Home >opinion >online views >RBI’s policy schizophrenia

Last week, just a day after announcing an expansionary credit and monetary policy—cutting interest rates and infusing more liquidity—the Reserve Bank of India (RBI) made the prudential norms more stringent.

Ideally, both the policy changes should have been a part of the credit and monetary policy to make it more than a nick and a cut policy that it has now become. A slow credit growth and much quicker credit impairment is a dangerous combination that makes monetary management extremely difficult. As cross-country experience shows, after a period of prolonged monetary contraction when the taps are opened, asset quality normally deteriorates.

The credit policy statement, far from sounding a note of caution, plays down these dangers and sees “risk aversion in the banking system stemming from concerns relating to growing non-performing assets (NPAs) as constraining credit flow". It goes further to advise banks that, “Notwithstanding the importance of repairing asset quality, banks should be discerning in their loan decisions and ensure adequate credit flow to productive sectors of the economy." (Third Quarter Review of Monetary Policy 2012-13, statement by D. Subbarao, governor, Reserve Bank of India, 29 January)

Even before banks could internalize this message and be emboldened to lend more, RBI increased the provision to 5% in respect of new restructured standard accounts (flow) with effect from 1 April and in a phased manner for the stock of restructured standard accounts from 31 March 2015.

Given the capital adequacy and the new regulatory requirements, these measures will constrain the capacity and dampen the willingness of banks to lend aggressively. In other words, the tone of RBI’s policy is at variance with the measures it has taken. The stance of the policy is in dramatic contrast to the substantive measures.

It gets even worse. The increase in the provisioning, desirable and long over-due as it is, flies in the face of RBI’s actions. Sometime before the credit policy, it surreptitiously allowed, even actively led, banks to go in for second restructuring in the power sector in such a manner that avoids classifying these restructured assets as NPAs. Under RBI’s own prudential norms, after the failure of one debt recast programme, the assets have to be declared NPAs.

To avoid this, in the case of power distribution companies which are facing massive stress and have been seeking restructuring with banks, RBI has endorsed the debt recast package of the Union government. The centre’s reform-linked scheme announced in September 2012 is nothing but a back door restructuring of the already restructured debt.

Indeed, in three states, Uttar Pradesh, Rajasthan and Haryana with 84,220 crore of outstanding liabilities, distribution companies had entered into bilateral debt recast schemes with lenders last year and the restructuring had just begun. Under RBI’s existing norms, all these loans—the total debt of the power distribution companies is in the range of 2 trillion—would have to be classified as NPAs.

In a thinly veiled attempt to evergreen these stressed loans, RBI has now taken the position that adopting the centre’s package by the states be treated as an alignment and not an exercise amounting to a second restructuring of the debt of the discoms.

The only difference between the centre’s package and the bilateral restructuring schemes entered into by the states is that the former involves sharing of the debt burden by the state governments. The centre’s scheme stipulates that states have to take over half of the outstanding short-term liabilities of discoms as of 31 March 2012.

In its latest report on state finances, RBI notes, quite correctly, that, “The recently-announced scheme for financial restructuring of the state-owned distribution companies is likely to increase the liabilities of the state governments in the coming years."

It goes on further to say, “There is also a need to improve the measurement and reporting of implicit obligations of the states to reflect their true fiscal positions, particularly in light of increasing off-budget liabilities on account of guarantees to state power distribution companies."

The increase in market borrowings of the state governments since 2008-09 is bound to lead to large repayment obligations from 2017-18 onwards. As these special securities are likely to be significantly larger in size than the power bonds that will be extinguished by the fiscal year 2016-17, the overall repayment pressure could be further aggravated from 2017-18 for states that decide to participate in the scheme for financial restructuring of state discoms with substantial accumulated losses and large outstanding short-term liabilities.

The real issue is that by making the states share a part of the discom debt, the centre is converting a limited financial problem into a much wider sub-national fiscal issue. And RBI, despite expressing serious reservations, is supporting it. Strange, but then these days, this seems to be the defining characteristic of RBI’s policy initiatives.

Haseeb A. Drabu is an economist, and writes on monetary and macroeconomic matters from the perspective of policy and practice. Comments are welcome at haseeb@livemint.com

To read Haseeb A. Drabu’s earlier columns, go to www.livemint.com/methodandmanner

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