The perils of a larger public sector
The government’s plan to empower public sector enterprises to take over stressed assets is a dangerous one
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As the Narendra Modi government completes three years in office, there is a lot of debate on its achievements and shortcomings. While supporters point to macroeconomic stability, foreign direct investment inflows and infrastructure building, critics talk about tepid job creation, intolerance and centralization of power. However, there is unanimous agreement on both sides of the aisle about a key challenge for the Indian economy: stressed assets in the banking sector. Stressed assets on the books of Indian banks are now higher than the net worth of the entire banking sector, according to a recently released McKinsey & Co. report, “Mastering New Realities: A Blueprint To Transform Indian Banking”.
One of the contributing factors in this crisis is the inability of private asset reconstruction companies (ARCs) to play a meaningful role, in spite of enabling regulations and support from the central bank. While lawyers attribute the dismal performance of ARCs to a barrage of legal issues, bankers point to one crucial factor: inadequate capital due to lack of interest among private investors.
To address this “buy-side” problem, there has been intense discussion around one solution: the bad bank. Proponents of this solution point to the success of bad banks in China. In 1999, China set up four centrally controlled asset management companies, or bad banks, to swallow toxic assets from banks. Today, China’s bad banks are “thriving as alternative lenders, evolving from bad-debt managers into some of the country’s largest financial conglomerates”, according to the Financial Times.
The hope was that India too would create a bad bank, which would centralize the sale of stressed assets and lead to a quick resolution. However, that seems less likely now. NITI Aayog vice-chairman Arvind Panagariya recently tweeted, “No plan to create bad bank to resolve NPAs.” As I have previously pointed out (https://goo.gl/FknK61), several political economy factors make the bad bank an unattractive solution for the government. So, what is the government’s plan?
According to recent reports, the government is planning to provide operational flexibility to central public sector enterprises (CPSEs) to take over stressed assets and turn them around. To facilitate the takeover of stalled projects, the cabinet secretariat will coordinate between various CPSEs under different administrative ministries and banks. While this would help unburden the banking sector quickly, it may not be an effective solution, given the state of India’s public sector.
The performance of India’s public sector leaves much to be desired. Between 2009 and 2016, the market value of the Maharatna companies—so-called “crown jewels” of the public sector—declined by 33% at a time when the Nifty index grew by 9%. Between 2010 and 2014, the market value of private sector banks rose by about $30 billion, while the market value of public sector banks (PSBs) fell by about $30 billion. Today, more than 80% of stressed assets in the banking sector are concentrated with PSBs. According to the latest Public Enterprises Survey, the market value of 46 CPSEs decreased by 16.6% in the financial year 2015-16.
In spite of this, the public sector still occupies a large space in the Indian economy. As of 31 May 2017, a mere 88 listed PSEs constituted more than 20% of total market capitalization on the Bombay Stock Exchange (BSE), which has more than 5,000 companies listed on it. The most extreme example is that of PSBs, which own 70% of India’s banking assets as compared to an emerging market average of 33%.
If all major upstream and downstream public sector energy firms in India are integrated, the combined entity will have a market capitalization of close to $100 billion and will be India’s most valued firm by a huge margin. Thus, any initiative which proposes to increase the size of India’s public sector should be discouraged.
The takeover of stressed assets by CPSEs also contradicts one of the core principles of Modinomics—Modi’s economic philosophy. Modinomics initially focused on three Ds: democracy, demand and demographic dividend. In 2015, Modi added a fourth D—deregularization—which is about reducing the government’s footprint in business.
In an interactive session at Facebook headquarters, Modi had said, “I am trying to free everything from the government’s control.” Modi has also said in the past that the government has no business being in business. The proposed solution will achieve exactly the opposite. Transferring stressed assets from PSBs to CPSEs will neither be efficient nor effective, since the burden will remain on the government and taxpayers. Also, the turnaround of stressed assets will be attempted by CPSE managers instead of turnaround specialists from the private sector.
Instead, the government should revisit the idea of setting up a bad bank, transferring stressed assets to its balance sheet at fair valuations and then securitizing the assets to distribute risk among a diverse group of investors. On 11 June, finance minister Arun Jaitley kept the conversation alive by saying that the finance ministry was still debating the creation of a bad bank. Whether the government sets up a bad bank or not, one thing is clear: India needs a smaller public sector, not larger.
Rohan Chinchwadkar is an assistant professor of finance at the Indian Institute of Management, Trichy.