An indecent proposal

The Economic Survey provides a preview of economic action that can be expected from the government in next year. Therefore, it is an important policy document.

This time the survey stresses that despite global slowdown and various challenges, including truant monsoon, India registered 7.2 per cent growth in 2014-15 and 7.6 per cent in 2015-16, becoming the fastest growing economy of the world. In 2016-17, India is expected to grow in the range of 7 to 7.75 per cent despite considerable headwinds.

However, the survey mentions that India has a potential to grow around 8-10 per cent and as a pre-condition, policy stance should move away from anti-market and pro-state to pro-entrepreneurship, pro-industry and pro-competition.

To facilitate growth, smooth functioning of the financial sector is necessary. But in India, in recent years, stressed assets have been rising. Stressed assets, highest in public sector banks (PSBs), are mainly emerging from mining, iron and steel, infrastructure and aviation sectors — areas that involve substantial resources. Consequently, the return on assets of PSBs is less than one while that for private sector banks is more than one.

A related challenge is the twin-balance sheet problem — highly correlated, impaired financial position of banks with some corporates because of the rising NPAs. The survey mentions that on account of deteriorating performance of commercial banks and asset quality, banks will need to improve their capital positions to meet unforeseen losses in the future.

The estimated requirement is likely to be about ₹1.8 lakh crore by 2018-19 and the gproposes to make ₹70,000 crore available in current and following years. PSBs have already been capitalised to the extent of ₹1.02 lakh crore between 2009 and 2016. Going forward, the survey states that a cogent strategy to follow would be recognition, recapitalisation, resolution and reforms in case of NPAs.

In this context, to recapitalise the banks, the survey moots a unique idea that the RBI should play a role in recapitalising PSBs by tapping on its reserves. This may not be a good solution. First, public sector banks are owned by the government and only the owner should capitalise it. If private sector banks are in difficult situation, should the government, using tax payers money, bail out banks.

Second, 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.

Third, 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 squandered away in unknown infrastructure projects.

Similarly, it brings to mind the sad saga of ad-hoc Treasury Bills and automatic monetisation of deficit that prevailed unabated from 1955 to 1993, and after much effort was finally closed in 1997.

Fourth, if the government is moving towards pro-market and pro-competition policy, then the principle of level playing field would demand that reserves of the central bank are not used to finance operations of any specific bank. Fifth, comparing the level of reserves of the RBI with those held in US Fed may not be a good benchmark to follow especially after the 2008 crisis.

Finally, given the illustrious track record of the RBI, 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.

It must be remembered that these very PSBs were nationalised not too long ago, in three distinct phases, in 1955, 1969 and 1980 to pursue a social agenda.

Since then, PSBs have been in forefront of social activities such as priority-sector lending, channelling resources to the government through statutory liquidity ratio, extending rural banking network, and spreading financial inclusion. PSBs have been contributing to nation building through extensive deployment of resources in activities requiring large sums of money and long gestation periods with low returns.

The public sector undertakings, like electricity boards and transportation corporations, have also been financed mainly by the PSBs.

Instead, a better solution to rising NPAs in PSBs would be to recognise that their social role is starkly distinct from that pursued by private sector banks.

Therefore, there should be different performance measures, and benchmarks for PSBs. And more importantly, institute corrective measures in sectors and industries, mainly public sector understandings, which cause such stress on assets held by PSBs.

The writer is RBI Chair Professor in Economics, IIM Bangalore. The views are personal

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