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Indian banks spectacular compared to global peers

By Subir Roy
April 15, 2009 12:05 IST
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The bank credit figures for 2008-09 (lowest overall credit and commercial credit growth in five years) provide further evidence, if any was needed, that a credit crunch lies at the heart of the severe slowdown that continues to beset the economy.

The other deceleration comes via fall in global demand reflected in falling exports. While there is little domestic policy can do to counter the latter, there is much that can be done to revive domestic demand.

The successive stimulus packages in the last two quarters have till now succeeded in delivering a very limited objective- there is enough liquidity for banks to lend more if they want to. But it is clear that they do not want to or even lower the price at which they lend. (Lending rates are down at best 150 basis points whereas policy rates are down 400 basis points.)

Indian banks - the larger and better public sector banks at least which account for the bulk of commercial credit dispensed - are likely to turn in a fairly decent performance in the last financial year. In fact, compared to global banking leaders, their performance will be spectacular and they will be able to lay claim to being in good health, in splendid isolation to the world around them.

Part of their good health will of course have been facilitated by the regulator which has made it easier for them to restructure troubled assets through 'deep restructuring', or to use the more impolite term, 'evergreening'. But the banking regulator has done this with a purpose, so that banks can go on providing much needed credit to a troubled economy without having to worry about their balance sheets.

The primary policy goal before the system- reviving demand - has now been delivered in only a very limited fashion. Directly putting more cash in the hands of people has been partially achieved by waiving farmers' loans, creating employment and wages through the employment guarantee scheme and raising the pay of government and public sector employees.

The big task that still remains is to revive business activity which will both raise employment and wage incomes and thus create demand. And the agency that stands in the middle of this is the banks.

Since banks are run by rational human beings, it needs determining whether they are faced with perverse incentives. First, there is no incentive to become proactive to maintain balance sheet health, as the regulator has already changed the rules of the game so that the accounts are properly dressed up to look respectable.

There is also no firm hand at the top - a powerful finance minister as owner - telling banks what to do. In the absence of Mr Chidambaram and with a part time finance minister in Mr Pranab Mukherjee, the public sector banks which control the vast bulk of banking resources are in effect on auto pilot.

The last bit of disincentive to go out and lend has been provided by the government's borrowing programme, which has had to be stepped up to provide for the budgetary stimulus undertaken to counter the slowdown. The borrowing programme is keeping government paper yields high and so banks are happy to put their extra cash, that which they will not lend to business, in government securities.

Left to himself, the public sector bank manager will always lend to only the safest entities and pass on the surplus to the government. (Only 45 per cent of extra liquidity created since October has been on lent commercially.) Hence the spectacle of banks holding SLR securities far in excess of statutory requirements.

At this juncture the government needs to take two key measures to speed up recovery. One, throw out the additional borrowing programme and print notes so that government borrowing does not stiffen bond yields.

Most commentators are against printing money to revive the economy and the regulator remains unmoved by most developed economies doing so because they are no longer the repository of all wisdom after the mess they have landed their financial systems in.

It is idle to expect bank officials to go out and lend - a particularly hazardous action in the public sector with the way 'vigilance' goes after you when a loan gets troublesome - when you can simply park the funds in government securities and earn maybe even a 6 per cent-plus real rate of return! 

The other action urgently needed is to up investment in infrastructure by both raising budgetary support in the case of government projects and offering interest rate incentives in the case of public private partnership projects or even private projects.

It is mystifying why the railways should not get all the money they can invest when they are among the best equipped to do so. If viability gap funding has already been raised then it can be raised a bit more to revive the lagging national highway development programme.

Be it power projects or ports, there is no reason why their attractiveness and hence pace of financial closure should not be raised by offering credit at a concessional rate.

It is doubtful if this is going to create inflationary pressures in the short run, and in the long run the infrastructure so created will be able to sustain a higher level of growth. The RBI governor has referred to consumer prices remaining high.

If the culprit for that is food prices, then the solution lies in lowering procurement prices and drastically liberalising private trade in foodgrains, not raising government borrowing.

The process of fiscal consolidation since the nineties laid the foundations for the spectacular growth that India experienced in this decade. Equally, infrastructure inadequacies did not allow India to attain the growth levels that China did and nobody can say it did not fudge its way through it. It is heretical to advocate printing money and offering interest rate subsidy for infrastructure projects, but these are exceptional times. 

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Subir Roy
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