Tuesday, August 24, 2010

Game Banks Play - Car loan @ 8.5% and Food Grains @ 11.25%

Under the present policy of procurement of Food grains, all the food grains ( wheat, rice & coarse grains) brought by farmers and confirming to required specifications are procured by Government agencies such as Food Corporation of India (FCI) & agencies of the State Governments such as HAFED, PUNSUP, NAFED & various State Civil Supplies Corporations for the Central Pool at Minimum Support Price (MSP). Procurement this way is open ended in the sense that whatever quantity is offered by farmers has to be procured by these agencies. While it leads to increasing procurement, the logic behind such a policy is to ensure that the benefit of MSP reaches as many farmers as possible. Farmer has the option of selling his produce to Government agencies at MSP or in the open market to traders/wholesalers/private operators if he is offered a price better than MSP. It is interesting that MSP , in absolute terms and as a percentage of cost of cultivation, has been increasing impressively over the years and as a result, procurement has been increasing both in absolute terms and as a percentage of Production. The 3 years moving average of procurement (wheat+rice) which for long was around 25% of production now stands at 31% for 2007-10.
The production of Food Grains itself is on the rise. Agriculture in India primarily continues to be dependent on vagaries of rains. It is worth noticing however that the combined production of wheat and rice which averaged 158.48 million tones since 1999-2000 till 2006-07 increased to an average of 174.9 million tones for the period 2007-08 onwards showing a healthy growth of 10% plus. And it is in this light that increasing procurement (as a percent of increasing production) becomes even more impressive. While there is a reason to feel happy that MSP is reaching the farmers and that part of it will be ploughed back in capital improvement in productivity, it raises a serious question whether MSP is not fixed too high and not in tune with market prices of foodgrains as determined by the forces of demand & supply and thus distorting the market operations and inflating the official foodgrain inventory.
Such bulgeoning of foodgrains in Government accounts comes with its set of headaches. The first issue is storage. There are two types of storage in India. There are ‘Covered’ godowns belonging to FCI, Central Warehousing Corporations (CWC) and State Warehousing Corporations (SWC). Most of these godowns are hired by FCI. Once all these godowns are full and if there still remains procured foodgrains stocks, they are kept in ‘Cover & Plinth’ (CAP) – a pucca plinth constructed in open and covered (okay-supposedly) from top. The total capacity under ‘covered’ storage in India is around 47.5 million tones. Any stocks, in excess of this have to be kept under CAP and that’s where the issue of rotting/damage comes in (http://www.thehindubusinessline.com/2010/08/21/stories/2010082152480400.htm or just switch on tv sets).
The second issue is concerning cost of these food grains procured. State agencies & FCI while procuring foodgrains have to pay @MSP to the farmers. However, Government releases funds to State Governments ( who procure directly for their agencies) and to FCI, not on the basis of procurement done by them but based on the average offtake of foodgrains under Targeted Public Distribution System (TPDS) – the subsidized foodgrains distribution to the ration card holders, during the last six months in these States. Let me explain. Suppose a State procures 500 units of foodgrains from the farmers and the average monthly offtake under TPDS is 30 units. The State will be released subsidy only for 180 units thus leaving a gap for 320 units which the State has procured. The annual requirement under TPDS for such a State will be 360 and the State will still have an excess procurement of 140 units for which it will not be reimbursed any subsidy till such time this stock is actually lifted under TPDS. And by that time, next cycle of procurement would have commenced. This does imply dis-incentivizing efforts of the State Governments to maximize procurement and impedes efforts in increasing procurement to meet requirements under the proposed Food Security Act. This is a flaw in the method of meeting the cost of foodgrains procured we need to address at the earliest.
This brings us to the question as to how do States & FCI meet this differential (cost of foodgrains procured minus what’s lifted under TPDS)? This Cash Credit (CC) requirement is met by borrowing from ‘Food Credit’ consortium of Scheduled Commercial Banks chaired by State Bank of India. It has 60 Banks in it. Till June 2010, it was based on 245 points less than the Prime Lending Rate (PLR) for FCI, as Government of India had extended a ‘Single Default Guarantee’ Scheme for an amount of Rs 34000 crores. The State’s rate was 100 points higher. The actual interest charged by Banks, however was 10.25% from FCI & 11.25% from the State Governments (in violation of their own norms of 245 points for FCI and 145 points for States whereby it would have implied 9.30% for FCI & 10.30% for States and no reasons are given by Banks for unilaterally enhancing the rates).
During a recent meeting held with the consortium where RBI top officials too were present, this point was raised that while car loans are available at 8-9% interest why should foodgrains credit be at 11.25%? The response was that interests are determined by the realizable value of the asset in question and since cars have greater realizable value in case of default it is charged less. Foodgrains as per ‘Banking credit rating norms’ ( whatever that means) has got zero value after six month and is treated as a ‘dead stock’! and it has, as per banking wisdom, little or no realizable value even during first six months and that’s the reason interest rates are higher on food grains. What baffles me is their interpretation despite the single default guarantee of Government of India which is a sovereign guarantee and Bankers refusal to take cognizance of State Government’s guarantees on the ground that their credibility is low! The excess amount paid by the State Governments and FCI on this account could be around Rs 3000 crores! (which could certainly, despite all the inefficiencies, have been put to better use such as creation of additional storage facilities). This is a careless, monopolistic arm-twisting by Bankers while all of us become a victim of accompanying inflation.
FCI and State Governments, in order to avoid such high rates of interest, hitherto , were resorting to Short Term Borrowing from Banks which carries a much lesser interest. Food Credit Consortium, not so surprisingly, in its recent meeting held on August 11, 2010 has banned the Short Term Lending for the purpose of Food grains!! ( and to imagine they are Nationalized Banks catering to the needs of priority sector).
Banks have switched to Base Rate based lending w.e.f. July 1, 2010 and instead to reworking the interest rates for foodgrains on a scientific and rational basis, this is how they re-fixed the interest for FCI
Earlier Maximum PLR – 245 points = 930 (or 9.30%)
So Banks decided that this will be the rate under the new Base Rate regime! And how did they justify?
930 = average Base Rate of Consortium (7.9%) + ‘X’
And thus ‘X’ = 140 points or 1.4% ( and this is defined as risk liability of FCI!!)
It will be 10.30% for State Governments (100 points extra because of their low credibility)
How scientific is this? It is a mockery of the Banking system which is supposedly based on a rational method of considering risk factors and other factors.
I leave it for your judgment. And all this while, car loans continue to be available at 8.5%!!


  1. Hi Arvind - some thoughts - first, the interest rate that you see for a car loan is not quite the correct one. Typically, its almost twice the headline rate - since there is an EMI involved, and usually, there is some subvention from the manufacturer. To give an example, NBFC's are reporting almost 27% yield on 2 wheeler financing of late. So the world is not so unfair.
    Second, why does the FCI not access the debt market directly? Why not issue commercial paper, or even bonds for say 1 year - with government guarantee. The market will indicate to you the yield at which it is prepared to trade the paper, and you can then use it as a benchmark to set the rate with the banks. A 1 year instrument with a govt guarantee will be an attractive retail offering as well.

    Anand Tandon

  2. thanks Anand for very useful insights. You are right regarding the true value of car loan.

    And we are working for the debt market issue for FCI