RBI governor Shaktikanta Das
RBI governor Shaktikanta Das

RBI’s Shaktikanta Das needs to dispel the mistrust in the economy

  • A central bank survey shows that the average Indian is not confident of future income or employment
  • It’s important to note that the lack of trust has broken the funding chain and has already brought India’s GDP growth rate to a six-year low in June quarter

Mumbai: In the cult Bollywood film Jaane Bhi Do Yaaron, the corpse of murdered municipal commissioner D’Mello is central to the satirical take on corruption. D’Mello’s corpse is a fair metaphor of the state of trust among India’s economic stakeholders—it’s dead.

Banks don’t trust corporate borrowers and non-banking financial companies (NBFC) beyond a few names. Lenders are willing to park a record 2 trillion with the Reserve Bank of India (RBI) for a paltry interest (repo rate) on a daily basis rather than lend to companies and earn more.

And what else can explain that bank credit flow to the commercial sector, net of repayments, was negative between April and September this year (see chart)?

Where does RBI, the main actor, stand on all this? Clearly, the central bank has disappointed in building trust through verbal assurances, something that central bankers have used to great effect in the past.

(Graphic: Sarvesh Kumar Sharma/Mint)
(Graphic: Sarvesh Kumar Sharma/Mint)

RBI governor Shaktikanta Das on Friday assured that India’s banks are stable and RBI is monitoring NBFCs closely. To the market’s chagrin, Das didn’t offer any clarity beyond this.

There are ways to build back the trust. Ananth Narayan G., associate professor of finance at SP Jain Institute of Management and Research, pitches for a stressed asset fund to deal with the bad loan mess and give banks confidence to lend.

Modelled on Malaysia’s government-backed asset management company Danaharta, an Indian version would complement the insolvency process, Narayan believes.

The idea of a fund was floated earlier, but didn’t gain currency owing to the moral hazard arising from the government owning the stressed asset fund and transferring bad loans from the banks it owns, hence becoming both the buyer and seller of assets.

“Yes, it is difficult to ignore the moral hazard. But what are the other options with policymakers?" asks Narayan.

It’s important to note that the lack of trust has broken the funding chain and has already brought India’s gross domestic product (GDP) growth rate to a six-year low in June quarter.

Moreover, investors suspect that banks and NBFCs are hiding the full extent of bad loans.

Nerves were frayed last week when a small co-operative bank went into trouble because of its exposure to a single real estate developer.

“There is a trust deficit and to some extent, it has been addressed through the AQR (asset quality review) on banks. But a similar AQR on NBFCs would be disastrous unless followed by a solution," says Narayan.

Trust needs to be built elsewhere too. RBI’s survey shows that the average Indian is not confident of future income or employment.

Das is betting that his mandate to banks asking them to link consumer and small business loans to the repo rate would improve transmission and make it cheaper to borrow. This, in turn, would inspire individuals to borrow for consumption. More consumption demand would bring back companies on the path of investment.

But here, it needs the government’s help. “The RBI needs the backing of the government through fiscal measures to revive growth. Some measures like personal income tax cut are needed to boost consumption and sentiment," said Gaurav Kapur, chief economist at IndusInd Bank.

Indeed, increasing the spending capacity of individuals would be a more direct stimulus than prodding them to borrow and spend.

Last, RBI needs to make markets trust the government and itself. The central bank bungled this a bit on Friday after Das showed blind faith on government’s fiscal calculations. “We have no reason to doubt the commitment of the government in maintaining fiscal deficit," Das told reporters on Friday. Most economists have already priced in a fiscal slippage of around 0.5% of GDP due to the corporate tax cut. “The RBI has not given clarity on the fiscal part. Instead of giving a clean chit to the government over fiscal deficit, the governor should have acknowledged the uncertainty over the fiscal numbers," said an economist, requesting anonymity.

Credibility of fiscal numbers will be earned when the government and its banker come clean on the slippage, economists say. Speculation on fiscal deficit and possible extra borrowing has kept bond yields from responding to the RBI’s policy rate cut on Friday.

“Addressing dislocation in credit markets along with creating an enabling environment for more efficient policy rate transmission remains crucial for policy rate cuts to filter through to the real economy," said Rajeev Radhakrishnan, head of fixed income and fund manager, SBI Mutual Fund.

Which brings us back to the trust deficit among lenders. If India’s most credible banks cannot be trusted, other institutions stand little chance.

But unlike D’Mello’s corpse, trust can be revived. Analysts say RBI’s commitment to be accommodative as long as it is necessary to revive growth is a good start to restore confidence. Restoring trust among domestic stakeholders is the only way to command the same from foreign investors. Mahesh Nandurkar, India strategist at CLSA, feels that Indian equities are now not a hope market but rather a show-me-the-money market.

In an interview with BloombergQuint last week, Nandurkar had said that investors want to see earnings manifest before buying into India’s companies. One boost to earnings has already happened through the corporate tax cut. A leg-up to consumption demand is key. Surely, the government and the RBI cannot say jaane bhi do yaaron (just let it be, friends) for this.

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