Home / Opinion / Columns /  Opinion | What the government can do to keep bad loans from piling up

One of my former students proudly shared his first credit rating assessment in his new job that he recently started. A line in his assessment said the industry to which the firm belonged was highly fragmented. That is, firms were not operating at scale efficiencies. That was not surprising. When Gulzar Natarajan and I wrote Can India Grow? in 2016, we had noticed that industry after industry in India was fragmented.

We perused the headlines in newspapers over the previous two years and we found that India simply lacked scale in many sectors: transportation, logistics, pharma, learning, landscape and outdoor, media, and so on. Our not-so-benign conclusion was that the Indian economy was prone to bursts of rapid economic growth giving way to overheating. Within a few years of high growth, the economy would hit structural supply bottlenecks and price pressures would increase. That seemed to go well with India’s actual economic performance on growth, inflation and economic overheating in general. Fast forward to 2019.

India’s annual consumer price inflation rate was 3.2% in August. Core inflation rate was 4.25% and its peak was 10.4% in January 2012. The annual inflation rate measured by the wholesale price index was barely 1.0% in August. It was over 10%, too, in 2012. India remains a highly fragmented economy, and if inflation has still come down so much, it means that the economy is operating well below potential, and this makes a case for an economic stimulus—fiscal and monetary.

A fiscal stimulus is constrained by the contours of the legislation on Fiscal Responsibility and Budget Management. Monetary policy transmission is still in doubt. However, two mitigating factors for the effectiveness of monetary policy must be mentioned. One, the Reserve Bank of India has ensured that banks link their lending rates to an external benchmark rate like the repo rate, including on housing loans. Countries like Singapore and the UK, to name two, have been operating with such a mechanism, wherein the interest rate charged on housing loans (which are usually long-term) have been linked to short-term interbank rates. The resets happen at preset frequencies.

Second, Niranjan Rajadhyaksha had written in these pages recently that, as per the Taylor’s Rule—which is used as a rule of thumb to determine the correct policy rate and takes into account actual growth and inflation rates, and also their desired levels—India’s policy interest rate (the repo rate) could go down to 4.0%, or lower. The repo rate currently stands at 5.4%. In an earlier piece, he had commented on the recent tendency of Indian households to increase their holdings of cash. He had suggested that this called for the central bank’s balance sheet to grow faster than the rate of nominal GDP growth. In addition, he wrote that this called for an urgent fixing of the problem of inadequate credit flows to non-financial segments of the economy.

This is more important than interest rate cuts by the central bank and their transmission challenges. There should be a willingness to lend and an appetite to borrow. Let us focus on the former. The government has been infusing capital in state-run banks so that they could expand their balance sheets. It has also taken a baby step towards shielding honest lending decisions from vigilance enquiries. Of course, I had written last week—borrowing from Y.V. Reddy’s speech in 2002 and from recommendations of the P.J. Nayak Committee—that the government should take public sector banks out of the ambit of their special Acts of nationalization, and bring them under the Companies Act to level the regulatory playing field. However, even this does not go far enough.

Banks will be wary of lending decisions that have a high likelihood of generating non-performing assets in future. Piquantly, such a possibility exists because of Central and state government policies with respect to coal pricing and tariff-setting for renewable and non-renewable energy, respectively. Apart from government policies on coal linkages and pricing, backtracking on power purchase commitments is creating trouble for government-owned banks.

Therefore, the Prime Minister should have the government take ownership of the credit flow problem. This could be the single biggest contributor to lifting the economy out of its funk. He should knock heads together in the coal and finance ministries, and arrive at answers for assured raw material supply at committed prices to independent power producers. Without delay, he should call for a conclave of chief ministers of Bharatiya Janata Party-ruled states and have them make binding commitments on policies with respect to electricity tariffs that make (renewable and non-renewable) power generation viable, and, thus, attract investment. Importantly, that will stanch the creation of non-performing assets in this sector.

Bankers’ aversion to further lending is an understandable apprehension under the circumstances. Without eliminating that apprehension, conventional monetary policy responses will not achieve the desired effect.

V. Anantha Nageswaran is the dean of IFMR Graduate School of Business, Krea University

These are the author’s personal views

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