– SK Mohan
Ham saada hi aise the ki yuun hi pazirai / Jis baar khizan aai samjhe ki bahar aai..
(We were so simple minded and accepted just like that/ When the autumn came, we took it to be the spring)
– Faiz Ahmad Faiz
On the 8th of November they claimed it was a surgical strike on the ‘black’ money. The Union Minister of Finance admitted in a written reply to the parliament on 16th of December that, ‘there is no official estimation of the amountof black money either before or after the government’s decision of November 8, 2016’.1
And the Reserve bank of India (RBI) is silent on the amount deposited in the banks after 10th of December 2016. They changed the tune and started talking about going cashless after 27th of November. The Minister of State for Finance then announced that the government never talked of going 100 per cent cashless, and it will be a big achievement even if the country achieves 15-20 per cent success in going cashless.2 While the ‘good governance’ is reflected in the 60 policy changes in 43 days3, the people at large are still searching for ‘Pokémon’ money in the defunct ATMs. The Prime Minister’s discourse talks about the difference between ‘Neeti’ (policy) and ‘RannNeeti’ (strategy). Kautilya, Machiavelli and Sun Tzu lived in different times and different settings. Yet, they had one advice in common. That was about diverting the attention of rivals from the real intentions. Economics, politics and the battle strategy do not exist in isolation. That the financial policy, political moves and the strategies appear incongruent is not fortuitous. It is by design. It doesn’t matter if the prime minister and the government appear to be talking in different voices, in a choking and emotional voice at times and a heckling tone at other times. The political statements are just a smoke screen.
There have been many an analyses on the impact and consequences of the government policy decisions. One can argue these are mere speculations on future which are yet to be proven. However, we can look at the events in the recent past that have led to the present which in turn will help us assess the future.
Banks on the Verge of a Crisis
There were many pointers indicating to a deepening crisis affecting the banking sector over the past few years in India. The speech4 by Raghuram Rajan, the then Governor of RBI at ASSOCHAM – Interactive Meet with Industry & Trade, on 22nd of June 2016 in Bengaluru revealed some interesting details. He presented the data indicating that ‘public sector bank non-food credit growth has been falling relative to credit growth from the new private sector banks (Axis, HDFC, ICICI, and IndusInd) since early 2014’. He showed that the there is a slowdown in lending by public sector banks vis a vis private sector banks. There was a rise in the credit growth to industry and micro and small enterprises by the private sector banks. The Interest rates set by private banks are usually equal or higher than the rates set by public sector banks. He argued that the reason for the slowdown of the public sector bank lending can neither be attributed to the lack of demand for credit nor to the higher interest rates. He reasoned that the public sector banks were shrinking exposure to infrastructure and industry risk right from early 2014 because of mounting distress on their past loans. He further said, ‘there are two sources of distressed loans – the fundamentals of the borrower not being good, and the ability of the lender to collect being weak. Both are at work in the current distress’. He noted that a number of these loans were made during 2007-2008. Accepting the fact that, ‘sometimes banks signed up to lend based on project reports by the promoter’s investment bank, without doing their own due diligence’, he termed it as a phenomenon of ‘irrational exuberance’’.
Around a year before, the keynote address5‘Financing for Infrastructure: Current Issues & Emerging Challenges’, delivered by Harun R Khan, Deputy Governor of RBI, at the Infrastructure Group Conclave of the SBICAP at Aamby Valley on 8th of August 2015, revealed the numbers. The outstanding bank credit to the infrastructure sector, which stood at Rs.9,500 crore in March 2001, has increased to Rs.10.074 lakh crore by March 2015. The gross NPAs and restructured standard advances, have increased considerably from Rs.19,300 croreas at the end of March 2010 to Rs.2.22 lakh crore by the end of March 2015. The percentage of gross NPAs and restructured standard advances as against the gross advances to the sector rose from 5.1% to 22.8% in this period.
A recent RBI report released on the 29thof December 2016 revealed that while private sector banks and foreign banks reported net profits during the year 2015-16, the public sector banks incurred losses. The public sector banks losses amounted to the tune of Rs.18,000 crore.6 The total gross NPAs of banks stood at Rs.5,94,929 crores by the end of March 2016. Over 90% of these bad loans were on the books of public sector banks. As at the end of December 2015 quarter, the total GNPAs stood at about Rs. 4,00,000 crore.Thus it was a substantial jump of Rs.2,00,000 crore in just one quarter from Dec 2015 to March 2016.7 This significant increase in the NPAs was due to the March 2017 deadline set by RBI for banks to clean up their books. Till then the banks were showing these as restructured loans through ‘ever greening’.
Thus there were many reports from RBI as well as various research and rating agencies on the increasing burden of NPAs seriously crippling the public sector banks. The important questions now are – What pushed the public sector banks in to such a quagmire? What was the solution adopted by the government? What does the government intend to achieve in the future?
Evolution of Banking and the Change in the Priorities
What do the banks do? To simplify the matter, they collect deposits from the customers and lend the money to those who need it. The lending activity involves loans to individuals (personal loans) and loans to business (small, medium enterprises and large corporate). There are unsecured loans and secured loans where the assets/ properties are placed under a mortgage. Apart from other sources of income, the banks primarily make their money from the difference in the rate of interest paid to the depositors and the rate of interest charged to the borrowers (interest spread). The central bank, RBI, regulates the domestic and foreign banks operating in the country.
Banks play an important role in the Indian economy. An RBI discussion paper8, ‘Banking Structure in India -The Way Forward’ released in August 2013 noted that, ‘despite significant progress, one aspect of banking in India that requires deeper analysis is the still inadequate coverage of the banking and financial sectors. It is instructive that even with 157 [26 Public Sector Banks, 7 New Private Sector Banks, 13 Old Private Sector Banks, 43 Foreign Banks, 4 Local Area Banks (LABs), 64 RRBs] domestic banks operating in the country, just about 40 per cent of the adults have formal bank accounts’. Further there are 1,606 urban co-operative banks (UCBs), 31 State co-operative banks (StCBs), 371 district central co-operative banks (DCCBs), 20 State Cooperative Agriculture and Rural Development Banks (SCARDBs) and 697 Primary Cooperative Agriculture and Rural Development Banks (PCARDBs). Despite the presence of so many banks, the paper noted, ‘based on data given in Basic Statistical Returns, it is estimated that rural India had only 7 branches per 1,00,000 adults in 2011 in sharp contrast with most of the developed and even BRICS economies having over 40 branches. Regionally, north-eastern, eastern and central regions are more excluded in terms of banking penetration’.
The banking system in India has evolved in different phases. A closer look reveals four notable phases in its evolution – first phase starting from 1969 which started with the nationalisation of 14 major banks, second phase starting in the 1980s, the third phase starting with the liberalisation in 1990s and the fourth phase starting from 2000.
· Prior to 1969, the country side was not considered to be the problem of commercial banks in India. The nationalisation of banks in 1969 can be traced to the increased (credit) requirements of rural rich with the introduction of ‘green revolution’ and concomitant costs of inputs and farming machinery. This phase included establishment of Regional Rural Banks and setting up of a target of 40 per cent of advances for the ‘priority sectors’ for commercial banks. The priority sector covered agriculture and allied activities, and small-scale and cottage industries.
· The second phase in the 1980s witnessed the focus on ‘anti-poverty’ programs and programs for the creation of employment in the rural areas. The rhetoric of ‘land reforms’ was abandoned. The Integrated Rural Development Programme (IRDP) was introduced during this phase which was a directed credit.
· The changed situation in the 1990s also brought in a change in the banking outlook. This becomes evident in the 1991 Narasimham committee report. This is the period when the focus moved away from the rural banking and a contraction in the banking credit provided in the rural areas. 2,723 rural bank offices were closed between March 1994 and March 2000. This phase is also marked by a significant rise in the suicides of farmers who were driven to desperation by usury and spiraling costs of cultivation. This phase is also characterised by the shift in the priorities and even a change in the definition of ‘priority sector’ itself. ‘Priority sector’ lending now includes advances to newly-created infrastructure funds, to non-banking finance companies for on-lending to very small units, and to the food processing industry. Loans to multinationals like Pepsi, Kelloggs, Hindustan Lever and ConAgra now counted as priority sector advances. More recently, loans to cold storage units, irrespective of location, have been included in the priority sector.9
· The fourth phase witnessed a lending spree by the banks. Loans to big corporate and industrialists involved in the public private partnership projects developing infrastructure (roads, railway lines, shipping ports, airports, power and communications) sector. Prior to 1990s, the infrastructure development projects were primarily handled by the government. The reasons for this were – huge investment requirements, relatively lower returns and longer gestation period. But this situation has changed with the advance of privatization and liberalized bank lending to such projects. This phenomenon is not limited to India. An IMF paper states that ‘in all a total of over 2700 projects were initiated in developing countries between 1990 and 2003’.10 It also noted, ‘almost 20 years after privatization began to be touted as the solution to infrastructure woes, the role of the large scale private sector in the delivery of infrastructure services in energy, water or transport is far from being as widespread as many had hoped for, at least in developing countries.’
Project Finance –Leaving to Twist in the Wind
Project finance has emerged as a preferred financing technique for the long term financing of large infrastructure projects. In the traditional or corporate financing the lenders provide capital to the company on the basis of assets on its balance sheets. Instead, project finance loans are sanctioned to a Special Purpose Vehicle (SPV) on the basis of the projected cash flow of the particular project. Thus the liability of the borrower is much lower. In other words, the loans to such projects are left to twist in the wind. Though project finance lending started in the 1990s, it took off in the years after 2000 in India. In 2005 alone, India’s market share in project-financed transactions in the Asia-Pacific region increased from 2.8 per cent to 12.5 per cent. The State Bank of India (SBI) had moved up from the fifteenth position in 2004 to the first in 2005 in the Asia-Pacific project finance league tables. Within a span of four years, India ranked on top in the global project finance market by year 2009. The domestic Indian market had raised USD 30 Billion (Rs.1.38 lakh crore) accounting for 21.5 per cent of the global project finance market. The SBI alone accounted for 67 per cent (USD 20 Billion) of the total debt in the Indian market. Those funded by SBI include, Sasan Power, Adani Power, Sterlite Energy, Vodafone and Unitech among others.11
The effects of ‘irrational exuberance’ in the lending have started seriously affecting the banks since year 2014. The 12 large corporate houses of India have borrowed Rs.10 lakh crore accounting for more than 15% of all borrowings in India. About a fifth of the loans to these groups are bad loans.12 Can we expect these loans to be repaid?
The key question now is, how did the public sector banks land in this situation? One has to look at the lending pattern of public sector banks and the private sector to know the answer. The ratio of corporate loans to consumer loans for the seven private sector banks in this time period (2010-2014) is roughly 1.5, i.e. private banks lent Rs.150 to corporate for every Rs.100 to the consumer. While public sector banks lent Rs.700 to corporate for every Rs.100 to consumers.13 Thus the public sector banks have lent largely to fund the corporate. This huge lending cannot but be a part of government policy. Thus, the rise and growth of the corporate is intimately linked to those in power, the government and its policies to help the corporate. The murkier side of this becomes clearly evident in the large number of scams that shook the country.
The burden of the NPAs and distressed loans of public sector needs to be analyzed in this backdrop. The current demonetisation measure is a disingenuous solution adopted by the current government to tide over the crisis caused by reckless lending to the large corporate. The government also intends to reduce its stake in the public sector banks and make them more attractive to the private capital. The Basel III requirements also require a huge infusion of capital in to the banks. The forced deposits due to the demonetisation of 86% of currency in circulation in the country and the restrictions on withdrawals are part of the design.
The lending spree is not going to stop with this. There are more to come. Mega infrastructure projects are underway across the globe. Nuclear power plants, smart cities, expansion of airports, eight lane high ways and railway projects are all part of the grand design. Further, the ‘Make in India’ scheme allures with its multibillion deals in the making of military equipment and armaments with public private partnership. All these will require humungous amounts. A cutting-edge example of one of the largest public private partnership projects ever to be envisaged, currently in the final pre-construction stage in the UK, is the Hinkley Point C nuclear power EPR plant. The total capital commitment for the two reactors is expected to be around 43 billion Euros (roughly Rs.3 lakh crore). The government in India has already paved the way for the entry of private sector in the nuclear power projects. The recent Indian government initiative of Smart Cities envisages an investment of nearly Rs.1 lakh crore. The Indian Railways is planning to invest USD 142 billion (roughly Rs.9 lakh crore) over the next five years, and intends to double the investments in the next five-year cycle.14 The Indian private sector is also scouting for foreign partners with USD 130 billion (roughly Rs.8 lakh crore) of military contracts up for grabs in the next few years.15
The history of the previous phase of development is also linked to the Rs.500 and Rs.1000 currency notes. As the liberalization measures reached their peak, the Indian government issued Rs.1000 currency notes in the year 2000 November. Apart from being a marker of inflation, these notes also played a role in the large scale corruption, hoarding and distribution of money associated with it. The current government went a step ahead and has issued a new Rs.2000 currency note in its place. There are more grand schemes and further plans for mega projects. Do we get to see the future here?
6Report on Trend and Progress of Banking in India 2015-16, Reserve Bank of India
8Banking Structure in India – Way Forward, Discussion Paper, RBI, August 13
9Financial Liberalisation And Rural Banking In India, V.K. Ramachandran and Madhura Swaminathan, December 2014
10 From Global Savings Glut to Financing Infrastructure: The Advent of Investment Platforms, IMF Working Paper, Prepared by Rabah Arezki, Patrick Bolton, Sanjay Peters, Frederic Samama, and Joseph Stiglitz, February 2016
11Down the Rabbit Hole, The Research Collective – PSA, February 2014
12 Concentration, Collusion and Corruption in India
’s Banks, Roots of the Bad Debt Crisis, Sumit K Majumdar, Economic & Political Weekly, July 16, 2016
– SK Mohan