Resolving the bad loan problem

Briefing members of the Parliamentary Committee on Finance on Thursday, outgoing Reserve Bank of India Governor Raghuram Rajan reportedly said that a three-year term for any incumbent is too “short”. This has once again reignited the debate surrounding his impending exit. It is not necessary that we look at global practices to which Rajan reportedly alluded to in his briefing. 

In spite of the stipulated three-year term, all RBI governors, except S. Venkitaramanan, since 1985 have served for more than three years. The practice of giving extensions itself proves the need for a longer term. Anyone with a basic knowledge of economics will agree that addressing macro stability issues like GDP growth, unemployment, and inflation is a time-consuming process. Inflation has come down from 9.52 percent in August 2013 to 5.24 percent in April 2016. 

Aided by the RBI's prudent monetary policy decisions, the drop in inflation was largely down to favorable international factors like low crude oil prices. However, with the price of crude oil gradually surging, inflation is raising its ugly head again. This has been exacerbated by upward pressure from food inflation- recorded at 7.5 percent in May 2016. Moreover, the effects of "Brexit" on the Indian economy have not yet been fully understood. It is important that the RBI governor is allowed to steer monetary policy in the best way possible, as the Indian economy treads on turbulent waters. It is not about just about Raghuram Rajan. Any future Governor needs more than three years to fulfill his/her obligations.

Even the banking sector clean-up initiated under the RBI’s Asset Quality Review is far from over. To the uninitiated, the RBI’s asset quality review covered 36 banks (including all those in the public sector). The RBI’s latest Financial Stability Report is full of bad news. Foreseeing a worsening situation of bad loans in the country, the Central bank announced on Monday that the gross non- performing assets of the banks can rise to as high as 9.3 percent in 2016-17 after hitting 7.6 percent in March 2016. Banks' gross NPA had stood at 5.1 percent in September 2015. Meanwhile, net non-performing advances as a percentage of the total net advances increased to 4.6 percent in March 2016 from 2.8 percent in September 2015.  Furthermore, if the economy takes any unexpected hit, the bad loan situation is likely to get worse, the report adds. 

However, the good news is that banks have been forced to recognise bad loans as bad loans and not pass them off as restructured assets. It is now important that they go after the borrowers, especially the major corporate defaulters and recover as much as they can. The more the loans they can recover, the lesser will be the capital that the government will need to get these banks up on their feet. The first step in tackling a problem is to recognise that it exists. The Indian banks, in particular, the public sector banks, have started that process. But the worst is still not over for India’s banks.

 In his note to RBI staffers, it is notable that Rajan had unambiguously expressed his willingness for an extension which was met by a cold response from the Modi government. The unwillingness of the government could be explained by Rajan’s determined opposition to the government’s inclination to dip into the Central bank’s emergency funds—up to Rs 4 lakh crore—to recapitalise commercial lenders laden with bad loans. Experts opine that this stripping of the Central bank’s assets will weaken its capacity to withstand economic shocks in the future. 

Experts also allege that the capitalisation of ailing banks with RBI’s money is being done to protect big defaulting businesses. On the one hand, it is ironic that the Prime Minister recently urged citizens to pay taxes honestly. Meanwhile, on the other hand, there is a feeling that the government is working to comfort big business by working behind closed doors to strip the RBI of its funds and in the process its autonomy.