Ashima Goyal

The economy suffers from a trust deficit

Ashima Goyal | Updated on May 06, 2018

Growing mistrust Over regulation can hit genuine entrepreneurial activity   -  /iStockphoto

Regulatory overkill is creating an atmosphere of suspicion and hindering the prospects of wealth creation

A major reason for the growth slowdown in India since 2011 is the atmosphere of suspicion and mistrust. As the economy started creating wealth, there were fears that some were cornering this illegally.

It began with telecom. The government’s auditor (CAG) estimated a huge loss to the exchequer from the 2G allocation when A Raja (belonging to the DMK, a coalition partner in the UPA government) allocated mobile licences at a low price on a first-come-first-served basis. But poor realisations from later auctions held at a high reserve price, cast doubt on the CAG figure. Even so the CBI filed chargesheets against 17 people including Raja and several corporates executives in 2011. But the trial court acquitted all of them in December 2017, although the CBI has appealed against the acquittal.

Collateral damage

As growth raised the value of natural resources, and potential kickbacks, the checks and balances and vigilance mechanism of Indian democracy were activated. These have an essential role, but the collateral damage was unnecessarily high because of systemic issues such as a clause in the Prevention of Corruption Act (1988) that defines criminal misconduct by a public servant to include obtaining a pecuniary advantage for anyone where no public interest is involved. This is incompatible with a market economy that runs on profit. An official’s decision that results in someone making a profit can be construed as criminal. And in India’s overburdened legal system, and an overactive media, an allegation can not only destroy reputations but also take years out of a person’s active life.

Similar suspicions arose with bank NPAs. Here again the problems are partly systemic.

India needed a big push in infrastructure in the 2000s. With the shutting down of development banks , relatively undeveloped bond markets and the government trying to reduce deficits how was this infrastructure development supposed to be financed?

Enter public sector banks (PSBs), who saw this as a potentially profitable nation-building exercise despite an obvious asset-liability mismatch. Private banks, however, played safe with retail lending.

PSBs needed repayment earlier but infrastructure has a long gestation, so many loans were non-performing from the beginning. Global and internal (permission paralysis) shocks compounded firms’ losses. Essential rollovers were regarded as ‘evergreening’ even though they were inadequate.

There were problems such as too little owners’ equity, or siphoning of money, or a Mallya who partied even as his employees were not being paid. But there were also sincere entrepreneurs who failed in an impossible situation. Public sector bankers — who had given the loans that had created assets such as roads, power plants, and airports — became liable to be charge-sheeted and imprisoned because the loans they had given were in default.

Banks must take commercial risks and failure cannot be treated as a crime. Since they could be questioned for loss of value they tended to avoid decisions on restructuring. As a result national assets deteriorated. While crooks like Nirav Modi escaped, the regulatory over-reaction that followed hurt the honest. Instead of recognising current efforts at recovery, strictures based on past data made recovery more difficult for the public sector banks. While the IBC did impose valuable deadlines, given the different types of large NPAs, to lump them all on an untested IBC only increased NPAs and provisioning for banks and further reduced asset value.

Earlier it was bank executives who were questioned, but recently a department of the Finance Ministry issued a First Information Report (FIR) against more than 20 IDBI Bank officials, including independent directors, for a loan given in 2014 in an account that had already become an NPA. The loan was given against a security that subsequently lost value.

The Companies Act, 2013, Schedule IV, II.1 describes the roles and functions of a part-time independent director as ‘…bringing an independent judgment to bear on the Board’s deliberations..’; duties III.6 ..ensure their concerns are addressed and if not insist they are recorded in the Board minutes, but III.8 ‘not to unfairly obstruct the functioning of an otherwise proper Board.’ Independent directors do not run the company and if they go against a commercial decision built from the bottom, following due processes and with the involvement of the relevant experts and committees, they are likely to be accused of obstruction.

The Code of Criminal Procedure, 1973, Sec. 154, which defines an FIR, clarifies that the police can take action if the offence is cognizable (that is, likely to carry a punishment greater than three years). In this case action was taken, including searches and confiscation of mobile phones, without any proof of complicity. Is just agreeing to a decision a cognizable offence? Names were published in the press hurting reputations built over years of hard work and contribution to society.

Better incentives

Regulation needs to be forward-looking and improve governance for better functioning PSBs. Robust systems, risk-rating and fintech based diversified low-value lending can reduce the probability of frauds. But this requires stronger boards with an independent Chair. Backward-looking punishment will only reduce entry of independent experts and paralyse decision-making. Boards have become more professional. There is little evidence of discretion or pressure. But will they be willing to take a commercial decision with the risk of being labelled a criminal? Directors will not agree to the sale of an asset or a restructuring with haircuts if years down the line the decision is questioned and the sale is deemed as creating a loss to tax-payers. The priority for the economy should be to get assets functioning again but such resolution will suffer.

Those guilty of corruption must be punished. But to minimise collateral damage accusatory lists must be short, well-researched and based on robust evidence of a cognizable offence. A commercial loss should not be assumed to be a criminal offence unless there is evidence of kickbacks, violation of procedures, or misuse. The system that sets them up to fail needs to be reformed rather than blaming individuals or seeking scapegoats.

There is the well-known story of crabs that tried to escape from a fisherman’s basket being pulled down by others.

This is a mentality born out of scarcity. Today there is possibility of real prosperity provided the crabs begin to trust and let each other get there.

The writer is an independent director at IDBI Bank and a member of the PM’s Economic Advisory Council. Views are personal.

Published on May 06, 2018

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