Gold loans hide threat of shadow banking in India
Dec 20 2012 , Bloomberg
When Rashmi Deshmukh needed money for her hand-knit clothing business in Mumbai, she couldn’t wait for bank approval. Instead, she put up her wedding jewellry as collateral at a loan-for-gold company to get cash on the spot.
Muthoot Fincorp, which advertises three-minute gold loans and has 3,125 branches across India, charged 24 per cent annual interest. While a bank gets half that rate, it would have loaned her less and required paperwork, she said.
“It’s faster, it’s easier, it isn’t cheaper, but I get more for my gold from Muthoot than the bank,” said Deshmukh, 37, who borrowed Rs 2,50,000 ($4,576) in October because she had more orders than yarn ahead of this year’s holiday season.
Assets at non-bank lenders such as Muthoot have increased 20 per cent annually for the past five years to $670 billion, according to a November report by the Financial Stability Board. That makes India the world’s second-fastest-growing market, after Indonesia, for lending outside the banking system, or shadow banking. It also poses risks for a country where 65 per cent of the population and 92 per cent of small businesses don’t have access to banks, World Bank and government data show.
“With non-bank companies accounting for almost 40 per cent of India’s financial system, policy makers are struggling to tame inflation and reverse slowing growth,” said Ashima Goyal, a Mumbai-based economics professor and member of the central bank’s technical advisory committee. While the Reserve Bank of India (RBI) raised interest rates 13 times from mid-March 2010 through April of this year, inflation has remained above 8 per cent for 21 of 26 months, according to data compiled by Bloomberg.
Having so much money outside government control “stands in the way of smooth transmission of monetary policy,” Goyal said. “This challenge is at the root of India’s struggle to administer policy that will trigger the kind of growth the world is expecting out of India.”
The largely unregulated shadow-banking system also creates risks for Indians putting money into alternative investments. More than 6,000 people in the southern state of Tamil Nadu filed complaints in the past five months after investing in emu farms that failed to pay promised returns. Sahara group, which owns New York’s Plaza Hotel, was ordered by India’s Supreme Court in August to refund 22 million investors $3 billion obtained through improper bond sales in the country’s largest case involving a non-bank financial firm.
The official figure for India’s shadow-banking industry counts only what non-bank financial companies register with the central bank. The true size is much larger, including private lending and money channeled into more than 10,000 collective investment funds known as chits.
“It’s impossible to calculate,” said Kavita Rao, an economist at the National Institute of Public Finance and Policy in New Delhi who was appointed by the government last year to lead a panel to study the black-market economy. “India’s shadows are dark and deep. There’s just no way to know how much our informal lending is worth.”
“If the government knew where all loans went, it could more effectively target measures to direct the economy,” said Shinjini Kumar, a director at PricewaterhouseCoopers in Mumbai.
“When liquidity goes and gets trapped and doesn’t create economic activity, that’s where there’s great concern for stunting economic growth,” Kumar said.
Expansion of India’s $1.85 trillion economy slowed to 5.3 per cent in September, from 11.2 per cent in March 2010, when it was the highest in at least a decade, according to the government statistics office. November’s wholesale price index was 7.24 per cent, the highest inflation rate among so-called Bric nations.
Muthoot Fincorp, which advertises three-minute gold loans and has 3,125 branches across India, charged 24 per cent annual interest. While a bank gets half that rate, it would have loaned her less and required paperwork, she said.
“It’s faster, it’s easier, it isn’t cheaper, but I get more for my gold from Muthoot than the bank,” said Deshmukh, 37, who borrowed Rs 2,50,000 ($4,576) in October because she had more orders than yarn ahead of this year’s holiday season.
Assets at non-bank lenders such as Muthoot have increased 20 per cent annually for the past five years to $670 billion, according to a November report by the Financial Stability Board. That makes India the world’s second-fastest-growing market, after Indonesia, for lending outside the banking system, or shadow banking. It also poses risks for a country where 65 per cent of the population and 92 per cent of small businesses don’t have access to banks, World Bank and government data show.
“With non-bank companies accounting for almost 40 per cent of India’s financial system, policy makers are struggling to tame inflation and reverse slowing growth,” said Ashima Goyal, a Mumbai-based economics professor and member of the central bank’s technical advisory committee. While the Reserve Bank of India (RBI) raised interest rates 13 times from mid-March 2010 through April of this year, inflation has remained above 8 per cent for 21 of 26 months, according to data compiled by Bloomberg.
Having so much money outside government control “stands in the way of smooth transmission of monetary policy,” Goyal said. “This challenge is at the root of India’s struggle to administer policy that will trigger the kind of growth the world is expecting out of India.”
The largely unregulated shadow-banking system also creates risks for Indians putting money into alternative investments. More than 6,000 people in the southern state of Tamil Nadu filed complaints in the past five months after investing in emu farms that failed to pay promised returns. Sahara group, which owns New York’s Plaza Hotel, was ordered by India’s Supreme Court in August to refund 22 million investors $3 billion obtained through improper bond sales in the country’s largest case involving a non-bank financial firm.
The official figure for India’s shadow-banking industry counts only what non-bank financial companies register with the central bank. The true size is much larger, including private lending and money channeled into more than 10,000 collective investment funds known as chits.
“It’s impossible to calculate,” said Kavita Rao, an economist at the National Institute of Public Finance and Policy in New Delhi who was appointed by the government last year to lead a panel to study the black-market economy. “India’s shadows are dark and deep. There’s just no way to know how much our informal lending is worth.”
“If the government knew where all loans went, it could more effectively target measures to direct the economy,” said Shinjini Kumar, a director at PricewaterhouseCoopers in Mumbai.
“When liquidity goes and gets trapped and doesn’t create economic activity, that’s where there’s great concern for stunting economic growth,” Kumar said.
Expansion of India’s $1.85 trillion economy slowed to 5.3 per cent in September, from 11.2 per cent in March 2010, when it was the highest in at least a decade, according to the government statistics office. November’s wholesale price index was 7.24 per cent, the highest inflation rate among so-called Bric nations.
Black money: India ranked 8 among 150 countries
India is among the top 10 developing countries in the world with a black money outflow of $1.6 billion ( Rs.8,720 crore) in 2010, a report by Global Financial Integrity (GFI) said. The report, to be released on Tuesday, said the total outflow of black money from India since independence until 2010 was $232 billion generally in the form of corruption, bribery and kickbacks. The cumulative value of illicit assets held by Indians during the same period is estimated to be $487 billion.
In the post-reform period of 1991-2008, deregulation and liberalisation accelerated the outflow of illicit money from the Indian economy, the report by Washington-based GFI, 
Illicit Financial Flows from Developing Countries, said.
Illicit Financial Flows from Developing Countries, said.
“Almost three-quarters of the illicit assets comprising India’s underground economy — which has been estimated to account for 50% of India’s GDP (around $640 billion in 2008) — ends up outside of the country,” the report’s author and former economist with IMF Dev Kar, said.
The earlier edition of the report has been quoted by the government in its white paper on black money.
The report found illicit financial flow in 2010 from these countries was $858.8 billion, just below the all-time high of $871.3 billion in 2008.
Maximum outflow of illicit money was from China with India ranked eighth.
The report said that astronomical sums of dirty money continue to flow out of the developing world and into offshore tax havens and developed country banks, meaning that the poor in source countries are being deprived of their right to development.
There is a statistical correlation between larger volumes of illicit flows and deteriorating income distribution in the developing countries, the report said.
The finding that only 27.8% of India's illicit assets are held domestically supports the argument that the desire to amass wealth illegally without attracting government attention is one of the primary motivations behind the cross-border transfer of illicit capital.
Opportunities for trade mispricing grew and expansion of the global shadow financial system - particularly island tax havens - accommodated the increased outflow of India's illicit capital flight, the report said.
The government has, however, claimed that it has taken several steps including signing treaties with foreign countries to know about Indian black money stashed in foreign banks.
It also claimed that the Income Tax department had initiated action against persons regarding whom information has been received from these countries.
Govt asks agencies to step up vigil to check gold smuggling
NEW DELHI, DEC 20:
The Government has asked its agencies to step-up vigil on international borders to check spurt in Gold smuggling, Parliament was informed today.
“Department (Revenue) has issued instructions to all field formations to maintain increased vigil so as to curb smuggling of Gold along international borders and to keep a close watch on the trends of smuggling of gold,”
Finance Minister P Chidambaram said in a written reply in the Rajya Sabha.
The value of gold seized by customs department at the international borders during the April-October period rose to Rs 50.02 crore, from Rs 15.81 crore during the corresto ponding period a year ago.
“Specific modus operandi circular has also been issued alerting the field formations against smuggling of plain unbranded gold jewellery by misusing provisions of Free Trade Agreement (FTA),” Chidambaram said.
Cases of gold seizure during the year 2012 include seizure of gold jewellery made from the passengers arriving from abroad and gold seized from importers for misuse of provisions of FTA.
The Government has already taken a number of measures to restrict import of Gold. It has changed the duty structure on Gold from specific rate to ad-valorem and also lowered the limit allowed for passengers to import Gold at concessional duty from 10 kg to one kg.
Further, to bring down prices of Gold, RBI has advised banks not to grant advances for purchase of Gold in any form.
Gold imports in value terms declined by 30.3 per cent in the April-September period of this year to $ 20.2 billion.
During the April-September period of 2011, the Gold imports had increased by 66 per cent to $ 29 billion.
In a separate reply, Minister of State for Finance Namo Narain Meena informed Parliament that India’s foreign exchange reserves stood at $ 294.5 billion at the end of November 2012, as against $ 286 billion at the end of May.
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