Another dynastic legacy
The govt’s borrowing binge and the overall debt-fuelled economic growth of the UPA years have left the banking system broken
Photo: Pradeep Gaur/Mint
Last week, the Reserve Bank of India (RBI) granted in-principle approval to IDFC Ltd and Bandhan Financial Services Pvt. Ltd to set up banks. However, the Indian banking system is badly in need of capital and the problem will persist regardless of how many new bank permits are issued.
These days, the discussion on the legacy of the United Progressive Alliance (UPA) decade revolves around comparing economic growth in the UPA and the National Democratic Alliance (NDA) years, ignoring lags and leads. In fact, when it comes to economic growth, the NDA years should run from 1998 to 2008 and the UPA years should run from 2009 to 2019 because the ill-effects of the two UPA regimes will be with India for many years to come. The government’s borrowing binge and the overall debt-fuelled economic growth of the UPA years have left the banking system broken.
When the NDA took office, the gross non-performing assets ratio in public sector banks was 16%. When they left office, it was 7.8%. In September, this ratio had climbed to 12.3% (including restructured loans), with one crucial difference. The absolute sum at stake is too large now. Gross advances by public sector banks was Rs.2.85 trillion in March 1998. In March 2012, it was Rs.35.0 trillion. That the overall lending to the commercial sector(other than the government) by both public and private banks amounted toRs.46.7 trillion by March 2012 underscores the dominance of the nationalized banks in domestic credit creation (around 75%).
Why is India’s government-dominated banking system bankrupt? Why didbad debt rise rapidly in UPA years? An important reason is that the government destroyed the credit culture in the country with its farm loan waiver. In December 2007, the government announced a waiver of farm loans and included it in the budget for 2008-09 presented in February 2008, one year ahead of the elections.
A report in Mint published in February 2012 says that on the aftermath of the loan waiver: “… effects of the massive Rs.76,000 crore farm debt waiver announced by the government during the 2008 budget are now being felt in the countryside…At a banking conclave hosted by Mint on Tuesday, State Bank of India chairman Pratip Chaudhuri did not pull any punches when he said that the moral hazard created by the 2008 loan write-off has become a reality now. ‘Agriculture is a bit of an issue. That is because of moral hazard that was created in 2008 when there was a write off of largeagriculture loans,’ he said, and also suggested that the credit culture in rural India was deteriorating.” Raghuram Rajan, then chairman of the committee on financial sector reforms, said in 2008 that, “after 15 years of getting away from the problem, the government had vitiated it again”.
In a first formal study of its kind (The Economic Effects of a BorrowerBailout: Evidence from an Emerging Market, Xavier Gine and Martin Kanz, 21 October 2013), researchers from the World Bank set out to examine the implications of the farm loan waiver scheme.
Their study traces credit allocation and loan delinquencies in 491 districts and covers the period 2001 to 2012. Their findings are a severe indictment of the credit culture that the UPA is leaving behind in the country.
After the waiver, the default rate of borrowers increased. The higher default rates were not due to the changed behaviour on the part of banks. The banks did not become aggressive lenders anticipating that government bailouts for borrowers would wipe out non-performing loans from their books. Instead, the reason that defaults increased was because borrowers began to anticipate similar debt waiver programmes, especially around elections. More worryingly, the programme “gave rise to severe ex-post moral hazard problems, concentrated among borrowers that had previously been in good standing and who did not benefit from the bailout”. There was no evidence of improvement in farm productivity following the loan waiver.
As long as banks remain under dominant government ownership, politicians desperate for re-election will be tempted to go down this path, ignoring the long-term damage to the nation. As India looks set to end the dominance of the Nehru-Gandhi dynasty in politics, it is time to end the legacy of government dominance of the banking sector bequeathed to the country by the former prime minister Indira Gandhi. Otherwise, the broken credit transmission mechanism in a country that is still very much dependent on bank credit will hold down the country’s growth rate for a long time to come.
To be sure, a financial sector dominated by private sector banks will have its own share of problems, as the West is realizing now. But the Indian financial sector is in the safe hands of RBI and its present leadership.
V. Anantha Nageswaran is co-founder of Aavishkaar Venture Fund and Takshashila Institution. Comments are welcome at baretalk@livemint.com.
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