The budget of FY
2020-21 is on the anvil. Incontestably, the Indian economy is performing below
par. Without doubt, the Modi government has its task cut out in energising the
animal spirits. Despite some contraction, there continues to exist a current
account deficit. By almost all accounts, fiscal deficit is likely to breach the
target. The high level of NPAs coupled with prospective NPAs are making banks
reluctant to lend. Firms are saddled with high debt and thus unable to generate
fresh investment. The reluctance of the banks to lend until existing balance
sheets are cleaned is aggravating the problem. To add to the woes, is low
capacity utilization thanks to lower aggregate demand. The NBFC collapse compounds
the misery on the consumer lending front. Partially, the decline in automobile sales is
on account of contraction in lending by non-banking institutions.
In the backdrop,
economists and industry experts have argued for the recapitalization plan for
the banks, housing firms, and non-banking finance companies. The government has come out with
recapitalization plans more than once for public sector banks accompanied by
mergers resulting in larger banks. There is also a plan announced for housing
companies for recapitalization. Further there could be a possibility of similar
bail out being offered for the non-banking finance institutions. Already,
credit guarantee schemes for NBFCs are being put in place and banks are being encouraged
to help NBFCs with respect to their stressed assets. Ostensibly, a fresh lease
of life will resurrect the virtuous cycle of firm and consumer lending, in turn
causing an uptick in consumption and investment.
Yet there is an
element of moral hazard. This arises when an institution is allowed to abdicate
or forgiven for the negative consequences of its business actions. Moreover, consequences
are endured by someone else. If the firms realize, they will not be held responsible
for their actions, some experts argue, it will set in motion a chain reaction
resulting in ‘irresponsible’ behaviour on part of the firms. To many, the
current crisis is on account of similar past government bail outs whenever the
business was in crisis. A case in point is of Air India which continues to
bleed. Every time it bleeds, fresh blood is given at somebody else’s expense
rather than allowing it to die. The same might get repeated with public sector
banks, non-banking companies, housing finance companies etc. The critics have
definitely a valid argument.
To the government
however, if the banks have to be privatized for instance, their valuations need
to pick up and in the current environment, the valuations are unlikely to
increase owing the large NPAs. Further the possibility of future NPAs weaken
the valuations. For an enhancement in financial health, it is indispensable
that governments plug-in more money into the banks so as to enable them tide over
the crisis. The banks landed in the soup partly of their own making and partly
of succumbing to the political pressures in the previous regime.
For the housing
companies, who would raise money from buyers and use to same to start and
operate multiple projects, many of which might remain incomplete, RERA has come
a damper. The rotation of money across multiple projects is not happening and
their past business practices is coming to haunt them. The non-banking
financial institutions too are paying essentially for their past business
practices wherein the bubble had to burst at some point of time.
The obvious
question is should the government bail them out. For the government, it would
be as in case of any decision, an exercise of cost-benefit analysis. At one
level, the economy has to be revived, the growth has to hit close to double
digits to reach the five trillion dollar mark as also to double the incomes of
farmers and lower income groups. The investment has to rise accompanied by rise
in consumption. The classic Keynesian fiscal multiplier has its limits. Keynesian
prescriptions has saved the economy from blushes at the present but going
forward, need structural reforms. For investment
to rise, lending has to increase and need recapitalization is essential. The Keynesian
prescription of government driven recapitalization is something to be pondered
about.
The government actions
are subject to the credibility enjoyed by the government. If the feeling
pervades that government will bail out each time, then the credibility would
shrink and government actions might in the long run backfire. The current
government over the last five years has enjoyed credibility in terms of managing
its fiscal deficit. The deficit despite tough times has managed to be in the
projected bounds. Therefore, one instance of slippage might not be viewed as an
adverse event. Secondly, the priority is to revive the economy and as such certain
tough measures need to be taken. Loosening the fiscal purse as they say would
not be a bad idea. In the given context, government recapitalizing the
distressed financial sector would not seem a bad idea.
There is a possibility
of the moral hazard, but current dynamics suggest it be given a go by for the
moment in the larger interest of the economy. The costs of pursuing bad cop
strategy might be a difficult proposition when confronted with economic
failures. Yet the government should not give unconditional licence in the
context of recapitalization. It should be seen as an exception and conditions
must be attached. There has been long
debated option for creating ‘bad bank’ to buy up stressed assets but the progress
has been scanty. ARCIL has been a pioneer but there needs to be more done on
the said regard. To the RBI focused on inflation targeting, allowing easy
liquidity implies lowering interest rates, thus a prospective rise in inflation,
there are no easy choices to be made.
In the current environment,
the government has to exercise some tough choices and the moral hazard can be
side-lined for the moment. The procrastination principle might be in handy for
short term redressing of the problems accompanied by long term protection
measures to ensure credibility retention.
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