Expediency & cronyism win. Again

Ever wondered how it would be to witness retrograde policies being implemented right in front of our eyes by netas and babus? Recent events in the financial sector offer exactly such a picture. Policy decisions over the past two months have allowed the government to preserve the status quo at public sector banks (PSBs), whose bad loans have repeatedly sunk humungous amounts of taxpayers’ money, and also allowed crony capitalists to become very wealthy.

The story began sometime in 2017, but action picked up in the third quarter of 2018 as the cold war between the Reserve Bank of India (RBI) and the government escalated over two issues: The government’s demand for the transfer of a higher portion of the RBI’s reserves to the Centre; and to relax the prompt corrective action (PCA) norms imposed on some of the worst PSBs to get them to start lending again — even as many PSBs remained headless! 

In September 2018, the giant Infrastructure Leasing & Financial Services (IL&FS), defaulted on its commercial paper borrowings, creating a crisis of confidence about non-banking financial companies (NBFCs). They ran to the ministry of finance, crying for help. Now, there was a third demand from the government to the RBI — inject more liquidity to save overleveraged NBFCs. Apart from this, after the Swadeshi Jagran Manch ideologue S Gurumurthy joined the RBI board in August, he added his own demands to the policy agenda:  Give micro, medium and small enterprises (MSMEs) a bailout package. All four ideas were straight out of the playbook of expediency and cronyism of the previous governments.

But the data showed there was no need for any of these measures and so the government was not having its way so easily. They were purely political demands with little benefit to the economy; perhaps with seriously negative long-term outcomes. So, on October 26, RBI Deputy Governor (DG) Viral Acharya warned in a speech that “governments that do not respect central bank independence will sooner or later incur the wrath of the financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution”. Three days later, another DG of the RBI, N S Vishwanathan, fired his own salvo: “[T]he job of banks is not to bail out borrowers whenever they get into difficulties as the primary commitment of lenders should be to depositors.” This hit directly at the government’s position that the RBI shower unconditional love on PSBs and NBFCs.

In a simple lesson in policymaking, Mr Vishwanathan pointed out “banks are not supposed to be shock absorbers of first resort of the difficulties faced by their borrowers, as banks do not have the luxury of delaying payments to their depositors”. On relaxing PCA, he said “frontloading of regulatory relaxations before the structural reforms fully set in could be detrimental to the interests of the economy”. But a strong “nationalist government” was in no mood to relent. Keeping the pressure on, ministry of finance (MoF) babus were openly critical about the RBI and seemed prepared to use their powers to make the central bank fall in line.

According to media reports, in mid-November, the prime minister (PM) met the then RBI governor, Urjit Patel, apparently to understand the issues first-hand. Subsequently Mr Patel quit the day before the assembly election results were declared. One day later, Shaktikanta Das, the MoF’s own man, became RBI governor. In quick succession the “harsh” PCA framework was suspended, MSMEs got a relief package and there are plans to transfer a huge amount of money from the RBI’s reserves for some pre-election scheme. The political expediency of the netas supported by babus won. 

The government also prevented the collapse of the house of cards some NBFCs built. NBFCs have been among the hottest market segments in the past few years because they were playing a market-cap game: Borrow more short-term, lend more long-term, show huge business growth and raise more money. Most of them indeed have strong risk management and diversified portfolios. But a few large ones, in their desperation to play the market-cap game, recklessly lent to shaky real estate companies. These assets were made to look good by passing them through a couple of friendly private banks.

As the IL&FS crisis spread, the music stopped for these shady players and they were in deep trouble. They wanted a “liquidity window”, which the RBI had refused under Mr Patel. On Wednesday, December 26, the prime minister, who is rarely seen with businessmen, met some of the panic-stricken NBFCs. This was a signal to the RBI to “help” them. The RBI, under the new governor, quickly agreed to do so.

It is quite likely that a particular segment will need temporary relief in an extraordinary situation. But that was not the case here. Most NBFCs did not need help. A few bad ones had created a problem for themselves, and to the system, due to their unbridled greed and ambition to grow at any cost. Instead of allowing them to be taken over by their more efficient competitors, as always, the government has let them off the hook. 

The writer is the editor of www.moneylife.in

Twitter: @Moneylifers