Banks Up The Creek: This Is No Time For Fiscal Rectitude Or Monetary Bravado

It’s odd, but the government’s decision to lob the bad loans problem into the Reserve Bank of India’s (RBI) lap is coming home to roost. The process began when the government issued an ordinance giving the RBI powers to resolve bad debt issues by amending section 35 of the Banking Regulation Act. The government did this to avoid political criticism that the bad loans of big businesses are being written off while farmers are heavily indebted and committing suicide.

But the RBI has now sent the ball back to government, by directing that banks must provide as much as 50 per cent against loans of companies referred to the bankruptcy court, the National Company Law Tribunal (NCLT). Since 70 per cent of banks are in the public sector, the government will have to pick up the bill. It could be more than Rs 50,000 crore in 2017-18.

In the process, both the RBI and the Finance Ministry will now have to work to a different beat and forget their old enmities: the RBI will have to give monetary policy secondary importance and focus on fixing the banking system, and the government will have to bid fiscal rectitude goodbye in the short run.

Bank stocks (unsurprisingly) crashed yesterday (27 June) after the RBI’s provisioning diktat, for it means banks will bleed all through 2017-18. Twelve major loan defaulters accounting for over Rs 1.75 lakh crore of bad loans have already been identified by the central bank for bankruptcy proceedings. The capital infusion that will allow banks to take this kind of hit this year – to be distributed over four quarters – will have to come from the government, since public sector banks are holding the bulk of these bad assets.

The 12 defaulters identified so far for insolvency are Bhushan Steel and Bhushan Power, Essar Steel, JP Infra, Alok Industries, Electrosteel Steels, Lanco Infratech, Monnet Ispat, Jyoti Structures, ABG Shipyard, Amtek Auto and Era Infra.

The move to liquidate these companies will change the short-term focus of both the RBI and the government.

The RBI will now have to concentrate on rescuing the banking system itself from insolvency by helping them clean up their bad loans. It will have to prevent a systemic crisis brought on by loads of unresolved bad debt, now exceeding Rs 7 lakh crore. Currently, the RBI has a nonsensical stance on monetary policy, where it still believes inflation is a possible threat when there is no such thing visible. It has to abandon its Quixotic stand and move in the direction of helping banks improve their profits, which means cutting rates as soon as possible. This will boost banks’ treasury profits.

As for the Finance Ministry, it should kiss goodbye to fiscal rectitude this year and announce a fiscal holiday to get banks out of the ditch.

Providing Rs 50,000 crore for bank recapitalisation, taking revenue hits on telecom, which too is teetering on the edge of collapse, and the tax collection disruptions ahead of us due to the goods and services tax (GST) will mean the fiscal deficit target of 3.2 per cent is a pipe dream.

We can forget about any major recovery in corporate investments this year, and both fiscal and monetary policy must do the heavy lifting by easing policies. Rates must be cut, and the fiscal deficit has to be freed from the promises made in the budget.

When the economy is in the ditch, and banks are up the creek without a paddle, and India Inc is sinking under debt, you need a counter-cyclical policy that stimulates the economy, not fiscal or monetary policy bravado.