There’s fear over the city. Dread can be induced through multiple channels and manifests itself in many forms. On occasion, it is the unintended consequence of a policy misstep or a series of administrative failures. It acquires the characteristics of a systemic risk once feelings of anxiety immobilize business decisions and slow the economy down. The policy response then required to reverse the situation needs some creative thinking, a few bold moves, and lots of communication. The Indian economy right now is vulnerable to the effects of apprehension in the Mumbai-based financial sector because risk aversion and loss of confidence have all but shut down business decisions. The Reserve Bank of India’s half-yearly Monetary Policy Report holds up a mirror to the systemic stress: the flow of funds to the commercial sector has dropped precipitously by 88% during the first six months of the financial year. Against ₹7.36 trillion flowing from banks and non-banks to the commercial sector during April-September 2018, this year has seen only ₹0.9 trillion flow over the same period. What is even worse is negative fund flows from banks, implying that lenders are either seeking faster repayments that are higher than fresh credit flows, or are refraining from any fresh lending. Credit is the lubricant that moves the wheels of commerce, and a bank-lending freeze is bound to have a direct impact on India’s economic ambitions. The low 5% growth in India’s gross domestic product witnessed in the April-June quarter—and the sequential slowing down of the economy—is probably an outcome of this credit rigidity.
Lowering interest rates, flooding the system with liquidity and taking recourse to RBI’s risk reserves have clearly not worked. Getting out of this logjam will, thus, require more than just tinkering at the edges or incremental policy changes. This is a situation custom-built for demand-side intervention, since the supply-side measures adopted will take some time to have a measurable impact on the broader economy. The tax breaks announced recently, for example, have too many devils lurking in the small print and might induce an avalanche of litigation. It is also evident that any rejuvenation of spirits will need the government to demonstratively work on lifting the pall of trepidation that hangs heavy over the financial sector. Assurances that bank officers will not be persecuted for commercial misjudgements have not convinced the industry’s rank-and-file, it would seem. One reason might perhaps be the overwhelming presence of the government and its proxies on the boards of banks, either directly or indirectly.
While the political economy might make outright privatization of public sector banks difficult at this stage, the Centre has to start distancing itself from how they function. It has to not just reduce, but give up its influence over their management, exercised at least partly through the direct appointment of top executives. At a broader economy level, the country’s bankruptcy process has not delivered painless resolutions, as was envisaged. Many large firms have successfully gamed the system. It is also worth recalling that the current impasse is an outcome of the credit binge that occurred after demonetization, when banks, flush with deposits, threw caution to the winds while dispensing loans without proper risk appraisals to large companies and non-bank financial firms. Therein lies the key to a mood revival: the government must deliver on its promise of keeping economic management independent of other factors.