A bad idea in the Economic Survey

Updated on: Feb 26, 2017




Its proposal to use RBI funds to finance ailing banks and the proposed bad bank could affect the RBI’s credibility as a regulator

The Economic Survey, an important document of the Government, is generally released a day before the Union Budget is announced. The ES documents the official view of major economic developments that have occurred during the year and thereby provides a preview of the Government’s thinking on various economic issues. Therefore, it is an important policy document for academicians, researchers, analysts and policymakers.

The latest ES resembles a collection of research articles, with hypotheses pertaining to a few subjects removed from India’s economic realities, rather than a survey of economic events in the last one year. For example, the ES discusses the twin balance problem of commercial banks and their relationship with the corporate world, with both under stress.

It has been nearly a decade since the twin balance sheet problem began to emerge and therefore there is a sense of urgency to resolve the issue.

Don’t rope in RBI Banks under stress tend to restrict loans, and credit flow to industry gets impacted. Commercial banks have been trying through various ways to correct the situation, like raising the interest margin, but difficulties continue unabated.

The Government has been attempting to restore health by recapitalising banks. The suggested solutions in the ES include creating a public sector asset rehabilitating agency (PARA). This has been adopted in some countriesbut not always successfully. It comes at a price which finally the taxpayers have to shell out.

Another source could be funding from the capital market. Finally, as in the previous year, the ES suggests that the Reserve Bank of India (RBI) could transfer some of its reserves to ailing commercial banks and PARA. This measure, not argued in the ES, would make the RBI vulnerable to market forces.

In India, in recent years, stressed assets, highest in public sector banks (PSBs), are mainly emerging in select sectors like mining, iron and steel, infrastructure and aviation. This proposal to tap the RBI may not be a good solution.

Firstly, PSBs are owned by the Government and only the owner should capitalise it. Secondly, as a matter of principle, reserves and resources held within the RBI serve manifold purposes to stabilise the economy and should not be used to capitalise PSBs, which are commercial entities.

Thirdly, and more importantly, this proposal is similar to the one made earlier in 2003 that because foreign exchange reserves are accumulated and held within the RBI, they should be used to finance unknown infrastructure projects.

Similarly, it is a throwback to the sad saga of ad hoc Treasury Bills and automatic monetisation of deficit that continued unabated from 1955 to 1993, and after much effort and two special agreements, was finally stopped in 1997.

Fourthly, comparing the level of reserves of the RBI with those held in advanced countries or oil-rich countries may not be a good benchmark to follow, especially after 2008. Finally, given the illustrious track record of the RBI, the reserves, independence and credibility of the institution should not be eroded by such ad hoc policy measures.

A robust balance sheet of the RBI is a first line of defence in any crisis and should not be weakened for short-term benefits, especially when the world faces unprecedented uncertainty. Rather, it would be prudent for the RBI to maintain the traditional discipline of paying dividend to the Government. The Government could then consider distributing such dividends, through the Budget, to PSBs.

The opening of the direct channel of the RBI recapitalising commercial banks may not be appropriate and may set a wrong precedent. After all, the RBI is the regulator and supervisor of commercial banks, including PSBs.

Compensate PSBs Further, to address the problem of rising stress on commercial banks, the Government could consider placing cost value on the social role and compensating the banks, mainly PSBs, accordingly. For example, PSBs have been in the forefront of opening Jan Dhan accounts and could be appropriately compensated for the same. Similarly, in the recent demonetisation drive, PSBs have been doing the major task of accepting cash and remonetising the economy over and above their regular activities.

PSBs should also be encouraged to charge commercial rates on services that are being availed of by competitors and new entrants. For instance, some PSBs have blocked customers from transferring money to wallets of other companies. The official reason provided includes security lapses but anecdotal evidence reveals that there could be financial calculations in this decision. All said and done, tapping RBI reserves to recapitalise PSBs is indeed not a good economic proposal.

In the final analysis, the ES reads more like a research conference volume with international references double that of domestic references.

It is not a survey of the country’s economy during the previous year. It overlooks prominent topics such as the gold monetisation scheme, the Stand Up/Start Up India initiatives, and even financial inclusion.

In view of the sanctity of the traditional Economic Survey and its importance for domestic researchers and scholars, the current avatar does not meet the requirements.

The author is a professor of economics and social sciences at IIM Bangalore.

Published on January 13, 2018

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