India should ideally have 5-7 large banks, says CEA Arvind Subramanian

He attributed the twin balance sheet problem to the problem of exit and more cases of public sector banks-to-private sector lending, saying that in future, the country should have more private sector-to-private sector lending. “The problem in India today is that you can’t exit, you can’t leave…India has gone from socialism with limited entry to capitalism without exit…exit is difficult because when you have to wind down something, you create a lot of social dislocation and there are a lot of vested interests that benefit from this which resist this kind of exit. So, if you look at twin balance sheet of India, it is very much a problem of exit. There were all these loans made, what we need to do is to get rid of all these loans, write them off and that’s proving very difficult and in a sense, India had in some ways, a terribly difficult combination,” he said.

“We had public sector banks lending to private sector firms, especially in infrastructure. Once that happens, in a sense, the government has to bail out the public sector banks, which benefits the private sector and often the rich private sector. That is politically very difficult and that is the heart of the twin balance sheet challenge that we have. We have to in some ways forgive bad behaviour in the past but that takes the form of the government having to reward the private sector as it were. So, this public sector to private sector lending has proved toxic in India. And, so in future, maybe we should just have more private-to-private lending,” he added.

He said that the interest burden of recapitalisation bonds would be around Rs 9,000 crore but they will not have an inflationary impact. “First, the true fiscal cost of issuing the Rs 1.35 lakh crore recapitalisation bonds is the interest payment of about Rs 8,000-9,000 crore. But cost can be offset by the confidence impact of addressing the critical economic bottleneck, thereby increasing credit supply, private investment and growth,” he said.

On the impact of the recapitalisation bonds on fiscal deficit, he said that they would have an impact on the fiscal gap as per the accounting method followed by the Indian government even though under standard international/IMF accounting, they do not lead to increase in deficit since the recap bonds are treated as “below-the-line” financing. But, he warned about breaching the fiscal deficit target if these bonds are added to the deficit. “It’s important because the government has a fiscal deficit target every year and if this adds to the deficit, there is a danger that the deficit target might be breached which might have adverse consequences. So, it’s not an unimportant issue,” he said.