India's zombie raj: Companies on life support, and distressed banks

Given Indian corporates' high indebtedness, new credit will be used for servicing loans rather than building factories. This is setting us up for more companies on life support and more zombie banks

The old line that it was the job of the Federal Reserve “to take away the punch bowl just as the party gets going” needs to be reworked. The metaphor referred to the large silver bowls filled with juice, lemonade, fruit often spiked with alcohol that were so popular at parties in the 1950s and 1960s. But, what it meant is that it was the job of the central bank governor to raise interest rates when the economy was getting giddily overheated by way of retail prices or asset bubbles.
 
Today, it is the central bank governor who serves as a punching bag for politicians. In late November, Donald Trump told the Washington Post, "I'm not even a little bit happy with my selection of Jay (Powell, the Federal Reserve chairman)." Like the government of Prime Minister Narendra Modi, Trump chose not to ask a well-regarded Fed governor (Janet Yellen) to continue even though she had been in the post for just four years. Modi is a somewhat more sophisticated politician than Trump. His tweets are as saccharine sweet as he is sarcastic about the Opposition. "He (Patel) steered the banking system from chaos to order and ensured discipline," the prime minister tweeted on Monday, even though the only chaos was in the aftermath of demonetisation.

 
In Britain, meanwhile, the Tory politician Jacob Rees-Mogg recently described Mark Carney as being “a failed second-tier Canadian politician”. Never mind that Bank of England governor Carney never was a politician. Carney’s crime? He warned that Britain would face economic decline if it crashed out of the European Union without a deal. The central bank’s report was just the kind of stress testing a central bank should be doing under the circumstances.
 

So it goes in the age of demagoguery. Technical expertise is dismissed as just plain wrong. “My gut tells me more sometimes than anybody else's brain can ever tell me," Trump said, explaining why he thinks US interest rates are too high. Majoritarian hyper-nationalist leaders around the world do not shrink from rewriting the laws of economics. If you see yourself as a de facto king, who cares what Keynes thought? In Turkey, President Recep Tayyip Erdogan attacked the central bank in September, prompting the lira to decline. Erdogan said that interest rate hikes only lead to higher inflation.

 
In the absence of economic theory, we have in the post-truth era “alternative facts”. India’s version is the new back data series for GDP, whose flattering growth numbers for the Modi administration’s four years are implausibly at odds with almost every other indicator, whether exports or car sales. Perhaps this government uses old-fashioned abacuses instead of computers. Being blindfolded on relative GDP growth rates is a child’s game in comparison to not knowing when a bank is insolvent. Watch this space for new leniency and perhaps new definitions of non-performing loans.
 
One of the many areas of contention between the government and the Reserve Bank of India over the past few months after the IL&FS default has been whether there is adequate support for non-bank financial institutions. There has been plenty. Ten days ago, Viral Acharya’s confirmation that the RBI’s open market operations in this financial year had exceeded Rs 1.36 trillion, and that it would buy another Rs 400 billion in December, immediately pushed down yields. NBFCs have continued with business as complacently as usual, as if IL&FS never happened. In the past month, some of the weaker NBFCs have issued bonds where the pricing differential with blue-chip HDFC was pretty much as it was before. Government-owned financial institutions are thought to have been key supportive buyers. As of November 23, credit to the commercial sector was growing at 15 per cent, one and a half times the rate of nominal GDP growth. 

 
Given the high indebtedness of Indian corporates, much of this will be used for servicing loans rather than building factories. This is setting us up for more companies on life support and more zombie banks. Even State Bank of India’s results last month showed that its assets went up while its capital declined significantly for the quarter ended September 2018 versus a year earlier. The RBI’s one-day overdue rule may be too rigid, but delaying meeting capital adequacy ratios, relaxing lending restrictions and ignoring the RBI’s push to put state-owned banks under independent management is not sound policy. By some estimates, four additional government-owned banks ought to be subject to lending restrictions.

 
Urjit Patel may have been a poor communicator, but not so long ago we were told by highly-placed sources that Raghuram Rajan talked too much. Both were guilty of pushing for reform. Instead, we now have the speeches of leading Modi government ideologue and RBI board member S Gurumurthy to decode. Among the many segues in his rambling Vivekananda International Foundation speech last month was that “the entire expertise of the world failed” to understand Trump’s economic policies, prudential banking norms should apply to international banks and heavy import restrictions on capital goods are necessary. His original thinking is impossible to summarise – or even understand — so here’s a link: Gurumurthy Speaks On India’s Economy, RBI, Demonetisation, Imports.... I am an agnostic, but reading and re-reading Gurumurthy’s speech made me discover the need for prayer. God help our economy.