Saturday, June 25, 2016

Fixing the banking system

The banking system is floundering. The NPA burden, which seemed manageable a few months ago, threatens to get out of hand partly because the government has not moved decisively to fix the problems in the banking sector.

We are in a situation where public sector banks (PSBs) don't want to lend or are not in a position to lend to corporates. At the most, they may provide working capital. Project finance is a no-no. Like private banks, they are happy to seek to retail loans.

PSBs don't want to lend because they don't have enough capital and because of a pervasive fear psychosis. They don't have enough capital because they are unable to effect recoveries on loans (on which they have made provisions), because the government is not infusing enough capital into them and because they are not generating enough earnings for want of adequate credit growth.

How to get out of this low-level equilibrium? First, the government must provide them enough capital- and the Rs 70,000 crore earmarked under Indradhanush just isn't enough. Secondly, they must be empowered to effect recoveries but taking suitable hair-cuts on loans and seeing viable projects through to conclusion. This isn't happening because any banker who takes a loss on a loan exposure will be implicated as a 'scamster'.

Bankers are not going to do what it takes to get projects completed and effect recoveries until they have the assurance that they won't be hauled for writing off some portion of loan dues. I have been saying for long that an apex authority which vets all loan proposals is required, otherwise bankers aren't going to lift their little fingers. The news is that such an authority is being constituted. It will have to get cracking on large loans quickly.

Some banks don't have chairmen or MDs. The Bank Board Bureau must remedy these lacunae as fast as it can. Amidst all this comes the talk of the decision to merge SBI with its associate banks. This could well go down as one of the worst decisions in banking ever. SBI needs to focus on sorting its bad loan problem first. Trying to assimilate associate banks will drain the energies of the bank for at least two or three years- and even after that one is not sure of the outcome.

Make no mistake: the SBI merger has the potential to weaken one of the strongest banks in the country and a key pillar of the banking system. A good way for the next RBI governor to give an early demonstration of his independence and assert the RBI's autonomy would be to dissuade the government from staying with this ill-advised course.

More in my article, Banking revival must be a priority.

Also read Montek Ahuliwalia's article on the subject.

Thursday, June 09, 2016

8 per cent growth in 2016-17 ? Unlikely

The growth rate of 8 per cent in the last quarter has revived talk of a return to 8 per cent growth rate in the near future. Sorry to be a bit of a spoilsport but I'm afraid this is highly unlikely.

In 2015-16 the Indian economy grew at 7.6 per cent compared to 7.2 per cent in 2014-15. This was mainly on account of the steep fall in oil prices which translated into a surge in private consumption and also into higher government capital expenditure through higher taxes on oil products.

The hope was that this bonanza would continue in 2016-17 although in a muted form, with oil prices falling further to $30. This hope is being dashed by the rebound in oil prices to $50, which was the average for 2015-16. This takes away the whole of the contribution of 1-1.5 percentage points to growth that arose from the sharp fall in oil prices in 2015-16.

Some analysts think this will be compensated by greater rural consumption following better monsoons and better urban consumption because of the Pay Commission hike. I estimate the benefits on account of this two factors at 0. 3 per cent and 0.6 per cent of GDP respectively. As you can see, this doesn't compensate for the impact of oil prices.

Another blow is that the world economy is not only not reviving but is likely to slow down. The Economic Survey (2015-16) expected exports to contribute a solid 1.3 percentage points to growth. This looks likely to get washed out. In fact, export growth could slow down even further, dragging down economic growth.

Lastly, analysts have been making a hoopla over increased public capital expenditure. They overlook the fact that this is being offset by compression of government expenditure on other counts and also higher taxes. The fiscal deficit is going to shrink by 0.4 percentage points. That, basic economics should tell us, means a shrinkage in demand from the government. Using a multiplier of 1, this means minus 0.4 percentage points of growth.

I add up the numbers and find that the Indian economy is likely to grow at 7 per cent rather than 8 per cent in 2016-17- unless oil prices fall back to well below $50.

That's the short-run view. The medium-term outlook is just as sombre. Whoever is forecasting a return to 8 per cent growth has some explaining to do.

More in my article in the Hindu today, Tempering economic ebullience.