relaxation of the Prompt Corrective Action (PCA) framework and easing of lending norms for the MSME sector
- The issue of relaxation of PCA framework, which the Finance Ministry has been pitching for, will be reached in the next few weeks. As a result of relaxation, some banks may come out of the PCA framework by the end of the current fiscal year.
- Of the 21 state-owned banks, 11 are under the PCA framework. These are Allahabad Bank, United Bank of India, Corporation Bank, IDBI Bank, UCO Bank, Bank of India, Central Bank of India, Indian Overseas Bank, Oriental Bank of Commerce, Dena Bank and Bank of Maharashtra.
- The PCA framework kicks in when banks breach any of the three key regulatory trigger points — capital to risk weighted assets ratio, net non-performing assets (NPA) and return on assets (RoA).
PCA Framework:
- PCA framework is supervisory tool of RBI, which involves monitoring of certain performance indicators of banks to check their financial health as early warning exercise and to ensure that banks don’t go bust.
- Its objective is to facilitate banks to take corrective measures including those prescribed by RBI, in timely manner to restore their financial health.
- It also provides opportunity to RBI to pay focussed attention on such banks by engaging with management more closely in those areas.
- PCA framework is invoked on banks when they breach any of three key regulatory trigger points (or thresholds).
- They are capital to risk weighted assets ratio, net non-performing assets (NPA) and Return on Assets (ROA). Depending on risk thresholds set in PCA framework, banks are put in two type of restrictions, mandatory and discretionary depending upon their placement in PCA framework levels.
- The mandatory restrictions are on dividend, branch expansion, directors compensation while discretionary restrictions include curbs on lending and deposit.
2. French govt. didn’t guarantee Rafale deal, Centre tells SC
Context:
The Law Ministry had raised the lack of a sovereign guarantee as a key “problem” associated with the Rafale deal during inter-ministerial consultations before the Inter Government Agreement (IGA) was signed on September 23, 2016.
Issue:
- In September 2016, India and France signed a €7.87 billion Inter-Governmental Agreement (IGA) for 36 Rafale multi-role fighter jets in fly-away condition
- The surprise announcement for the 36 aircraft was made by Prime Minister Narendra Modi during a visit to Paris in April 2015, citing “critical operational necessity” of the IAF.
- RB 008 will be the 36th aircraft to be delivered to the IAF in 2022, 67 months after the contract is signed.
Details:
- The Centre admitted in the Supreme Court that there was no sovereign guarantee from the French government on the deal for 36 Rafale jets in case the manufacturer, Dassault Aviation, defaults.
- Attorney-General said there was a “Letter of Comfort” from France, which was as good as a sovereign guarantee. The petitioners countered that such a letter had no legal validity.
Sovereign guarantee v/s Letter of Comfort:
- Sovereign guarantee is a promise by a government to discharge the liability of a third person in case of his default.
- A Letter of Comfort (LoC) is merely a letter issued by the government acknowledging support of the attempt for deal by that company. A letter of comfort does not imply that the government guarantees discharge of the liability of the third person in case of his default. It merely gives reassurance that the government is aware of the deal, and supports its decision.
Rafale:
- The Rafale is a twin-engine fighter, multi-role fighter aircraft manufactured by French aviation company Dassault.
- These aircrafts are capable of carrying out all combat missions such as interception, air defence, in-depth strikes, ground support, reconnaissance, anti-ship strikes including nuclear deterrence
- It is a 4th generation Aircraft.
Category: SCIENCE AND TECHNOLOGY
1. GSAT-29 has a perfect launch
Context:
Despite the apprehension that the cyclonic storm Gaja would come in the way of Indian Space Research Organisation – ISRO’s latest launch of latest communication satellite GSAT-29, it had a perfect launch. The feat was pulled off to perfection.
Details:
- GSAT-29 is the country’s heaviest satellite to be carried on board an indigenous rocket from Indian soil.
- GSAT-29 was on board ISRO’s second developmental flight GSLV-MkIII D2 and was launched from the Satish Dhawan Space Centre at Sriharikota.
- The satellite was placed in a geo-synchronous transfer orbit. It will be placed in a geo-stationary orbit at its intended location after three orbit raising manoeuvres
- The communication satellite, weighing 3,423 kg, “is a multiband, multi-beam communication satellite, intended to serve as test bed for new and critical technologies
- The Ku-band and Ka-band payloads are expected to cater to communication requirements for people in remote areas in the country, especially Jammu and Kashmir, and the North-East.
- The first operational mission of this vehicle (GSLV-MkIII) is going to be none other than the Chandrayaan-II mission in January next year. This vehicle is going to carry a human to space three years from now.
D. GS4 Related
Nothing here for today!!!
E. Editorials
(Issues concerning temple entry of women and the Blasphemy law of Pakistan)
The News:
- There are two important developments which experts have commented on- these are the Sabarimala case in India and the Asia Bibi case in Pakistan.
- Experts point out that the two have striking similarities, however, what differentiates them is the ability of the two states to enforce their writ.
A Note on Sabarimala:
- It is important to note that Sabarimala is considered to be one of the holiest temples in Hinduism, with one of the largest annual pilgrimages in the world.
- The faithful believe that the deity’s powers derive from his asceticism, and in particular from his being celibate. Women between the ages of 10 and 50 are barred from participating in the rituals.
- The exclusion was given legal sanction by Rule 3(b) of the Kerala Hindu Places of Public Worship (Authorisation of Entry) Rules, 1965.
- The validity of the rule and other provisions restricting the entry of women was decided by the Supreme Court last month. The Court, by a majority of 4:1, held that the exclusion of women between these ages was violative of the Constitution.
Larger Background:
- The Supreme Court of India ruled, in a 4:1 majority, that the exclusionary practice of women in the 10-50 age group from the Sabarimala temple in Kerala, violates the rights of women devotees.
- The apex court was assessing the constitutionality of the Sabarimala custom of excluding women in their ‘menstruating years’. The custom was allowed by Rule 3(b) of the Kerala Hindu Places of Public Worship Act, 1965.
A look at the majority view:
- The majority held that devotees of Lord Ayyappa do not constitute a separate religious denomination and that the prohibition on women is not an essential part of Hindu religion.
A look at the dissenting view:
- Justice Indu Malhotra was the lone dissenting voice.
- Justice Indu Malhotra chose not to review the religious practice on the touchstone of gender equality or individual freedom.
- Her view that the court “cannot impose its morality or rationality with respect to the form of worship of a deity” accorded greater importance to the idea of religious freedom as being mainly the preserve of an institution rather than an individual’s right.
- She asserted that issues of deep religious sentiments should not be ordinarily be interfered by the court.
- Further, she went on to add that the court should not interfere unless if there is any aggrieved person from that section or religion. What constitutes essential religious practice is for the religious community to decide, not for the court.
Editorial Analysis:
The Judgement surrounding Sabarimala:
- From a legal standpoint, it is important to note that the then Chief Justice of India Dipak Misra and Justice A.M. Khanwilkar held that the practice of excluding women did not constitute an “essential religious practice”.
- Crucially, the judges also relied on Section 3 of the Act mentioned above which stipulates that places of public worship must be open to all sections and classes of Hindus, notwithstanding any custom or usage to the contrary. It was held that Rule 3(b) prohibiting the entry of women was directly contrary to this. A concurring judge, Justice R.F. Nariman, further held that the right of women (in the age bracket in question) to enter Sabarimala was guaranteed under Article 25(1). This provision states that all persons are “equally entitled” to practise religion. According to him, Rule 3 prohibiting the entry of women, was violative of Article 15(1) of the Constitution.
Observation made by Justice D.Y. Chandrachud:
- Justice D.Y. Chandrachud emphasised the transformative nature of the Constitution which was designed to bring about a quantum change in the structure of governance.
- However, more importantly, it was a founding document, designed to “transform Indian society by remedying centuries of discrimination against Dalits, women and the marginalised”.
- Further, it is important to note that ‘Morality’ used in Articles 25 and 26, the judge held, referred to constitutional morality which includes the values of justice, liberty, equality and fraternity.
- He also held that barring menstruating women from entering the shrine is violative of Article 17 (the constitutional provision prohibiting untouchability). The judge held that the concept of untouchability is grounded in the ideas of ‘purity and pollution’. These same notions form the basis for excluding the entry of menstruating women into religious shrines.
- The sole woman judge, Justice Indu Malhotra, who dissented, reasoned,
“Issues of deep religious sentiments should not be ordinarily be interfered by the court. The Sabarimala shrine and the deity is protected by Article 25 of the Constitution of India and the religious practices cannot be solely tested on the basis of Article 14… Notions of rationality cannot be invoked in matters of religion… What constitutes essential religious practice is for the religious community to decide, not for the court. India is a diverse country. Constitutional morality would allow all to practise their beliefs. The court should not interfere unless if there is any aggrieved person from that section or religion.”
A Look at the Asia Bibi case:
Background:
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- A Christian woman in Pakistan was accused of blasphemy.
- The woman, Asia Bibi, was convicted in 2010 on little evidence of violating Pakistan’s law against blasphemy by insulting the Prophet Muhammad.
- She spent years on death row before she was acquitted on 31st October, 2018 by the country’s Supreme Court.
- However, despite her legal victory, which was hailed worldwide by rights groups, Ms. Bibi’s lawyers and her family have expressed fears for her safety because hard-line Islamist parties in Pakistan have called for her execution.
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Ms. Bibi, an illiterate berry picker, was convicted of defiling the name of the Prophet Mohammed.
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She was accused by her Muslim neighbours who objected to her drinking water from the same glass as them because she was Christian.
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Under Pakistan’s blasphemy law, her alleged comment is punishable by death.
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In 2010, Ms. Bibi, at age 39, was sentenced to hang, but her final appeal remained pending until the Supreme Court decision on 31st October, 2018.
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Asia Bibi has now been released and expected to be granted asylum in Europe. Her lawyer has fled Pakistan and the judges now fear for their lives. Pakistan faced the threat of mob violence led by the radical Tehreek-e-Labbaik Pakistan party.
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As a matter of fact, the Chief Justice of Pakistan, Saqib Nisar, has reportedly defended himself by saying, “No one should have the doubt that the Supreme Court judges are not lovers of Prophet Muhammad… How can we punish someone in the absence of evidence?”
Concluding Remarks:
- In conclusion, it is important to note that India was built on a secular foundation while Pakistan was built on a majoritarian Muslim agenda.
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- Further, years of majoritarianism have brought Pakistan to the point where its institutions have had to defend themselves before doing justice to minorities.
- Some critics have pointed out that India is at a stage, where its majority is seeking to bring its institutions to acquiesce in majoritarian instincts. A majority whose forebears had committed themselves to a magnificent constitutional compact now has elements who seek to regress from those values.
- The question is whether the people and the institutions succumb to pressure or adhere to principle.
- Finally, one must note that each individual, regardless of birth ascribed identity, is a minority of one entitled to an individual guarantee of rights protected by the Constitution. It is in the adherence to individual rights that the greater public good rests. Those who sacrifice a little man or woman’s liberty for the security of the many will find neither liberty, nor security.
Category: ENVIRONMENT AND ECOLOGY
1. Protecting the tiger’s habitat
The News:
- Maharashtra government had permitted a hunter to kill the tigress- Avni. The tigress, which is believed to have attacked and killed 13 people, was shot dead in Yavatmal, its habitat on the 2nd of November by a civilian hunter with a team of Forest Department officials.
Details:
- The power to declare a tiger as man-eater is vested with chief wildlife conservator of the state.
- Only when the attack is confirmed as deliberate one and there are instances of more than one deliberate attacks the tiger can be declared as Man eater.
Editorial Analysis:
- It is important to note that since 2016, the deaths of 13 people in the Pandharkawda divisional forest of Maharashtra have been attributed to tigers and at least five of them to Avni, a 6-year-old with two cubs.
- India’s wildlife laws permit a tiger which is believed to have preyed on humans to be killed.
- The State’s chief wildlife warden claimed he had evidence.
Brief Historicity of Events:
- The decision to shoot T1 (known as Avni) was taken in January, 2018 but stayed by the Bombay High Court after appeals by activists.
- Three more deaths later, the Supreme Court, in September, 2018, cleared the way for the forest department to have the tiger killed.
- On November 2, 2018, it emerged that forest officials along with Asghar Ali, the son of hunter Nawab Shafat Ali, claimed to have chanced upon the tiger which, they said, charged at them.
- It is important to note that the hunting party failed to tranquilise Avni, as the rules required, and shot at it fatally.
- Union Minister for Women and Child Development Maneka Gandhi described the killing as “murder”, and several activists and some veterinarians have alleged that no attempt was made to tranquilise the animal.
- The National Tiger Conservation Authority has commissioned an independent team of wildlife experts to investigate the killing.
The Seriousness of Tiger-Human conflict:
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It is important to note that the killing of man-eating tigers in India is rare, but not unprecedented.
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As tigers are India’s apex predators and symbols of its success at conservation, the unusual death of even one tiger causes disquiet in forest departments and among conservation biologists, tourism officials and activists.
A look at some important statistics: Out of 553 tiger deaths from 2012 to 2017, 22.1% were due to poaching, 15.4% were seizures, and 62.4% were attributed to natural causes and causes not attributable to poaching, according to information from the Rajya Sabha.
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India has 50 tiger reserves, but with forest area increasingly spilling into hamlets, there have been several instances of tigers preying on cattle, livestock and, sometimes, people.
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Days after the killing of Avni, villagers in Lakhimpur Kheri, U.P., crushed a tiger to death with a tractor after it fatally attacked a farmer.
Concluding Remarks:
- In conclusion, it is important to note that while there is a larger concern about the shrinking space for tiger habitat in India, conservationists have also said that a few tiger reserves are being pampered at the expense of others.
- As a matter of fact, a recent study by the World Wildlife Fund said that eight tiger sanctuaries in India could, over time, support more than four times the current population of tigers in these sanctuaries.
- Ullas Karanth, the noted conservationist, has said that it is futile to preserve individual members of a species and that efforts must be made to conserve the species as a whole.
- Finally, it is important to note what conservationists have said. Conservationists have said that “man-eaters” is a legacy term from colonial hunters and incorrect in today’s times. Tigers don’t actively seek out humans; it is only because of increased contact between humans and animals that there are more conflicts which leads to deaths.
1. Full disclosure (NBFCs, IL&FS Crisis)
Note to the Students:
This article, i.e. “Full Disclosure” connects to a larger issue which has been featuring in the news for quite some time now. The issue here to be read by students in detail is the series of defaults by the IL&FS holding company and group outfits beginning in August, 2018 which set off a market-wide contagion.
We have dealt with this issue extensively over the past few weeks now. However, since another update has featured in the Hindu, we have recapped some of the points that would lend a sense of continuity with the topic especially for first-time readers of this news.
Students are advised to go through this article as it has a relevance from the perspective of the GS-3 Paper (Indian Economy).
- Here we have suitably signposted the Editorial Analysis into multiple headings.
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“Larger Background”: This particular section talks about the broader background of the issue, taking into consideration specific points that may have been featured in previous editions of The Hindu. The thought process behind including this section is to give a ‘storyline’ approach to an aspirant when he/she goes through this topic.
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“Editorial Analysis”: This particular section gives an insight towards the specific points covered in the specific editorial that is the subject of our study.
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“The Way Forward/Concluding Remarks”: This sections gives aspirants concluding points that are taken from the article in question as well as some forwarding looking points taken from other articles, as and when required.
The important aspect to note here is that the issue being discussed in the news assumes priority over just the article.
Background:
- Infrastructure Leasing & Financial Services Ltd. (IL&FS) was set up in 1987 by the legendary M.J. Pherwani (former chairman of Unit Trust of India, National Housing Bank, etc.) to finance and promote infrastructure projects in the country.
- This holding company is now a financial behemoth with assets of over Rs. 1,15,000 crore and a debt of Rs. 91,000 crore.
- IL&FS Finance, which is a group company of the holding IL&FS company, defaulted in late August on a commercial paper repayment. This development was followed by a default by IL&FS on repayment of a Rs. 1,000 crore deposit to Small Industries Development Bank of India (SIDBI).
- Pursuant to this, a series of defaults by the holding company and group outfits followed. These defaults ran into the weeks leading up to the annual general meeting of IL&FS on September 29, 2018.
- Infrastructure Leasing & Financial Services Ltd. (IL&FS) is listed as “systemically important” by the Reserve Bank of India. The company has over Rs. 1,15,000 crore of assets and Rs. 91,000 crore of debt. Thus, it is too big to fail. This is further underlined by the fact that interlinkages between IL&FS and other financial sector entities such as banks, mutual funds and infrastructure players are too strong and the company would have taken them all down with it if it were allowed to fail.
A Note on IL&FS:
- IL&FS is a holding company that operates through 169 other companies.
- These 169 other companies are either subsidiaries, group companies or joint ventures with others. It has been in the past and is currently as well, associated with landmark projects.
- A few among these projects include the tunnel under the Zoji La Pass, Delhi-Noida toll bridge, Gujarat International Finance Tec-City (GIFT) and a host of road, power, water and port projects.
- Three of IL&FS’group companies are listed on the stock markets.
- These group companies are IL&FS Investment Managers Ltd., IL&FS Engineering and Construction Company Ltd. and IL&FS Transportation Networks Ltd.
- IL&FS was originally promoted by the Central Bank of India, Unit Trust of India and HDFC. Orix Corporation of Japan, Abu Dhabi Investment Authority, LIC and SBI joined in as co-promoters later.
How did this crisis take place?
Essentially, the company borrowed many times its equity. This figure is rumoured to be between 10-18 times its equity. This money was borrowed to fund its infrastructure projects, most of which bring in returns over 20-25 years.
To compound matters, IL&FS’s borrowings were all repayable in the short to medium-term of roughly 8-10 years.
The chokepoint for IL&FS came from the fact that its projects were stalling and not being completed due to various reasons. These reasons ranged from:
- statutory approvals not coming in
- problems of land acquisition and
- projects simply becoming unviable as it happened in the case of power plants.
Further, with returns from these projects not coming in, IL&FS was forced to borrow more. Lenders pulled the plug leading to trouble for IL&FS.
It is important to note that assets and receivables were exaggerated in the financial statements and the top managers took home large pay-outs and continued to pay dividends to shareholders despite the financial situation. An investigation has been ordered by the Serious Fraud Investigation Office.
A Look at Certain Specifics:
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- Recently, the Centre moved to supersede the Board of Directors.
- The decision to change the management has ushered in the appointment of experienced people, such as Uday Kotak, who has rich experience in the finance sector; G.C. Chaturvedi, former bureaucrat and non-executive chairman of ICICI Bank; and G.N. Bajpai, former chairman of the Securities and Exchange Board of India and the Life Insurance Corporation. It is believed that these appointments should lend confidence to lenders and investors.
- The Life Insurance Corporation of India is the largest shareholder in IL&FS with a 25.34% stake, followed by Orix Corporation of Japan with 23.54%.
- The Centre has explicitly stated its intent, which is to “ensure that needed liquidity is arranged for IL&FS from the financial system”.
- By doing so, the Centre has sent out an unambiguous message to the markets that it will not allow the company to fail.
- It is believed that any rescue plan for the company obviously had to begin with replacing the existing management that was responsible for mismanaging its affairs.
- Currently, the problem appears to be one of liquidity and not solvency.
- It is believed that this is a classic case of over-leveraging, and an asset-liability mismatch caused by funding projects of 20-25 years payback period with relatively short-term funds of 8-10 years.
Certain Questions that Remain:
- In conclusion, there are some important questions that need to be answered.
- If IL&FS was a systemically important company, how did its over-leveraging escape the notice of the Reserve Bank of India?
- What did the periodic inspections of the company by RBI reveal? How did the developing situation pass the attention of shareholders? Did they look the other way since their dividends were serviced?
- Finding answers to these questions is as important as rescuing IL&FS.
- Finally, it is felt that there is a need for long-term finance sources for infrastructure projects.
- Currently, the LIC and some insurance companies are the only domestic sources and they too do not lend beyond 10 to 12 years.
- Thus, the Centre and the RBI should look at ways to deepen the debt markets where infrastructure players can borrow long-term.
- Moreover, it also needs to be analysed as to how a company listed as “systemically important” managed to fly under the radar with misgovernance. It is important to note that the debt pile-up due to over-leveraging did not happen overnight.
A Deeper Insight:
- Experts believe that much before the crisis at Infrastructure Leasing & Financial Services (IL&FS) came out into the open last month, mutual funds were comfortably holding bonds – commercial paper, debentures, structured obligation – issued by the company amounting to nearly Rs. 3,500 crore.
- Further, IL&FS was a tiny part of the overall debt exposure of mutual funds to NBFCs and other brokerages, which was pegged at Rs. 11.25 trillion as on September 30, 2018.
- This is a little over 51% of the total assets under management (AUM) — Rs. 22.04 trillion — of mutual funds in India.
- However, everything changed when two IL&FS group entities were downgraded early in September that directly put around Rs. 1,000 crore worth of debt papers at risk.
- Since this development, questions have been repeatedly raised about the quality of assets that fund houses are holding and whether they need to act on them.
- Experts believe that the default of Infrastructure Leasing & Financial Services (IL&FS) on several of its debt obligations over the last couple of months has raised serious questions about how regulators missed the growing debt pile of a systemically important financial institution.
- Crucially, the IL&FS saga has also exposed the underlying weaknesses in the non-banking financial company (NBFC) sector as a whole which has depended heavily on low-cost, short-term debt financing to sustain its shaky business model.
- Currently we observe that both international and domestic interest rates continue to rise. As a consequence to this, the stocks of NBFCs have been punished as investors expect the profit margins of these companies to come under pressure as their borrowing costs rise.
- Added to this, there is the further risk of NBFCs being unable to roll over their short-term debt in case of a severe credit crunch in the aftermath of the IL&FS saga. Experts believe that this is a more serious risk.
- Experts believe that the steep crash of shares of Dewan Housing Finance Ltd. has been the defining moment of the present crisis.
- Currently, we see that the Reserve Bank of India, the National Housing Bank and the State Bank of India decided last week to increase the supply of liquidity in the market to keep interest rates under control.
- We have also observed that the RBI has urged NBFCs to make use of equity rather than debt to finance their operations. This is apart from the government’s decision to replace IL&FS’s management and commitment to providing the company with sufficient liquidity.
- Experts believe that the prolonged supply of low-cost funds to the NBFC sector also creates the risk of building an unsustainable bubble in various sectors of the economy.
- Experts further assert that the defaults associated with any such bubbles will eventually only affect the loan books of lenders.
- There is a concern with State bailouts as well. It is feared that State bailouts could also fuel the problem of moral hazard as other financial institutions may expect a similar lifeline in the future.
Why weren’t red flags raised?
It is important to note that while all fund houses have an internal valuation policy for debt instruments, it typically gets triggered only after a security is downgraded by rating agencies such as CRISIL and ICRA.
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- Once the instruments fall below investment grade, it is the call of the fund houses to value it. It is the Securities and Exchange Board of India (SEBI) which mandates that once a non-government security falls below investment grade, it has to be valued at a discount of 25% to its face value.
- Although there is a valuation policy in place, a fund house can choose to decide whether or not it wants to gradually mark down the asset or just write it off.
- Fund houses typically choose to write it off when the downgrades or defaults are swift and sudden.
- It is important to note that any mark-down or write-off impacts the net asset value (NAV) of the scheme and hence fund houses prefer to gradually mark down securities where there is a risk of delay in payment or even default.
Why is the rescue important?
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- It is important to note that on a standalone basis, the IL&FS may constitute a small portion of the overall debt assets of mutual funds, but a default creates a ripple effect for all NBFCs.
- Such a ripple effect is created for all NBFCs as the cost of funds goes up with mutual funds becoming wary of buying such securities.
- According to industry players, NBFCs have already seen the cost of funds going up by 20-30 basis points in the last one month. A direct quantifiable impact is visible in the stock markets wherein many of the listed NBFCs have seen their value erode by more than 50%, compared to their recent highs.
- In conclusion, it is important to note that if IL&FS had been allowed to collapse, it would have impacted the whole NBFC industry. It would have hit sectors such as:
- housing finance,
- capital market fund raising,
- margin financing and even
- retail loans to a large extent.
It is important to note that a recent report by the government sent to the Ministry of Corporate Affairs (MCA) said a default by IL&FS could have significant repercussions, including widespread redemption pressures, sell-off in the debt market, liquidity crunch and 1,500 smaller NBFCs shutting shop for lack of adequate capital.
The government further said that avoiding a default would require a combination of measures of asset sales, restructuring of some liabilities and fresh infusion of funds by investors and lenders. Currently, the RBI is believed to be looking at strengthening the regulatory framework to avoid asset liability mismatches by NBFCs.
A Look at the Current State of Affairs:
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- A new board of Infrastructure Leasing & Financial Services (IL&FS) was appointed by the Centre on October 1, 2018. This was done after it secured the approval of the National Company Law Tribunal (NCLT) to supersede the previous board.
- The previous board was accused of ‘mismanagement’ and ‘compromise of corporate governance norms,’ leading to financial issues.
- The State Bank of India, which also happens to be the country’s largest lender, has also stepped in to support with liquidity as it decided to triple its target for loan purchase from NBFCs to Rs. 45,000 crore for the current financial year.
- The government also stepped in to address the governance issues at IL&FS.
- Based on a report of the Ministry of Corporate Affairs, which indicated serious deficiencies in IL&FS, the holding company, and its subsidiaries, the government moved the National Company Law Tribunal to dismantle the board and bring in new members to avoid a collapse.
- The board is expected to submit a resolution plan by October 31, 2018.
Who’m does the board comprise of?
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- The stewardship of the new board, has been entrusted to Uday Kotak, executive vice-chairman & managing director of Kotak Mahindra Bank.
- Mr. Kotak will join hands with Vineet Nayyar, who has been named vice-chairman & managing director.
- Vineet Nayyar had played a role in the rescue of Satyam Computer Services after its founder Ramalinga Raju admitted to a massive accounting fraud.
- The newly constituted board also includes former banking secretary G.C. Chaturvedi and former SEBI chairman G.N. Bajpai.
- G.N. Bajpai had also served as chairman of Life Insurance Corporation of India, which is also the largest shareholder in IL&FS.
- Nand Kishore and Dr. Malini Shankar have been roped in as the other directors, while C.S. Rajan’s name was added on October 3, 2018 after seeking fresh approval from the NCLT.
A Closer Look:
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- Currently, we observe that shares of non-banking financial companies (NBFCs) have witnessed a steep fall in recent weeks after concerns over whether they can successfully meet their short-term dues.
- Further, Housing finance companies (HFCs) in particular have seen their shares punished severely over fears of a severe liquidity crisis.
- Dewan Housing Finance has been the worst hit among HFCs.
- The current crisis began with the default of Infrastructure Leasing and Financial Services on several of its dues.
- The Union government subsequently decided to step in and assure lenders to the company that their money would be paid back safely without any default.
How did the situation concerning NBFCs Precipitate?
- It is important to note that many NBFCs use short-term loans borrowed from the money market to extend long-term loans to their customers.
- This leads to a mismatch in the duration of their assets and liabilities and exposes NBFCs to the substantial risk of being unable to pay back their lenders on time.
- NBFCs usually resort to rolling over, or refinancing, their old short-term debt with new short-term debt to compensate for the mismatch in duration.
- However, even though NBFCs usually manage to roll over their short-term debt smoothly, there are times when they may fail to do so.
- Such risk is high particularly during times of crisis when lenders are affected by fear.
- In such cases, they may have to resort to sale of their assets at distress prices to meet their dues.
- This situation can turn a liquidity crisis into a more serious solvency crisis, wherein the total value of the assets of a company falls below the value of its total liabilities.
- Further, NBFCs also face the risk of having to pay higher interest rates each time they refinance their short-term debt.
- Further, as interest rates rise across the globe, equity investors believe that the cost of borrowing of NBFCs will rise and affect their profit margins. This is seen as the primary reason behind the fall in the shares of many NBFCs. Investors may be pricing in the prospect of falling profits for NBFCs in the coming quarters.
- Currently, it is estimated that NBFCs need to repay about Rs. 1.2 trillion of short-term debt in the current quarter. How they manage to meet these dues remains to be seen.
Editorial Analysis:
- After the IL&FS crisis, the Securities and Exchange Board of India is now trying to increase the level of scrutiny on credit rating agencies that failed to warn investors about it.
- As a matter of fact, SEBI has come out with new guidelines to improve the quality of disclosures made by credit rating agencies.
- According to the new norms:
- Credit rating agencies will have to inform investors about the liquidity situation of the companies they rate through parameters such as their cash balance, liquidity coverage ratio, access to emergency credit lines, asset-liability mismatch, etc.
- Further, rating agencies will have to disclose their own historical rating track record by informing clients about how often their rating of an entity has changed over a period of time.
- It is important to note that SEBI has been working hard to improve transparency and credibility among rating agencies for some time now, including through a circular issued in November 2016 calling for enhanced standards for rating agencies.
- However, the latest disclosure norms seem to be a response to the IL&FS defaults and the ensuing crisis.
- It is also important to note that while rating agencies already make at least some of these disclosures one way or the other, mandating the formal disclosure of these facts is still welcome. The ready availability of information can help investors make better decisions.
The Way Forward:
- Experts point out that the latest regulations can only help to a certain extent as a lot of the problems with the credit rating industry have to do with structural issues rather than the lack of formal rules.
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- The primary one is the flawed “issuer-pays” model where the entity that issues the instrument also pays the ratings agency for its services.
- Further, this often leads to a situation of conflict of interest, with tremendous potential for rating biases. Secondly, the credit rating market in India has high barriers to entry, which prevent competition that is vital to protecting the interests of investors.
- This is not very different from the case in many developed economies where rating agencies enjoy the benefits of an oligopoly.
- Experts believe that better disclosures can increase the amount of information available to investors, but without a sufficient number of alternative credit rating providers, quality standards in ratings will not improve.
- It is thus no surprise that even after repeated ratings failures in their long history, credit rating agencies continue to remain and flourish in business.
- Structural reform should aim to solve another severe problem plaguing the industry, which has to do with rating shopping and the loyalty of credit rating agencies in general.
- It is believed that Rating agencies will have to come up with lucrative business models that put the interests of investors above those of borrowers. Such a change requires a policy framework that allows easier entry and innovation in the credit rating industry.
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- Finally, regarding NBFCs, it is hoped that banks will offer a helping hand to NBFCs to meet their short-term dues to lenders like mutual funds.
- Many experts further believe that a widespread financial panic may not be on the cards as the government will act as a lender of last resort.
- However, it is important to note that such bailouts, create the risk of moral hazard in the wider financial system.
- NBFCs, for instance, may continue to borrow short-term to extend long-term loans to their customers because they expect the government to bail them out if they get into trouble.
- In fact, some experts believe that financial institutions in general have traditionally resorted to borrowing short-term to finance long-term loans simply because there is an implicit guarantee extended by the government.
- As the cost of borrowing funds rises, NBFCs may have to settle for lower profits unless they find a way to pass the burden of higher rates on to borrowers.
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- Experts believe that policymakers should try to focus on taking steps to address structural problems that contributed to the crisis. This includes steps necessary to widen the borrower base of NBFCs which have been banned from accepting deposits. This step would allow NBFCs to tap into more reliable sources of funding and avoid similar liquidity crises in the future.
- The biggest challenge for the IL&FS board is to raise funds in quick time so that fresh defaults can be avoided.
- One possible way to get money is to sell assets.
- However, a more permanent way of getting funds is to raise equity capital.
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- Capital can be raised through a rights issue.
- It is important to note that the proposal for a rights issue was mooted by the previous board too, but they were unable to convince the large shareholders.
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- Another option is to sell stakes to a new promoter. Again, that was also mooted by the previous board, but some existing shareholders could not agree on valuations. So the new board has its task cut out.
- As Uday Kotak, the newly appointed chairman of IL&FS, indicated, the crisis is much bigger and more complex than it was initially thought.
- An example to illustrate this is the fact that the new board found that there are 348 entities in the group, significantly larger than the 169 entities it was aware of. This itself underscores the task at hand.
- It is also to be seen if the new board, which the government has thrown its weight behind, could convince the shareholders for more fund infusion.
F. Tidbits
1. Share trading rings louder on mobiles
2. Free smartphones for women self-help groups
- Odisha Chief Minister announced that the government will provide free smartphones to all the six lakh women self-help groups under its Mission Shakti programme.
- He opined that the women in Odisha had come a long way and the next ceiling to be broken was the digital one.
3. No plans to give India MFN status: Pakistan
Pakistan has “no immediate plans” to grant ‘Most Favoured Nation’ (MFN) status to India, said Abdul Razak Dawood, a senior aide to Prime Minister Imran Khan on Tuesday. India has already granted this status to all World Trade Organization (WTO) members, including Pakistan.
MFN:
- The MFN principle of the WTO states that each of the WTO member countries should “treat all the other members equally as ‘most-favoured’ trading partners.”
- It leads to equal treatment amongst countries and ensures a more stable, predictable, reliable and competitive international trade.
- MFN status is very desirable between trading partners because it allows each country the greatest access into the other’s domestic markets without the hindrances of tariffs or quotas. That means it receives the lowest tariffs, the fewest trade barriers, and the highest import quotas (or none at all). It reduces the ill effects of trade protectionism.
G. Prelims Fact
Nothing here for today!!!
H. Practice Questions for UPSC Prelims Exam
Question 1. Consider the following about Call Money Market:
- It is an inter-bank money market where funds are borrowed and lent for one day.
- Collateral is required to borrow money from this market.
Select the correct answer using the code given below:
- Only 1
- Only 2
- All of the above
- None of the above
See
Question 2. With reference to ‘Geosynchronous Satellite Launch Vehicle Mark III (GSLV Mk III)’,
which of the following statements is/are correct?
- It is India’s most powerful launch vehicle yet built.
- It can lift satellites weighing 6 tonnes to space.
- It is powered by cryogenic engines.
Select the correct answer using the codes given below:
- i only
- ii and iii only
- i and iii only
- i, ii and iii
See
Question 3. Consider the following statements:
- During the first session of INC in Bombay, the training and organization of public opinion in the country was declared to be its only aim.
- Initially, Congress delegates were elected by different local organizations and groups.
- To persuade British government, a British Committee of the INC was started in Britain.
Select the correct answer using the codes given below:
- 1 and 2 only
- 2 and 3 only
- 1 and 3 only
- All of the above
See
Question 4. With reference to the European Organization for Nuclear Research (CERN), which of
the following statements is/are correct?
- At CERN, physicists and engineers are probing the fundamental structure of the universe.
- The CERN laboratory sits astride the Austria-Germany border near Vienna.
- India became an associate member of the CERN in 2016.
Select the correct answer using the code given below:
- 1 only
- 2 and 3 only
- 1 and 3 only
- 1, 2 and 3
See
I. Practice Questions for UPSC Mains Exam
- SEBI has enhanced the quantum of disclosures by introducing additional norms while performing rating actions, but the need of the hour is the structural changes in the Credit Rating Agencies. Critically comment.
- Increase in the GDP numbers should have commensurate increase in budget allocation to reduce malnutrition. Draw a holistic plan to solve stunting and underweight issue prevalent in India.
Also, check previous Daily News Analysis
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