The Covid-hit world GDP shrank by 3.5% in 2020. Shoppers have fallen by 20% in the US and 97% in Germany compared to pre-Covid levels. Many analysts believe that global travel and tourism won’t return to the pre-pandemic normal until 2025. The Western world is still grimly fighting the Covid menace.
World looks to India
Against this background, the IMF projects that the growth of India (11.5%), China (8.2%) and the US (5.1%) would lead the global recovery. India’s Economic Survey projects the Nominal GDP growth at 14+% and the Real at 11%. India, which seems to have overcome the Covid-19 challenge, invented its own vaccine and is poised to make billions of vaccines for the world. And the world is keen to include India in the global supply chain hitherto dominated by China. The world’s expectation is a new geo-political status for India. If India grows, it will recover and contribute to the world’s recovery and win acclaim. If it dithers, not only the huge investment it is making for growth will go down the drain, it will also disappoint the world. Stakes are huge.
The risks to India’s well-conceived growth in the Budget lie not in, but outside, the Budget. It is obvious to the eyes of those who look deep into the fundamental differentials that set India apart. As the saying goes, what is obvious is the most difficult to detect. Deep fundamental differences distinguish the Indian economy from the Anglo-Saxon West it tends to copy. While India is dominantly family-oriented, the West is predominantly individualist. This differential affects not only spending, savings and investment, but also the State-Individual financial relations and a host of economic issues.
The default savings mode in Anglo-Saxon economies is equity. But that is the last option in India. Indian families prefer safe, not risky, investments because traditional families have to take care of elders, infirm and unemployed through their own savings. That burden is outsourced to governments in the Anglo-Saxon world by universal social security and pension schemes. This enables the individual freed from such obligations to go for risky savings and lavish spending. The traditional Indian families therefore save a lot. Theirs is about one-fifth of the national savings.
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And most of it is in safe mode. The latest RBI data says that bank deposits constitute 51.5% of the financial savings, PF and pension funds 26.2%, and insurance 17.14%, making the safe investment 94.8% — leaving just 5.2% in risky equity. A study says just 18 million Indians invest in equities. In contrast, 55% of American adults invest in equity. Why? The universal social security in the US frees families from the need for safe savings, and allows them to spend lavishly. The Indian government will go bankrupt if it thinks of universal social security.
The celebrated high Sensex and Nifty are driven by global liquidity, not domestic risk savings. If the Indian savings go mostly into banks, Indian business finance cannot but be bank-driven. All attempts from the 1990s to turn the Indians away from banks to Dalal Street have failed. Indian economy will continue to be bank driven till Indians give up their traditional family culture. Being a bank-based economy is no shame. It is no sign of financial backwardness as the US used to mock Japan before 2008. Like Indians, Japanese, too, invest less than 10% of their savings in equity. Also, only one in seven Germans invest in equity. And yet Japan and Germany are efficient. Now it is necessary to recall how not factoring the Indian differential into the prudential norms for providing bank credit to business did the Indian economy in from 2016, as a similar situation is emerging in 2021-22.
An instructive recall
Raghuram Rajan was Chief Economic Adviser to the UPA II from August 2012 to September 2013, and from September 2013 to September 2016 he was the RBI governor. As governor, Rajan cornered glory for detonating the Non Performing Assets (NPA) bomb on the Modi 1.0 regime, even though Rajan himself had said that reckless lending by banks in 2006-08 was the origin of bad loans and blamed the UPA decade for the bad loan mess [theprint.in 11.9.2018].
Rajan could not deny knowing that the NPA had been kept neutralised by loan restructuring schemes and he had accepted that model from 2012 to 2016. The 2012-13 Economic Survey Rajan had authored as Advisor to the UPA II said that “some sectors are experiencing” NPAs because of slowdown and high levels of leverage, adding that some of the reasons for the increase in NPAs are technical, but stress also stems from slow growth and project delays.
A revival of growth will help contain NPAs.” Rajan first talked about NPA only a year after he became governor, on September 15, 2014 at the FICCI/IBA Banking Conference where he just said, “NPAs have increased.” The Rajan-led RBI report released in September 2014 said the ‘NPAs had risen because of cyclical downturn but their growth had moderated,’ cautioning not to be overly confident “the worst is over”. Further, the Rajan-headed RBI report in August 2015 spoke of the NPAs rising steadily from 2.2% in 2010 to 4.7% in 2015.’ That was all.
Despite being in the know of the NPAs before 2008, either as Advisor to the UPA in 2012, and as the RBI governor in 2013 till mid-2016, Rajan never foresaw or forced an NPA crisis. And even as the NPA was rising, the economy too was doing extremely well with the GDP rising from 6% in 2013-14 to 8% in 2014-15 and to 8.2% in 2015-16. Suddenly, in mid-2016 Rajan wielded his sledgehammer and mandated that all NPAs must be identified on arithmetic formulae and provided for, even if the debtor was viable, driving the entire banking system and the economy into despair.
NPA sledgehammer in 2016, GDP crash
Under the force of the Rajan mandate, the NPA of 5% in 2014-15 shot up to 9.3% in 2015-16, 11.7% in 2016-17 and 14.6% in 2017-18. The consequences were enormous and predictable. Forced provisions eroded banks’ capital, landing them in crisis. The government had to shell out `3.2 lakh crore to recapitalise the banks. This affected the government’s fiscal side. In the melee and time gap between provisioning and recap, the banks’ credit to business declined and the economy crashed.
The credit to industry declined; as of November 2020 it stood almost where it was five years ago. The credit to Micro and Small Enterprises, too, declined and stood in November 2020 at less than where it was five years ago. And the GDP growth that had taken off from 6% in 2013-14 to a high of 8.2% in 2015-16 and stood at 7.2% in 2016-17, crashed to 5% in 2019-20. Compare this with what happened from 2014-15 to 2016-17. The hidden NPA from 2006-08 did exist in 2016, but that did not affect growth, as it did not stop credit delivery. Even when the debt is secured by collaterals and recoverable and the debtor is viable, Rajan mandated provisioning and that strangled credit delivery and consequently cost the growth from 2016.
The torpedo replay of 2016-18 in 2021-23
The RBI now forecasts a base level NPA of 13.5% to a worse case level of 14.8% by September 2021. This recalls the peak NPA of 14.6% in 2017-18. The question is: will the Rajan whip of 2016 be back to force provide for NPAs. If it does, the government will find it difficult to realise the dream growth projected by the Budget 2021. It may even have a crisis on its hand with banks forced to make arithmetic-based provision landing in losses and the government having to recap the banks. A replay of the 2016 whip can torpedo and sink the Budget and the economy.
When Rajan cracked the whip in 2016, the banks had no surplus funds, till the fortuitous demonetisation put funds in their hands. Now, in January 2021, the banks, unable to find borrowers to lend, have a surplus of 6.72 lakh crore, which they have parked with the RBI at 3.35%. Everyone pretends, like the emperor in clothes, that there is just credit aversion and so no borrowers. But the reality is that the viable borrowers — all of whom are unlisted companies and MSMEs — hit by downturn have been declared as defaulters and disqualified to borrow.
Banks can generate funds overnight but cannot create borrowers instantly. Borrowers are the asset base of the banks. With the borrowers shut out, banks can’t and therefore don’t lend. How long can banks keep the monies with RBI at such low interest as 3.35%? Banks thrive on lending and earning margin on interest paid. If they do not lend they do not earn at all. If the banks got into difficulties by recklessly lending in the UPA period, they will now get into trouble by not lending. Besides, there is a paradox of liquidity infusion and liquidity absorption happening at the same time. The RBI is infusing liquidity into the banking system as Covid-19 stimulus on the one hand, and on the other, the banks are depositing surplus cash with the RBI!
Learn from the Japanese experience
Here is Japanese experience that can help India. In the late 1990s, Japanese banks made crash provision for NPAs. Consequent recap of banks cost the Japanese government a trillion dollars. The Japanese also brought the same bankruptcy law we adopted. In a paper titled “Japan’s disposal of bad loans: failure or success. A review of Japan’s experience with bad debt disposals and its implications for global financial crisis,”
Richard Coo and Masaya Sasaki of Nomura Research Institute [March 2010] reviewed the Japanese experience and concluded that there is no need to rush to bad debt disposal and it is possible to deal with the problem at minimum cost to the taxpayers by “putting the time on our side”, adding the government must encourage banks to dispose of their bad loans gradually in a credible fashion. Unlike our banks whose funds were frozen in sticky loans in functioning businesses, Japanese banks lost money in asset bubbles that would take longer to recover. The lesson from Japan is self-evident: Give time to banks to deal with NPAs, and avoid crash provisioning by blind application of the rules of arithmetic.
The Reserve Bank of India now forecasts a base level NPA of 13.5% to a worse case level of 14.8% by September 2021. This recalls the peak NPA of 14.6% in 2017-18. The question is: will the Rajan whip of 2016 be back to force provide for NPAs.
Editor, Thuglak, and commentatoron economic and political affairs