Will India’s economic juggernaut stall?

This article written by me was first published at https://www.myind.net/will-indias-economic-juggernaut-stall

India’s economy is in limelight due to its performance which is head and shoulders above its emerging market peers. Its GDP grew by 7.9% in January-March 2016 quarter. As recent corporate results show, there is a broad based recovery helped by lower raw material costs and rise in discretionary consumption (Read). This has come about despite successive droughts for last two years. It has happened due to public infrastructure investments, rising FDI due to Make in India and Ease of Doing Business initiatives, and a big turnaround in power and mining sectors. The credit for this turnaround must go to Modi government.  A normal monsoon this year should help things further. The massive Jan Dhan Mudra platform should give a leg up to economic activity at grass roots level.  Although global environment for exports remains difficult, all these factors point to a strong economic performance in years ahead.

Banking bottlenecks

India’s economy can hope to have a dream run. But our banks and financial institutions pose significant hurdles. Banks are intermediaries that pool savings and channel them into credit for economic activities like investments, working capital etc. Banks can help or hinder growth. Unfortunately banks are hobbling due to a mountain of bad loans (Gross NPA) of Rs 5.7 Lakh Crore (Source: Financial Express June 1, 2016). (Read) India’s economy is not just expanding but it also undergoing massive transformation due to both top-down (e.g. FDI led, investment led)  and bottom-up (through small business loans and faster subsidy transfers)  forces.  Our public sector banks, which dominate the sector due their sheer size, can’t match the needs of our economy.

The banking bottlenecks exist already. As economy keeps coming out of a deep and wide trough the bottlenecks can pose serious hurdles. When the real economy of industry, agriculture, and services doesn’t get enough credit to keep moving faster, shortages result. Shortages lead to inflation leading causing rise in real interest rates. The economy starts stuttering.

The above scenario is quite plausible.

The ‘Rajan’ debate

If the above scenario is considered, the current ‘debate’ on Raghuram Rajan’s tenure does seem strange.

Ever since the BJP leader and MP Subramanian Swamy fired salvos against Raghuram Rajan, the Indian and Foreign Media have come to Rajan’s rescue. He was appointed as RBI Governor in 2013 by P Chidambaram, UPA’s Finance Minister. Even the current Finance Minister, Arun Jaitley disapproves of Swamy’s criticism.  That Rajan is the best performing RBI Governor has been argued without any performance yardsticks (Read). Those who support Rajan talk about ‘his reputation’ and ‘sending positive signal to international investors’. “He is very well respected across the world. He is a very capable person and I think if his term is extended then it’s a good thing for India,” said Adi Godrej Chairman of Godrej Group (Read)

It is interesting to note that the ‘Rajan debate’ started only after Swamy raised his objections. No one is also discussing responsibilities for the banking mess.

 

Bad loans and the new financial landscape

Amazingly, Public Sector Banks’ huge Non Performing Asset (euphemism for loans which will not be paid back to banks) crisis gets discussed without any reference to Rajan and his role. One exception to this is the Supreme Court.  “Its (RBI’s) role in regulating the banking sector has come under scrutiny by the SC. Last month, it slammed RBI for not being “bothered about the mounting bad corporate debt.” It reminded RBI of its duty as a watchdog and wanted it to make public the “mind boggling” outstanding bad loans, even if it didn’t want to name defaulters who owe over Rs 500 crore to banks. It told RBI that “if a bank does not manage funds prudently and there is no hope of recovery, what do you do? Aren’t you supposed to keep vigil and take action if banks violate guidelines or are found in the wrong?”  However, RBI wriggled out by saying it does not monitor daily functioning of banks” (Read)

To be fair, Rajan has flagged the bad loans problem and has asked banks to provide for loan losses. But is this going to be enough? The following questions need to be answered.

1. How much of the bad loans can be recovered? How?

2. What caused them? Shouldn’t those who caused the bad loans willfully be probed and brought to book? Shouldn’t the bank boards which presided over such a massive problem be held accountable and changed? (Example: Vijay Mallya episode)

3. What is needed to prevent creation of further bad loans of such magnitude?

4. How to make banks more efficient and nimble to adapt to changing market conditions?

India’s financial sector has seen a lot of progress like establishing modern stock exchanges and fast electronic fund transfers. The Jan Dhan/Mudra platforms are giving a massive boosts to subsidy transfers and small loans.  New universal payment systems are coming up too.

Are our banks, particularly the public sector banks, equipped to deal with this entirely new landscape? Unfortunately, not much has changed in how our public sector banks do business. Nor they are in any position to undertake systemic and technological changes. As an example, technology makes it possible to mine formal and informal credit information of potential borrowers and help faster decision making. Do we see our Public Sector banks making use of such technology anytime soon?

What do we get from RBI and Bank Boards’ Bureau?

The regulator RBI and the PSBs’ major shareholder Government of India should be busy with the above issues.

Despite some bad loans that seem scandalous, Rajan says “Separate morality from NPA clean-up” (read).  Not much is heard from Vinod Rai, Chairman of the Banks Board Bureau. For Rai, the issue is how banks can sanction more credit without getting bogged down with audit questions. “We have given them comfort… You will see from the next month onwards,” he says (read)

Government has launched ‘Indradhanush’ program, but its progress is slow.

We also keep hearing about consolidation of public sector banks. Will merging large weak banks with small weak banks make things better?

 

Syndrome of ‘Banking Business as Usual’ will cause difficulties

Instead of discussing the above questions, Indian media, expert economists, Finance Minister, RBI, and the Banking Boards Bureau Chief have reduced the entire subject to:

1. Bad loans were caused by poor economy. So banks should take a ‘haircut’. There is no moral issue here.

2. Banks should recapitalized through public money (or even better: sold to foreign funds)

3. Interest rates should be reduced.

4. The problem will be less acute or will even go away with economic recovery.

5.  Consolidate public sector banks to create a few larger banks.

Government has launched ‘Indradhanush’ program, but its progress is slow. It sticks to the above macro-economic analysis that ignores weaknesses of public sector banks mentioned above.

With Rajan saying ‘No moral issue in bad loans’, Vinod Rai ‘Giving comfort to PSB managements’, and Arun Jaitely disapproving of ‘personal comments about Rajan’. It is business as usual.  Even if we don’t have a proper banking crisis, our banks are likely to put brakes on economy’s juggernaut that has started rolling.

Will India’s economic juggernaut stall?

PM Modi has said that ‘Appointment of RBI Governor is an administrative issue and it shouldn’t concern media’.  One hopes that this means that he will not get influenced by media’s love for Rajan and by his ‘reputation’.  One hopes that Modi recognizes the above threat to economic progress and preempts it. After all, Modi’s ‘Sabka Saath, Sabka Vikas’ hinges on ability of financial sector to support the real economy.

Modi government has been doing a lot for reviving India’s real economy. It is going to be much harder to do the same for its financial sector. If this is not done in time, the good work being done for real economy will not be enough to bring desired results. We may just have a cyclic recovery followed by a bust.

The time to act is now.

– See more at: https://www.myind.net/will-indias-economic-juggernaut-stall#.dpuf

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s