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RBI Guv’s astute observations

 MPost |  2016-01-26 21:32:03.0  |  New Delhi

Time and again Reserve Bank of India Governor Raghuram Rajan has shown the requisite clarity to pinpoint the problems of Indian capitalism. In a recent interview to an Indian news channel, Rajan made some astute observations about the nature of crony capitalism in India and the systemic impact it has on the nation. “If you flaunt your birthday bashes even while owing the system a lot of money, it does seem to suggest to the public that you don’t care. I think that is the wrong message to send. If you are in trouble, you should be cutting down your expenses,” he said. It was an implicit reference to Vijay Mallya, who celebrated his 60th birthday in lavish fashion, despite owing the banks more than Rs 7,000 crore. It is abundantly clear that Mallya has taken the entire system for a ride, despite issuing numerous personal guarantees that he would repay these loans. Suffice to say, the problem is not with conspicuous consumption, but with the system’s inherent failure to punish these defaulters. 

The second observation Rajan made was that the system is inherently “geared to favour those who have the ability to work the courts”. Moreover, during fruitful times, the large corporate, Rajan argued, flows along with the upside in economic growth. But when times are bad, these large corporate go the banks “and ask how much of a haircut (loan write-off) are you going to take”—something this column has addressed in the past. The issue is not about casting certain corporate entities as the villains of the piece. It is an attempt to show how their debt-fuelled mania has systematically downgraded the Indian economy. It is precisely why the Mallya example is so pertinent.

The liquor baron’s commercial airline venture, Kingfisher Airlines, was doomed from the very start. Despite clear warning signs that the airlines would not make good on its loans, public sector banks were under pressure (note the use of political connections) to keep on lending. Private sector bank ICICI, however, saw the writing on the wall and sold off its entire debt of Rs 430 crore to a Kolkata-based debt-fund way back in 2012. Meanwhile, public sector banks continue to carry Mallya’s bad debts even today, after he worked the courts. When the United Bank of India, a public sector entity, finally gathered the courage to declare Mallya and three of his former directors as “willful” defaulters, the Calcutta High Court let him get away on a mere technicality. By using their political connections and working the overburdened judicial system, these large corporate entities continue to default on their loans, without paying the price for it. However, one must remember that Mallya is only one example. The list of major defaulters includes Reliance ADA, Vedanta, Essar, Adan and the Jaypee Group, among others. These banks are now stuck with large amounts of bad debts or Non-Performing Assets (NPAs).

With a large amount of NPAs, banks are forced to push up the risk premium, which in other words amounts to raising the cost of lending. “That’s exactly why there is such a huge gap in the commercial lending rate and the policy rate of the RBI. This, in short, is the price of crony capitalism. It is not just banks that are impacted. The resulting high-interest rate regime precludes investments, erodes the competitive ability of Indian business and leaves a big hole in our wallets through payouts on EMIs,” according to a leading Indian business daily. There are wrongdoers among the Indian business community who have raised the cost of borrowing for the common man. Suffice to say, the knock-on effect of these bad debts has been deleterious for the entire economy.  Experts have argued that the bankruptcy code, which has been introduced in Parliament, will ensure that the political class will have the requisite legislative tool to tackle these wasteful behemoths. The code, if passed into law, can ensure quicker resolution of the bad loan problems dogging PSU banks, through a formal insolvency process of the defaulting business. However, the problem is not one of law, but of political will.

In the past, governments have been hesitant to throw the book at these major defaulters. Loans of companies such as Deccan Chronicle, Kingfisher Airlines, Essar Steel, amounting to a whopping Rs 30,000 crore have gone bad, with public sector banks at the heart of the crisis. No professionally managed private bank would lend so recklessly. This is the consequence of “social control” of banks, which neither the Modi government nor the previous UPA government has been able to resolve. Unless structural changes are introduced to the banking sector, especially those in the public sector, this problem will not go away. With the nation under a serious credit crunch, it is imperative that the political class acts soon. 

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