Governor Reddy famously once said that you cannot find a financial sector solution for every real sector problem. But this time around, all were agreed that unless one fixed the financial sector, especially public sector banking, it would be a huge challenge to ensure sufficient funding for post-Covid recovery and future growth. Also, there was consensus that infrastructure execution and financing need focused attention. Both these aspects have been taken up in earnest by the Union Budget 21-22 and for this, the FM needs to be congratulated.
The bold action of stepping up outlay for capital expenditure financed mainly from larger deficit, divestment and monetisation of government assets augurs well for growth.
The demand for credit was slowing even before the Covid-crisis. This was apparent in the real estate sector and in investment expenditure. Consumption expenditure fueled by retail loaning was a growth driver in 2019-20. When Covid hit, this fell off. The recent recovery in the economy is triggered by the increase in government expenditure and a pent-up consumption demand especially among the middle and high-income groups. There is some sign of pick up in retail lending. Whether V shaped or K shaped, as mobility and normalcy return to the economy, this budget was looked upon as one that should provide the requisite fiscal stimulus for capital expenditure for infrastructure and crowd in private investment expenditure. The bold action of stepping up outlay for capital expenditure financed mainly from larger deficit, divestment and monetisation of government assets augurs well for growth.
The three most important measures announced by the FM to fix the banking sector are; first the privatisation of public sector banks, second, the setting up of an asset reconstruction company (bad bank) and third, the setting up of a development financial institution (DFI).
Recap and privatisation of Public Sector Banks
The Budget has announced recapitalisation allocation of Rs. 20,000 crore for the public sector banks in 20-21. It is not clear whether this will be through recap bonds or direct infusion. This is clearly inadequate, looking at the huge need for capital in public sector banks. Given the smallness of the amount and also considering the decision to privatise two of the public sector banks, the choices available are
- Provide the recap funds to those banks that have been using capital more efficiently to retain the government share at 51% and allow these banks to access the markets for more capital. The infusion by government will make these banks more attractive and in current conditions, infuse good amounts in these banks. As in the case of navaratna PSUs, these banks can be provided with full operational autonomy and the government can exercise its control through the Board.
- Select two banks for privatisation that have shown the need for repeated larger doses of government recapitalisation in the past. The offer for sale of these banks could be through a transparent process and can be made to those seeking to get a banking license - with all the eligibility conditions for licensing continuing.
- As mentioned, privatisation of government banks will need legislative changes. The opportunity may be seized to bring all public sector banks under a single legislation applicable to all banks viz. the Banking Regulation Act. The government will not lose any control and as recommended by the Narasimhan Committee it can reduce its ownership to 33 per cent and still exercise control over the bank including choice of CEO, directors etc. through the Board.
Bad Bank
It is assumed that the new asset reconstruction company will be predominantly owned by the Government.
Pros of setting up a bad bank
- The removal of stressed assets from the public sector banks will make them focus on fresh lending
- As the ARC is government owned, the PSBs would be more confident about taking larger haircuts while transferring the assets as their decisions may not be challenged
- Sovereign backing of the ARC will enable it to raise funds for restructuring units considered viable
Cons of a bad bank
- Most pre-covid NPAs already recognised and provided for
- Most stressed assets that are likely to be transferred may not be backed by assets whose value can be realised and may finally have to be written off.
- In order to be effective, the stressed assets pertaining to the same company in different banks - both public and private - will have to be acquired. Valuation decisions made by the ARC in terms of a comprehensive and transparent policy should be protected and should not inhibit decision making
- Unless the ARC is provided sufficient autonomy and functions in a professional manner, there could be the same problems as those faced by PSBs in the past.
Valuation of stressed assets.
Valuation of assets will be most critical in ensuring the successful functioning of the ARC. All the lessons learned should be used to arrive at fair valuation. Recent suggestions by Rajan and Acharya (Sep 20) to have a transparent market for distressed assets need to be examined.
Development Financial Institution DFI
A “professionally managed DFI” with Rs. 20,000 crore capital has been proposed by the FM in the Budget with a lending portfolio of at least Rs. 5 lakh crores in three years’ time. The impediments in infrastructure funding are well known. Timely completion of projects within the cost and time estimates, require close monitoring of milestones and removal of legal, regulatory and administrative hurdles that may impinge on execution. User charges and tariffs can either make the services too high-cost or unsustainable. In order to succeed, it is critical that the execution risks are addressed and the DFI has some oversight on these risks. Single window regulatory clearances and milestones monitoring should be part of such oversight. Otherwise, it will become a case of “guaranteed to fail”.
The impediments in infrastructure funding are well known. Timely completion of projects within the cost and time estimates, require close monitoring of milestones and removal of legal, regulatory and administrative hurdles that may impinge on execution.
There are already huge problems of NPAs in the infra-sector such as in power, telecom, airlines, shipping, roads and bridges. The reasons for these need to be studied so that lessons learnt can be factored in by the new DFI. There are DFIs like REC, IRFC, PFC and of course IIFCL. They also have NPAs. It would be very useful if all infra-assets are looked at - especially in stalled projects - so that productive assets could be put to use. There is a mention in the Budget of a national monetisation pipeline of brown field infra assets. Hopefully, this refers to the stalled projects.
To conclude, there are bold initiatives in the Budget to address some critical issues in the financial sector and infrastructure financing. Careful execution, taking into consideration lessons from the past, can turn these proposals into a huge win-win for the economy.
(Usha Thorat is a former deputy governor of the Reserve Bank of India)