Govt must fund every free lunch

WITHOUT CONTEMPT

Last weekend, the finance minister staged a walk-out from a live post-budget television interview, upset at repeated questions on how the government would fund the Rs 60,000-crore loan waiver by public sector banks he had announced. Of course, he returned to complete the interview.

As an excellent senior counsel, Mr Chidambaram is, by now, used to doing his best to defend a client's case, even if the facts present the advocate with a bad case. This time, the clients, whose brief he holds "" the coalition government fettered by compulsions from 'inside' and 'outside' partners, including the economics think-tank comprising three other shadow finance ministers including the Prime Minister "" have a bad case.

In 1989, when the V P Singh government formed the second-ever coalition government in Indian history, the then deputy prime minister Devi Lal, who had a huge farmer voter base, pushed through a loan waiver for farmers using the public exchequer. Their case was not well presented to the world. The government's image and finances took a drubbing, and by 1991, the nation was mired in the worst ever financial crisis (indeed, not necessarily attributable only to the loan waiver).

This time, the government has emphasised that it does not have a Devi Lal-type loan waiver in mind. The ways and means to effect the waiver are still being worked out, we are told. After one-time settlements are effected by the banks, the government would "provide liquidity" to the banks. What shape this will take, and in what form and manner the government would "provide liquidity", is quite unclear.

Indeed, prime minister Narasimha Rao, who came in as PM after the short stint by Chandra Shekhar as PM in June 1991, said: "There is no free lunch," referring to the loan waiver, and standing beside him was the current prime minister Manmohan Singh, then, the finance minister.

This column is not elitist and does not frown upon the very concept of loan waiver, just because the intended beneficiaries are farmers. If Indian industry can be bailed out through corporate debt restructuring (CDR) packages, so can genuine farmers, who produce food for the nation. The CDR mechanism has a system and a process to it, and one can only hope that the government will ensure an effective system and procedure to identify the farmer dues that are proposed to be written off or settled.

There is a larger governance issue here. Several public sector banks are listed companies. They have raised funds from the public and are accountable to their shareholders. The shareholders make their decisions to invest, to hold on, or sell the shares they hold in such banks, on the basis of the actions of the board of directors of the banks. Banking laws are very stringent about how the boards of directors are to be constituted, and no single shareholder, is permitted to control any bank.

It is for the boards of directors to deliberate, consider and decide on when and how to write off loans. Both in the case of CDR packages, and the farmer loan waivers, the boards of directors hardly seem to have had any say. The only morally right way to implement any such scheme is to get the prior approval of shareholders conferring authority on the board of directors with a broad mandate and a capped budget for writing off loans. With no shareholder having a right in India to cast a vote of more than 10 per cent of the bank's voting capital (which also ought to apply to the government as a shareholder), it would indeed be a fair means of going about any loan waiver.

In the alternate, the shareholders of the banks ought to be completely protected and indemnified from such write-offs, by the government cutting a cheque to fund waivers. Such a cheque ought not to give the government more equity interest in the banks, since that would dilute the ownership interest of the rest of the shareholders. Therefore, the government and the banks are left with only one option for "providing liquidity" in an ethical, legal and moral manner. The government would have to write a cheque to subscribe to non-equity, zero-coupon, non-convertible debt instruments to be issued by the banks, to ensure that the banks and their public shareholders do not foot the bill.

All forms of bank write-offs, whether of the CDR variety, or the farmer-loan variety, involve moral hazards. The government is surely required to be responsive to its constituents, be it Indian industry or farmers, to adopt ways and means to respond to ground realities. Public sector banks may be important tools in the formulation of such response. However, it is critical to remember the late Narasimha Rao's words "" that the free lunch can only be funded by the government.

The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.

somasekhar@jsalaw.com