Financing the recovery

The burden of the recently released Report on Currency and Finance (brought out by Reserve Bank of India) is that the task of reviving an economy laid low by Covid is not going to be easy. Rather sombrely, the report points out that the output losses on account of Covid (and subsequent setbacks) are expected to be overcome only by 2034-35. These have been pegged at ₹19.1 lakh crore, ₹17.1 lakh crore and ₹16.4 lakh crore for 2020-21, 2021-22 and 2022-23. In observing that the ‘permanent scarring’ is hard to quantify, the report debunks the claim that the effects of the pandemic have been fully overcome. The challenge is to revive consumption and investment, while at the same time sticking to prudence in fiscal and monetary policies. The fiscal constraint, according to the report, is that “growth is at risk once general government debt exceeds a threshold of 66 per cent of GDP”. However, it predicts that “Even under best possible macroeconomic outcomes, general government debt may not decline below 75 per cent of GDP over the next five years”. While advocating a five-year roadmap to get to 66 per cent, the RBI report could have elaborated on the underlying basis of this target, when the level globally is assumed to be higher. As for the monetary constraint, the report observes that “every percentage point increase in surplus liquidity above 1.5 per cent of NDTL causes average inflation to rise by 60 basis points in a year”. In view of these post-pandemic constraints, the report lays store by productivity forces such as digitisation, supply chain logistics, e-commerce and renewables to act as growth drivers.

However, it is with respect to the financial sector that the RBI report leaves questions unanswered. Gross NPAs are slated to rise from 6.5 per cent in December 2021 to 8.1 per cent this September, not least because the IBC has been less effective in realisations. Meanwhile, the private ARCs do not inspire confidence among banks, who fear huge haircuts. The report advocates a “need to expand the ambit of pre-pack mechanism (under the IBC framework), presently available to MSMEs, to larger corporates” — a step which may clear up bank books, but also lead to errant promoters retaining control and good money being thrown after bad. While acknowledging the role of bank mergers in raising capital buffers, it anticipates the need for more capital infusion in the short term. The report rightly asserts PSBs need to be weaned away from government recapitalisation “as a precondition to achieving greater privatisation of the sector”; but it is silent on how governance practices can be improved to get there. This silence is surprising in view of the presence of RBI nominees on PSB boards, which anyway goes against the grain of arms-length regulation.

The RBI report, notwithstanding its erudition, could have referred to the role of Basel III norms in dealing with the pandemic-induced crisis. The Bank of International Settlements has noted that banks that had met Basel III criteria did better in rolling out counter-cyclical moves. Yet, its executives have wondered whether “operational flexibility” should be allowed in such times. This could well apply to India, where the credit-to-GDP ratio is just over 50 per cent and capital adequacy norms are being adhered to.

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