Be consistent in accounting: Govt should not ignore costs of bank recap

It is very important that the government transparently and accurately report its fiscal deficit target

The fiscal deficit number in the Union Budget is always keenly watched, and for good reason. It is a measure of government profligacy, of whether public debt and inflation will experience upward pressure, and of whether the private sector will get crowded out of borrowing. This year, there is higher-than-usual interest because many influential voices have called for a pause to the fiscal consolidation process to combat growth challenges. In addition, the approaching Assembly elections, as well as the general elections in 2019, mean that there is a political incentive to turn on the spending tap. It is very important, therefore, that the government transparently and accurately report its fiscal deficit target.
 

In that context, the treatment of recapitalisation bonds that are an integral part of the government’s plan to bail out public sector banks raises some questions. Over two years, the government is to issue these recapitalisation bonds, worth Rs 1.35 trillion, which will be used to buy more shares in public sector banks. Many have argued that, under some international accounting regulations, this does not need to be counted towards the government’s fiscal deficit — only the interest paid on the bonds need be. However, in its essentials, this argument does not add up. If the purchase of shares against cash is not to be counted as increasing the fiscal deficit, then why should the receipt of cash against shares be counted as decreasing the fiscal deficit? Yet the latter is, after all, what is known as disinvestment, and forms an important chunk of government revenue. One increases and the other decreases public debt; logically, one should increase and the other decrease the fiscal deficit. If the argument is that recapitalisation is related to the capital account and the fiscal deficit measures current transactions, then there is no logic for including the effects of disinvestment, also a capital transaction, in the fiscal deficit numbers. Any inconsistency in how recapitalisation bonds and disinvestment proceeds are treated in the finance ministry’s accounting will only lead to observers taking the government’s fiscal arithmetic less seriously.
 

A related point is the manner in which the recapitalisation scheme has been worked out. While it will strengthen the balance sheets of the public sector banks and help them to be in sync with the regulatory requirements of capital, the governance reforms linked with the package do not offer much comfort as previous such efforts have not worked out in the absence of a proper institutional mechanism. Also, while the government has repeatedly ruled out privatisation of these banks, IDBI Bank, the only one where it intended to offload its majority stake, has received the largest allocation, sending out confusing signals. Recapitalisation should not lead to some of these public sector banks going slow on prompt action on asset quality. The Economic Survey has correctly pointed out that an end to the “twin balance sheet problem” — a debt overhang for companies and bad assets for banks — is necessary to restore investment and high growth in the Indian economy. This cannot happen unless recognition, resolution and reform are quickly, transparently and speedily implemented. There are no shortcuts to reform of the state-banking sector. The uninterrupted process of bank recapitalisation, not being adequately matched by expected improvements in the banks’ performance, can at best be a band-aid solution.