Home / Opinion / Views /  Opinion | Look beyond the conventional methods to get credit flowing

Last week, the People’s Bank of China announced a 50 basis points cut in the required reserve ratio (RRR) of its banks with effect from 16 September. It is expected to free up some $126 billion for lending. Further, there will be an additional full percentage-point cut in RRR for certain urban commercial banks. That would be implemented in two phases: 50 basis points from 15 October and the balance from mid-November.

It is a different matter that investments have simply not responded to the increased lending that is already happening in China this year. Perhaps, the bulk of the new lending is being used to repay old loans. That is a dire situation. Nonetheless, China has gone ahead and further boosted lending, the logic being that if only a small percentage of additional credit is going into desirable purposes, then raising the overall quantum of loans by a big sum should mean more money going into what’s needed. This logic has not escaped the attention of many commentators here.

Some commentators on Twitter have suggested that if India’s monetary base growth was not translating into higher broad money growth, then the Reserve Bank of India (RBI) should be enlarging the monetary base further and faster. Broad money growth is indicative of how far and fast credit flows to the non-financial economy. One danger with such prescriptions is that a big chunk of easy money has never gone into productive investment and employment generation. India’s persistent non-performing asset problem is evidence of the wastage of too much capital, both pre- and post-2008.

There is also the complaint that RBI has been pusillanimous with its monetary easing. Its repo rate peaked at 6.5% in nominal terms in mid-2018. That was when the Federal Reserve was normalizing its monetary policy and threatening to accelerate it. Since then, the official repo rate has edged down to 5.4%, but India’s core consumer-price inflation rate has come down from just over 6% to about 4.1%, causing the real repo rate to move higher.

In the meantime, RBI has engaged in aggressive open market operations throughout the 12 months ending June 2019. Some have calculated that its balance sheet expanded 13.5% during this period, whereas nominal GDP grew only 10%. According to Ananth Narayanan, formerly of Standard Chartered bank, “Over the past twelve months, with 3.5 trillion of bond purchases through open market operations and now 1.76 lakh crore of surplus transfer, the quantum of monetisation is higher than the annual net borrowing program of the central government. We already are deep in the midst of an uncharted print-and-spend cycle." The lurking question or worry is where RBI will stop, and whether it has a road map or will its behaviour be determined by the desperation of North Block.

There are only contextual answers, however, to concerns over how much of RBI’s balance sheet growth is too much and how much monetization is bad. Real estate inflation is tame; the conventional inflation rate is low; the financial sector is still in a state of disrepair; the non-financial private sector is in a state of funk; fiscal policy has maxed out; monetary policy, unfortunately or otherwise, is the only game in town. If other engines start firing, RBI can throttle back. To assume that it won’t, of course, is our prerogative. Thus, to some critics, RBI has been too timid, while to others, too aggressive. On balance, it must have got it right.

There is a better way to help raise the ratio of M3 (broad money) to M0 (the monetary base). The way to stimulate faster growth in credit aggregates is to lower risk aversion among government-owned lenders. The government has boosted their capital base. Second, the merged public sector banks will have a higher tier 1 capital ratio and a higher risk-adjusted capital than the pre-merged entities. That was one of the important objectives of their consolidation. Their higher capital base should encourage lending. Third, the finance minister has directly addressed risk aversion among bank officials.

On 23 August, in her announcement, she mentioned that the Central Vigilance Commission has issued directions to the internal advisory committees of banks to classify cases as vigilance and non-vigilance. Genuine commercial decisions gone wrong should not be subject to a witch-hunt. This is a good first step. But, the government could and should do more. As proposed by Y.V. Reddy in a speech in 2002 (Indian Banking: Paradigm Shift In Public Policy), the government should implement the following, pronto:

“All public sector banks could be converted into companies, to accord flexibility for changes in ownership, mergers, acquisitions, sound corporate governance and motivation for workforce to compete effectively." Two, “the provisions of central vigilance, CBI, etc., would be applicable to a public servant, but not to any person employed in an organization that is substantially competing with private sector organizations, procedures similar to private sector should apply."

Conventional economic solutions will work only when behavioural blockages are removed.

These are the author’s personal views.

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

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