A number of issues dominated the economic headlines in 2018 ranging from what Donald Trump threatened to do to the desperate efforts of all political parties to reach out to the farmers in the form of the announcement of farm loan waivers.
Probably the most intriguing issue that came up this year was in the realm of the perceived difference of opinion between the RBI and Government of India on various subjects. The debate has brought to the fore several aspects of not just institutions but also policies which we all felt were solutions to the problems that afflicted the financial sector. On second thoughts doubts have come in.
This financial puzzle, so as to term it, probably superseded other issues on currency and inflation as even the now structured monetary policy approach has been almost fixed by legislation.
On the institutional side, the central bank has always been looked at as being unique and had its own recruitment process and more importantly had appointments at the deputy governor and governor level from outside. Therefore there was always this tacit understanding that the so-called chief was appointed by the government. The talk today is on the autonomy of the central bank which makes sense.
But a little-known fact to the outside world is the concept of Section 7 of the RBI Act which gives superseding powers to the government to make the RBI do what it wants. This means that if the reading of this section is right then from inception in 1935 the independence factor of the central bank was subject to certain caveats that could be exercised by the government. This may not have been overtly enforced, but at the end of the day it is the government which legitimately can have the casting vote if there is a serious difference of opinion.
On the policy front, we have seen that solutions in the financial sector are not easy and it is hard to actually get in some tough measures. Therefore while we have tended to mock the system - which includes the government, RBI and banks for ‘kicking the can’ on the non-performing asset (NPA) issue for over a decade now, the fact is that it is difficult not to do so. Therefore, having the Insolvency and Bankruptcy Code (IBC) is one thing which is good on paper.
The reality is no company is willing to give up its assets and would like to delay things and would like to settle with the bank taking the highest haircut. This is why all the resolution schemes were non-starters. Bankers did not want to settle because the post-retirement syndrome of having all the investigative agencies on them was a deterrent. And quite rightly so. Therefore, everyone applauded when the IBC came in.
Now the RBI stepped in with the 12 February circular which said that a single day default would start the resolution process and within 180 days it would be the IBC and all the Special Mention Accounts (SMAs) would cease to exist. The fear of loss of assets became palpable and the power sector which is affected the most sought redress from the government which exacerbated the tension between the two.
The question is where do we draw the line? If we allow for power, why not steel? If steel is okay, then it can be extended to textiles, which is the largest employer in the country? The logic has already gone to the Small and medium-sized enterprises (SMEs) where it is argued that NPA levels are around 11 percent and lower than that of large industry and that there should be a special dispensation here. If this is okay, then what is wrong with loan waivers for farmers who account for 60 percent of the workforce and are critical for GDP growth. Therefore, the extended logic also seems compelling. With this reasoning, everything can be compromised and the credit culture gets vitiated. But if it is not done industries or sectors will perish which is also inimical for growth.
Another major policy decision taken was relating to the PCA banks where the weakest banks defined by certain operating principles were constrained from doing certain businesses. This made sense especially when the net worth is eroded and the government was not willing to capitalise them. But at some of time, it was realized that these banks got funds through deposits which were going for investment in GSecs and were not being used for credit. As the liquidity issue surfaced, the demand was for relaxation of these rules so that they can lend.
The question we have not been answered is as to what do we do with banks which have negative net worth? If they were private banks, they would have gone down under. By virtue of being public sector banks (PSBs) where the government support is there, they are secure. Should we allow them to lend only after they become commercially viable? The recent decision to infuse more capital to the extent of Rs 1.06 lakh cr in FY19 sounds convincing and will help to alleviate the situation.
Here it can also be concluded that the scheme of Indradhanush which was to transform the PSBs has not quite performed even satisfactorily. Either the will was missing or the idea was not on spot. As long as there is intervention by the government the health of these banks will always be vulnerable as they have been used for all kinds of purposes.
The NPA issue was due to directed lending to infra in the days of high growth. Now there is pressure to lend to SMEs with several emotive issues being put forward. Farm loans are always an uncertainty given the dependence on monsoon. Hence PSBs, in particular, have been subject to all kinds of pressures.
Another related interesting issue which got flagged was the central bank providing funds to NBFCs. The RBI so far has used the conventional approach of providing funds to banks which could lend to the NBFCs based on commercial judgment. Therefore, conceptually the RBI did ensure that there was no liquidity deficit. But what happens in case banks do not want to lend to NBFCs and the market prices them high which affect their viability?
A thought which came up for the first time was to have a QE kind of an approach and the question asked was that if the Fed and ECB could do it why not the RBI? Here too the logic is compelling and it can be hoped that when the Board of Directors of the RBI keep meeting they also take a call on whether or not we should be doing the same. So far the RBI has never bought commercial bonds and restricted itself to GSecs. But can we still consider this idea?
Hence what we have seen is that the dualistic picture that has emerged on the banking side. One way to look at it is that we just can’t take tough decisions because we do not want to hurt any section. On the other side, by taking such a stance we can seriously affect growth prospects especially if some sectors collapse and the IBC becomes a disincentive for investment as all business is fraught with risk.
The third view in this 3D frame is whether we are misusing deposit holders’ money and just like how we are critical of how government tax collections are used for what could be meaningless projects like statues, shouldn’t the same yardstick be applied for deposit funds? Quite clearly there are no clear answers in a democracy.
(The writer is chief economist, CARE Ratings)
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Updated Date: Dec 25, 2018 19:41:46 IST