Research

On the 19th of July 1969, the Indian government nationalised 14 private banks of India- a decision that is said to be one of the biggest reforms in the country till date. What exactly is nationalisation and why did it happen? Let us have a look.

After Independence, the Government of India adopted the socialist path with India’s first Five-Year Plan in 1951, which required a lot of banking sector support to complete. 

Many countries suffered heavy financial losses in the immediate aftermath of World War II. Many European countries nationalised their banks to overcome the crisis. India was also plagued by economic and political shocks. There were wars with China in 1962 and with Pakistan in 1965, which put immense pressure on public finances. 

Till 1968, all private banks in India were limited to big cities only. All of them were monopolised by industrialists, with the share of industry in the credit disbursed by private banks doubling between 1951 and 1968 from 34 per cent to 68 per cent, while sectors like agriculture were receiving less than 2 percent of the total credit. 

• Overview

At the present times, privatisation of banks is happening. 

• Nirmala sitharaman statement
• Legislative changes

Bank nationalisation

• Economic situation
• Private banks lending, but not to backbones
• Govt decided to take the ownership. Based on the decision of the imperial bank in 1955.

2nd phase of nationalisation also happened in 1980. This step brought 80% of banks under government ownership.

What are the factors that led to nationalisation?

Benefits:

• 10fold increase in rural banks
• 2fold in semi urban and urban banks
• Deposit in rural areas
• Credit to/ deposit in rural areas increased
• Credit to agriculture
• Public deposits increased
• Increased credibility 
• Comparison between number of beneficiaries, women and accounts

Negative:

• NPA crisis, due to credit bubble
• Complex interest rate  structure
• Public banks- weak board, fragile, fragile financial position
• 1 rupee= 71 paise in psbs as 1=3.7 in pvt. Market to book ratio.

 

Nationalization is the process in which the government of a country or a state takes control of a specific company or industry. The post-1967 period saw a series of radical economic policies such as the nationalization of the 14 biggest commercial banks (1969), insurance (1972), coal industry (1973), an effort to nationalize wholesale wheat trade (1973), the takeover of ‘sick’ companies, etc.

• Market Force
• Situation

• Implications
• Positive

However, nationalization did help the Indian economy as it led to:

• Higher penetration of banking in rural areas and underdeveloped sectors: from just 8,262 bank branches (1969) the number rose to 30,303 in 1979.
• Liberal credit availability by banks led to India’s growth process, particularly during the Green revolution.
• Credit to rural areas increased from Rs 115 crore to Rs 3,000 crore, a twenty-fold increase.
• Both rural bank deposit mobilization and rural credit increased significantly after the 1969 nationalization
• Priority-sector lending:e. setting aside 40% of banks’ net bank credit for agriculture, micro and small enterprises, education, housing, and “weaker” sections.
• Domestic saving: The rates of domestic savings and investment increased rapidly from 10% in the 1950s to 20% by the 1980s.
• Removed monopoly of the private sector in some sectors such as coal: After the nationalization of the coal industry in India, India never witnessed a demand-supply gap until 1991
• Investment in Government Securities: There has been a significant increase in the investment of the banks in government and other approved securities in recent years.
• The Balance of payment situation improved considerably after nationalization as the green revolution led to a reduction in food and other imports. By 1978-79, foreign exchange reserve had risen to about a peak of $7.3bn.
• Soared employment opportunities: The huge expansion of PSUs created job opportunities, giving employment to a vast number of educated youths in the country.
• Success of “JAM Trinity”: JAM stands for Jan-Dhan, Aadhaar and Mobile number.
• The initiative would have been a non-starter had there been only private banks and no PSBs in the country.
• Of the total 46 crore beneficiaries, only 1.3 crores have accounts in private sector banks — that is just 2.82%.

• Negative

Nationalization of the 1970s was a bad move as it led to:

• The emergence of structural features that bred inefficiency: The strategy of nationalization together with import-substitution-industrialization (ISI) and ‘Licence Quota Raj’ stifled entrepreneurship and innovation.
• Nationalization led to lesser competition between the public sector and private sectors, this has again led to the bureaucratic attitudein the functioning of PSUs, Lack of initiatives and responsibility, populist pressures, irresponsible trade unionism, red-tapism, etc.
• India lost out on ‘internationalization of production’:
• India’s policy of nationalization and ‘protectionist’ inward-looking economy’ failed to take advantage of globalization that created East Asian miracle economies.
• The implication of it was that India’s export shrank from 2.4% (1948) to 0.42 in 1980.
• Erosion of fiscal prudence: Government expenditure kept rising due to the proliferation of subsidies and grants, salary increases with no relationship to efficiency or output, overstaffing, and other ‘populist measures.
• Because of the lack of performance audit, finance from the public banks and PSUs failed to accomplish large public interest
• Present Impact:
• NPA crisis is considered the legacy of nationalization of banks of the 1970s and 80s: Government ownership and political interference reduced the accountability of banks and the twelve public-sector banks (PSBs) recorded gross NPAs worth Rs 5.47 lakh crore, more than twice the NPA of 19 private banks in 2020.
• Also, nationalized banks are either operating under losses or experiencing falling dividends
• The insurance sector is facing issues of low penetration (only 3.76% of overall insurance penetration in India), public sector monopoly, low non-life insurance (less than 1%), and poor financial health of public sector insurers.
• The government has still not been able to close down all the nationalized ‘sick’ PSUs, thus draining taxpayer’s money.
• Nayak Committee report (2014): Public sector banks have the poor financial position, selection process compromised and non-transparent, high NPAs, board governance weak.
• Economic Survey review of bank nationalization (2020): Every rupee of taxpayer money invested in PSBs fetches a market value of just 71 paise ( in contrast private sector banks fetches a market value of Rs 3.70)
• Issue of “phone banking”: Public sector bank officials can be forced to extend loans when such loans don’t make economic sense.
• Economic survey 2020 pointed out that PSBs enjoy less strategic and operating freedom because of majority government ownership.

• What was the impact on businesses
• Response of businesses
• Creative Outlook Activity: Some creative activity that involves thinking about what would have a present day startup done, or what startup you would have opened at that time. This could be self recorded.
• According to many economists, the long-term impact of these decisions is being felt now, in terms of a looming banking crisis, inefficient coal sector, and poor insurance penetration (3.76% in 2019; one of the lowest in the world).

Topic 2: The Rupee’s 57% International Slide

The 6th of June, 1966 - a day called devilish for INR by the public due to unpopularity.

This was the day when ​​ the rupee was devalued dramatically in response to the first significant balance of payments crisis faced by independent India.

To be clear, this is different from the usual increase and decrease due to supply and demand. Devaluation refers to the conscious decision when a country’s central bank decides to lower its exchange rate in a fixed or semi-fixed exchange rate.

The then Prime Minister, Indira Gandhi, devalued the currency, which was a devaluation of 57% against the US Dollar. But before addressing the reasons behind this decision, let us clear a myth.

Was Re. 1 worth Us Dollar 1 in 1947?

It is an illusion that on August 15, 1947, when India became independent, 1 INR was equal to 1 USD. We compared the IN to the British Pound before the USD became the accepted worldwide currency. Furthermore, India did not engage in trade and had no external borrowings in 1947, therefore INR could not have been equal to USD 1. Additionally, India's 0.8% growth at the time prevented the INR from being equal in value to the USD.

The devaluation in 1966 also happened against the GBP, and after converting INR to GBP to USD, the devaluation figure was 57%.

What was the reason behind this decision?

It had hardly been a decade-and-a-half since India had attained independence. The economy, still finding its feet, needed additional access to foreign exchange. Foreign investments were frowned upon, and exports were negligent. Therefore, the 1950s and the early 1960s were years when India ran up significant trade deficits. Foreign aid from wealthier nations was what came to India’s rescue.

Things got rough in 1965 as India and Pakistan went to war. Military spending soared, putting extra pressure on the Indian government’s resources. At the same time, countries like the US, which were in those days aligned with Pakistan, withdrew help from India.

This financial crisis decimated her foreign currency reserves, and the INR became unacceptable overseas. India could not pay for imports; the only alternative left was borrowing money abroad. Hence, the government resorted to a sharp devaluation of the rupee in a much-criticised decision. 

The rupee in those days was still linked to the Pound, which, in turn, was pegged to the dollar. The devaluation meant that the practical value of the rupee went from ₹ 4.76 against the dollar to ₹ 7.50 per dollar. That worked out to be a devaluation of 57%.

The Reserve Bank of India (RBI) marks 1966 as the second episode of rupee devaluation, the first being a consequence of a devaluation in the Pound, to which the rupee was fixed.

The step was also resorted to retain the present exports by bringing about a better alignment between internal and external prices, thus, giving exports greater competitive power. The related new exchange rate was ₹7.50 to 1 US dollar as against the previous rate of ₹ 4.76.

Did this decision work?

This decision was certainly one of the many unpopular decisions taken by Indira Gandhi. While we can only speculate as to what would have happened if this decision would not have been taken, it can be said that the devaluation did not work. It led to a spike in inflation and did little to help in the long term as it was not accompanied by any other reforms. 

According to data, inflation levels went up from about 5.8% in 1961-65 to about 6.7% in 1966-70 and the trade deficit did fall after the devaluation. However, it would be tough to argue there was a sustainable improvement in India’s external economy, which faced another major balance of payments crisis in 1991. The data shows the trade deficit narrowed from a peak of ₹ 930 crore in 1965 to ₹ 100 crore in 1970, led more by a contraction in imports than a rise in exports.

It is said that since then, the Indian government in ways other than devaluation has used this as a tool that has led the INR to be depreciated to what it is today. The alarming rates of USD to INR have ripples in many places, but is mainly due to these reasons:

Crude oil prices

The price of crude oil has always significantly impacted the value of the INR against the USD. When the price of crude oil rises, the INR depreciates. In the same way, when crude prices decline, the INR appreciates because India imports around 80% of its crude oil and pays for those imports in USD.

Capital Flows

Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) can affect the value of the Indian Rupee. High FDI flows have given stability to the Indian Rupee. When foreign investors withdraw their money from India, there is significant demand for the US dollar. The value of the Indian Rupee falls, and this leads to even more sales.

 The Fed’s monetary stance

The monetary stance of the Federal Reserve (Fed) of the US decides the future direction of interest rates. The Fed’s stance affects the course of action of global investors. They do not need to invest in risky emerging markets if they can earn higher returns by investing in safe US bonds. The US dollar strengthens when the Fed raises interest rates, and the Indian Rupee weakens.

Current account and balance of payments

A country’s current account reflects its balance of trade and earnings on overseas investments. It reflects all the transactions, including imports, exports, and debt. A current account deficit occurs if a country spends more of its currency on imports than it earns from exports. Higher imports of crude oil, gold, products, raw materials, etc., can depreciate the INR against the USD.

Political stability

Political stability and economic performance also impact the strength of the currency. A country with a lower risk of political turmoil will attract more foreign investors. Growing foreign capital flows make the value of the currency appreciate. If a country has sound trade and financial policies, there is more certainty about its currency.

What is the Impact Of Falling Rupee On Funding And Valuation of Startups in India?

Since January, the rupee has declined over 9 per cent against the dollar, hitting its lowest at 81.9 last week. 

Most of the startup funding in India comes from funds denominated in dollars, with startups assessing portfolio values and receiving eventual exit returns in dollars. As a result, it is assumed that any sharp movement in the INR-USD rate would impact a startup’s portfolio value and returns.

A sharp movement impacts a startup’s valuation. For instance, it would take longer for a startup to reach unicorn status. A business in India with rupee revenues and a 10x on revenue valuation would have reached a billion-dollar valuation of Rs 750 crore revenues with an exchange rate of 75. They must get nearly Rs 800 crore in revenue to become a unicorn. In fact, there’s a high chance that even the multiple of 10x may have dropped to 6x or 7x and, hence, higher pressure on the business to achieve a billion-dollar valuation.

However, it is more complicated. The exchange rate impact assessment is different for enterprise businesses and consumer businesses. For example, for enterprise businesses — where revenues are from global enterprises — rupee depreciation has a positive impact because in domestic books if companies manage that, there will be a mild incremental revenue.

But for consumer business, there is zero impact because the bulk of the cost base (other than marketing costs) and the revenue base is rupee denominated.

The exchange rate impact also differs from location to location. A startup outside India will benefit from this depreciation, getting more rupees for the same dollar. Another factor would be the potential investments in the pipeline, which differs concerning portfolio companies. 

Regarding startup investments, the rupee depreciation has little impact as investors factor in rupee movements while investing. The rupee investor will, in any case, negotiate the rupee terms, and the USD will factor it in any case. The only impact is on the valuation amount. 

Short history

Reasons of devaluation

Impact of devaluation on startups

Interesting take

Similar but simplified