Banks never expected the government to be so inadequately prepared to handle the aftermath of the November 8 demonetisation decision, but they couldn’t escape the mayhem at their doorsteps in the days that followed. Going forward, at least half the coming year will probably be spent nursing the wounds inflicted on the system. It was a bold political move indeed, but one whose adverse impact far outweighs the advertised benefits. After all, who can say no if the question is “Do you want to get rid of corruption, black money and fake currency notes?” — all in one go?
A bolder move, again to do with banks, could have been to sort out the ballooning bad loan mess. A decision to resolve this would have prepared banks to fuel the economy as it gathers momentum. This, however, requires conviction that good economics is good politics. Just the reverse of the personal belief that Prime Minister Narendra Modi had for demonetisation: that good politics would be good economics.
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It has often taken a crisis for an Indian government to sit up, think through difficult options, and take tough decisions. For instance, during NDA-I with Yashwant Sinha as Finance Minister, all hell broke loose on July 2, 2001, when then Unit Trust of India Chairman P S Subramanyam announced at a press conference in Delhi that sales of units in its flagship US-64 scheme were being suspended for 6 months. In those days, the sale and repurchase prices of US-64 were decided by UTI; its net asset value was never disclosed, but it offered handsome dividends to investors. Given that UTI had more than a dozen guaranteed schemes besides US-64, with the middle class amongst its biggest patrons, the issue assumed political overtones — and the Opposition finally forced the setting up of a Joint Parliamentary Committee (JPC). A close scrutiny of UTI’s portfolio opened a can of worms with investment in dud companies, and the resultant chaos kickstarted the process of UTI reform. Many options were explored, including one to close down the mutual fund behemoth. Finally, the UTI Act was repealed, and it was split into two — Good UTI and Bad UTI. ‘Good UTI’ is the UTI AMC in which US-based investment firm T Rowe Price picked up 26%. To the ‘Bad UTI’, also called the Specified Undertaking of UTI (SU-UTI), were transferred all the guaranteed schemes and holdings of US-64. This too has earned money for the government, and will continue to.
Although there are one too many public sector banks in India with bad assets, the UTI example is pertinent. It’s more about the principle of separating the good from the bad. It’s about not wasting more good money on bad assets. The government has been toying for far too long with the idea of a National Asset Reconstruction Company that can hold the bad assets of all state-owned banks. There are many mechanisms to proceed with how to realise value from the NARC. Though India has over a dozen private ARCs, no state-owned banker in the current environment will be courageous enough to sell his bad assets to these at a discount, for fear of prosecution by state investigative agencies at a later date. And private ARCs will ask for a massive haircut from banks. It’s here that a national ARC can inspire confidence amongst banks. The proposal has gone around in circles between the Finance Ministry, the Niti Aayog and the Prime Minister’s Office. Unfortunately, the NDA-II government, spooked by the Congress vice-president Rahul Gandhi’s ‘suit boot ki sarkar’ jibe, doesn’t want to take any chances. It doesn’t want to be seen as pardoning those who cheated the banks and resulted in banks getting saddled with huge NPAs in the first place. But it is exactly here that the Prime Minister can exploit his remarkable communication skills to build a narrative. The UTI example will help the cause.
It’s been 31 months since Modi took charge. Even as he emerged as the BJP’s prime ministerial candidate, well-meaning experts, including Niti Aayog Vice Chairman Arvind Panagariya, laid out a description of the economic landscape for him. Modi was told he was inheriting a banking sector — one dominated by government-owned banks — that was in poor shape. Clearly, for the development agenda he pitched so hard during the Lok Sabha election campaign — and which won him an spectacular mandate — it was critical he turned his attention to the banking system after infusing new energy in the bureaucracy that drives decision-making in the government. It’s been two-and-a-half years, and there have been only piecemeal efforts to revive the banking sector.
The Reserve Bank of India and the government did take steps in recognising the bad loan mess, understanding the extent of the malaise, and then addressing it. These have been one at a time, and certainly do not lead towards a lasting solution to the mountain of a problem that non-performing assets are. In fact, the stressed assets ratio — gross non-performing assets plus restructured standard advances — of the banking sector, steadily rose from 10% in March 2014 to 12% in June 2016. In government-owned banks, which account for roughly 70% of total banking assets, it was higher at 15.4% in June. It essentially means that out of every Rs 100 advanced by a state-owned bank, Rs 15.4 is restructured or bad loan.
In a period of low private investment, banks gave money so that their existing advances to debt-laden companies did not turn bad. The previous RBI Governor Raghuram Rajan did goad banks to reveal their hidden bad loans, and banks grudgingly disclosed a somewhat true picture of their books. A good start, but in hindsight, this process could have been initiated earlier. But some other measures such as letting banks take over majority stake in companies in a hopeless debt situation were hardly practical. Imagine a public sector bank turning around a steel or power company when it has been unable to set its own house in order.
In Viral Acharya, the government’s choice for the RBI Deputy Governor, there may be hope. Acharya has in the past stressed on the need to separate the ‘good’ from the ‘bad’, and to set up a bad bank. The file proposing the setting up of a national ARC or a Big Bad Bank — currently forgotten — may be dusted. The economy will pick up sooner or later, and there will be need for ‘good banks’ with capacity to lend.