The government, stung by criticism of its handling of the economy, finally sprang into action and came out with a ₹2.11-trillion bank recapitalisation plan. The banks are to be given more money by the government to shore up their capital, enabling them to lend more. The thinking is that this is expected to lead to credit growth and consequently, a revival of the economy.
This recap plan is to be followed by long-pending banking reforms, which includes greater divestment of government ownership and creating a more professional approach to management within banks.
Divided opinion
The plan has, predictably, divided opinion, with some claiming it is the government’s most important economic initiative in the last three years, and others expressing scepticism.
As TT Ram Mohan, Professor of Finance and Economics at IIM-A, noted in a recent newspaper column , stressed assets in the banking sector or NPAs have risen by five percentage points — from 10 per cent in 2012-13 to 15 per cent in 2016-17, which is alarming.
Also, he argues, credit growth, which had been over 20 per cent during the ‘India Shining’ period in the first decade of this century, has fallen to the 15-20 per cent range in the 2009-15 period, roughly corresponding to the time when the global financial meltdown occurred.
Making a choice
So the government’s logic is, once the banks are shored up with adequate capital, they can lend more and spur economic activity. However, given the stressed balance sheets of the corporate sector, how many would come forward to take loans, even if the banks are willing to lend?
Ram Mohan argues that big firms may be saddled with debt, but smaller firms still require a lot of working capital, especially after the rollout of GST.
There are the usual worries of the massive recap throwing the fisc out of gear. But as Chief Economic Advisor Arvind Subramanian said later, if one took the IMF method of calculation, the fiscal deficit will not rise. But under the Indian method, it would go up.
So the government can either indulge in some accounting jugglery to keep the fiscal deficit at 3.2 per cent, as targeted, or it can say that given the dire economic situation, a slight variance from the target will not hurt.
Capable of change?
But many critics have said that this recap is just a bailout and not a major reform move as touted, chief among them being columnist Swaminathan Anklesaria Aiyar. Their major gripe is this bailout will not root out the bad lending habits of the PSU banks and after a period, they will land in a similar NPA mess, if serious governance reforms are not implemented. There is also the problem of moral hazard — knowing that the government will always shore up their capital, banks will not have the incentive to mends its ways.
Banks, especially public sector ones, landed in this stressed asset mess because they lent to risky infrastructure projects in the early part of this century, when the economy was witnessing a boom and growth rates were soaring. Many analysts allege that PSU banks are often coerced by politicians to lend to big, risky projects. So political interference in what should essentially be financial decisions is a major reason for the mess that PSU banks have landed themselves in.
So, serious governance reforms, autonomy in functioning, more stringent project assessment and risk analysis are some of the reforms suggested. Also, political interference in the functioning of PSUs must stop. But given the prevailing culture, this would be a tall order for now.
Public vs private
Some have argued for greater disinvestment of PSU banks, their logic being less government interference would lead to greater professional functioning. But this argument flies in the face of reality.
~ One, private sector banks too have a major problem with stressed assets, though not to the extent of their PSU cousins.
~ Two, the assumption that private sector banks would, by default, mean more professional, transparent and accountable functioning is debatable. Almost 10 years ago, the global financial system was brought to its knees, resulting in the worst recession the world has seen since the 1930s, by the reckless and toxic assets hawked by Western banks, none of which were state-owned.
All these major banks had to stand in a queue in front of their respective governments for a bailout, without which many of them would have collapsed. So private is not necessarily beautiful.
For now, the government is claiming the bank recap programme will be a major stimulus dose to the economy. It has to be seen whether the corporates, already saddled with idle capacity, will take the government’s bait and start borrowing from banks again.
Now, will the RBI oblige the government and cut rates? All eyes will, no doubt, be on its monetary policy review next month.