Gold Loans - Part II

Gold loans were discussed in October 2011.


Gold Loans


In a recent development RBI has imposed certain restrictions on the operations of Gold Loan companies. I am putting them out in short:


1. LTV (Loan-to-value) ratio <= 60% on all gold loans.
2. 12% Tier-I capital adequacy for all Gold Loan NBFCs by April 2014.
3. No lending against gold bars/biscuits. Only jewellery allowed as collateral.


Very heady growth, high RoEs or umpteen new entrants??..difficult to pin point what exactly would have been the reason for RBI action.


High RoEs are a big function of asset quality. As we have discussed, gold loans are almost AAA standard loans (unless lending was done at 85%+ LTVs). Good quality assets, even if growing fast, logically should have not worried RBI. 


Moreover, the industry as a whole is drawing people away from the pawn brokers, who charge exorbitant rates on similar loans. So it had some social benefits as well.


So then what prompted RBI to take such severe action??


Maybe we should just step back and have a look at the broader picture.


Muthoot Finance was expected to end the year at 26000 cr of AUM. As has been discussed in the previous article, this would have roughly meant that Muthoot has disbursed around (75000 cr of loans in the year, taking on an avg of 4 months tenure as per company provided information)
If Muthoot is 20% of the overall organised gold loan industry, that would have meant a rough disbursement of anywhere between 3.5-4 lac cr. in FY12. That number would have meant that gold loan NBFC/Banks were giving short term funds to support approximately 4-5% of India's GDP!!! And this was only the organised sector!!!


The calculations can be slightly off, but the quantum is probably enough to make RBI apprehensive, I think. 
What may have added to RBI's anxieties is that the end-use of all such loans is not well documented. Given the fungibility between cash and gold, I would think, it was discomforting for RBI to see the kind of numbers that were being talked about. 
(I am personally very sceptical of asset size and growth being talked about, but I have been wrong many times before)


Attractive RoEs lured many new entrants.That would have increased the probability of mischief.
 
I, unfortunately, cant read RBI's mind. But what I have outlined above, could probably have been the triggers for RBI to come up with some action.


These restrictions are sure to dent the business prospects of all involved in the industry. They may hurt newcomers more than the well settled ones.
The size of the effect and how long will they last, is still not clear to me.


"All that glitters is not gold" is very clear, though!!

Next Time: INR may not stop at 54...

I am always confused whether its good to have a provocative or sensational title for an article. What if the content is miserable and fails to keep excitement of the title going??


On the other hand, an eye-catching title gives you a better chance of exciting the viewer enough to, at least, read it once. You may call it the "Times Of India" strategy. After that, the content takes over and I have a chance to prove that the article and its title, both, were justified.


In short, its a double edged sword.


I do not know if the title excites you enough but if you are reading this line, its purpose has been served. So I quickly move on to the topic itself.


I have written before on INR at various points. In this article, I will try to put my point with the help of a few indicative charts.


At the very first lets take a look at the historical Current Account Balances.

                   Souce : Bloomberg


As can be seen, trend-line Current Account Deficit (CAD) has zoomed in the last 3-4 years. This is the result of "consumption" boom, without a parallel manufacturing/production/mining (whatever it is called as) growth.


Now lets look at the historical chart correlating the USD-INR with the CAD.

                    Souce : Bloomberg
                             (White line - CAD, Orange line - USD-INR)


Persistent CADs ensured that INR kept depreciating through 80s and 90s. This included the 1991 currency crisis, where RBI and Central Govt were left with no option but to devalue the INR substantially.


But then came the first decade of the 21st century where the trend-line CADs  were under control. INR actually went through a period of appreciation against the USD starting from 2000 to early 2008, thanks to the burgeoning foreign exchange reserves. These reserves were a big function of FII/FDI inflows and some external foreign currency borrowing as well. Have a look at the chart below. 

                                         Souce : Bloomberg
                                        (White line - CAD, Orange line - USD-INR, Yellow Line - Forex Reserves)


Then came along the global crisis in 2008. FII inflows dried up and crude oil also shot through the 100$ mark. INR suffered. It went all the way from 40 to 52 in no time.

Since March 2009, with the world flush in fresh liquidity, FIIs came back, crude oil was at reasonable levels and Indian government threw all fiscal caution to the winds inducing a domestic consumption boom. 
Over and above the FII/FDI inflow, foreign currency debt was also coming in.



But this time, forex reserves did not oblige (at least not till now) and remained essentially flat.


In fact, after having reached a peak of about 320 bn USD, reserves have gone down to closer to 290 bn USD. All this has been a function of the sustained CADs that the consumption boom has induced.


Lets have a look at the final chart:

                      Souce : Bloomberg
                                 (White line - Forex REserves, Orange line - USD-INR, Yellow Line - External Debt)


Early 2008, external debt was a good 100bn USD below the forex reserves. Now the external debt is above the forex reserves.
We are still running reasonably big CADs. Our savings rate has been going down. Our dependence on foreign inflows has magnified in the last few years. Its almost like living on the edge, or at least very close to it!!


The slightest hint of a crisis globally and INR suffers. We got a glimpse of that in late 2011, when INR went from 44 to 53 before anybody could blink.
RBI used all its levers to pull it back. But that came at the cost of domestic liquidity. And that also means that there are not many arrows left in RBI's quiver.


There are the usual saviours/hopes:


- Crude oil crashes to 90$ or below.
- FII/FDI keeps pouring in to fill the gap left behind by the trade deficits.
- Gold imports collapse.
- Governance improves dramatically.


As things stand now, the next time a crisis comes, INR may not stop at 54!!!


As I suggested earlier in the article, I am playing with a double-edged sword. I hope not to get my head chopped!!