<B>A V Rajwade:</B> All fiscal deficits are not evil

There is a case for analysing the fiscal deficit, separately for expenditure and investment

Earlier this week, the Reserve Bank of India came out with yet another mechanism to help Sustainable Restructuring of Stressed Assets: this is in addition to several earlier initiatives like 5:25 Flexible Restructuring, Strategic Debt Restructuring and the Joint Lenders’ Forum. The Corporate Debt Restructuring Scheme goes back 15 years. While all these may help mitigate the problem of non-performing assets (NPA), are the roots in recent macroeconomic policies?

In an earlier column (“The Budget: A few question marks”, March 3), I had argued that two contributory macroeconomic factors to the sharp increase in the banking system’s NPAs are monetary:

• The extremely high, double-digit, real interest rates measured in terms of the Wholesale Price Index, currently paid by most business borrowers. No wonder, the interest cover ratio of the top 10 business houses has dropped from 10.4 in 2007-08 to 3.7 in 2015-16 according to a report in Business Standard on June 13;
   
• The overvalued rupee, which makes it difficult for businesses in the tradables sector to compete with imports — or in third markets.

Is the holy cow of rigid limits on the fiscal deficit another contributory factor? In the last few decades, fiscal austerity and strict limits on deficits have led to a number of important sectors of the economy, which earlier used to be financed through Budgets — power generation, road construction, ports, etc —being transferred to the private sector and bank financing. These capital-intensive projects have long gestation and payback periods, and often face regulatory, land or environmental hurdles. These are the sectors to which public sector banks are more exposed and form a sizeable proportion of their NPAs. Arguably, many such infrastructural projects are not “fair banking risks”.

As for the mechanisms, a cautionary tale from Italy, which also has a huge problem of bad debts, is worth narrating. (Incidentally, most banks there are not government-owned, nor were those which created the global financial crisis of 2008: clearly privatisation of public sector banks, which some advocate, is not a panacea.) As part of the euro zone, Italy has to observe strict limits on its fiscal deficits. It has around €200 billion of bad debts, of which €85 billion are still to be provided in the accounts (Financial Times, April 21). A measure of NPAs estimates the total at €360 billion. Italy, therefore, created a €5-billion capitalised fund, Atlas, with some equity from the government, but mostly from banks and other investors to help resolve the problem — an exact parallel to what we are trying to do with two new agencies: one to contribute equity to “sick” companies (Stressed Asset Equity Fund), the other to provide soft loans. Atlas ran out of money within months of its creation, helping mitigate only a small part of the problem. Will our funds fare any better? As it is, public sector banks face a huge shortfall in capital to meet the Basel III standard in the next three years. How much can they contribute to such funds?

One administrative initiative that looks promising is the effort to reduce the undue influence of the vigilance system on resolution of the problem. This certainly is one area where public sector banks are worse placed than their private sector counterparts, which have only internal and external audits. NPAs require prompt decisions, both preventive and curative. The vigilance culture focuses on procedural rather than substantive issues, tempting executives to avoid taking decisions and passing the buck to the next level — this surely is not helpful in resolving the problem.

Coming back to fiscal austerity, another corollary is that public sector undertakings are being forced to declare higher dividends, than they otherwise would have, to reduce the deficit. This obviously affects their investment resources. LIC has become an “investor/lender of last resort” to entities — from the National Infrastructure and Investment Fund to the Indian Railways and bonds and equity of public sector banks. But for the pressure from the owner, would LIC have made these investments? In short, adherence to fiscal deficit is increasingly coming at the cost of future investments in the real economy — and increasing NPAs in the financial economy. This surely will affect future growth.

Is there a case for looking at the fiscal deficit, separately for expenditure and investment, the latter being treated differently from the former? The N K Singh Committee needs to examine this issue pragmatically and without assuming that all fiscal deficits are evil.

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The author is chairman, A V Rajwade & Co Pvt Ltd;
avrajwade@gmail.com